COMMENTARY — Gold deal restores confidence

The agreement signed in September by the European Central Bank and the central banks of most European nations transforms the gold market in several ways, according to the World Gold Council.

First, although it is a gentleman’s agreement in that it does not have the legal force of an international treaty, it has been signed by each central bank governor, the vast majority of whom have legal responsibility for their gold reserves.

Second, the agreement is comprehensive. The central banks participating hold 15,998 tonnes. The U.S. has already announced its intention not to sell or lend gold, and Japan soon followed suit. The International Monetary Fund (IMF) and Bank for International Settlements are to abide by the spirit of the agreement. In addition, Australia has said it will not sell any more gold, and South Africa is unlikely to sell part of its reserves.

Third, an unexpected and important part of the statement was the limit placed on gold leasing, or lending.

The signatories to this agreement agreed not to expand their gold leasing and use of futures and options over a 5-year period.

It is not clear whether gold leasing is to be frozen at current levels or whether some leeway will be allowed, as long as the total at the end of the period equals that at present. But this uncertainty, coupled with the fact that neither the U.S. nor the IMF can lend gold, implies that the supply of additional gold for lending will be substantially reduced in the next five years.

Lease rates jumped to 10% in the first few days following the agreement, and, although they have fallen back, they remain at a high level of 4-5% — more than two times the historic rate of 1-2%. The market remains tight, with little gold coming on to it.

The restriction on lending will underpin the recovery of the spot price; the sharp increase in the net volume lent in recent years undoubtedly played a part in depressing the price, as most gold that is lent is sold on the spot market.

The jump in the price shows that the market fully expects the agreement to be observed.

The main reason for believing the agreement will hold is that it has been signed by the central banks, which have (with the exception of England) control of their nations’ official gold reserves.