Central Banks to Dictate Direction of the Gold Market?

Central Banks with GoldOver the long term, I am watching how central banks are reacting in order to assess the gold market. I believe they will be a major force driving the yellow metal prices higher.

Central Banks with Gold Aren’t Selling

You see, those who have the yellow metal stored in their reserves aren’t selling it.

Consider the Central Bank Gold Agreement (CBGA) signed by the European Central Bank (ECB) and 20 other European central banks. They signed an agreement that limits them on how much gold they can collectively sell—so they don’t impact the gold market. These central banks roughly hold 35,500 tons of the yellow metal—that’s one-fifth of all the gold being mined. (Source: World Gold Council, last accessed May 5, 2015.)

This agreement has been signed four times; first the CBGA was signed in 1999, when the central banks limited themselves to selling about 400 to 500 tons each year under each agreement.

With this, one must ask: how much are they selling? The answer is surprising.

They were selling their gold fairly close to the limit, but in 2009, it all changed. Please look at the table below. It shows how much gold was sold under the CBGA since 2009. The values are written as how much was sold over the limit amount.

Year Reported Gold Sales
2009-2010 136.2/400 tons
2010-2011 53.3/400 tons
2011-2012 5.9/400 tons
2012-2013 5.1/400 tons
2013-2014 6.8/400 tons

(Source: World Gold Council, last accessed May 5, 2015.)

Notice how the selling has almost stopped? This is very critical to note. Central banks refusing to sell are a supply constraint. If they don’t sell, those who want it will have to get the precious metal through other means—either through an open market or through buying mine production.

How Much Will Those Who Want Gold Buy?

If we assume the ideal amount of gold a central bank should hold is about 10% of the reserves, then the vast majority simply don’t have very much. More specifically, this applies to those countries that are witnessing a significant amount of growth.

Consider this: India, as of April 2015, held just 557.7 tons of the yellow metal, which amounted to just 6.5% of its reserves. Other fast-growing countries are in similar situations; Brazil holds only 0.7% of its reserves in gold; the Philippines, Thailand, Peru, Colombia, Singapore, and many others hold less than 10% of their reserves in gold. (Source: World Gold Council, last accessed May 5, 2015.)

At the end of the day, gold brings some safety to the reserves. This essentially is what a nation’s wealth is comprised of. The countries that lack the yellow metal in their reserves will require more of it to gain stability.

This, in turn, will create huge demand. We already see certain central banks making solid strides in accumulating the precious metal. Most likely, more will follow. Just give it some time.

Where Is Gold Headed Next?

As it stands, investors remain way too focused on the short term. They are completely losing sight of the big picture—which is nothing new. As central banks become more active in the gold market, only then do investors rush to buy as well.

Don’t expect central banks to announce how much gold they will buy and when. If they do this, they will send the prices soaring. They will do it quietly, and only report after they have the metal on hand.

I remain optimistic toward gold. In the long run, I just don’t see how one can be bearish toward it. The yellow metal is selling for a massive discount. And I firmly believe these prices won’t stick around for too long.