Gold has staged a dramatic comeback. How did the change come about? What's next?
Following my last post on gold, I got several comments: for and against.
One said that the real reason gold has come back over the past 10 years is that central banks have stopped selling and started buying again. Indeed!
Net gold purchases by central banks in 2012 were 534 tonnes – a level last seen in 1964. Buyers included central banks of Russia, Brazil, Paraguay, Iraq, South Korea, Philippines, and Turkey. Since turning from being net sellers to net purchasers in 2009, central banks have added 1,100 tonnes, bringing global gold reserves to 31,597 tonnes. In Turkey, increased reported reserves ( from 193 to 359 tonnes) reflect the increasing role that gold plays more broadly in the Turkish financial system – the WGC reports that these reserves are pledged from commercial banks as part of their required reserves.
None of the central banks that signed the original 1999 Washington Agreement on Gold (WAG), which limited sales to a certain predetermined amount over a five-year period, and that now are able to sell gold under its latest version (the first year of the fourth central bank gold agreement has just begun) are exercising their right to sell. They are content to hold onto their gold. Meanwhile, more emerging markets are buying. This is sensible diversification. But is it also a step towards the possible remonetisation of gold?
I think it could be. Much against their will, central banks will find they are in effect managing the gold market, which means the gold price, within a range – they cannot let it slip too far, or rise too far. In other words, there is an unannounced, and as yet undefined, corridor. One day the market will test the upper bound. This is a measure of the change initiated by WAG. In effect it put a floor under the market. The fashionable cynics, who knew nothing about central banks, were routed.
Gold has come a long way since the dark days of the 1990s, when gold bears wrongly predicted that central banks would go on selling on a large scale. The turning point was the statement read out by the late Wim Duisenberg, then head of the ECB, in the press room of the IMF during the annual meeting on September 26, 1999. I was there a few minutes after he made the announcement. Duisenberg had sauntered unexpectedly into the press room late in the evening, and, gathering a few journalists together, read out the statement.
I proposed calling it the Washington Agreement on Gold or WAG and the term quickly gained widespread acceptance. This was important because the central bankers originally framed it merely as a clarification of intentions. There was a risk that this would again be discounted by the market. It had to be seen as a watershed that had permanently altered the central banks’ relations with the gold market. If the central banks really would abide by it – which many in the market initially doubted – it would be a game-changer. But confidence was not immediately re-established.
As the main adviser on central banking to the World Gold Council since 1991, I had been working towards this for years. A few months before, at a meeting with the governor of a leading central bank, I had told him that the gold market was demoralised by the recent sales and the fear of more sales, despite reassurances from some central bankers. I told him that these carried little credibility. He was outraged that the market did not believe the word of a leading governor like him!
Well, I said, if you want to stop the rot, you have to do more. The London market would love to get all that gold out of central bank vaults – then the speculators can play with it to their heart’s content! The hired hacks are drumming up a campaign to persuade more central banks to sell, and Gordon Brown of the UK has given them lots of ammunition by disposing of much of Britain’s gold stock.
A high point in the process of education was when Thabo MBeki, then president-elect of South Africa, agreed to give a private, informal talk to a select group of central bank governors, including Duisenberg, in the wings of the World Economic Forum in Davos early in 1999. A powerful speaker, you could see the effect of his words on their faces. Gold was not just inert yellow metal in their vaults, but the product of much human labour, a product on which the fortunes of millions of people in many poor countries depended.
After a few key governors became convinced of the need for action, much of the detailed work on the statement was done in the Bank for International Settlements. From then on there was no doubt that the big European central banks were determined that gold would not be driven out of the system, or out of their vaults. Duisenberg himself said the central banks had been influenced by the World Gold Council, South African mining groups and the need for stability.
Now, 14 years later, not only is there record demand from the official sector (especially if you take into account buying by sovereign wealth funds) but Europe’s most powerful central bank has given the world a recent reminder of this attachment to gold by its decision to bring home a large portion of the gold placed with the French and US central banks to Frankfurt for safekeeping.
This decision reflected the play of political influences, and politics will continue to shape the gold market. Gold remains a concealed source of tension between the United States and the euro area. China is the world’s leading gold producer and largest creditor. Historically, all reserve currencies have been backed by gold. Those who have no historical understanding, like the know-nothings who predicted 20 years ago that the major central banks would sell their gold, will continue to misinterpret what is happening.
Gold is also one of the few defences that emerging market central banks have to counter the waves of monetary instability being whipped up by western governments and central banks. Every $1 billion invested in gold in 2000 is now worth $5.7 billion.
In “The Money Trap” I analyse the pros and cons of returning to gold as a reference point for monetary values, among alternative monetary anchors, and the potential uses of gold in the currency politics of the future.