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The Bullion Report

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December 8, 2010 in 'The Bullion Report'

A Gentleman's AgreementA Gentleman's Agreement

12-8-10

A Gentleman’s Agreement


Following the 1980 price peak in gold, there was a sell-off that probably left more than one investor wondering if precious metals had completely lost their luster. The Hunt Brothers’ manipulation of the silver markets also added its own tarnish to the world of bullion. As these two markets march to fresh highs this year, it is time to think about what pulled both markets down and why support may come at a higher level than you think.

As mentioned in previous reports, catalysts for rising prices include geopolitical tensions, inflation, and a host of other fear-inducing fundamentals. The jittery reaction to uncertain world and economic conditions doesn’t always cause the pendulum to swing towards higher ranges. There is one thing in particular that can make gold buyers into gold sellers. That is an increase in gold sales from large banks or investors.

This fear was one of the biggest culprits for the most recent low price in gold.

In the late 1990s, there were a number of gold sales that were thought to be impacting the broader market. Sales were coming from central banks including Bank of England auctions and other European nations. The result of rumors over more central bank sales, especially considering the lower prices for gold, was a threat of destabilizing the market. Since central banks held so much of the physical gold at the time, some of them came together to take action to prevent a rapid decline in prices. The result of their meeting was a gentleman’s agreement on gold sales.

The Central Bank Gold Agreement

 
Past performance is not indicative of future results.
***chart courtesy Gecko Software’s Track n’ Trade Pro


During an IMF meeting in the fall of 1999, the Central Bank Gold Agreement (or Washington Agreement on Gold) was signed, passing into history with a pledge to limit sales of gold. Prices for the precious metal responded accordingly. In essence, the agreement proposed maintenance of gold as an important component of reserves and to cap annual gold sales. In its first version, the cap on sales was 2,000 tons total over 5 years, or no more than 400 tons each year. Signatories included:

•    Oesterreichische Nationalbank
•    Banca d'Italia
•    Banque de France
•    Banco do Portugal
•    Schweizerische Nationalbank
•    Banque Nationale de Belgique
•    Banque Centrale du Luxembourg
•    Deutsche Bundesbank
•    Banco de España
•    Bank of England
•    Suomen Pankki
•    De Nederlandsche Bank
•    Central Bank of Ireland
•    Sveriges Riksbank
•    European Central Bank

Although not officially part of the agreement, the US, Japan, Australia, and the IMF “associated” themselves with it, often committing to not becoming potential gold sellers. In fact, the current 403 ton gold sales intention from the IMF was written into the third Central Bank Gold Agreement, recognized as being “accommodated within the…ceiling.”

The Central Bank Gold Agreement has been reviewed and renewed twice since its inception. The second version raised the gold sales ceiling to 500 tons per annum, not to exceed 2,500 tons total. The third and current version caps things at a combined 400 tons per year through to September 2014.

Criticism of the agreement included a charge by the Gold Anti-Trust Action Committee (GATA) which suggests that the intentions behind it were not as wholesome as they appear. The GATA appears to conclude that a dance between central banks and bullion banks over leased gold prevented currency depreciation under the agreement, and that central banks were involved in a price suppression scheme. Other issues include the notion that the agreement is not a treaty and is potentially akin to a cartel. As such, there is a potential for significant material manipulation of the supply side of the global gold market.


Of course, nothing is forever and it might be argued that the Central Bank Gold Agreement could build up to potential disaster if signatories ever change their minds on renewal. Previous attempts in the last century to govern gold prices and sales were not maintained in perpetuity.

Summary

Charges of potential manipulation, suppression or currency bolstering aside, the central bank agreement was a boon in some ways. It offers the potential to prevent a large run-off based on the idea that some of the largest holders of bullion would be auctioning off their assets. Even though the laws that govern central banks are not transparent, it is the gentleman’s agreement between these banks that can quickly quash rumors that led to sharp price declines in gold in the 1990s. The apparent transparency of the agreement removed a lot of the fear-factor surrounding the market and potential sales. Following the initial price spike after the agreement, the sector could focus on other fundamentals. This kind of accord, as long as it is maintained, will likely help to support precious metal prices, especially in the midst of continuing weaker economic conditions.

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Gold and silver, like other commodities, have an intrinsic value, which is not arbitrary, but is dependent on their scarcity, the quantity of labour bestowed in procuring them, and the value of the capital employed in the mines which produce them. -David Ricardo

 


Disclaimer: The prices of precious metals and physical commodities are unpredictable and volatile. There is a substantial degree of a risk of loss in all trading. Past performance is not indicative of future results.