Central Bank Gold Agreement 3

Last week, there was a news of major importance for all the people interested in gold: the Central Bank Gold Agreement, the third of it kind.

Interestingly enough, it didn't make any headline, not even on the gold bugs blogs or sites that I usually follow.

Aug. 7 (Bloomberg) -- European central banks agreed to a third five-year cap on gold sales and said planned disposals by the International Monetary Fund could be done within the accord.

The European Central Bank and 18 other banks agreed to sell no more than a combined 400 metric tons of the metal a year through September 2014. That’s less than the annual cap of 500 tons in the current agreement, which expires Sept. 26.

Gold sales haven’t been approved yet by the IMF’s board. [...]

The Swiss National Bank, one of the signatories to the new accord, in a statement today said it isn’t planning any gold sales in the near future, and that its gold is an important part of monetary reserves. Switzerland has 1,040 tons of gold, making it the seventh-largest holder.

All this is quite bullish for gold's fundamentals. Central banks are now starting to behave like greedy holders of gold and reducing or even stopping any sales.

The best analysis I have read has been made by Adam Hamilton, and I highly recommend reading his report (I am a big fan of Zeal anyway).

Here are some quotes that I find particularly smart and interesting [CB means Central Bank]:

Just like any investor at the end of a multi-decade bear, in 1999 CBs wanted to lighten their gold holdings. No one is excited about any asset after 20 years of price declines. In addition, the European central banks’ reserves portfolios were dominated by gold. With 70% to 90%+ of their foreign-exchange reserves in gold, they felt the need to diversify out of such a poor-performing asset. But each time one sold gold, it would further spook private investors. Few would buy with the ever-present threat of future CB sales.

Thus the European CBs, wanting to minimize the adverse price impact of their own gold selling on their own reserve gold, collectively decided to create a formal and transparent framework for gold sales. On September 26th, 1999, 15 European central banks signed the equivalent of a treaty then known as the Washington Agreement (they met in DC during the annual IMF meeting). They issued a simple press release outlining the principles of what would later be called the Central Bank Gold Agreement. [...]

In 2000 and 2001, the UK sold 24% and 27% of its total reserve gold! Incidentally the driving force behind these gold sales, Gordon Brown, is now the Prime Minister of the UK. The 415t he sold near multi-decade lows ($285 4-year average) cost the British people $9b compared to what that gold is worth today. Gordon Brown, and other guys running CBs, made the classic investor mistake of succumbing to fear and selling near secular lows. [...]

While individual CBs have different reasons for slowing their gold sales, a couple overarching themes probably apply to all. When gold was in the $200s, psychology was bearish and no one including the CBs wanted to hold it. But now with it up in the $900s, central banks are much more bullish on it and thus less inclined to diversify away from it. The CB fear is gradually morphing into greed, just like in all investors!

On top of this, most of the European CBs selling gold over the last decade were diversifying into the US dollar. But since July 2001, 3 months after gold’s secular bottom, the US Dollar Index has lost 41% of its international value in a nasty secular bear. If you ran a central bank, even if you felt you had too large of allocation to gold, would you want to sell it to buy US dollars when the former is growing stronger while the latter is growing weaker? Me either. Gold looks far more relatively attractive today, thus much harder to sell.[...]

Based on this long history of CB gold-trading action, it is illogical and naive to actually fear central banks today.

This secular gold bull, driven by growing global investment demand, will continue powering higher no matter what the CBs do with their gold hoards. Every tonne of gold the CBs sell lowers their current market share and future influence in the global gold market. And outside of Europe and the US, most of the rest of the world’s CBs have too little of their reserves portfolios in gold so they’ll probably become big buyers.