along those lines:
A Watershed in
Central Banks' Role
in the Gold Market?
by Timothy Green
As the curtain is set to rise on the euro, the new European common currency due on January 1, 1999, a clearer picture of the role that gold will play in the reserves backing it is emerging. The new European Central Bank (ECB) will hold 15 percent of its reserves in gold, according to Wim Duisenberg, its first president. That will comprise about 29 million ounces of gold contributed by the central banks of the eleven founding members of the euro club. While this proportion is less than gold miners had hoped for, it appears to be a reasonable compromise, given that some rumors had suggested under 10 percent or even no gold in the reserve basket. The crucial fact that gold is included is confirmation of gold's special role in the public's perception.
As Rudolf Trink, Head of Treasury at the Strategy Division of the Austrian Central Bank (one of euro's founding members) told the Financial Times World Gold Conference in Barcelona at the end of June: "Public confidence in central banks is largely based on the idea that they are not primarily income-driven institutions, but are responsible for maintaining confidence and trust in the currency. Therefore psychology is, and should be, an important factor factor the holding of gold by central banks.
What is not resolved, of course, is what happens to the 386 million ounces that will remain with the national central banks in Europe. Some of them, notably Belgium and the Netherlands, have been significant sellers during the 1990s, in part to help them meet the various criteria for joining the euro. That incentive is now over (or it is too late). In the future, national central banks will almost certainly need approval of the ECB itself to indulge in outright sales. But that is not to stop them lending gold to the market (as many do already) or entering into swaps. Indeed, the European Central Bank itself may well enter the market. Luis Linde, Director General of the Bank of Spain's foreign department, told the FT's Barcelona conference that the ECB will become a new participant in the gold financial market, because there is little incentive for a central bank to hold gold as a non-revenue producing asset. He added that "more active gold management is obviously a compromise between not holding gold and holding unproductive gold." That trend, however, could bring back more stability and confidence to the gold market. Active management is quite distinct from the secret sales that have plagued the market in recent years. As Brad Klein of the AIG Trading Group pointed out at the FT Conference, central banks will probably change their approach to gold, becoming stabilizing forces rather than "going on the rampage" with uncoordinated sales.
Although the recent announcement that the Swiss government is proposing a referendum and legislation during the next year or two to sever the official link between gold and note issue (which must be 40 percent gold backed) might seem counter to this new vogue, we must realize that the proposal may not win approval of Swiss voters, and that subsequent gold salesperhaps half the Swiss reserveswould be carefully managed and spaced over a decade. Moreover, the market would know what was happening.
Thus, the gold market may be approaching a watershed on the controversial matter of central bank participation. We have been through nearly a decade of unheralded gold sales by central banks addressing their own national agenda (quite apart from supplying the market with liquidity by lending at low rates), but most are now moving to positive management of gold. That does not mean an end to lending. As Brett Kebble of JCI Gold argued at the FT Conference, they might start holding out for higher interest rates of 5 to 6 percent instead of the current 1 to 1.5 percent. But in Europe, at least, they may present a more coordinated, transparent approach.
That, in itself, could help the market. The problem of the last year, as AIG's Brad Klein told the FT Conference, has been that the U.S. hedge funds, fearing European central bank gold sales, sold the metal short, thus dragging the price lower than was justified. The sales were not the problem, it was speculators' fear of unquantified secret sales.
After the FT's Barcelona Conference, I asked Dr. Jessica Cross, Director of Crosswords Research and Consulting, who chaired the second day, if she detected a new, more encouraging mood about central bank participation. "I believe the hump of central bank sales is over," she said. "And if central banks could now move off center stage and operate on the management of their gold more like fund managers, then the hedge managers of the U.S. funds themselves could `read' the market much better. And then, beyond the millennium, a much healthier, more stable gold market will emerge."
Editor's Note: Timothy Green's book The World of Gold and other books in The Gold Collection are available through The Gold Institute, Suite 240, 1112 16th Street, N.W. Washington, DC 20036, telephone: (202) 835-0185. Visit the Web site at www.goldinstitute.com.
thebullandbear.com |
