Has gold regained its glitter?
By Hnry T. Azzam
Published on Monday, May 13, 2002
Arab News
SAUDI ARABIA'S FIRST ENGLISH LANGUAGE DAILY
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Gold prices hit a two year high of $312 last week, before closing below $310, up 12 percent since the start of the year. This follows an increase of 2.3 percent in 2001. The FTSE Gold Mines Index has risen 55 percent so far this year, on top of the substantial gains recorded in 2001. In contrast, the US stock market as measured by S&P 500 index is down by more than 6 percent from the beginning of the year, while the MSCI index of the world’s major stock markets lost 3 percent during the same period on top of the 17.6 percent loss recorded in 2001.
Besides worries about the strength of the US economic recovery, the Middle East crisis and the weakness of the US dollar, there are technical reasons for the latest rise in gold prices. Many producers had reduced their hedge books i.e. they lowered the amount of gold sold in the forward market.
This could bring about 8 million-10 million fewer ounces to the market this year, or about $3 billion worth of gold. Furthermore, part of the rise in the gold price has been due to the sudden surge in demand for gold from Japan. The lifting on April 1, 2002 of full government guarantees for bank deposits encouraged many Japanese savers to seek the security of gold rather than keep their money in the country’s fragile banking system at interest rates on yen deposits as low as 0.001 percent.
The increase in gold prices are unlikely to continue. Gold has bounced from the lows of $257 an ounce in early 2001, but even at $312 an ounce it is still 63 percent below its all-time high of $850 attained by the end of the 1970s. Rising prices will undoubtedly encourage renewed hedging and central bank sales. The amount of gold sold by central banks around the world has outweighed the amount purchased in recent years. The price of gold has fluctuated significantly in the past ten years but the general trend was clearly down. In 1991, gold prices per ounce averaged $362.1, fell to $343.8 in 1992 and then climbed back up in the next four years to reach $387.8 in 1996. 1997 was one of worst years for gold since the price became subject to market forces in 1971 and on Nov. 26, 1997, the spot gold price closed below $300 (at $296) for the first time since March, 1985. Gold ended 1997 at $289.9, however it averaged $331 for the year. The $300 "floor" which had supported gold ever since it first rose above that level in July 1979 had now become a "ceiling". The annual average price of gold retreated further to reach $279.1 and $273.2 in 2000 and 2001 respectively. Between 1991-2001, the price of gold fell by around 25 percent.
Central banks worldwide have long held part of their reserves in the form of gold. At the end of the year 2001, gold reserves at central banks and monetary authorities around the world stood at around 950 million ounces, which is well below the level that prevailed in the 1970s. Gold reserves held by eleven Arab countries (Bahrain, Egypt, Jordan, Kuwait, Lebanon, Oman, Qatar, Saudi Arabia, Syria, UAE and Yemen) amounted to 22.5 million ounces in 1991, remained steady at that level until 1994, and then declined gradually to reach 20 million ounces in 2001, a drop of 11 percent on their level in 1991. This was mainly due to a significant decline in the gold holdings of three countries; Jordan, Yemen and Qatar, while gold reserves of the other Arab countries remained unchanged throughout the 1990s period.
Lebanon is by far the largest holder of gold reserves in the region, at 9.22 million ounces at the end of 2001, followed by Saudi Arabia with 4.6 million ounces, Kuwait (2.54 million ounces) and Egypt (2.43 million ounces). At 62.2 ounces per head, Lebanon has the highest level of gold to population in the world. The decline in gold prices recorded in the past ten years had led to a substantial loss in the value of gold held as reserves by central banks around the world. Global gold reserves dropped in value from $340.1 billion at the end of 1991 to $259.6 billion by the end of 2001, a decline of 24 percent. For the Arab countries, the value of gold reserves held by central banks and monetary institutions fell from $8.16 billion to $5.8 billion over the same nine-year period. This represents a loss of $2.4 billion or 29 percent, supporting the argument that maintaining reserves in the form of gold is inefficient in comparison to foreign exchange and other assets.
In addition, holding reserves in the form of gold also carries a substantial opportunity cost. Traditionally gold earned no return unlike financial securities such as Treasury bills or bank deposits. Although this has changed in recent years with the development of the gold leasing market, which allows central banks to earn around 2 percent a year (depending on maturity) on the gold holdings they are willing to lend to the market place, this is still considerably lower than the return on other assets. Around 118 countries including several in the Middle East lend more than 35 percent of their gold reserves.
Gold reserves have historically been used as a hedge against inflation and as a support for the exchange rate of the domestic currency. Gold is looked upon as one of the few assets not prone to inflationary worries overhanging paper money. The precious metal is liquid and is universally accepted as a means of payment and provides diversification as a reserve asset. It is also looked upon as insurance against such events as war, or the international isolation of a country, especially if accompanied by the freeze of the foreign reserves that the country holds with international banks. Studies show that gold has been negatively correlated with the US stock markets as measured by S&P 500 index for the decade ending in December 2000. In certain cases such as Lebanon, holding gold has become a legacy that makes it very difficult for politicians to even discuss the prospects of selling the precious metal.
However, the reasons to hold gold as a reserve asset have become less convincing recently. Inflationary pressures worldwide have been subdued, and it has become more difficult to use gold as a means of payment and in the case of war or international isolation the freeze on foreign reserves will definitely restrict the country’s ability to dispose of its gold holdings as well.
Because of this and the prospects that central banks around the world will continue to sell part of their gold reserves in favor of income generating assets, one could argue that gold has not regained its previous glitter.
(The writer is chief executive officer of Jordinvest.)
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