Central Bank sales won’t knock gold price

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Central Bank sales won’t knock gold price
Garth Theunissen
Posted: Fri, 24 Aug 2007

[miningmx.com] --THE gold price will not be undermined by a possible acceleration in central bank gold sales as the third year of an agreement capping central bank gold sales at 500 tons per annum draws to a close.

That’s the view of Steve Shepherd, a gold analyst at JPMorgan Precious Metals Research, who says central bank gold sales are just one variable in the broader gold price equation.

“At the moment central banks are below par in terms of the rate they need to make the 500 ton quota,” he said. “On that basis there is a risk that they will accelerate sales as they approach the end of the third year of the agreement but our view is that this won’t have a significant impact on the gold price.”

a risk that they will accelerate sales

Shepherd’s comments come after the World Gold Council (WGC) released statistics showing that central bank gold sales under the Central Bank Gold Agreement 2 (CBGA2) amounted to just 294 tons as at 12 June 2007. That left scope for remaining sales of 206 tons until 26 September 2007 when the third year of the agreement comes to an end.

The CBGA2, which commenced on September 27 2004, is a pact between the European Central Bank and 14 other central banks that limits gold sales to 500 tons per year over a five-year period. Central banks are thought to control around 20% of the world’s gold supply.

Nikos Kavalis, a precious metals analyst at GFMS, said that if recent third-quarter gold sales by central banks were added to the WGC’s June figures, confirmed sales in the third year of the CBGA2 amounted to 391 tons.

“We expect underselling in the third year,” said Kavalis.

Standard Bank senior commodities analyst, Dr Walter de Wet, agreed that central bank gold sales would not dampen the gold price.

“Total global gold demand is in the order of 4,000 tons per annum so 500 tons amounts to just 12,5%,” he said. “Given that sales do not occur all at once but are spread out over a year I can’t see how it would have a major impact.”

De Wet also said that it would not be in the interests of central banks to disrupt the gold price.

“The minute central banks indicate that they want to sell gold the price of the metal would drop thereby reducing the value of their remaining reserves,” said de Wet.

Shepherd agreed, saying that the very existence of the CBGA2 indicated that Banks did not want a volatile gold market.

“It’s not in any central bank’s interest to have a disorderly gold market as it causes financial instability that hurts everyone,” said Shepherd.

David Davis, a gold analyst at Credit Suisse Standard Securities, concurred that there was little chance of central banks reaching the 500-ton quota by the end of September and that even aggressive selling would have a limited effect on the gold price.

“I don’t think they’ll reach 500-tons by the end of September,” he said. “Even if they do increase sales between now and then I doubt it would have a major impact as there’s a significant counterbalancing effect from increased de-hedging and exchange traded funds (ETFs), which both take gold out of the market.”

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David Hall, a gold analyst at Macquarie First South Securities, said the market had already priced in the likelihood of increased central bank sales in the third quarter of 2007.

“The market has been expecting these sales so I don’t think it would have any massive effect,” he said. “That’s why the gold price hasn’t really benefited from the recent strife in global financial markets.”

The gold price has fallen 3,3% since July 20 when a global liquidity squeeze stemming from the US subprime mortgage crisis sparked a rout in global equities.

“Traditionally gold benefits when there’s a flight to safety but thus far gold has not responded as we thought it would,” said Shepherd.

However, Hall said the recent pickup in gold jewellery sales was a positive sign.

World Gold Council figures show that gold jewellery sales increased 29% in volume terms in the second quarter of 2007 compared to the same period last year, reaching a total of 675,1 tons. In value terms, gold jewellery sales rose 37% to US$2,49bn in the second quarter of 2007 compared to second quarter 2006.

“That shows that jewellery makers are growing accustomed to a higher gold price,” said Hall.

Shepherd said that while he was positive on the long-term outlook for gold, current market conditions were too complex to draw any conclusions on the metal’s short-term prospects.

“The outlook for gold at the moment is complicated,” he said. “We’re not gold evangelists but on the basis of supply and demand fundamentals we’re positive on gold over the longer term. However, in the short term that trend can be punctuated by periods of volatility.”

Shepherd said it was still not clear how gold would respond to the US subprime mortgage crisis but suggested that moves by central banks worldwide to inject liquidity into financial markets could fuel inflation, in which case gold could benefit as an inflationary hedge.

Short-term positives for gold included the approaching Indian wedding season and the festival of Diwali, both of which are characterised by increased gold jewellery purchases.

“It’s also the year of the golden pig in China which is regarded as a very auspicious year for marriages,” said Shepherd.

One the downside, Shepherd said a lingering Monsoon season in Asia could dampen physical sales.

“Persistent rain makes it difficult for people to actually go out and buy the gold,” he said.