Philip Klapwijk

By Philip Klapwijk
Managing Director, Precious Metals Insights Limited

The September 1999 Central Bank Gold Agreement has had a tremendous impact on the gold market. Not only did the CBGA head off a likely plunge below $250, but the shock it provided also triggered important structural changes – the two key being reduced short selling by funds (with them eventually moving more to the long side) and, above all, an about turn by producer hedgers (with positions tending to decline rather than increase).

By September 1999 the market was ready for such a shift. The slide in the price, growth in producer hedging and short selling had all been taken to extremes. However, something – as it turned out, the CBGA – still was required to force a change in direction. During the third quarter of 1999 European central banks had become increasingly concerned at the danger of an uncontrolled fall in the price that would reduce the value of their own holdings. This fear, coupled with the need to provide a framework for Swiss and British sales, plus other intended disposals, led to the deal announced in Washington to limit sales to 2,000 tonnes over five years and to cap lending and derivatives activity at existing levels. Due to space constraints, this article focuses exclusively on the issue of sales.

After close to four years, it is clear that the CBGA has contributed to a stabilisation of total official sales, albeit at a higher level (i.e., around 200 tonnes per annum up on their gold holdings in a controlled fashion. So, 1989-98 average).The data also show that, looking ahead, the pertinent questions for the with the exception of 1999, when there was a gold market and the price are: which good deal of “front running” of UK and countries still want to sell and, of those that expected Swiss gold sales by other countries, do, how much? the sales numbers have been dominated by the CBGA signatories.

A Case for CBGA Renewal

Indeed, GFMS estimates show that in calendar years 2000-02, CBGA countries accounted for 80 per cent of net sales. Other countries’ net sales have averaged just over 100 tonnes per annum across the same three-year period (close to their long-run average). Looking at the global pattern of gold ownership and excluding other large holders like the United States and the IMF, it is clear that decisions by a handful of European countries will be key to the level of official gold supply in future. Although the odd large sale could emerge from elsewhere, it is only from Europe that a sustained high level of disposals is possible. In light of this, a critical issue for the market is whether the CBGA will be renewed and, if so, on what terms?

On balance, renewal is the most likely outcome, even though it is possible that a second CBGA might be on somewhat different terms, e.g., for a shorter period or with a higher sales quota balanced, perhaps, by a reduction in lending. The main reason for expecting renewal is that the CBGA has, after all, fulfilled its principal objectives: price stabilisation (and indeed recovery) combined with the orderly disposal of reserves by those wanting to reduce their gold holdings.

Even though the price stabilisation objective has become more a question of the dollar-euro rate than the gold price, the CBGA does at least provide an instrument for influencing the latter. Furthermore, there remains a strong case for certain “overweight” countries to reduce their gold holdings in a controlled fashion. So, looking ahead, the pertinent questions for the gold market and the price are: which countries still want to sell and, of those that do, how much?

Who’s Selling How Much?

At the end of 2002, signatories to the CBGA held 14,829 tonnes. On the basis of their stated sales plans, Switzerland and the Netherlands will both end the agreement with gold holdings below end-2002 levels. Similarly, we would expect further attrition of German and Portuguese reserves. None of this, however, changes the big picture, namely that for a renewed CBGA to deliver the same amount of gold to the market (i.e., 2,000 tonnes over five years) one or more of Germany, Italy, France or Switzerland would have to sell a large share of their gold holdings. By no means all “other” countries (including potential recruits from central and eastern Europe) can be expected to sell and, even if this were so, they would not have the necessary tonnage.

Taking Switzerland first, some local politicians have argued for additional sales over and above the 50 per cent of reserves that the Swiss National Bank is already committed to sell.

However, given the lengthy and difficult political process to be negotiated before this could ever become policy, it is inconceivable that the Swiss would be in a position to make any such decision within the next couple of years. With Switzerland out of the picture (though there will be some carry-over from the existing sales target beyond September 2004), the spotlight shifts to the three large Eurozone holders.

Of the three, France has traditionally been the most vocal and articulate advocate for gold. A volte-face from France would therefore be an extraordinary development. Such a shift is perhaps even less likely under a Gaullist administration, especially after it has gone to some lengths to argue its view on national sovereignty in opposition to the perceived hegemony of the United States (precisely the same considerations that influenced France’s explicitly pro-gold policy in the 1960s).

Things are less clear-cut when it comes to Italy or Germany. Nevertheless, the former has given no indication that it intends to reduce the level of its gold reserves. Germany, by contrast, would seem to have made its intention clear through comments made last year by the President of the Bundesbank, Ernst Welteke, who on several occasions pointedly referred to the possibility of large-scale gold sales by his institution.

However, German sales may now have become less certain due to differences between the government and the Bundesbank over what to do with the expected profits resulting from any sales. Indeed, on 26 March this year Welteke stated that unless the Bundesbank had the opportunity to invest the proceeds, it would be unlikely to go along with sales from its reserves (he also claimed it was “open” as to whether there will be another CBGA).

This raises the intriguing prospect that Germany may not after all become a major seller and, if so, it is difficult to see how, e.g., a 2,000-tonnes quota over five years could be filled. As indicated above, assuming no change in French or Italian policy, other sellers, of which there could be a handful, cannot make up the numbers. This would be very bullish for gold. Either way, in our opinion, Germany’s decision will be key to any new CBGA.

In conclusion, the GFMS view is that there remains a good chance of a second agreement, with Germany (probably) replacing Switzerland as the core seller. If this were the case, then the market will quite likely have to absorb a quota of at least 400 tonnes per annum and, possibly, a higher number – this would almost certainly be the case if, for instance, Italy were to make a move. On the other hand, a nein from Germany could well result in lower European and, therefore, global official gold sales, given the improbability of other countries making good any shortfall from the CBGA group.

Philip Klapwijk is Managing Director of GFMS, where he has worked as part of the gold research team since 1989. In his capacity as an analyst he covers the official sector, investment and fabrication demand in North America, Latin America and much of Europe.

In 1987 he was appointed Group Economist at Consolidated Gold Fields, responsible for developing the group’s economic scenarios and participating in the work for the annual Gold Survey.

Philip holds a degree in economics from the London School of Economics and a Master’s in economics from the College of Europe in Bruges.