Thx I HATE reading on grey background. Here's the article.
Fair use, etc.,..."
GOLD: UNCHAINED NY THE SWISS AND READY TO RISE
goldensextant.com
Barring the unexpected filing of a referendum petition by April 20, Swiss gold sales are expected
to begin in May. Gold's foes may be expected to hail the disappearance of the last legal barrier
to the Swiss sales as another bearish event. In fact, it is likely just the opposite. My guess is
that almost none of these sales will result in added physical supply reaching the market. Rather,
I expect this gold will mostly replace that previously leased into the market by Euro Area central
banks, allowing them to bring their physical gold stocks to the same levels as their officially
stated gold reserves.
By assuring sufficient physical gold to cover outstanding gold loans on the books of EA
central banks, to whom it can be directly channeled through the BIS, the Swiss sales obviate the
risk of embarrassing defaults that a rising gold price would otherwise bring, particularly in a
gold market that is net short by two to four years of annual production. And by removing this
risk, the Swiss sales leave the EA central banks, collectively the world's largest holders of
monetary gold, with many reasons to cheer -- and no strong reason to oppose -- rising gold
prices.
With respect to this commentary, the April issue of the World Gold Council's Gold in the
Official Sector gold.org contains some useful background
information, including articles on the Swiss sales (p.1), the BIS and gold (p.2), and the BIS's
smooth handling of the recent Dutch sales (p.4). The WGC, and the mining industry that
supports it, deserve criticism for their self-defeating aversion to speaking out for gold as money
or in protest against official manipulation of gold prices. Nevertheless, the WGC puts out a lot
of good information, even if its interpretation of some of that information is often at variance
with mine, as is partially the case with the Swiss sales.
Two prior commentaries may also be helpful: Two Bills: Scandal and Opportunity in Gold,
giving details about the genesis of the Washington Agreement, and It's the Dollar, Stupid,
especially the table showing official gold reserves as reported to the IMF. These figures include
leased gold as well as physical gold stocks, a fact underscored by Kuwait's reported gold
reserves of 79 tonnes notwithstanding that nearly all of it is admittedly on loan through the
Bank of England.
On April 7, the Swiss National Bank released its 92nd Annual Report 1999, which can be found
at the English language version of the SNB's website (www.snb.ch/e/aktuelles/index.html), but
the report itself is available only in French or German. The critical information on the SNB's gold
loan activities is contained in section 1.4 and notes 20 and 21.
As of year-end 1999, the SNB' total gold reserves were 2590.2 metric tonnes, the same figure as
reported to the IMF, consisting of 2274.5 tonnes of physical gold stocks (in various places both
in and outside Switzerland) and 315.7 tonnes of gold on lease. Total leased gold increased by
128.9 tonnes (or 69%) over 1998. In a new twist, 73.3 tonnes (or 23%) of this gold, having a
market value of SwF1102.6 million, were secured by collateral with a market value of SwF1089.5
million. The average maturity of the gold loans outstanding was 7.25 months, and the average
annual rate of return on gold loans in 1999 was 1.6%. The new practice of requiring collateral on
certain gold loans was instituted during the year to reduce credit risk even though it also
produced a lower rate of return.
The report also confirms the SNB's "intention to begin as rapidly as possible to sell the 1300
tonnes of gold no longer necessary for monetary purposes." These sales, as the report notes,
were included within, and are planned to be carried out pursuant to, the Washington Agreement
of September 26, 1999, regarding future sales and leasing of monetary gold. Under the
agreement, the participants (SNB, European Central Bank, 11 central banks of the Euro Area,
Bank of Sweden, and BOE for the British Treasury) are limited to selling no more than 2000
tonnes, at a rate of about 400 tonnes per year, in a coordinated program to extend for five years
from the date of the agreement. During this period, the same banks also agreed not to expand
their gold leasing or their use of futures and options.
The 2000 tonnes are allocated as follows: Switzerland, 1300 tonnes; Britain, 365 tonnes to carry
out the remainder of the sales program of 415 tonnes announced May 7, 1999; Netherlands, 300
tonnes announced in October 1999; and Austria, 90 tonnes announced at the beginning of
April. Altogether these announced sales total 2055 tonnes, so someone will have to cut back a
little to stay within the limit of 2000 tonnes.
Since the date of the agreement, Britain has sold 75 tonnes and plans to sell another 75 tonnes
in 3 auctions prior to October (May 23, July 12, and an unspecified date in Sept.); the Dutch
have already sold their first year quota of 100 tonnes; and Austria has sold 30 tonnes. Thus, of
the 400 tonnes permitted in the first year, at least 280 tonnes have been sold or are in process to
be sold, leaving no more than 120 tonnes to be sold by the Swiss before October.
Setting aside the British sales and disregarding the 55 extra tonnes implied by the Austrian
announcement, Switzerland and the EA are allowed sales of 1635 tonnes: 1300 by Switzerland
and 335 by the EA countries, mostly the Dutch. The planned sales by the EA countries
approximate quite closely the SNB's gold loans outstanding, which are about 12% of its total
gold reserves as reported to the IMF. In the absence of specific figures on gold loans for the EA
countries, it seems fair to assume that collectively their total gold loans are about the same
percentage of total reserves as the Swiss.
At the end of 1999, the EA countries as a group reported total gold reserves of 12,457 tonnes to
the IMF, or 11,710 tonnes excluding the gold held by the ECB itself. Putting their total
outstanding gold loans in a range of 10% to 12% gives estimates of 1250 to 1500 tonnes on the
full total, or 1170 to 1400 tonnes on the total excluding the ECB. If these estimates are
reasonably accurate, their total gold loans are about equal to the planned Swiss sales, just as
total EA sales are about equal to Swiss gold loans.
In these circumstances, final approval for the Swiss gold sales could put the last block in place
for a workout of all or most outstanding gold loans on the books of both the EA central banks
and the SNB. The essence of the plan would be to allow the leased gold on the balance sheets
of the EA central banks to be replaced by gold purchased from the Swiss, and leased gold on
the SNB's balance sheet to be replaced by gold purchased from the Dutch and Austrians.
Because the ECB reports total gold reserves for the EA in aggregate, including its own and
those of the member central banks, gold sales between EA central banks would wash out in
consolidation. To retire gold loans without drawing down its combined gold stocks, the EA
must have the ability to purchase gold from an outside country such as Switzerland. And for
Switzerland, with by far the highest per capita gold reserves of any nation, the logical quid pro
quo is assurance of effective inclusion in the EA while remaining formally outside it in
accordance with the currently expressed preference of a majority of its citizens.
The precise wording of the SNB's statement about "its intention to begin as rapidly as possible"
its gold sales may also be significant. It says nothing about completion of the sales. A previous
commentary queried the need for speed, so vigorously championed by SNB Vice President
Jean-Pierre Roth. But haste in securing legal authority to start a program is quite different from
quick completion of the program. Rising pressures in the gold market, described in more detail
later, would make anyone party to a plan relying on Swiss sales anxious to complete all legal
requirements as quickly as possible.
A plan of this nature would: (1) recognize that leased gold -- already sold into the market --
cannot be replaced without forcing many borrowers into the market, driving gold prices much
higher, and increasing the risk of defaults; (2) avoid any physical defaults on outstanding gold
loans of the EA central banks and the SNB by covering all of them with interbank gold sales;
and (3) put reported official gold reserves of all these central banks after the sales at the same
levels as their remaining physical gold stocks.
The plan would also carry two other important features. First, little or no new physical gold
would enter or leave the market. Borrowers on outstanding gold loans would be allowed to
settle in paper, effectively paying for the gold purchased from another central bank. All
transactions would be channeled through the BIS, generally at market prices, but leaving it in
full control of the destiny of the gold. Second, in the event of much higher gold prices
threatening the solvency of a bullion bank that is also an important commercial bank, the plan
would allow a rescue through paper instruments without fear of defaults on the bullion bank's
gold obligations per se.
The WGC has applauded the BIS's deft handling recent Dutch gold sales, noting that 100
tonnes were fed into the market over 12 weeks from December through February without any
apparent affect on gold prices. At the end of December, the SNB had secured gold loans of just
over 73 tonnes. The market value of the collateral closely approximated the market value of the
loans, suggesting that the security might really be serving in lieu of payment until physical gold
could be found to retire the loans. Not to take anything away from the BIS, but a pre-arranged
waiting market for the Dutch sales could also explain the benign market reaction.
Whether such a plan exists, of course, is speculation. But if so, three conclusions follow: (1) for
a total cost of some 1600 tonnes of gold, the EA and Switzerland -- the old gold bloc -- have
bought sufficient time to launch the euro successfully in relative monetary calm; (2) a net short
position of over 1600 tonnes will be accorded tolerable terms of surrender, resulting in less
upward pressure on gold prices from this particular source than might otherwise be the case;
and (3) the EA central banks and the SNB, no longer facing the prospect of defaults on their
outstanding gold loans, are in position to let the gold market truly run free. What is more, they
have some incentive to do so.
The EA and Switzerland are by far the world's largest holders of official gold. With the EA
already marking its gold reserves to market on a quarterly basis, rising gold prices are in its
interest. Recent rumors of French gold sales to fund state pension obligations were quickly
denied by the Bank of France, and anyway would not be permitted under the Washington
Agreement for more than four years. But as noted in an earlier commentary, ultimately much
higher gold prices may represent a partial solution to acutely underfunded pension programs in
many EA countries. In this connection, while the Swiss have not yet decided what to do with
the proceeds of their gold sales, dedicating them to the pension system currently appears to
have the most support.
In any event, whether or not the Swiss gold sales form part of a wider plan, gold's future looks
bright.
In Gold Watch (March 22, 2000, www.gold-eagle.com/gold_digest_00/veneroso032200.html),
Veneroso Associates analyses recent data from both Gold Fields Minerals Services and the
World Gold Council, and concludes that in all probability "there was absolutely huge
undisclosed official selling in 1999." Indeed, looking at the fourth quarter of 1999 for which only
about 100 metric tonnes of official selling was announced, Veneroso Associates now estimates
that there must have been undisclosed official selling of as much as 1000 tonnes or possibly
more. Because the official sector can and often does meet demand for physical gold through
leasing rather than outright sales, what the Veneroso study labels "undisclosed official selling"
would include leasing that ordinarily is not disclosed in IMF figures.
The Veneroso study attempts to track physical gold flows, i.e., gold demand for jewelry, bar
hoarding and official coin. By comparing these flows to new mine production of around 2500
tonnes annually, estimates can be made of official or other dishoarding needed to meet annual
new physical demand, now thought to run in excess of 4000 tonnes. Because new mine supply
has failed to meet physical demand for several years, knowledgeable estimates of the current net
short gold position run anywhere from about 4000 tonnes to well over 10,000 tonnes. Even with
1600 tonnes removed, there is plenty of fuel for a vicious short squeeze.
Following the Washington Agreement, lease rates spiked to around 8% from already high levels
of 3% to 4%. But since November they have returned to more normal levels of 1% to 2% and
remained there despite the size of the net short position. As discussed in a prior commentary,
when fundamental factors such as gross undervaluation of gold give rise to a gold banking
panic, both gold loan activity and lease rates are likely to remain depressed until gold is
revalued to a more realistic level. Current lease rates are consistent with this pattern. What is
more, despite a more normal contango, gold mining companies continue in general to cut back
on their hedging.
Activity and open interest in the paper markets has shown varying levels of decline, particularly
on the LBMA and TOCOM, but to some extent on the COMEX as well. One analyst has
produced some studies suggesting a repeating pattern of small gold price increases in overseas
markets being met by larger decreases in New York. H. Clawar, Making Money with
Manipulators (April 3, 2000, www.gold-eagle.com/editorials_00/clawar040300.html), and prior
articles cited. At the same time, unusual physical gold disposals such as Kuwait's underscore
the increasing difficulty of obtaining physical gold.
All these straws in the wind point toward an ever tightening physical market pushing to break
free from the bonds imposed by the paper and derivatives markets. Any manipulation by the
Exchange Stabilization Fund and its prototype, the Exchange Equalisation Account in the
British Treasury, the actual seller of the British gold, ultimately will be broken by market forces if
not by exposure. Whatever they have done to cap the price has only further compressed the
coiled spring that gold has become.
While current conditions in the gold market itself are sufficient to propel prices much higher,
external events could detonate a price explosion. Gold is typically a contrarian and
counter-cyclical investment. Collapses in other markets -- equities, bonds, the dollar -- could
quickly lead to new investment interest in gold on top of already strong physical demand. If
these collapses mark the end not just of an ordinary business cycle, but also, as I suspect they
will, of the whole the dollar-based post-Bretton Woods international monetary system, gold will
reclaim the monetary throne.
The gold shorts and their friends in high places will propagandize the Swiss sales as another
nail in gold's monetary coffin. But the Swiss are not bugling the death knell for gold. What they
may be sounding, however, is taps for the U.S. dollar. Perhaps that is the tune that triggered
Alan Greenspan's sudden nostalgia for the gold standard last Friday while stock markets were in
full retreat. |
