Turning point for gold as Central Banks become buyers

With the possibility of Central Banks becoming net gold buyers and the speculation that the IMF gold may be sold "off market" gold analyst Jeff Nichols remains bullish on the precious metal's prospects.

Author: Lawrence Williams
Posted: Wednesday , 02 Sep 2009

LONDON -

In his latest deliberation on the gold market, specialist gold analyst Jeff Nichols believes that gold has reached a turning point with purchases from official sources - Central Banks and sovereign wealth funds - perhaps outweighing sales as attitudes to the metal as a reserve asset become much more positive.

In particular Nichols points to China and Russia as two key nations with relatively low proportions of gold in their reserves as likely to be net buyers in the future - even if only soaking up gold from their own domestic production which otherwise would come on to the market. China announced earlier this year, for example, that it had moved 454 tonnes of gold into its reserves since 2003 - but still has only about 1.5% of its assets in gold. China's accounting system is complex. The gold is, apparently bought by one government entity, but need not show up in its reserve statements until an internal transfer has been made into reserves - or so it says. This in effect means that its real gold reserve position is far from transparent and there is certainly a view that China is continuing to buy gold from domestic sources - Nichols surmises at a rate of around 75 tonnes a year, but again this has not shown in official reserve figures as yet and would only do so when it suits China to announce changes in holdings.

Russia too, with only around 2% of its assets in gold, has been making purchases from domestic output - and with prime Minister Putin stating publicly that the country should hold 10% of its reserve assets in gold there is considerable scope for ongoing purchases. According to Nichols, some reports suggest the country has added some 40 to 50 tons to its official reserves so far this year while other reports put purchases this year at 90 to 100 tons.

The key, though, has to be the attitude of the European Central Banks, which have been selling significant quantities of gold onto the market over the past ten years. The U.K. is the prime example of this when then Chancellor of the Exchequer, Gordon Brown, who has, despite this financial disaster for country, built up a decidedly unwarranted reputation for financial prudence, sold half the U.K.'s gold reserves right at the bottom of the market, costing the country some several billions of dollars by some estimates.

Overall, the European banks are said by Nichols to hold on average about 55% of their reserve assets in gold - way above while Asian nations only about 1.5 - 2% - hence the big scope for purchase increases in the areas where economic growth has the highest potential. Be this as it may, Nichols reckons European Central Bankers' attitudes are changing towards gold as an asset with the recent sharp fall in gold sales from official sources representing a renewed respect for gold as a reserve asset and reliable store of value.

But perhaps key to the perception of bankers seemingly renewed confidence in gold will be the fate of the IMF sales programme of 403.3 tonnes scheduled to help support lending to the poorest countries. IMF membership is expected to approve these prospective sales before its annual meeting this October.

IMF strategists have suggested sales might occur gradually over two or three years - and generally within the new Central Bank Gold Agreement (CBGA) quota of a maximum sales level of 400 tonnes a year. However Nichols notes that others believe all 403 tons of IMF gold may be sold "off the market" directly to one or a few central banks - with China, Russia, India, Brazil, or the Gulf states mentioned as possible buyers. If this happens this would be a huge boost for the perception of gold's position as a monetary asset.

Coming back to Europe though, with the CBGA quota being reduced from maximum sales of 500 tonnes a year under the previous agreement to 400 tonnes a year under the new one, which comes into effect at the end of the current month, this is further expression of changing attitudes. It is felt that those Central Banks which have been keen to sell gold will have already done so - indeed sales during the final year of the current agreement are likely to be shown to have slipped to only around 150-160 tonnes as against the 500 tonne quota, and there is evidence that in the latest quarter official sources were actually net gold purchasers.

With the IMF sales already pretty well discounted by the markets, investment demand holding up and Central Bank sales seemingly diminishing, the portents for gold look reasonably strong for the immediate future.

As Nichols concludes "We are bullish on gold for the next few years, largely because of our reading of the macroeconomic situation - and the high probability of an overly stimulative monetary policy for years to come. But a more positive official section attitude - with some countries wishing to increase the proportions of official reserves held in gold - is simply one more support for a much higher price over the next several years.

Jeff Nichols' latest comments may be read on www.nicholsongold.com