Gold's flight to the developing world: A brief history

Demands for delivery by panicking Europeans in the wake of the Cyprus fiasco could only provoke one reaction. On Friday, April 12, 400 tonnes of paper gold were dumped on the market in two orders, triggering stop-loss sales and turning market sentiment bearish in the extreme. Western investors started to think about cutting their losses, and they sold down ETF holdings to the tune of 325 tonnes in 2013 by the end of May. However, this triggered record demand among those who looked on gold as insurance against currency and systemic risks.

Later that year, in July, Ben Bernanke told the Senate Banking Committee he didn’t understand gold. That was probably a reference to the April gold price smash orchestrated by the central banks and how it unleashed record levels of demand. It was an admission that he thought everyone would follow the new trend by acting like portfolio investors, forgetting that if you lower the price of a commodity, you merely unleash demand. It was also an important admission of policy failure.

Since those events in April, someone has been supplying the market with significant quantities of gold to keep the price down. We know it is not Arab gold, because I have discovered through interviewing a director of a major Swiss refiner that Arab gold is being recast from LBMA specification bars into one-kilo .9999 bars, which has become the new Asian standard. Arab gold does not appear to be being sold, only recast, and anyway, it is only a small part of their overall wealth. We also know from our long-term analysis that any European gold bullion is relatively small in quantity and tightly held. There can only be one source for this gold, and that is the central banks.

I discovered that there was a discrepancy in the Bank of England’s custodial gold of up to 1,300 tonnes between the date of its last Annual Report (Feb. 28) and mid-June, when a lower figure was given out to the public on the Bank’s website. This fits in well with the additional amount of gold needed to manage the price between those months. Furthermore, the Finnish Central Bank recently admitted that all its gold held at the Bank of England was “invested” i.e., sold and further added that the practice “was common for central banks.”

Bearing in mind Veneroso’s conclusion in 2002 that there must be 10,000-15,000 tonnes out on lease and loan from the central banks at that time, one could imagine that this figure has increased significantly. Officially, the signatories of the Central Bank Gold Agreement, plus the U.S. and U.K. own 20,393 tonnes. A number of other central banks are likely to have been persuaded to “invest” their gold, but this is bound to exclude Russia, China, the Central Asian states, Iran, and Venezuela. Taking these holders out (amounting to about 3,000 tonnes) leaves a balance of 8,401 tonnes for all the rest. If we further assume that half of that has been deposited in London, New York, or Zurich and leased out, that means the total gold leased and available for leasing since 2002 is about 12,000 tonnes. And once that has gone, there is no monetary gold left for the purpose of price suppression.

Could this have disappeared since 2002 at an average rate of 1,000 tonnes per annum? Quite possibly, in which case, the central banks are very close to losing all control over the gold price.

In Part II: The Very Real Danger of a Failure in the Gold Market, I discuss why the Chinese are buying so much gold and why the Reserve Bank of India is trying to suppress gold demand. I show that gold is substantially undervalued and why that undervaluation is likely to correct itself spectacularly, precipitating a financial crisis.

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About the Author
Alasdair Macleod

Alasdair Macleod is head of research for GoldMoney. He also runs FinanceAndEconomics.org, a website dedicated to sound money and demystifying finance and economics. He has a background as a stockbroker, banker and economist. He can be contacted at Alasdair.Macleod@GMYF.org and followed on Twitter @MacleodFinance.

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