A Golden Sword of Damocles?

It’s true – the United States and the IMF (International Monetary Fund) have a lot of gold in reserve. Some of you fear a good chunk of that gold could be dumped on the market, acting as a sharp break to the yellow metal’s rise.

Let’s start by asking the question, just how much gold do these guys have?

The World Gold Council regularly updates the stats on official holdings of central bank reserves. According to December 2008 data from the WGC, the U.S. holds 8,133.5 tonnes (metric tons) of gold. The IMF holds 3,217.3 tonnes.

When you do the math, that adds up to 11,350.8 metric tons (tonnes), or 12,512 short tons, of gold. Converted to ounces at $1,000 per ounce, that’s a touch over $400 billion bucks worth of bullion.

Does this count as a lot? Yes and no.

On one hand, it represents 8-10% (very roughly) of all the gold in the world. On the other hand, there are a heck of a lot more dollars in the world... and demand is the key driver to consider here.

Big Buyers in the Wings

Take Russia, for example. Russia has recently stated its intent to raise total gold holdings to 10% of total reserves.

Again according to the World Gold Council, Russia held 495.9 tonnes of gold as of December ’08, accounting for just 2.2% of reserves.

We can do the math and see that, for Russia to hit its stated target of raising gold holdings to 10% of reserves (assuming total reserve values don’t change), they would need to purchase 1,758 tonnes of gold in the open market.

By stating a desire to up their gold holdings to 10% of reserves, Russia has all but said “Yeah, we wouldn’t mind owning another 1,750 tonnes of gold or so.” And that’s just Russia.

When you think about it, 10% is a pretty modest allocation. You think China wouldn’t like to have more of its dollar mountain converted to gold?

What central bank wouldn’t want to have 10% of its assets (or more) in bullion at a time like this, with paper currencies getting debased like crazy and creeping geopolitical tensions around the globe?

Below is a table showing a cross section of central banks with sizable gold holdings and low percentages of total reserves.

You can see from the table how many tonnes (metric tons) each of these banks would have to buy in order to get their total allocation up to 10%.

Remember, the U.S. and the IMF hold roughly 11,351 metric tons of gold.

If just these 10 central banks elected to raise their reserve allocations to 10%, they could hoover up all that U.S. and IMF gold by themselves (and still be hungry for more). And believe me, there are plenty more than these 10 with the same thoughts... not to mention institutional demand, don’t even get me started on that.

This doesn’t paint anything close to the total picture, of course. But it should help give you a better grasp of supply and demand. Right now, demand for gold is high and rising... and there just isn’t that much of it left to go round in the world.

“We Hate You Guys”

Part of the reason many of these banks haven’t upped their total gold holdings, by the way, is because it’s hard for them to buy gold without running the price up. You’re just not seeing that much supply on the open market relative to total demand.

This is why some central bankers despair that they have nowhere to go but into U.S. dollars and U.S. Treasury bonds. The amount of available gold on the market is so small, relative to the amounts that would be desirable for them to own, that trying to get the reserve percentages up is a very tough task.

That is why Luo Ping, director-general of the China Banking Regulatory Commission, had this to say a few weeks ago:

Except for US Treasuries, what can you hold? Gold? You don’t hold Japanese government bonds or UK bonds. US Treasuries are the safe haven. For everyone, including China, it is the only option... We hate you guys. Once you start issuing $1 trillion-$2 trillion... we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.

If gold suddenly became easier to buy in the open market, bankers like Luo Ping would quickly change their tune.

“Oh, you want to sell gold in size? That’s wonderful, because we want to BUY in size... something, anything that will hold its long-term store of value better than these stupid treasury bonds! Thank you, Thank you!”

Remembering Gordon “Goldfinger” Brown

The world’s bankers, too, will no doubt remember the lesson of Gordon “Goldfinger” Brown.

Gordon Brown, now prime minister of the U.K., was treasury minister back in May 1999. In that capacity, Mr. Brown decided to dump half of Britain’s gold reserves at 20-year lows, as the Sunday Times reports:

GATHERED around a table in one of the Bank of England’s grand meeting rooms, the select group of Britain’s top gold traders could not believe what they were being told.

Gordon Brown had decided to sell off more than half of the country’s centuries-old gold reserves and the chancellor was intending to announce his plan later that day.

It was May 1999 and the gold price had stagnated for much of the decade. The traders present — including senior executives from at least two big investment banks — warned that Brown, who was not at the meeting, could barely have chosen a worse moment.

…“The timing of the decision was ludicrous. We told them you are going to push the gold price down before you sell,” said Peter Fava, then head of precious metal dealing at HSBC who was present at the meeting. “We thought it was a disastrous decision; we couldn’t understand it. We brought up a lot of potential problems at the meeting.”

…The decision to sell 400 tons of gold is seen in City circles as a financial bungle on the scale of the Tories’ “Black Wednesday” that cost the taxpayer £3.3 billion, according to Treasury estimates.

Dominic Hall, a former gold dealer who now runs thebulliondesk.com, a website for the gold market, said: “Brown was keen to throw mud at the opposition over Black Wednesday but this was a financial disaster on a similar scale.”

Dumping 400 metric tons of gold over the side at prices well below $300 per ounce was an epically dumb decision – something that is all too clear today. At present-day prices, that is much more than the Tories’ debacle of 3.3 billion pounds sterling lost... it is more on the order of ten billion pounds sterling lost.

So it is doubtful that many bankers today will want to emulate the stupidity of Gordon “Goldfinger” Brown, especially with the public so aware of what’s happening in the world. To sell gold now and trade it for what – Dollars? Euros, are you kidding me? – would serve as open invitation to be publicly tarred and feathered.

Bluffing Into the Nuts

We’ll close with a quick poker analogy.

In No Limit Texas Hold ‘Em, to hold “the nuts” means you can’t be beaten – that your hole cards in combination with the board give you the best possible hand.

Needless to say, it is useless to bluff a player who is holding the nuts. Why would they fold? They know they have the best hand. If you raise such a player, they will happily call... or better yet shove their own stack in the middle, a reraise to put you all-in.

If the Fed or the IMF were to dump gold onto the market in this environment, I believe it would be the poker equivalent of bluffing into the nuts. I don’t think the powers that be are that dumb.

But even if they were, what would happen? If they tried to increase the gold supply discreetly, the central banks and institutional holders who are quietly accumulating bullion would simply pick up the pace a little.

If they tried to talk down gold in the open market, blathering about how they planned to sell a huge chunk, gold might take a sizable short-term hit... but then it would bounce back, and then what they do?

Warm Regards,

JL