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The Gold Price - Its Structure

Speculators overwhelm the gold market - is it because of the new Central Bank Gold Agreement?

Prospective German Sales of Gold

The speculation surrounding the future sales of gold, by the leading Central Bank holders of Gold, received clarity last week. The gold market has been speculating on the review and renewal of the "Washington Agreement". The market has felt that the leading holders of gold have wanted to sell their gold holdings and had been restrained by the agreement. However, it became increasingly clear that the if future additional "Official" gold sales were to be arranged, they would most likely have to come from the leading Central Bank signatories to the Washington Agreement, primarily, Germany, France and Italy.

The most talked about and vocal of these three has been Germany, who have to date, failed to scotch the rumours that they could be significant sellers. This changed last week when clarity was given to the picture, when no less an authority than the Finance Minister of Germany, himself, spoke out on the matter.

Minister Hans Eichel said that he would envisage the sale of only small quantities of gold by the Bundesbank, if a new international agreement on gold sales is reached, "The gold market is sensitive and if the Bundesbank takes part in a new gold agreement, they can only enter the market in small amounts," he is reported to have said. This is good news for the gold market, and will help the media to see that the massive overhang of "Official" gold is more a figment of the imagination than a real threat to the gold price.

France and Italy have remained silent on the matter. France and Italy have always been thought to be less likely than Germany to sell and have a greater propensity to holding gold in their reserves. Hence, we feel that they too will not be significant sellers, if at all, of their own gold reserves.

Previously statements of Herr Welteke, the Bundesbank President, on gold sales from German reserves, were misunderstood by the media, for some reason constantly trying to headline possible sales of "Official Gold". When he stated that he would not sell gold, unless it were allowed to invest the proceeds in 'Income earning assets", he gave a clever and political statement, said in the full knowledge that the German Government would be unlikely to change the Federal law that ensures that the sale proceeds of such assets would go to the government and not be retained under the control of the Central Bank. [In view of the poor performance of the German economy and the poor history of German currencies, it was most unlikely that such a law would be changed anyway]. This Ministerial statement helps us to appreciate the true state of affairs. It also supports the views expressed in Gold-Authentic Money over the last year.

With only relatively minor Central Banks still indicating they may be sellers of gold, the market will have to get used to the idea of greatly diminished gold supplies emanating from "Official" sources. Indeed, such is the nature of this market, that the minor Central Banks may well follow the policy of the larger Central Banks and not now sell gold.

Additionally, the statements by the German Finance Minister have encouraged the market to believe there will be a renewal of the Central Bank Gold Agreement. On this we would like to emphasise that this does not automatically mean that there will be more "Official" sales of gold. Please remember that the agreement was clear that NO other sales, other than those previously arranged [PRE-1999] would take place. To now begin to arrange more sales would be a structural alteration of the 'Washington Agreement'. Consequently, a simple renewal of the agreement, i.e. for it to stand for another 5 years, would mean that once current, pre-1999 arranged sales are complete, no more "Official" gold sales from the signatories would take place, whatsoever. The German statement should be seen in the context of the possible terms of a new agreement, not simply a renewal.

Market weight of Central Banks

Why is the German Finance Minister's statement so important, you may well ask? Well, 32,000 tonnes of gold sit in the vaults of the world's Monetary Authorities. What they decide to do with it will dominate the gold market and the gold price permanently. This tonnage sounds huge and it is, as it is over and above an amount equal to ten years of new production. But its real significance is fully realised when one understands that any supply of these reserves to the market will constitute the marginal amount that decides the price level. Because of this, all market participants have to 'touch a forelock' to the Central Banks, by factoring in the behaviour of the banks, before deciding upon their own.

The coming together of the 15 biggest gold holders in the Washington Agreement, together with the tacit support of the biggest holder of gold, the U.S.A. and the two major "Gold" institutions, the B.I.S. and the I.M.F., has made the Central Bank Gold Agreement the definitive gold price level factor. Its review, and its possible renewal and the terms of its renewal, will decide the future of the gold rice, without a shadow of a doubt. Whilst there are presently 15 signatories to this agreement their "seniority" is in line with their present gold holdings. In other words the biggest holders of gold will dominate the attitude of the smaller holders of gold, we believe.

Current Speculations

The present rumours in the market place are as follows:

  • A statement will be made to say; 'once the pre-1999 arrangements to sell gold are completed, no further "Official" gold sales, by the signatories to the agreement will take place, whatsoever.
  • The Agreement will be renewed, as it stands, with no sales figures being announced whatsoever, confirming the original Agreement's statements that no further "Official" sales will take place from the signatory institutions in the future.
  • The stability of the gold market is of paramount concern to the Monetary authorities, so they will agree to sufficient sales per annum to maintain an orderly price rise. A figure of 500 tonnes a year is figure put forward by the bullion market, currently. No statements or evidence to support such speculation is available to support or deny such rumours. Were this to be the case, it would appear to us that this would go contrary to the spirit of the original Agreement. What is available to us is the previous policy statement made by these signatories. It appears more than reasonable that this policy will continue to stand.
  • Such a major policy decision [to sell more gold] would have to be preceded by an additional policy statement that the signatories are seeking to manage the gold price actively, with the intention of having gold play an key monetary role in the future.
  • The concept of gold forming a percentage of Reserves [In the EU this is set at 15%] would have to be linked to a method of valuation of these reserves, to define what that percentage is. Several systems of valuation of "Official" gold are used at present, some realistic some pedantic, amongst the many institutions holding gold.
  • With the gold price being a constant variable, the definition of a fixed percentage of reserves to be filled by gold, implies either an ongoing purchase / sales programme of gold, or an acceptance that gold, as a percentage of reserves, will climb or fall with the gold price. World monetary policy on gold has yet to address this problem.
  • The Agreement will be reviewed, but not renewed, leaving a 'free-for-all' for any "Official" buyers or sellers. Such a prospect is most unlikely, as this would negate the whole basis on which the Agreement was made in September 1999.

Weight of "Safe Haven" buyers on the Gold Price

The influence of "Safe Haven" buyers of gold, on the price is not simply a short term phenomena. Decisions to buy on this basis are long term decisions, particularly because of the difficulty in acquiring large quantities of gold at a predictable price. Such buyers may follow the type of policy decision that states 5% of ones portfolio should be held in gold. The acquisition of such amounts would take place over a period, and the percentage measured on the entry cost and exclude profits or losses, thereafter.

In view of the sheer size of Investment funds in the market place, a flow of a mere 1% of such funds into the gold market would drive the gold price to new far higher levels.

Such buyers would not only be driven by their perceptions of the future of the global economies and their soundness, but would follow the attitude of the Monetary authorities towards gold. Such an investment attitude cannot be said to prevail today, but it could well begin to grow.

Multiplier effect of different facets of the gold market

To emphasise this last point, the decisions by the signatories to the Central Bank Gold Agreement, will precipitate similar decisions amongst the investment institutions world-wide. If they make it clear they will not be sellers of gold, you can be sure that most other types of investor and their dogs would tend to follow such decisions, as a matter of prudence.

One of the possible followers of such a decision could be the so called "Speculator" presently the most dominant factor affecting the gold price. His vice-like grip on the market today calls for an examination of what this means and who he is.

What is a "Speculator"

At the top of this pile and the facet sitting in a dominant position, at the moment, are the "Speculators" of various types. Who are these people and how is the term "Speculator" defined by the market. The dictionary defines a "Speculator" as follows, "make investment, engage in a commercial operation, that involves a risk of loss&it carries the implication of loss."

We would add to that definition, the element of capricious behaviour, such as was seen prior to the Iraqi war, when 'speculators', with no substantial reasoning, related the buying of gold, to the war to take place in Iraq, as though world monetary conditions would be destabilised by the war. When no such event took place, virtually the entire amount bought on such a basis was sold back into the market, until the gold price dropped back to where it started from. Now, in the market place, a new attitude accompanies the "Speculators". So great is this change that it seems clear that there may well be a flaw in the market definition of "Speculator".

But how does the market define the players in this arena?: -

  • "Large-scale Speculators" are those with open positions of 200 contracts or more at any one time (in any contract month).
  • "Small scale Speculators" are smaller than those with open positions of 200 contracts or more.
  • "Commercials" would tend to be commercial users of gold that hedge their positions on the Exchange, i.e. jewellers, manufacturers of electronic components, etc.

The latest Commitment of Traders Report from the Commodity Futures Trading Commission (week to 29th August) shows that large-scale speculators added considerably to their gross long positions, Over the last seven weeks, the net change in the total speculative position has been the addition of over 11Moz to the total long position on the Comex gold contract. To put this in perspective, this 343t of buying in less than two months, is greater than the annual bullion demand in the US (228t),

Japan (147t), China (205t) and, on an annualised basis, would be greater than the two largest bullion markets India (558t) and Italy (429t). It is also considerably higher than the annual reduction in the outstanding producer hedge book (423t last year).

Below shows figures for the week ending 5th September [We are informed that this NEW NET position is now 541 tonnes as of the 8th September.

  Large-scale speculators Small-scale speculators Combined position
tonnes New Old Change New Old Change New Old Change
Long 455 365 90 181 162 18 636 527 108
Short 73 53 20 53 48 5 126 101 25
Net 382 312 70 128 115 13 510 426 83

According to the relationship between the gold price and the size of the speculative position on COMEX, allowing for a steepening of the graph, with higher prices, the net position is still well above what one would expect in the $370 area. Such a position if true to the recent past would be consistent with a price around $410 and not $380.

As we said in the gold report above COMEX is not seen as the place to buy physical gold, but the place used for short term speculation, only. But, with the physical market only able to deliver a fraction of that amount in the same period as these positions were established, there is good reason why a very large buyer would choose to buy through COMEX and catch them by surprise. If the Speculators have indeed, bought for physical delivery, which would be a complete departure from previous behaviour, the squeeze on short positions will have dramatic implications for the gold price and place a strain on the sellers of contract such as they have never known before!

If this is correct, the positions being held on COMEX will be more consistent with Investment buying. While it may be premature to believe that the capricious holding of these positions seems to have disappeared with the size of these positions moving up, the resilience, the sheer determination being shown by these "Speculators" describes an investment attitude, not a short term trading attitude.

Hence the classification of "Speculators", at the moment, should be put into the similar category as "Safe Haven" buyers, because of their present behaviour not their title.

The nature of the market seems to be indicating a fundamental change in nature, right now, but we foresee its former behaviour re-appearing often, before the change is complete, so expect dramatic levels of volatility from now on! But the long awaited appearance of the major investment buyer may well be underway! So, are the Speculators overwhelming the gold market because of the new Central Bank Gold Purchase agreement? We wait to see!

The series on the gold price continues in subsequent issues of "Gold-Authentic Money"

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