Eric Sprott: Investment Outlook (October 2012)

Investment Outlook - October 2012

Do Western Central Banks Have Any Gold Left???

by Eric Sprott, Sprott Asset Management

Somewhere deep in the bowels of the worldā€™s Western central banks lie vaults holding gargantuan piles of physical gold barsā€¦ or at least thatā€™s what they all claim. The gold bars are part of their respective foreign currency reserves, which include all the usual fiat currencies like the dollar, the pound, the yen and the euro.

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 todayā€™s gold price. Beyond the suggested tonnage, however, very little is actually known about the gold that makes up this massive stockpile. Western central banks disclose next to nothing about where itā€™s stored, in what form, or how much of the gold reserves are utilized for other purposes. We are assured that itā€™s all there, of course, but little effort has ever been made by the central banks to provide any details beyond the arbitrary references in their various financial reserve reports.

Twelve years ago, few would have cared what central banks did with their gold. Gold had suffered a twenty year bear cycle and didnā€™t engender much excitement at $255 per ounce. It made perfect sense for Western governments to lend out (or in the case of Canada ā€“ outright sell) their gold reserves in order to generate some interest income from their holdings. And thatā€™s exactly what many central banks did from the late 1980ā€™s through to the late 2000ā€™s. The times have changed however, and today it absolutely does matter what theyā€™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 ā€˜barbarous relicā€™ kicking around, collecting dust, just in case their experiment with collusive monetary accommodation doesnā€™t work out as planned.

You may be interested to know that central bank gold sales were actually the crux of the original investment thesis that first got us interested in the gold space back in 2000. We were introduced to it through the work of Frank Veneroso, who published an outstanding report on the gold market in 1998 aptly titled, ā€œThe 1998 Gold Book Annualā€. In it, Mr. Veneroso inferred that central bank gold sales had artificially suppressed the full extent of gold demand to the tune of approximately 1,600 tonnes per year (in an approximately 4,000 tonne market of annual supply). Of the 35,000 tonnes that the central banks were officially stated to own at the time, Mr. Veneroso estimated that they were already down to 18,000 tonnes of actual physical. Once the central banks ran out of gold to sell, he surmised, the gold market would be poised for a powerful bull marketā€¦ and he turned out to be completely right ā€“ although central banks did continue to be net sellers of gold for many years to come.

As the gold bull market developed throughout the 2000ā€™s, central banks didnā€™t become net buyers of physical gold until 2009, which coincided with goldā€™s final break-out above US$1,000 per ounce. The entirety of this buying was performed by central banks in the non-Western world, however, by countries like Russia, Turkey, Kazakhstan, Ukraine and the Philippinesā€¦ and they have continued buying gold ever since. According to Thomson Reuters GFMS, a precious metals research agency, non-Western central banks purchased 457 tonnes of gold in 2011, and are expected to purchase another 493 tonnes of gold this year as they expand their reserves.1 Our estimates suggest they will likely purchase even more than that.2 The Western central banks, meanwhile, have essentially remained silent on the topic of gold, and have not publicly disclosed any sales or purchases of gold at all over the past three years. Although there is a ā€œCentral Bank Gold Agreementā€ currently in place that covers the gold sales of the Eurosystem central banks, Sweden and Switzerland, there has been no mention of gold sales by the very entities that are purported to own the largest stockpiles of the precious metal.3 The silence is telling.

Over the past several years, weā€™ve collected data on physical demand for gold as it has developed over time. The consistent annual growth in demand for physical gold bullion has increasingly puzzled us with regard to supply. Global annual gold mine supply ex Russia and China (who do not export domestic production) is actually lower than it was in year 2000, and ever since the IMF announced the completion of its sale of 403 tonnes of gold in December 2010, there hasnā€™t been any large, publicly-disclosed seller of physical gold in the market for almost two years.4 Given the significant increase in physical demand that weā€™ve seen over the past decade, particularly from buyers in Asia, it suffices to say that we cannot identify where all the gold is coming from to supply itā€¦ but it has to be coming from somewhere.

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