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Executive Summary
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The UK will reduce its gold holdings
of 715 tonnes to an ultimate target of 300 tonnes. In the first year, only
125 tonnes are to be involved. In terms of supply, the impact of the sale is
minimal.
·
Because the UK is a major G-7 country, and because there
are no readily identifiable special circumstances to rationalize a UK official
sale, the BOE announcement of its intention to sell half its gold reserves is
likely to have a more adverse impact on gold market psychology than any other
official sector sale to date.
·
The G-7 central banks have
been very cognizant that a major G-7 official sale would have an extremely
adverse impact on gold market sentiment and the gold price. The UK's
unexpected break from this policy stance on the part of the G-7 central banks
provides considerable ammunition to perma-bears who
contend that a major new generation of central bankers will dispose of their
non-yielding gold holdings.
·
There have been meetings between
the major gold producers and central banks. The central banks acknowledged
that fears of official sales were depressing the gold price and provided
reassurances that they were in fact unfounded. The BOE's
decision to sell gold is a major blow to producer confidence and sentiment
and will thereby encourage more producer hedging.
·
On the recent rally in
gold, cyclical stocks were exploding to the upside, the price of oil had
risen some 80 percent and other commodities were beginning to follow. The US bond
market broke support . The XAU broke out above a
downtrend line that defined its three-year bear market. Thursday, the price
of bullion broke above several key-moving averages. The resultant technical
pattern would have attracted substantial buying interest. At this very
juncture the BOE dropped its sentiment-destroying bombshell on the gold
market.
·
The BOE's
extraordinarily timed and unique announcement has turned suspicions of
orchestrated intervention in the gold market into outright conviction. Funds
will be emboldened to sell more gold short, since there is now a prevailing
conviction that "City Hall" is behind them.
·
The BOE's
sale will increase the propensity of producers to hedge and speculators to
sell gold short. The extent of such short selling will depend greatly on the
response of the ECB and the Fed. If either were to indicate any tendency to
follow the Bank of England's action, gold hedging and short selling would
occur of an unprecedented scale. If, on the other hand, they move to decisively
disassociate themselves from the BOE's decision,
they may reduce its impact. The
odds favor positive statements by the ECB.
·
Rather than the inevitable
supply/demand driven rally we expected imminently, the gold market may trade
sideways to slightly down into the summer, when the weight of accelerated
short sales , BOE auctions and IMF related events is
at its likely peak.
·
The gold market's
supply/demand structure is powerfully bullish long term. This will eventually
become apparent. The odds are that a sentiment induced sell-off in gold this
summer following the BOE announcement will simply constitute a further phase
of base building at the end of gold's 19-year bear market.
Who Decided to Sell the UK's Gold…
The Treasury or the Bank of England?
In the unabridged version of this report on the proposed gold sale by
the United Kingdom,
we have referred to the UK Treasury and the Bank of England interchangeably,
implying a convergence of views on the issue. Recent statements by a number
of individuals, notably Ms. Haruko Fukuda of the
World Gold Council, however, imply a possible split between the two bodies
and suggest than the Bank may have been reluctant to sanction the proposed
sale. Last Thursday, Mr. Terry Smeeton, former head
of foreign exchange and gold at the Bank of England, who retired only last
year, made the following statement:
"[The gold sale] is not a policy I would have advocated when I
was at the bank. I am sad this action has been taken…It's clearly a
Treasury decision in which the Bank has had to acquiesce."
Smeeton was also critical of Britain's
timing given its vocal support for International Monetary Fund gold sales to
help finance debt relief in Sub-Saharan Africa:
"I find it at best ironic that our government, which has tried to
seize the moral high ground with regard to the IMF debt issue, then gets in
first with its own sales."
Smeeton agreed that BOE sales
would hit market sentiment not only because of the supply being offloaded by
the BOE, but also because of the Bank's leadership role amongst London's
bullion dealing community and other central banks holding gold:
"It's a pretty seminal event this sale, particularly as the
market will see the Bank as responsible for it. Where the Bank goes, others
tend to follow," adding that the 11 Euro-zone national central banks
might now pressure the European Central Bank to allow them to sell
gold." "I was reasonably confident up until last week that the ECB
was unlikely to allow the participating central banks to sell anything in the
near term. That's probably still the case but I think this must bring forward
the likelihood of sales. Whereas it appeared that gold was very much on the
back burner, in light of this there may be greater pressure from the other
central banks to be allowed to do that."(Reuters, 13 May 1999)
Terry Smeeton represents the accumulated
wisdom of the Bank of England as regards the gold market. His statements make
it clear that the Bank fully understood the damage to market sentiment and
the gold price that it would create by such a sale proposal. Smeeton also notes that the UK auction will hurt the sale of
the IMF gold, which Gordon Brown, and other Treasury officials, have been promoting so aggressively over the past few
months. For these reasons, Smeeton attributes the
decision entirely to the UK Treasury and distances the Bank from it.
We regard Terry Smeeton's statement as
notable. We are not alone in this regard. Andy Smith knows Terry Smeeton far better than we do, and argues that "last
night's Reuters outburst from former head of Bank of England's gold/forex operations, Terry Smeeton,
was remarkable for anyone in the market who knows him even in passing."
Terry Smeeton had a long career at the Bank of
England. Trusted careerists at major central banks tend to conduct themselves
in a manner, which is consistent with the central bank's ongoing positions
after their own retirement. We have to view Terry Smeeton's
statement as one, which, in all probability, reflects the views of the BOE.
The BOE is probably telling us that this was the Treasury's decision, not the
Bank's.
In the Sunday Times of London it was reported that the bank of England was
in full agreement with the UK Treasury on the proposed gold sale.
…The Bank defended the sale decision, and insisted that it had
agreed with the Treasury on the policy. "This is exactly the way the
gold sales were done in the seventies by the IMF," said a spokesman.
"We think the markets work best where they have full information."
It is our assessment that Terry Smeeton
reflects the real thinking of the Bank of England and that, once the decision
was made, the Bank has had to publicly accept the
Treasury's position. We understand that the Bank may not only have been
forced to acquiesce to the Treasury's decision; it may have been taken by
surprise. We understand that, in their public hearing on this issue, the Bank
appeared to be unprepared for the questions that were raised.
There is a remarkable degree of controversy and fevered speculation in
the wake of the recent decision to sell half the UK's gold reserves. Most extreme
has been the following rumor repeated Friday by the
widely read Gartman letter:
"There is a rumor sweeping through the
markets concerning Mr. Gavyn Davies, one of Goldman
Sachs European economists[Ed. Note: at this point,
for the sake of transparency, we must note that Goldman Sachs is a long
standing and revered client of The Gartman Letter
in New York, London, Hong Kong, and Tokyo, on the international equities,
metals and foreign exchange desks; thus reporting a rumor
concerning Goldman is a bit more difficult than would be the norm, in all
honesty. None the less, the rumor is being given
such wide dissemination that we've no choice but to report it here] and a
close friend and economic advisor of Prime Minister Tony Blair and Chancellor
of the Exchequer, Gordon Brown. The rumor suggests
that it was Mr. Davies who urged Mr. Blair and Mr. Brown to prevail upon the
Bank of England to reduce its gold reserves. The rumor
further posits that Goldman Sachs is short 1000 tonnes of gold for future
delivery. We are, of course, not privy to Goldman's gold trading
position…The rumor, true or not…is
becoming more and more widely debated by gold market participants."
We too have heard this rumor from several,
apparently unconnected parties. Their ultimate source appears to be one or
more high ranking persons in the UK political establishment. We
have no material information to contribute, but make the following comments.
First, Goldman Sachs knows the gold market as well as anyone. They
presumably have been successful gold traders in their firm's proprietary
trading accounts. The firm is noted as well for its strict internal risk
controls. Goldman knows that a 1000 tonne short position cannot be readily
managed. They conducted a seminar on gold last week, which, we understand,
was rather upbeat. We cannot imagine that Goldman was, or is, short 1000
tonnes of gold for its own account.
Second, it is possible that Goldman has a 1000 tonne bullion banking
book. In other words, they might have 1000 tonnes of deposits and swaps with
1000 tonnes of gold loans to producers, fabricators, funds, etc. If this is
so, it is still a surprise to us. As we have discussed repeatedly in the
past, we estimate that there are 37 deposit and swap taking bullion bankers
with aggregate gold deposits and swaps of 8500 tonnes from official and
quasi-official institutions and from private individuals. We thought Goldman
was a second-tier player in this market, holding a deposit and swap position
in the range of 300 tonnes. If they have a deposit and swap position of 1000
tonnes, the total volume of borrowed gold outstanding is probably
considerably higher than our year-end 1998 estimate of 8500 tonnes.
In any case, if Goldman has a very large 1000 tonne gold swap and
deposit position largely offset by gold loans to clients, Goldman would have
no obvious reason to encourage the Bank of England to sell its gold. Also,
several producers as well as several institutions who attended the recent
Goldman Sachs' seminar have reported that Goldman was in fact very surprised
by the Bank of England announcement, as reflected by their gold analysts'
immediate downgrading of the gold stocks following last Friday's
announcement.
Therefore, the rumor about Goldman Sachs
makes very little sense on the surface. Nevertheless, the gold market has
been hit with extraordinarily large supplies on rallies in recent months,
presumably from flows of borrowed gold. Goldman has been reported as a
featured seller on all of these rallies, and has been known to warn its major
gold producing clients on each successive rise that the gold price would not
rally significantly, thereby encouraging them to sell more gold forward.
Recent statements on this subject by the largest gold producers
provide some support to such rumors. We quote three
such statements. First, Kevin Williams from Anglogold.
"There are those others who will question the timing even more aggressively
than I am. Why, when the [gold] market looks robust and looks as if it has
the bad new built into it does [Bank of England Governor] Eddy George choose
this time to drop this news in the market?"
Second, Chris Thompson, Chairman of Gold Fields of South Africa.
"There are parts of this conspiracy theory that I am sure are not
true," said Chris Thompson, chairman of Gold Fields, one of South Africa's
biggest gold companies. But he said that there was a large amount of
circumstantial evidence that investment banks were involved in a plot.
Third, John Wilson, President and CEO of Placer Dome.
John Wilson, president and chief executive of Canadian gold group
Placer Dome, avoids words such as conspiracy, but believes malign forces are depressing
world gold prices, writes Gillian O'Connor. "I find it difficult to
believe, given what (Alan) Greenspan said in the middle of last year,
concerning the central banks intention to maintain a low gold price, that
there is not some concerted action going on between central banks to hold
inflation down through hold down the price of gold," Mr. Wilson says.
(Financial Times 5/18/99)
The gold producers quoted above are typically very cautious and
conservative. It is not like them to make public statements alluding to an
"intention" to manipulate the gold price that cannot be proven. It
is our guess that they have heard rumors similar to
those now circulating in the markets from sources they consider credible
enough to embolden them to make such public statements.
There is no question but that these rumors
would have very little credence if the UK Treasury or the Bank had been able
to come up with a more convincing rationale for the proposed sale and its
curious timing. Neither has been able to do thus far. If there is anything at
all to these now widespread rumors, it may suggest
that someone in the gold market may be very vulnerable in some way to a
strong rally in the gold price. Taken in conjunction with the very perplexing
and controversial nature of the action of the UK Treasury, it therefore
remains possible that there is a grain of truth to rumors
such as this one now circulating through the gold market.
By : Frank Veneroso
The Gold
Newsletter
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From
1991 to 1994 Frank Veneroso was the partner responsible
for global investment policy formulation at hedge fund Omega Advisors. From
1995 to 2000 and prior to 1991, through his own firm, Mr. Veneroso
was an investment strategy advisor to global money managers and an economic
adviser to institutions and governments around the world in the areas of
money and banking, financial instability and crisis, privatization, and
development and globalization of securities markets. His clients have
included the World Bank, the International Finance Corporation, and The
Organization of American States. He has advised the Governments of Bahrain, Brazil,
Chile, Ecuador, Korea,
Mexico, Peru, Portugal,
Thailand, Venezuela
and the United Arab Emerates. Frank is a graduate
from Harvard and has authored many articles on the subjects of international
finance.
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