International Gold Sales

THE G-7 APPROVED THE IMF’S GOLD SALES plan this weekend in Tokyo.

Quoting a Morgan Stanley analyst endorsing the plan, “This is arguably a good time to consider selling some of these gold holdings and investing the proceeds in financial securities with positive yields.”

According to the same article, the head of the IMF said, “There was an acceptance among the G-7 that resources should be raised by selling gold.”

Gold Bulls Should Not Panic

The media does not understand the situation, as usual.

The reports I’ve seen tend to point out that the IMF holds some 103 million ounces of gold, but leaves out the details of the plan discussed so far. Thus, readers are likely to think that it plans to sell all of it.

Au contraire. According to the recommendations of an advisory panel — this includes Morgan’s CEO, Greenspan and central bank heads from Mexico, Saudi Arabia, South Africa, the ECB and China, “only the gold acquired since the Second Amendment of the Articles in 1978…which amounts to about 400 metric tons” are to be sold. Moreover, it:

“Should be handled in a way that avoids causing disturbances to the functioning of the gold market and, accordingly, should be coordinated with current and future central bank gold agreements so as not to add to the volume of sales from official sources… It would simply take the place of some gold sales that would have been done by other parts of the public sector, other official sellers.”IMF Survey, Volume 36, No. 3 (Feb. 12, 2007)

Did you get that last sentence? I underlined it for you.

When Spain and Switzerland stepped up their selling last year at $700 per ounce, the market speculated that they were covering for some of the other members of the CBGA (Central Bank Gold Agreement) that were coming up short. This idea has substance if you consider that in the first three years of this agreement, central banks have regularly come up short. The cumulative shortfall is over 130 tons to 2007.

Add another 100-200 tons for the total decline in global mine production last year and this year, and more than half of the IMF’s 400 tons is spoken for. Putting aside the fuzzy math, the deal is not yet final. It potentially requires a few amendments to the IMF’s charter and approval by the U.S. Congress.

The U.S. has veto power because it has 16.79% of the voting power, and the charter requires an 85% majority. No one else has much more than 6%, so the U.S. is the only one with veto power. It has vetoed similar proposals in the past. This time could be different. Perhaps it is worth noting that some analysts believe the reason it has not approved gold sales in the past is that some members of Congress know that America does not own the amount of gold it claims. This may not deter approval, however, since the U.S. government could surely come up with 70 tons to keep appearances.

Nevertheless, the media ignore these controversial things.

Neither do they care much for the obvious conflict of interest implicit in the fact that the very same governments that are approving the gold sales happen to be the issuers of the bonds that the IMF intends to buy with the proceeds. That is, the deal allows governments to borrow without pushing up interest rates. It is focused on the more popular rationales motivating the IMF gold sales, such as locking in positive yields, securing a guaranteed source of future income, or funding its future losses.

The IMF has complained that it is losing money because the developing world does not need its help anymore. It is going through an identity crisis as world governments decide what to do with it. No one really talks about disbanding it, unfortunately. So it is evolving as a portfolio manager and policeman:

“The IMF’s income has fallen with the decline in new lending and recent early repayments by some countries. The institution’s income shortfall is projected at about $105 million in the current financial year, ending April 30. It is projected to reach $368 million by financial year 2010.”IMF Survey, Volume 36, No. 3 (Feb. 12, 2007)

It is one of the ironies of modern-day progressivism that bureaucrats be allowed the pretense of acting like portfolio managers. Since the advisory board’s recommendations alone — just one year ago — the IMF’s gold portfolio earned more than $30 billion in profits. It would take a similarly sized portfolio of government bonds four-six years to earn that amount at today’s yields. Since the new millennium, this gold portfolio has grown by about $65 billion. It would take 15 years to make the same off a 5% yield.

The IMF’s Track Record Speaks Volumes

The last time that the IMF sold a significant lot of gold was not at the beginning of the bear market in 1980 — as it might have if bureaucrats and ministers were actually wise in these matters.

Rather, it sold gold during 1957-70, and again in the 1976-80 period.

It has not sold any gold since.

And you can bet it sold most of that at prices well below $200-300 per ounce, since prices exceeded that level for less than two years over the aggregate 17-year selling period (1957-70 and 1976-80).

In the former period, the rationale for selling was twofold: To replenish its holdings of “currencies” and to invest in U.S. government bonds in order to generate income to offset operational deficits.

This theme, similar to the rationale offered today, was such a bad trade that by the time 1976-80 came around, the rationale for selling gold mutated to reducing its role in the international monetary system.

That’s right; they came right out of the closet.

What, with gold prices at five-10 times their original pre-1970 fixed level, and bond values depreciating ever since the IMF first started buying government bonds at a secular top in the mid-‘50s, who would believe anything else? They locked in yields somewhere in the neighborhood of 3-7%.

Soon after they finished locking in those “positive yields,” they turned negative, and then soared to just about 20% by 1980. The price of gold never again would fall to the values that the IMF received for most of it in that 17-year time frame — certainly in the 1957-70 and 1976-78 periods.

In the Final Analysis

The market should brush this off as another potential bureaucratic blunder.

The deal is not effective until the IMF ratifies it in April and the U.S. Congress approves it.

The real reason for the program is to cap gold prices and bond yields and to fill the dearth of physical gold that seems to be limiting central bank gold sales. It is far from a sound investment decision, given the supply situation and the policies of central banks today in debasing money at a 5-10% annual clip.

The IMF’s charter keeps it from destabilizing the market, but the market is too strong and big, anyway.

The amount of gold the IMF plans to sell is equivalent to about one day in trading volume on the LBMA.

The Nymex saw daily trading volumes peak at the equivalent of 28 million ounces in 2006 — twice what the IMF intends to sell. Heck, China could buy all 400 tons in one fell swoop and call it a day.

That transaction would be worth some $14 billion at today’s value for gold — that is about 1% of China’s $1.3 trillion in foreign exchange holdings. It’s less than one week in new foreign exchange gains. The market may give back some points in the next few weeks, but it may just be that traders were looking for an excuse to take profits after gaining 250 points in the last six months alone.

More significantly, should the bulls brush it off, we could see bullish confidence soar.

Gold should be bought on any dip, especially those subsidized by gold-unfriendly policies.

Ed Bugos
February 12, 2008