Report Raises Questions About Central Bank Gold Holdings

by John Browne
Euro Pacific Capital

Recently by John Browne: Silver Set to Soar as Paper Folds?

For years I have cautioned that changes in the ownership of gold held in the vaults of key central banks around the globe may not have been accurately reported. A report issued last month in Germany has once again brought these issues to the fore. In today's environment of rampant money creation and questioning of central bank activities, such uncertainty is bound to spark the curiosity of an increasing number of investors.

Since the depths of the 2008 financial crisis, central banks around the world have increased their gold holdings. As of January of this year, the International Monetary Fund estimated that official reserves had hit a six year high. Most of this growth has come from emerging and developing nations who are estimated to have swollen their gold reserves 25% by weight since 2008. Just a few years ago, India purchased 200 tonnes on offer by the IMF.

This increase may surprise those who have been led to believe that central banks do not traditionally accumulate gold during recessions. The fact that they are doing so could carry an important message for private investors.

The United States, which has gold holdings of some 8,133.5 tonnes as of 2010 (currently valued at some $420 billion), is still by far the largest holder of gold. Perhaps with deep memories of the social scars of its Weimar Republic, Germany is the world's second largest, with some 3,396 tonnes. Oddly, Germany keeps its horde largely abroad with an estimated 66 percent at the New York Federal Reserve and 21 percent at the Bank of England. The gold was moved out of Germany during the Cold War in the 1950s due to concerns of a potential Russian invasion of West Germany.

In late October, Ambrose Evans-Pritchard reported in the UK's Daily Telegraph that the German Court of Auditors told legislators in a redacted report that the German gold held abroad had 'never been verified physically' and ordered the Bundesbank to secure access to the storage sites. The report included the surprise revelation that Germany had slashed the amount of gold held at the Bank of England by two thirds back in 2000 and 2001. At that time, active gold selling by the UK government had apparently made the Germans nervous. Further, Evans-Pritchard reported that the Court called for the repatriation of 150 tonnes of German gold over the next three years to test its weight and quality. The report added fuel to the political movement within Germany to bring back all of its gold reserves. From my perspective, the report also sheds light on three fascinating issues.

First, Germany has increased its gold holdings significantly between 2000 and 2009, more than doubling the percentage of its foreign exchange reserves held in gold. According to 2010 figures of the World Gold Council, Germany's gold reserve now constitutes nearly 74 percent of its foreign exchange reserves. This increase came despite rising storage costs and the massively reduced threat of Russian invasion. What caused Germany to accumulate so much gold? This question should not be lost on investors.

Second, the report details a level of central bank cooperation and trust that staggers the imagination. Allied governments appear to have "trusted" one another with the stewardship of hundreds of billions of dollars worth of unallocated, and in some cases uninventoried, gold bars. This policy borders on financial negligence.

Third, some central banks, such as the Fed, publish the total amount of gold held in their inventories. However, they provide no details as to its ownership. It is well known that some countries keep considerable portions of their bullion reserves with the U.S. Fed and with the Bank of England. But the details are lacking.

From 1999 to 2009 central banks drafted and executed three Central Bank Gold Agreements that have the stated intention of coordinating the sale of gold on a global basis. Many private investors see these agreements as simply an attempt to "demonetize" gold by creating strategic price volatility, and thereby investment uncertainty. The massive trading required to achieve these desired price movements must have resulted in relative changes to central bank holdings. But as banks do not reveal the owners of their gold deposits, the data is unavailable to prove this.

In the coming years, we expect general interest in gold as a store of value to increase while confidence in fiat currencies declines. If this trend is energized by increasing uneasiness over the safety, security, and ownership of the gold held by the world's central banks, much greater volatility could result. If the general breakdown of trust in fiat money is increased suddenly by a sovereign debt crisis like we have seen in Southern Europe, the next action could be a move by central banks to lay more formal claims to their deposits held abroad. Such an eventuality could finally drag the shadowy central bank gold market into the light of day.

November 8, 2011

John Browne is senior market strategist for Euro Pacific Capital.

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