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A recent survey of central-bank
reserve managers predicted that the most significant change in their official
reserve holdings over the next 10 years will be their intentional
accumulation of gold.
In fact, central-bank reserve
managers are already moving in this direction, expanding their reported
bullion reserves by 439.7 tons last year - the biggest annual increase in
almost five decades . . . and this doesn’t count significant purchases
that remain unreported.
Central banks, taking advantage of
depressed market prices, were again big buyers of gold this past March
according to statistics just issued by the International Monetary Fund. Reported official gold
holdings increased by 49.8 metric tons last month and 55.1 tons during the
first quarter.
However, it is quite likely that
actual central bank gold reserves rose considerably more as some countries,
led by China,
chose not report or otherwise publicize their gold market activities.
Among those central banks reporting
to the IMF, Mexico
was perhaps last month’s most notable buyer, adding some 16.8 tons this
past March on top of the 98.8 tons purchased in 2011. As America’s
southern neighbor and close trading partner, this is yet another sign of the
diminishing faith and trust in the U.S. currency.
Argentina was a
“surprise” buyer of 7 tons in March, joining other Latin American
central banks that have increased gold reserves in the past year.
Turkey added
some 11.5 tons to official reserves, although this results from commercial
bank transfers to meet domestic reserve and collateral requirements.
Russia, a fairly
regular buyer in recent years, boosted its official gold reserves by some
15.6 tons last month and the country’s central bank has said it bought
another ton in the first three weeks of April. Proving itself to be an astute
trader, Russia’s central bank was a small seller at higher prices in
February.
Kazakhstan, like
Russia, buying from domestic mine production, added 4.3 tons last month. In addition, a few other countries bought
smaller amounts.
Readers of my NicholsOnGold reports and followers of my
more frequent Twitter posts should not be surprised by the recent news of
continued significant central bank gold purchases this past March. We have
repeatedly suggested that official purchases were giving the market some
downside protection with central banks buying on dips when their purchases
would not be disruptive or particularly visible to other market participants
and observers of the gold scene.
Central banks, like many private
investors, view gold as a hedge against debasement and devaluation of their
U.S. dollar- and euro-denominated currency reserves.
And, because it is the only financial
asset with no counterparty risk, central banks hold gold as a safe haven free
from confiscatory and political risk. Indeed, both Iran and Venezuela last
year, as a precaution against political risk in the form of economic
sanctions, repatriated some of their official reserves that were previously
held in Bank of England vaults.
With total reported global official
gold reserves at roughly 31,000 tons (997 million ounces) compared to annual
world gold mine output at 2,810 metric tons (about 90 million ounces),
relatively small percentage changes in central bank holdings can have a
significant influence on the metal’s price.
In the two decades through 2009, net
official sales added roughly 15 to 20 percent to the supply of gold entering
the market each year. One can imagine that this additional supply had a
considerable negative effect on the metal’s price.
Similarly, in more recent years, the
effect of central banks shifting gears - becoming net buyers rather than net
sellers - has had a very positive effect on the metal’s price.
I believe that net official gold
accumulation will not only continue but will likely expand in 2012 and for
years to come. With China and Russia leading the pack, a growing number of
central banks, underweighted in gold and over-weighted in dollars and euros,
will join the line to buy gold.
Importantly, the official sector will
continue to underpin the price - buying on corrections when significant
quantities are readily available and may be purchased discretely without
disrupting the market.
Fueling the rise in official sector
interest in gold is the anticipated future depreciation of the U.S. dollar in
world currency markets and the continuing erosion of its status and role as
the world’s key official reserve asset.
And, the dollar is not the only
currency suffering a loss of respect. A few weeks ago, an Asian-country
central banker told me his country’s recent gold purchases had been
motivated mostly by a loss of confidence in the euro as a reliable reserve
asset.
In recent years, China’s
central bank, the People’s Bank of China, has probably been the most
significant buyer. Three years ago - in April 2009 - the PBOC revealed it had
bought some 454 tons of gold over the preceding six years, an average of
about 75 tons per year.
Since then there has been no hard
evidence of additional buying . . . but my guess is that the PBOC continues
to buy regularly from domestic mine production and scrap refinery output -
perhaps as much as 50 to 100 tons or more per year. For its part, the PBOC
not long ago said it will “seek diversification in the management of reserve
assets,” possibly signaling their intention to accumulate gold without
actually saying so.
One day in the future we should not
be surprised to see by a PBOC announcement that China’s actual official
gold reserves are considerably higher.
Many other central banks have also
taken a much more positive view of gold in recent years. Indeed, the official
sector has been a positive net buyer of gold for the past two or three years.
This follows some two decades in which the official sector was a net seller of
gold to the market, reflecting mostly large-scale sales by European central
banks that mistakenly thought gold was in descent as a legitimate reserve
asset and sold at a mere fraction of today’s price.
Following many years of net annual
sales in the 400-to-500 ton range, the official sector became a net buyer of
gold in 2009. This is a “game changer” for the gold market.
Instead of supplying hundreds of tons, year in and year out, central banks
are now buying at what seems to be a net rate of 400 to 500 tons per year -
representing a swing in the annual supply/demand balance of 800 to 1000 tons
a year.
I don’t think most market
observers and participants fully appreciate just how significant this has
been - and will continue to be - for the world gold market.
The list of countries that have
reported gold purchases to the IMF in the past few years is itself growing
with new, surprising names joining the club:
- Russia has
been the most outspoken and one of biggest buyers of gold in recent
years. It has an explicitly stated policy to continue making monthly
purchases from domestic sources at a rate of about one hundred tons a
year . . . and has more than doubled its gold reserves over the past
four years.
- Mexico, as
mentioned above, has been another big buyer, joined by other Latin
central banks, including Argentina,
Colombia,
Bolivia,
and Venezuela,
which also repatriated much of its gold that was previously held abroad
at the Bank of England vault in London. Clearly, Asian central banks are
not the only ones interested in adding more gold to their official
reserve holdings.
- Kazakhstan is
another gold-mining country intent on buying its own mine output in
order to build up its official gold reserves. The National Bank of
Kazakhstan has announced plans to purchase their nation’s entire
gold production during the next few years.
- India made
a strong pro-gold statement, buying 200 tons directly from the
International Monetary Fund at the start of the IMF ’s gold-sales
program a couple of years ago.
- South
Korea last summer announced the purchase of 25 tons,
its first purchase since 1998 when it collected and resold gold jewelry
donated by patriotic citizens to help the country through a period of
economic emergency.
- Saudi
Arabia also bought significant quantities of gold - 180
tons, in fact but did not report these purchases until last June. It is
likely that the Saudi Arabia Monetary Authority continues to buy on the
sly . . . along with some of the other oil producers that, like the
Saudis, are over-weighted in U.S. dollar assets and grossly
underweighted in gold,
- Other
names on the list of recent central-bank buyers include Thailand, Turkey, Belarus, Ukraine, Sri Lanka,
Mauritius, and even Bangladesh.
Meanwhile, gold sales by European
central banks - those that had been big sellers in the 1990s - have dwindled
to practically nothing, only enough to supply their bullion and commemorative
coin programs.
Keep in mind that aggregate central
bank gold purchases probably exceed the official data by a wide margin.
The People’s Bank of China, the
Saudi Arabian Monetary Authority, and some other central banks with huge and
some might say “excessive” U.S. dollar- and euro-denominated
official reserve assets have an incentive to buy gold discretely and
surreptitiously - simply because the announcement of their buying programs
would likely boost the yellow metal’s price and raise these central
bank’s acquisition costs.
Importantly, much of the gold bought
by central banks has been bought for the long term - and will likely be held
not just for a few days, weeks, months or even a few years . . . No, much of
this gold will be held for decades or longer, even at much higher prices.
Central banks are now creating an
upside bias to the market and are reducing the “free-float”
available to meet future demand, even at much higher prices. As a
consequence, we can expect less downside volatility - and a more sustainable
bull market with much higher prices in the years to come.
Jeffrey Nichols
NicholsonGold.com
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