Metals Commentary: Rejection of IMF gold sales no cause for cheer

Gold bulls have cheered triumphantly to the news that both the U.S. Treasury and a group of U.S. senators have publicly stated their opposition to the proposal by U.K. Chancellor Gordon Brown for IMF gold reserves be sold to fund debt relief for Highly-Indebted Poor Countries.

The U.S. effectively has a veto, as it alone holds 17% of the IMF voting rights and the proposal requires an 85% majority. However, in our view, the rejection and particularly the primary justification for the rejection (that is, the negative impact on the gold price) reveal a sharp double-edge.

Large investors in gold become “prisoners” of their position. Ignoring the hysterical reactions from “mad gold bulls” to suggestions that gold ever be sold, the reality is that the gold market has insufficient liquidity to allow selling in large size.

Gordon Brown will know from experience that only a portion of the 103.4 million oz. (3,217 tonnes), worth nearly $44 billion at current market prices but valued at less that $9 billion, can be sold in a single year. After all, it was the U.K. that ultimately determined that the market could absorb no more than an additional 20 tonnes of gold every two months during its final set of gold auctions, held in 2002.

The gold market is, of course, far more buoyant in 2005 and already absorbing more than 40 tonnes per month in sales from the European Central Bank Gold Agreement countries. However, the point is that the U.K. Chancellor will already be well aware that there are significant capacity limitations to selling gold. Hence, for the so-called pro-gold lobby group to argue against IMF gold sales, owing to their negative impact on gold prices, is to accept (in contrast to the group’s own rhetoric) that the buying interest in gold, be it jewelry or investment, is insufficient to absorb a further 20-50 tonnes per month — not exactly a signal of confidence in the gold market or in the strength of the much-espoused, but erroneous, belief that the market is in deficit.

However, surely it should not even come to that. Critically, the lack of confidence in there being a buyer for the IMF gold highlights the absence of that great buying source of the past: central banks. It has been much argued that central banks, particularly in Asia and the Middle East, should, and indeed will, increase their gold reserves significantly in order to diversify away from their overweight U.S. dollar position. The full 103.4 million oz. (3,217 tonnes) of IMF gold represents a one-time opportunity for Japan or China, in particular, to increase its gold reserves as a proportion of its foreign-exchange reserves.

Why is it a one-time opportunity? The reasons are as follows:

– able to buy a large amount of gold in one purchase;

– avoids an inevitably complicated negotiation with the other mass sellers of gold — the European central banks;

– avoids paying the higher prices inevitable from buying large amount of gold in the spot market;

– provides moral high-ground, helping the world’s poor;

– public demonstration of country’s global importance;

– demonstrates independence from the U.S. and the U.S. dollar.

In our view, if neither Japan nor China volunteers to buy the full offering of IMF gold for their reserves, one can confirm that they have little or, probably no, intention of ever significantly increasing their gold reserves.

Finally, history shows that IMF gold sales do not have to be negative for the gold price. Between 1976 and 1980, the IMF sold about a third (50 million oz., or 1,555 tonnes) of its gold holdings. Half of that amount was sold in restitution to members at the then-official price of 35 special drawing rights per oz.; the other half was auctioned to the market to finance a trust fund, which supported concessional lending by the IMF to low-income countries. Over the same period, gold prices rose from US$140.25 per oz. at the start of 1976 and had reached US$512 by the end of 1980 (admittedly, the bulk of the gains occurred toward the end of this period).

“Mad gold bulls” have it the wrong way round — it is not the selling of gold that is the problem; it is the lack of buyers!

— The opinions presented are the author’s and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to the author at kamal.naqvi@barcap.com