Monday, October 01, 2007

European Central Bank's Insane Gold Sales

The Swiss central bank announces it has sold 113 tonnes of gold (3.6 million ounces, which at current value is $2.7 billion, although when they sold it the price and accordingly also their revenues wer lower). The Swedish Riksbank also announced it has sold gold again, although they "only" sold 10 tonnes (320000 ounces at a current market value of $240 million). ECB membership banks also probably sold a few hundred tonnes of gold.

There are several points that can be made in relation to this. First, it is noteworthy that the price of gold has been able to rise significantly despite these massive sales from European central banks. Imagine how much gold would have risen in absence of those sales.

There are four reasons why the gold price has kept soaring despite these central bank sales. First of all, gold's rise has been a lot more moderate in most other currencies and the rise in its dollar price to a large extent reflects the decline of the dollar. Which brings us to reason number two, which is that central banks have inflated more and more and an increasing number of people realize that central banks will continue to inflate and probably inflate even more, which means that the demand for gold as an inflation hedge increases. Reason number three is that many emerging economy central banks, including that of Russia and India have in contrast to the Western central banks actually increased their gold reserves. Reason number four is that non-monetary demand for gold (for example as jewelry) in many emerging economies, particularly China and India is increasing rapidly.

Another aspect of this is just how bad investors these central banks have been. I called attention to and argued against the Swedish Riksbank's gold sales -10 tonnes or 320,000 ounces then as now- back in 2005 and 2006.

I warned both in 2005 and 2006 that the Riksbank would lose a lot of money from this, and I have been proven right. If you look at the prices I discussed in these posts, you can see that the price was $416 per ounce in 2005 and $600 per ounce in 2006. As the Riksbank said it would re-invest the proceeds from the gold sales in foreign government bonds, this means with interest rates of 4.5%, that the value from the first sale is equivalent to $454 per ounce (416×1.045×1.045) and $627 (600×1.045) per ounce. Compare this to the current gold price of $750 per ounce. The morons at the Riksbank have thus lost a total of $137.3 million ((320,000× (750-454))+ (320,000× (750-627))) or nearly SEK 900 million. To be sure, the real number may be somewhat lower since this calculation is based on U.S. government bonds, so to the extent the Riksbank invested in European government bonds whose exchange rate adjusted returns were better, the losses were smaller. However, we're still talking about at least -probably more like 600 or 700- SEK 500 million in losses from these idiots strategy to switch from gold to government bonds, which was laughably motivated by a desire to "increase [sic] the risk-adjusted return"

Why the hell aren't the morons responsible for these massive losses fired? And how come they're allowed to continue with their losing strategy? Because mark my word again, gold will continue to outperform government bonds, particularly U.S. government bonds, but also European ones.

However, there could of course be an alternative explanation to incompetence for these seemingly insane gold sales. Central banks could -I'm not saying this is certain, but it can't be ruled out- have an ulterior motive for this action. The Chinese central bank presumably know that they will have negative returns from their U.S. government bond holdings, but they keep buying them to prevent the yuan from rising in value faster than it desire. Similarly, central banks in the West know that many people consider gold to be a good inflation hedge and inflation indicator. And as central banks have a vested interest in keeping down inflationary expectations they also have a vested interest in keeping down the gold price. This is of course is what gold sales achieve, all else being equal.


Anonymous Per-Olof Samuelsson said...

I agree this is crazy, but I believe it is an old policy by central banks - practiced for decades - to try to keep the gold price artificially low by selling their own gold.

Why they do this, I cannot imagine - unless it is some notion that gold would cease to be money if the central banks could just get rid of their own gold. But then, why don't they sell all of it?

6:13 PM  
Blogger flute said...

Very well put! I also nearly dropped off my seat when I read the other day that Riksbanken sold gold. Now? When it just seems to be heading higher. To buy what? Government bonds? Let's just hope those morons at Riksbanken at least have the sense to buy government bonds from some reasonable country. But they probably buy a large proportion of US bonds, I suspect. Anything to keep the current system going until we crash into the wall!

9:38 PM  
Anonymous Contrarian Investors' Journal said...

You may find this article interesting:

[European] Central Banks to Support US Dollar by Selling Gold

2:35 AM  
Anonymous Anonymous said...

I do not think that any country ever will return to the gold standard. Politicians do believe in the supposed magics of inflation.

Therefore I salute the gold sales of central banks and hope that they will sell off all gold they have since after this there will be no opportunities left for central banks to manipulate the gold price.

A truly free global gold market without any central bank manipulation and the already existing gold leasing market will, I believe, pave the way for a sponanteous return to gold as the world's standard money.

11:50 AM  

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