It is not a particularly enviable task to write an article about central bank activity in gold that will French and then the only be seen a mere six weeks after I have typed the final full stop. Indeed, it is fraught with the chance to slip up badly by asserting strongly that a particular event will never happen – only to see such an announcement appear in the press in the intervening period. Notwithstanding the risks, I am delighted to have the opportunity to, I hope, put the record straight.

Sitting at my desk at the end of November, the gold market is making yet another 18-year high, and it seems as though journalists will need to keep cutting and pasting the story for some time to come – at least until we hit 23-year highs before moving ever upward. Indeed, Pierre Lassonde of Newmont was quoted quite recently as saying to Australian television that gold will be trading USD1,000 within five to seven years. While Reuters did not carry the rationale behind this forecast, the market seems to be talking about little else other than central bank buying, and this is likely to have been one of the factors that drove Mr Lassonde’s prediction.

While this story does pop up every now and then, it has assumed much wider credence this year – probably dating back to when the Dutch rejected the European Constitution at the end of May. This was the signal for a variety of commentators to determine that the euro was entering its death throes, and consequently a search was launched for a substitute reserve currency. Added to this were rumours that European central banks had reacted to the referenda by pulling their gold sales and, in some instances, were repurchasing metal that had previously been sold. Just to add fuel to the flames, a number of large investors were confidently asserting that both the ECB and the Fed had been talking to their counterparts at the People’s Bank of China to urge them not to buy any more euro- and USD-denominated debt, as both institutions were keen to see longer term rates rise. Instead, so the story went, the Chinese were being told to buy gold.

Clearly these talks had an effect, with gold currently trading at USD498 and EUR425 – as against sub-USD420 and a bargain EUR336 per ounce when these stories first surfaced at the start of June. Certainly the influential Gartman newsletter was in no doubt. Dennis Gartman pointed out the disparity between the gold holdings of Asian central banks (under 2%) against “the large nations of Europe…” holding “on average, 51.6% of their reserves in gold....”This led him to conclude that, “If we were the Governor of the People’s Bank of China or the Reserve Bank of India or the Bank of Japan, we would know what we would be doing: we would be quietly, but consistently, putting EUR and USD reserves on the offer and we would be, quietly and consistently, on the bid for gold.”

Clearly the governors heard his call. Or at least the supposition of a large part of the market is that they did/will. However, while Mr Gartman makes no comment as to the proportion that gold should constitute of these countries’ reserves, one would have to assume that it is in excess of 10% – anything less and gold fails any sort of test at replacing the euro and, indeed, at small percentages it has no claim to be a diversifier either. So, on the assumption that these three nations add a further 10% of gold to their reserves, we are left with the following calculation:

International Reserves

In a nutshell, these countries have USD1.64 trillion in reserves among them. An allocation of 10% of this to gold would mean an investment of some USD164 billion, or 328 million ounces of gold at a modest USD500 per ounce – certainly enough to get the price considerably higher, since this is in excess of 10,000 tonnes of gold. Alternatively, this number equates to roughly four years of global production, or over 20 years of buying if these three nations chose to accumulate at the same speed that the European central banks are choosing to sell.

The Jo-Burg Bandwagon Grows Crowded

Central banks are renowned for their long-term horizons, but even they would baulk at a position that took some 20 years to put on – let alone how long it would take to sell it again. In all fairness to Dennis Gartman, he did reprint my argument, but has subsequently decided that the “second tier” central banks might decide to buy gold – an argument that was considerably advanced by press reports of the LBMA Conference in Johannesburg.

The bandwagon started to roll with the keynote speaker, Harvard Professor Kenneth Rogoff, making somewhat similar remarks to those discussed earlier with his assertion that central banks might have reasons to buy gold. But there was no discussion of either the amounts or the market’s limitations in dealing with such large quantities.

Tito Mboweni, governor of South African Reserve Bank, made what seemed to me a fairly innocuous remark about the desirability of gold reserves before pointing out that South Africa has plenty of the metal below ground – if I remember correctly, a rationale similar to that advanced by the Reserve Bank of Australia when they sold gold in 1997. Inevitably, though, the press reports stated that South Africa was in favour of adding to its holdings.

However, the real petrol was added by Maria Gueguina, Head of Foreign Exchange Reserve Management for the Central Bank of Russia. In her speech to the Conference, Ms Gueguina looked at the composition of the bank’s reserves from a theoretical point of view as to the optimal portfolio.

She said: “Calculations of the Central Bank of Russia…showed that about 10% of gold in reserves would be appropriate with regard for special requirements… Today the proportion of gold in our reserves is about 5% in market valuation…”

Buying the Arguments vs Buying the Metal

Certainly, this appears to be close to confirmation that the Central Bank of Russia needs to buy some 500 tonnes of gold – an impression reinforced by Central Bank Chairman Sergei Ignatyev, who said that the “question is being discussed” (Reuters). Clearly, though, the idea is receiving serious consideration since “Russian President Vladimir Putin threw his weight on Tuesday (22 November) behind the idea of boosting the share of gold in the central bank’s fast-growing reserves,” as Reuters reported it. The news agency also pointed out that the comments were made during a visit to the Far Eastern gold mining hub of Magadan, and theorised that the remarks “appeared aimed at Russia’s ailing mining industry”.

In my opinion it is this that is the crucial remark – and one that seems to have got lost in the general chatter. On a more base level it would seem strange for a potential buyer of gold to announce their plans to the market in advance of any actual buying – one would assume that any country considering adding to its reserves would turn to domestic production in the first instance anyway. Indeed, on 24 November First Deputy Chairman Alexei Ulyukayev of the Central Bank of Russia was reported by Reuters as saying that they have no short-term plans to increase the weighting of gold in its reserves and, “Doubling the share of gold has not been discussed, either by the expert community or by the agencies responsible for such decisions.”

So, if the Chinese and Russians are apparently unlikely to be buying imminently, then it must be the governments of the Middle East that will be stocking up on gold. Certainly, they will be looking for a home for the windfall petrodollars, and clearly the region’s largest exporter will be at the front of the queue. Except that Mr Muhammad Al-Jasser,Vice Governor of the Saudi Arabian Monetary Agency, was quoted by Reuters in May 2004 as saying “Central banks from industrial countries are afraid of a collapse in the value of the mountain of gold that they have. They would otherwise sell gold faster because it doesn’t give them returns.” So, unless there has been a major about face, it does not look as though Saudi Arabia has much interest either.

Welcome to the Lobster Pot

Then which central banks are buying gold? While there is plenty of noise from the markets, there seem to be few obvious candidates. Essentially the problem that gold has is that the factor that used to be an attribute – its relative scarcity – is now a hindrance. There is not enough metal, and certainly not enough liquidity, for gold to assume a major role in central bank reserve management. Moreover, the emotion that gold engenders works against it as well, since any sale is subject to scrutiny in the way that no other asset class is – a lobster pot approach where you can get in, albeit in limited size, but it is nearly impossible to get out again.

While I would not rule out small-scale purchases by central banks, I cannot see this becoming a trend, and certainly those countries that find themselves overweight in gold are under no illusions that they are witnessing an attractive level to sell rather than a sea change in the metal’s role. So that on a week where the press continued to speculate as to which central bank might be buying, the ECB announced, too little attention, that the “decrease of EUR226 million in gold and gold receivables reflected sales of gold by three Eurosystem central banks.…” So, while the market continues to agonise on who the buyers might be, the sellers are continuing to offload metal.

Perhaps by the time this article is published, there might have been a major policy announcement or the news of a completed buying programme. However, until I see this, I continue to believe that the market is long of metal and looking for a reason to keep believing that the price will continue to move up. This post-rationalisation has the ability to keep the price up in the short term, but for there to be a true bull market, the price needs long-term holders – not simply opportunistic buying in advance of supposed investment by central banks.

Jonathan Spall is responsible for the Barclays Capital’s commodity relationships with central banks and governments on a global basis. He has over 20 years experience in related markets including working for nine years in Asia/Pacific. He joined Barclays Capital in September 2004. Prior to his current position, he worked for ten years at Deutsche Bank, most recently as a London-based Director with responsibility for Official Sector Marketing (Commodities) and Head of Metals Marketing (Europe/Africa). He earlier worked for Deutsche Bank in Hong Kong as Head of Metals for Asia Pacific and in Sydney as a Senior Associate Director.

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