Central Banks & Their Gold Strategy

We all know that the biggest demand for gold comes from central banks. Just how has their buying or selling strategy been over the last 12 months? Is their strategy influenced by the amount of USD being printed into circulation? Are they afraid of the dollar not being able to uphold its long term value? Will they ever regard holding US Treasuries as an option only? Is any of them seriously hinting of reverting back to the gold standard? By holding more gold and less USD does that mean more flexibility to their monetary policy?

• Reduced central bank gold selling and increased investor buying may have been helping to underpin high prices in 2008 at a time of turmoil in financial markets. The renewal of the central bank gold selling agreement with a lower threshold suggests that gold sales by central banks will be lower in the next five years, a move the could support gold prices.
• Gold's share in global foreign exchange reserves is about 10%, the third largest asset by value despite being unevenly distributed across countries. The U.S. and European central banks account for the highest amounts both in absolute terms and as a share of reserve holdings (about 50%). Emerging market central banks have a much smaller share. Gold's share in global reserves declined sharply since the 1950s -1960s.
  

Regulation of Central Bank gold sales


• In August 2009, the central banks party to the central bank gold agreement (CBGA), who collectively have a gold share of just under 60% in their reserves, agreed to renew the treaty but with a lower maximum sales threshold. Analysts suggest that the marginally lower threshold could provide a "mild support" for gold.
• The annual sales by the central banks party to the treaty will be less than 400 tons. The previous agreement had a cap of 500 tons per years. The IMF's planned sales of 403 tons are included in the overall cap of 2000 tons from 2009-2014. With the Swiss National bank suggesting it will not sell, only the European central bank and the Banque de France are likely to take advantage to sell. The Italian and German central banks have been reluctant to sell their gold holdings.
• In H1 2009, estimated net sales by official holders of gold were 39 tonnes, 73% lower than in H1 2008. Net gold official gold sales are expected to be only 140 tons in 2009, the lowest since 1994.
  
• In 2008, European central banks sold the lowest levels of gold in about decade, reversing the practice of recent years whereby official sales helped depress gold prices. Banks bound by the central bank gold agreement (most of the European central banks) sold about 343 tons of gold , the lowest since the first agreement was signed in 1999, and well under the 500 ton annual limit.
• In the fall of 2008, central banks stopped lending out gold to banks as they were afraid they would not get it back. This reluctance contributed to an increase in bullion borrowing costs to 2.649% for one month, the highest since May 2001 and high above recent levels (5yr average 0.12%).
  
• An asset allocation assessment would suggest European central banks still have too much gold. EM central banks have low gold holdings in part because of the rising cost of gold and worries about an inability to sell when forex liquidity is required.
  

Gold holdings of Emerging Market Central banks

• GCC private investors have much higher stocks of gold than its central banks do. However, Qatar increased its gold reserves in 2007.
• China announced early in 2009, that it had increased its total gold holdings by 75%, likely from shifting non-monetary gold to the central bank. Although that increase now makes China one of the top 5 official gold holders, gold makes up less than 2% of China's $2.1 trillion in foreign exchange reserve by value. On the margins, China is likely to keep adding slowly to its holding but it is unlikely to make purchases on the open market given the potential for disrupting prices and reducing the value of USD holdings
• Aside from China with 1054 tons, the emerging market central banks with the largest gold holdings are Russia (540 tons), Taiwan (424 tons), India (358 tons) and Venezuela (356 tons) as of May 2009. Aside from Venezuela and Lebanon, the gold shares of which make up 37.5% and 27.5% respectively of total reserves, most of the other large holders have a gold share of only about 4% of reserves.
  

Gold Sales by the IMF

• The IMF, the third-largest official holder of gold, intends to sell 403 tons (12%) of its 3217 tons of gold, pending approval from 85% of its members which will likely be given in the fall. Any sales are likely be gradual though and may be sold to central banks.
• IMF gold sales are unlikely to be disruptive for the gold market and could be positive if the gold is purchased by other official investors (like central banks).
  
• The IMF is likely to start selling in 2010, selling about 200 tons a year.

p/s photos: Aya Nakata

European Union Financial System Might Be Even Worse Off

The media tend to focus on the credit crisis too much on just the US and maybe the UK. Even the secondary focus was largely on how China would figure in being a catalyst for recovery. There are pockets of the world that are facing the crisis with more devastation, and urgency for help. In a sense for them, its should be called a debt crisis rather than a credit crisis. We are talking of Eastern Europe, Western Europe, Russia and Ukraine... hey, basically the EU. Most of what's written below was taken from The Telegraph, UK.

In much of Western Europe, things are nearing boiling point. Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria's GDP.

"A failure rate of 10pc would lead to the collapse of the Austrian financial sector," reported Der Standard in Vienna. Unfortunately, that is about to happen.

The European Bank for Reconstruction and Development (EBRD) says bad debts will top 10pc and may reach 20pc. The Vienna press said Bank Austria and its Italian owner Unicredit face a "monetary Stalingrad" in the East. Mr Pröll tried to drum up support for his rescue package from EU finance ministers in Brussels last week. The idea was scotched by Germany's Peer Steinbrück. Not our problem, he said. We'll see about that.

Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities. It must repay – or roll over – $400bn this year, equal to a third of the region's GDP. Good luck. The credit window has slammed shut.

Not even Russia can easily cover the $500bn dollar debts of its oligarchs while oil remains near $33 a barrel. The budget is based on Urals crude at $95. Russia has bled 36pc of its foreign reserves since August defending the rouble.

In Poland, 60pc of mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America's sub-prime debacle. There is a crucial difference, however. European banks are on the hook for both. US banks are not.

Almost all Eastern bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets. They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).

Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico's car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia.

Whether it takes months, or just weeks, the world is going to discover that Europe's financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus. The European Central Bank already needs to cut rates to zero and then purchase bonds and Pfandbriefe on a huge scale. It is constrained by geopolitics – a German-Dutch veto – and the Maastricht Treaty.

It is East Europe that is blowing up right now. Erik Berglof, EBRD's chief economist, said that the region may need €400bn in help to cover loans and prop up the credit system. Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. Athens has ordered Greek banks to pull out of the Balkans.

The sums needed are beyond the limits of the IMF, which has already bailed out Hungary, Ukraine, Latvia, Belarus, Iceland, and Pakistan – and Turkey next – and is fast exhausting its own $200bn (€155bn) reserve. We are nearing the point where the IMF may have to print money for the world, using arcane powers to issue Special Drawing Rights. Its $16bn rescue of Ukraine has unravelled. The country – facing a 12pc contraction in GDP after the collapse of steel prices – is hurtling towards default, leaving Unicredit, Raffeisen and ING in the lurch. Pakistan wants another $7.6bn. Latvia's central bank governor has declared his economy "clinically dead" after it shrank 10.5pc in the fourth quarter. Protesters have smashed the treasury and stormed parliament.

In almost every way, this is much worse than the Asian financial crisis in the late 1990s, as indicated by the table below. There are accidents waiting to happen across the region, but the EU institutions don't have any framework for dealing with this. The day they decide not to save one of these one countries will be the trigger for a massive crisis with contagion spreading into the EU. The governments and ECB cannot risk NOT saving any one country or banking institution, but that strategy is drawing almost all the reserves and ammunition these institutions have.

Europe is already in deeper trouble than the ECB or EU leaders ever expected. Germany contracted at an annual rate of 8.4pc in the fourth quarter. Germany will have shrunk by nearly 9pc before the end of this year. This is the sort of level that stokes popular revolt. The implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece and Portugal as the collapse of their credit bubbles leads to rising defaults, or rescue Italy by accepting plans for EU "union bonds" should the debt markets take fright at the rocketing trajectory of Italy's public debt (hitting 112pc of GDP next year, just revised up from 101pc – big change), or rescue Austria from its Habsburg adventurism.

Hungary’s forint fell to an all-time low in recent days, and Poland’s zloty slumped to the lowest in five years on plunging industrial output. Half of all loans to the private sector in Poland are in foreign currencies so borrowers face a severe debt shock after the 40pc fall of the zloty against the euro since August.

There are contagion worries for Western banks that have lent $1.74 trillion (£1.22bn) to the ex-Soviet bloc -- split between $1 trillion in foreign loans and $700bn in local currency debt through subsidiaries. Austria’s banks are the most exposed with the share of risk-weighted assets tied to the region reaching 54pc for Raffeisen and 38pc for Erste Bank. The exposure of Germany’s Bayern Bank is 48pc, Italy’s UniCredit is 45pc, and Swedbank is 29pc.

The region needs to roll over $400bn in foreign debts this year, equivalent to a third of total GDP, raising concerns that it may need a massive rescue programme from the International Monetary Fund and the European institutions.

p/s photos: Elva Hsiao