Currencies: IMF Gold Revaluation Wouldn?t Tarnish the USD
Karin Kimbrough & Sharon Yeshaya (New York)
IMF gold sale unlikely
Gold took a tumble last week on the back of UK Finance Minister Gordon Brown’s proposal before Parliament to revalue and or sell a portion of the International Monetary Fund’s gold holdings. The communiqué issued from the G7 last weekend said that the IMF would look into the revaluation and sale proposal over the next few months, and that managing director Rodrigo Rato would report back in April, when the IMF is scheduled to meet in Washington.
While a revaluation is plausible, we see a sale and revaluation as unlikely. There are several key obstacles. First, the IMF would probably need to get agreement from major gold producers such as Canada and South Africa, which in the past have opposed sales of gold by the IMF because this would be detrimental to the mining companies that are contributors to those countries’ economies. Second, the IMF would need to obtain an 85% favorable vote from its members before being able to revalue or sell any of its gold. The entire G7 represents only 45% of IMF votes, and as discussed below, it’s not even clear that all members of the G7 would be in favor of the IMF doing anything with its gold. The US holds a 17.3% share of the votes, but the US vote would be dependent on approval from both houses of Congress. Moreover, the US administration has already effectively given the thumbs down to any such plan: On February 4, just ahead of the G7 meetings in London, John Taylor, US Treasury Under Secretary, said: “We’re considering all options, but we’re not convinced of gold sales for dealing with debt issues.”
Little price impact when IMF last revalued or sold gold
Even if the IMF were to decide to revalue or sell part of its gold reserves, we don’t think that the price would necessarily suffer. Previous examples of IMF revaluation and sale did not drive the price lower.
Revaluation: In theory, a simple revaluation would not have any material effect on the price of gold. Basically, the IMF would be marking its positions to market, without a supply shock,[1]and we think it is likely to maintain this policy in future. In December 1999, the IMF began revaluing 12.9 million ounces (12%) of its total gold holdings in order to generate funding for the heavily indebted poor countries (HIPC) trust fund. This was a pure revaluation — the IMF did not sell any gold on the open market — and there was no discernible downward effect on the price of gold.
Sale: Under the gold sale scenario, there is a theoretical possibility that the price of gold could decline, but in the past this has not happened. Between 1976 and 1980, the IMF sold (but did not revalue) 23.5 mn oz of its gold in a series of pre-announced auctions. In this case, there was no decline in price, because the IMF had given clear signals to the market about its intentions, and scrupulously observed its own auction timetable.
Who is selling this year?
A number of signatories to the second Central Bank Gold Agreement are on track to sell gold in 2005. France intends to sell 500–600 tonnes over the course of the five-year agreement. Switzerland, which sold the most tonnage under the previous Central Bank Gold Agreement, has already announced intentions to sell a further 130 tonnes before April this year. By contrast, Argentina has been an active buyer of gold throughout the year, picking up almost 55 tonnes in 2004 as it rebuilds its reserves.
Speculators in the gold market have long been concerned about the prospect of central bank selling. In June 1997, the Reserve Bank of Australia quietly sold 167 metric tons of its gold reserves (equal to about AUD 2 billion), prompting knock-on declines in the gold price to 11-year lows when market participants became concerned that other central banks might follow the same path.
Exchange rate effects
Over the years, it has often been suggested that the price of gold affects the value of the USD. However, the available econometric evidence seems to suggest that, if anything, the USD influences gold prices and not vice versa. We note that gold prices have dropped far more than the EUR/USD exchange rate in the last two weeks, which we think is an indication that gold prices are mainly being driven by gold-specific factors currently. Moreover, the 1997 sale of gold by the RBA caused the gold price to fall temporarily, but FX market participants didn’t consider that this action should have much effect on the value of the AUD. Instead, the FX markets were more concerned about the possibility that the RBA would cut interest rates, and this was the reason for the weakening of the AUD/USD rate.
Bottom line: USD higher, gold lower
Given our constructive views on the direction of the dollar, we think that USD-denominated gold prices are likely to come down over the medium term. But in the very near term, both our metals desk and our technical analyst, Drew Baptiste, expect gold prices to rise. Drew is looking for levels as high as $430–440/oz into late winter but shares our view that over the medium term gold prices will fall further. His six-month target for gold is $370/oz. |
