CBs Favour Gold

Central Banks Favour Gold Amid Credit Crisis

By Jan Harvey, Reuters | October 2008

LONDON— Sales of gold by European central banks are likely to be lower than expected over the next year as the global banking crisis boosts bullion's appeal as a "safe" reserve asset. And banks elsewhere in the world, most notably in Asia and the Middle East, may even become buyers of gold in an attempt to diversify their reserves away from the U.S. dollar, analysts say. Under the terms of the Central Bank Gold Agreement, signed in 1999 by key European institutions including Germany's Bundesbank and the European Central Bank and renewed in 2004, members can sell up to 500 tonnes of gold a year.

But in the fourth year of the latest agreement, which ended recently, sales fell well short of this ceiling, to just over 357 tonnes. With banks worried by the outlook for the financial sector, sales could be even lower in the final year of the pact. "Given the damage done to a lot of other paper assets that were formerly considered secure, there will be greater risk aversion among central banks," said Philip Klapwijk, executive chairman of metals consultancy GFMS. "This will only boost gold's status within central bank reserves."

A key reason why central banks want to hold onto gold is the instability of their most common reserve asset, the dollar. The U.S. currency slipped to record lows against the euro earlier this year, and although it has since taken on a firmer tone, doubts remain over its outlook. "Gold assets have moved up in value in euro terms whereas dollar assets have fallen considerably," Mr. Klapwijk said. "There has been a reassessment of gold given developments in last few years."

Aside from the pressures associated with the current financial crisis, with a number of European central banks now having completed previously announced sales programs, analysts say a dip in selling is to be expected. Germany's Bundesbank, with the second largest gold reserves in the world after the U.S. Federal Reserve, said this week it would make no gold sales over the next 12 months, aside from a small sale already agreed with its finance ministry. The Swiss National Bank also said on Monday it had completed the sale of 250 tonnes of gold it announced last June, and had no plans for further sales.

The correction in the gold price from the all-time high of $1,030.80 (U.S.) an ounce it hit in March is also relieving some of the pressure on banks to sell gold to rebalance their reserves. "One reason people had been selling was because the gold price had risen and therefore the reserve value, relative to foreign exchange, had increased," said RBS Global Banking & Markets commodity strategist Nick Moore. "There was some selling pressure in order to rebalance reserves back to levels people were comfortable with."

"The fall in the gold price from over $1,000 puts us in a situation where the percentage of gold as a proportion of banks' reserves will be lower, so that will take some pressure off for rebalancing," he added. CBGA signatories aside, some central banks are more likely to be buyers than sellers of gold as the outlook for financial markets and the dollar stays rocky, analysts say. These purchases are most likely to come from Asian and Middle Eastern central banks looking to diversify their dollar assets into gold than their European counterparts.

"Central banks flush with dollars in Asia and the Middle East may try to diversify into gold," said Calyon metals analyst Robin Bhar. "The argument in favour of that may have been made stronger by recent events, which may encourage more diversification away from depreciating currencies."

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