Western central banks maybe holding less gold than they claim

The price of gold as on January 1, 1979 was $226 per ounce (one troy ounce equals 31.1 grams).
On August 6,1979, Paul Volcker took over as the Chairman of the Federal Reserve of United States. The price of gold on that day was at $282.7 per ounce having risen by 25% since the beginning of the year.
When Volcker took office things were looking bad for the United States on the inflation front. The rate of inflation was at 12%. The price of gold against the dollar had also been rising at a very past pace. The price of gold on August 31, 1979, at the end of the month in which Volcker had taken charge was at $315.1 per ounce, up by 11.5% from the day he took charge.
The world had clearly lost its faith in the dollar. By the end of September 1979, gold was quoting at $397.25 per ounce having gone up by 26% in almost one month. And so the dollar would continue losing value against gold. On January 21, 1980, five and a half months after Volcker had taken over as the Chairman of the Federal Reserve of United States, the price of gold touched an all time high of $850 per ounce. In a period of five and a half months the price of gold had risen by an astonishing 200%. What was looked at as a mania for buying gold was essentially a mass decision to get out of the dollar and buy gold.
The mania ended quickly and the very next day(i.e. on Jan 22, 1980) the price of gold was down by around 13.2% to $737.5 per ounce. The price of gold kept falling over the next two decades and reached a low of $252.8 on July 20, 1999.
The central banks of Western Countries (i.e. United States, Canada, Japan and Europe) were the largest hoarders of gold. With gold prices having fallen to levels of $250 per ounce, the value of their gold holdings had taken a tremendous beating over the years. Also sitting in their vaults gold wasn’t earning any interest either. Hence they started lending out this gold to banks known as bullion banks.
As Eric Sprott & David Baker write in a recent report titled Do Western Central Banks Have Any Gold Left? “It made perfect sense for Western governments to lend out (or in the case of Canada – outright sell) their gold reserves in order to generate some interest income from their holdings. And that’s exactly what many central banks did from the late 1980’s through to the late 2000’s.”
This allowed the Western central banks to put gold which is essentially a useless asset to some use. As James Turk and John Rubino write in The Collapse of the Dollar and How to Profit from It – Make a Fortune By Investing in Gold and Other Hard Assets “Lending, for instance, involves, the central bank transferring gold to a major private bank, known as bullion bank, which pays the central bank a small-but-positive interest rate, then sells the gold on the open market,” write the authors. This allowed central banks to convert their gold into cash and also earn some interest on it.
Sprott and Baker suggest that “Collectively, the governments/central banks of the United States, United Kingdom, Japan, Switzerland, Eurozone and the International Monetary Fund (IMF) are believed to hold an impressive 23,349 tonnes of gold in their respective reserves, representing more than $1.3 trillion at today’s gold price.”
While it did not matter what central banks did with their gold in the eighties, nineties and even in the 2000s, things have changed now. These countries now are highly indebted and are printing money left, right and centre to repay their accumulated debt as well as get their economies up and running again.
Given all the money printing that is happening it would be good for them if they do have some gold left in their vaults and haven’t lent out all of it. “The times have changed however, and today it absolutely does matter what they’re doing with their reserves, and where the reserves are actually held. Why? Because the countries in question are now all grossly over-indebted and printing their respective currencies with reckless abandon. It would be reassuring to know that they still have some of the ‘barbarous relic’(as John Maynard Keynes referred to gold) kicking around, collecting dust, just in case their experiment with collusive monetary accommodation doesn’t work out as planned,” write Sprott and Baker.
The central banks do not have to declare about the gold that they are lending out. So it continues to show as a part of their book even though they have lent it to bullion banks, which in turn have gone ahead and sold that gold. As the authors point out “Under current reporting guidelines, therefore, central banks are permitted to continue carrying the entry of physical gold on their balance sheet even if they’ve swapped it or lent it out entirely. You can see this in the way Western central banks refer to their gold reserves. The UK Government, for example, refers to its gold allocation as, “Gold (incl. gold swapped or on loan)”. That’s the verbatim phrase they use in their official statement. Same goes for the US Treasury and the European Central Bank.”
So the actual physical gold with the central banks might be much lesser than they claim. Also, Sprott and David feel that central banks are continuing to “lend” out their remaining gold reserves. This they conclude through a mismatch in the supply and demand for gold. The demand from the five main sources i.e. gold being bought by central banks all over the world, US and Canadian mint sales of gold coins, gold bought by exchange traded funds, Chinese consumption of gold and the Indian consumption of gold has increased by 2,268 tonnes over the last 12 years. Over and above this there is demand from private buyers of gold which go unreported.
“Then there are all the private buyers whose purchases go unreported and unacknowledged, like that of Greenlight Capital, the hedge fund managed by David Einhorn, that is reported to have purchased $500 million worth of physical gold starting in 2009. Or the $1 billion of physical gold purchased by the University of Texas Investment Management Co. in April 2011… or the myriad of other private investors (like Saudi Sheiks, Russian billionaires, this writer, probably many of our readers, etc.) who have purchased physical gold for their accounts over the past decade. None of these private purchases are ever considered in the research agencies’ summaries for investment demand, and yet these are real purchases of physical gold,” write Sprott and David.
Hence, the gold demand figures that are actually reported are actually underreported as many of the investments in gold aren’t taken into account. And thus demand is made to match supply of gold which is believed to be at 3700 tonnes. If more accurate demand numbers were to be used a huge discrepancy between demand for gold and the supply of gold, would be revealed. And the demand side would exceed the annual supply of gold. “In fact, we know it would exceed it based purely on China’s Hong Kong gold imports, which are now up to 458 tonnes year-to-date as of July, representing a 367% increase over its purchases during the same period last year. If the imports continue at their current rate, China will reach 785 tonnes of gold imports by year-end. That’s 785 tonnes in a market that’s only expected to produce roughly 2,700 tonnes of mine supply, and that’s just one buyer,” write the authors.
So the question is where is all this gold coming from? It might very well be that Western Central Banks are continuing to lend gold to bullion banks which in turn are continuing to sell this gold. As Sprott and David point out “They (i.e. Western Central Banks) are the only holders of physical gold who are capable of supplying gold in a quantity and manner that cannot be readily tracked… it can only lead to the conclusion that a large portion of the Western central banks’ stated 23,000 tonnes of gold reserves are merely a paper entry on their balance sheets_– completely un-backed by anything tangible other than an IOU from whatever counterparty leased it from them in years past.”
What are the implications of this on the price of gold? As the Turk and Rubino write “Because the bullion banks have promised to eventually return the borrowed gold to the central banks, they are, in effect, “short” gold. That is, at some point in the future they are obligated to buy gold in order to repay the central banks.” And when this happens “the result will be a classic “short squeeze,” in which everyone tries to buy at once, sending gold’s exchange rate through the roof.”
Of course, the assumption here is that central banks demand their gold back. Whether that happens, remains to be seen. As Sprott and David conclude “At this stage of the game, we don’t believe these central banks will be able to get their gold back without extreme difficulty, especially if it turns out the gold has left their countries entirely.We might also suggest that if a proper audit of Western central bank gold reserves was ever launched…the proverbial cat would be let out of the bag – with explosive implications for the gold price.”
The article originally appeared on www.firstpost.com on October 26, 2012. http://www.firstpost.com/economy/western-central-banks-may-hold-less-gold-than-they-claim-503343.html
(Vivek Kaul is a writer. He can be reached at [email protected])