Another Rally Snuffed Out

January 28, 2002 – It happened yet again. That same $292 barrier that has stopped so many rallies in the past has proven insurmountable yet one more time. I’ve lost count how many times that has happened.

As the price started falling back over the last week or two I have been asked several times when do I think the central banks that have been putting a lid on the gold price will finally lose control? Well, as readers know I thought that they would lose control in 1999. And we positioned ourselves beautifully that summer for the big rally that occurred that autumn.

However, the central bankers back then somehow managed to put the genie back into the bottle. We did walk away with some good trading profits from that rally, but here we are more than two years later still waiting for the moon-shot that we all know is coming.

So I can understand and fully appreciate the frustration of everyone who is thinking, when will the central bankers finally lose control of the gold market? When will the gold price finally soar? And the cheerless answer is, we just don’t know for sure. Nevertheless, there is one thing we do know, and it does provide some meaningful encouragement.

We are getting very, very close to that moment when gold will skyrocket. The reason is that central bankers are running out of bullets.

According to IMF statistics, central banks and international financial institutions like the IMF and BIS have reported that they own 33,723 tonnes of gold that is stored in their vaults. However, we know that they actually have a lot less gold than that.

The reason is that for over ten years central banks have been lending more and more of their gold to banks, which use this gold to make gold loans to those miners who sell future production (the so-called ‘hedgers’). These same bullion banks also use this gold to fund some of their dollar assets (the so-called ‘carry-trade’). How much gold is on loan to the bullion banks from central banks in this way?

Unfortunately, we don’t have the exact answer because most central banks obfuscate their gold lending activity. They defy open and honest disclosure as well as generally accepted accounting principles by reporting as one asset the gold they have in the vault together with the gold they have on loan. Even Enron could have learned a thing or two from the central banks about fictitious accounting.

However, the picture of central bank activity is not entirely uncertain. We can put together a rough idea of what is involved by using the limited information the central banks and the IMF do make available. I’ve done this in the first table.

There are three things that I am trying to illustrate with this table. First, we can see the total amount of gold reported by central banks, which is 33,723 tonnes. Second, there are 18,416 tonnes of what I have labeled as “Gold in Vault”, which I will explain shortly. Finally and most importantly, we can see how much of gold is available for lending. The total amount is 15,307 tonnes.

I noted above that most central banks report “Gold & Gold Receivables” as one asset on their balance sheet. There are some exceptions. For example, Switzerland and Russia report the weight of gold in their vault as well as the weight of gold they have on loan.

Interestingly, some of the central banks report no Gold Receivables. France, Japan and India fall into this category. Presumably the US is in this category as well because the Treasury does not report any Gold Receivable on its balance sheet. And I have also recorded the total weight of gold within the IMF as not available for lending.

I have made some other assumptions in this table. First, I have assumed that none of China’s gold is on loan. And although they only recently reported the increase to 500 tonnes, I have reason to believe that it is accurate to show that they had 500 tonnes at December 2000.

My remaining assumption deals with the entry labeled miscellaneous. I have assumed that 100 tonnes of gold is being held in various smaller central banks around the world, and that this gold is not available for lending.

So by looking at the balance sheets of various central banks, we can determine what gold is not being loaned. Then by subtracting this amount from the total weight of gold controlled by central banks, we can determine that the total pool of gold available for lending is 15,307 tonnes.

Now instead of looking at central bank gold from the perspective of what they report on their balance sheet, we can also look at central bank gold based on what is reported by vaults. And in this regard, there are two major vaults. One is the US Treasury vault, in which is stored the US Gold Reserve. The other is the vault in the Federal Reserve Bank of New York, which stores gold for other central banks.

There are two other vaults of importance, the Bank of England vault and the major vault at Zurich airport. However, the gold stored in these vaults is not reported. But we know that these vaults have relatively little gold available. The reason is that as gold lending developed in recent years, these were the first vaults to empty because London and Zurich are the two markets where gold lending takes place.

The NY Fed does not release the names of the central banks for which it stores gold. All it does is report the total amount of gold in its coffers.

Thus, the two tables are not directly comparable. For example, we don’t know whether the Japanese gold is stored in Tokyo or the NY Fed. And I assume that nearly all of the IMF’s gold is stored in the NY Fed, but we just don’t know for sure

Because of the limited reporting by central banks, we have to make some assumptions about what is happening. So in the second table I have assumed that there is another 3,000 tonnes of gold stored in various central bank vaults around the world. Most of this 3,000 tonnes is probably accounted for gold held by the Swiss National Bank and the Bank of France.

So by these calculations, there is 17,844 tonnes of gold accounted for in vaults. The balance of 15,879 tonnes I assume is out on loan.

A year or so ago gold analyst Frank Veneroso suggested that the total weight of gold loans was approaching 15,000 tonnes. I think he was right. And over the past year, those loans have increased to something around and possibly over 15,000 tonnes.

The significance of this observation gets backs to my basic conclusion stated earlier that central banks are running out of bullets. There is not a lot of gold left for them to throw into the market to keep the gold price suppressed. That there is not a lot of gold left to the devises and scheming of central bankers is evidenced by the rush in recent years to get gold out of the NY FRB vault to make it available for lending.

I am assuming here of course that there is gold in the US Treasury vaults and that it will remain there. It is not important for this analysis whether that gold is owned by the US Treasury or has been partially swapped with the Bundesbank. But I assume that gold is not being shipped from Fort Knox to Europe.

If the central banks keeping a lid on the gold price want to keep their game going, they have to turn France into a lender of gold and/or tap further into the hoard of the Swiss National Bank. Otherwise, they will have to go to some of the central banks with smaller gold hoards (e.g., India, Russia, Japan) in order to find the metal they need to keep suppressing the gold price.

Unfortunately for the central bankers but fortunately for us, there is not a lot of gold left in these smaller central banks. In recent years we have seen the central bankers go after the gold in Kuwait, Uruguay and the other small countries that have now become lenders of their gold reserve. In other words, these small countries are already largely tapped-out.

The important point to note is that barring the mobilization of the large hoards in the US, France and Switzerland, there is little gold left in the vaults for the central bankers to tap. My guess is that the crunch point will come this year. Just like the London ‘gold pool’ eventually ran out of physical metal in March 1968, central bankers are about to run out of gold this year, assuming that US, French and Swiss hoards remain untouchable, which I think is a realistic and therefore safe assumption.

Lastly, to put the weight of gold into proper perspective, the big picture shows free-market forces are more powerful than they probably surmise. After WWII, some 90% of the world’s aboveground stock of gold was in central banks’ vaults, making it very easy for them to manage its price. Today, though central banks report owning 32,000 tonnes of the approximately total aboveground stock of 130,000 tonnes of gold, in my view at least 15,000 tonnes of central bank gold has been loaned, so they have at most about 17,000 tonnes in the vault, which is only 13% of the world’s aboveground gold stock.

These figures show that year-by-year central banks and government involvement in the gold market are becoming marginalized. They own only 13% of the gold; private hands own 87% of the gold. Compared to their position after WWII, they have relatively less gold resources at their command to manage the gold price.

The impact of governments is only felt because they act in unison, compared to the private owners of gold who together do not seek to manipulate the price, but rather, find good value for their purchasing power. Further, governments very effectively use the media to disparage gold. But in the end, the private hands buying gold continue to exchange their fiat money day-in and day-out for physical metal at record levels.

In conclusion, it’s an imprecise game trying to guess how much gold is in central bank vaults and available for lending. But generally speaking, so long as gold does not start getting shipped out from the US reserve and/or the NY Fed, and France and Switzerland do not change their policy on lending, then it seems that the end-game of the central bank scheme to keep a lid on the gold price is about to end. In fact, I expect that it will end this year.