The 15% Solution

January 11, 1999 – One of the biggest issues facing the Gold market over the past couple of years has been the weight of Gold sitting in European central banks. This Gold has been a problem, created in the run-up to the launch of the Euro because so many questions were left unanswered by the different national central banks in Europe (NCB’s) as well as the newly created European Central Bank (ECB).

These unanswered questions created uncertainty, which in turn created anxiety. That led to worry, and when it came to worrying about Gold, there were no shortages of bearish articles in the media to further entice many people to dump the precious metal. And dump it they did. This weight of metal from individual holdings, along with the dishoarding by some of the NCB’s like the Belgians and the Dutch, helped contribute to the low Gold price we face today.

As if this dumping of Gold was not bad enough, there was a bigger worry. Even after their well publicized dishoarding episodes, the NCB’s still held 12,000 tonnes of Gold, which was about 40% of all the Gold held by central banks worldwide.

Announcements from the ECB indicated that Gold would form only 15% of the ECB’s foreign reserves. Many commentators took this statement to imply that only 1,000 tonnes would be transferred to it from the NCB’s on January 1, 1999. What would happen, they asked, to the remaining 11,000 tonnes? Would it too be unceremoniously dumped onto the market?

The media, which generally presented a bearish picture, had a field day with this issue, which was never clearly addressed by the ECB nor the NCB’s. Most observers concluded that these 11,000 tonnes were not needed (sic) by the new monetary regime in Europe, and would therefore be dumped into the market.

It has always seemed to me that it takes a lot of arrogance to conclude that 11,000 tonnes of Gold were not needed. Gold had been money long before central banking was ever created, and has remained the pillar of central banks from the formation of the Bank of England in 1694 until today. Therefore, it was a bit of a stretch to conclude that these 11,000 tonnes would no longer ‘be needed’. Nevertheless, such light-weight thinking came to dominate the discussion about Gold during the past year. Here’s how the 1,000 tonnes was calculated.

The politicians masterminding the Maastricht Treaty that created the single currency determined that the ECB would hold Ecu 50 billion of reserves, about $55 billion at the time. When in July the ECB indicated that Gold would form about 15% of its reserves, most everyone assumed that Gold would therefore be about $8.3 billion of the total, which roughly equated to about 1,000 tonnes. I held a different view throughout last year.

In Letter 219 published on February 16, 1998, I compared the soon-to-be-created Euro to the Dollar:

These 11 countries [forming the Euro] have between them a weight of Gold totaling $99 billion at current rates of exchange. If this Gold was transferred from the member countries to the new European Central Bank to hold as foreign reserves, and if the 11 member countries also turned over…[Ecu $50 billion]…in foreign currencies as the non-precious metal component of the foreign reserve, we get a surprising result. The Gold component would equal 64% of total reserves, surprisingly close to the 58% Gold composition of the foreign reserves supporting the Dollar.

I considered this conclusion to be important. The Euro was launched for two reasons. Firstly, it was to unite the monetary system among the eleven participating countries in Europe. But secondly, and just as importantly, it was intended that the Euro would serve as an international reserve currency in competition with the Dollar.

I noted that the first goal could be achieved by using legal tender laws to force the Euro upon the European people. However, the second purpose for the Euro was a bit more problematic. Its acceptance internationally would be a matter of choice, not compulsion. Clearly, no one in any country outside of Europe could be forced into holding the Euro.

I therefore concluded that: “If the Euro is to circulate internationally in competition with the US Dollar, then it must have foreign reserves as good as the Dollar’s foreign reserves.” If all the Gold held in the NCB’s were used to back the Euro, my analysis showed that the reserves would then be as good. The Euro’s reserves would be backed by foreign currencies and Gold in amounts approximately equal to the Dollar. This was a very important conclusion for the Gold price because:

If the foreign reserves of the Euro were made to look like those of the Dollar, the remaining Gold [11,000 tonnes] in European central banks is needed. Consequently, Gold reserves for the Euro comparable to the Dollar would mean no Gold was available for dishoarding by European central banks.

We now know that the Euro will have a Gold component similar to the US Dollar. The ECB released on January 4th the “Consolidated opening financial statement of the Eurosystem as at 1 January 1999”. It reports Euro 99.6 billion of “Gold and gold receivables”, which equates to about 12,000 tonnes of Gold. Because this statement consolidates the assets of the ECB and the NCB’s, the entire weight of 12,000 tonnes of Gold is included.

More to the point, this Euro 99.6 billion worth of Gold approximates the 15% Gold component stated last Summer by the ECB, when measured not against the Ecu 50 billion original target for the foreign reserves of the ECB, but rather, against all of the foreign currency and Gold assets of the ECB and the NCB’s in the aggregate. Euro 99.6 billion of Gold is about 14.3% of Euro 697.2 of total assets, which is close enough to 15% for government work.

Thus, most everyone got it wrong except me, but I’m not jumping for joy nor gloating about being right – it is in reality a rather minor point. While my correct interpretation on this most important issue of Gold reserves at the ECB does of course provide some momentary satisfaction, there is a bigger matter of greater import. It is the matter of the Gold price.

I concluded last February that the Gold price would be rising if there were no European central bank dishoarding. Therefore, contrary to popular thinking, the Euro may end up with a large Gold component, which would be a very bullish development for the Gold price.

This large Gold component would mean that the 11,000 tonnes of so-called ‘unneeded’ Gold would not be dumped on the market. Consequently, the market was in my view supposed to react favorably to this development, and reward us with a higher Gold price. Why isn’t Gold over $300 per ounce and on its way to higher levels, including my long-standing $500 target?

We don’t have the answer to this question – yet. There is no doubt in my mind that we will learn the answer in time. In the meantime, we can only watch and wait and ask ourselves some basic questions about what is going on with the Gold price because there are only a few alternatives.

Either the huge gap over the past several years arising from the demand for fabricated Gold in excess of annual mine production is itself a unintentional fabrication of those who keep these records. Or if this gap is real, then from where is the supply of Gold needed to keep the price down coming? It is from sources not imagined? Or are various government keeping a lid on the Gold price, through active lending of their Gold and/or by unreported dishoarding from their stockpiles. This is the conclusion the conspiracy theorists suggest, and they picked up another piece of evidence in the ECB’s financial statement.

Note that the ECB is reporting “Gold and gold receivables” as an asset. Gold can only become a “receivable” when it is loaned. Therefore, it is accounting proof that one or more of the NCB’s in Europe, and perhaps the ECB itself, are lending Gold. How much Gold? That we don’t know for certain because the ECB does not provide any details on this asset. Remember, it is a well known fact that governments only tell us what they want us to hear – or see, when it comes to financial statements.

In any case, I suspect that we will probably know the answer to these all-important questions about Gold’s supply and demand soon after Gold finally breaks back above $302 per ounce. But I’m tired of waiting. I really hope a Gold price above $302 and the answers to these questions come soon.