Undermining gold

After investigating the sale of a substantial portion of the United Kingdom’s gold reserves, Britain’s National Audit Office (NAO) has concluded that the auction method used was more suitable than the London Gold Fix and didn’t much affect the price received by the treasury. However, the report did suggest that in the future, “the Treasury should give further thought, in consultation with the gold market, to using the London Gold Fix as an alternative or additional means of selling gold.” It also stated that the majority of participants in the world’s biggest gold market believe the fix to be “fair,” and that selling smaller amounts of gold more regularly would be “less disruptive” to the market.

Confused? Join the club. Even the World Gold Council (WGC) found more questions than answers in the report, which was designed to determine whether or not the British taxpayer received value for money from these sales. The NAO’s mandate was limited, and therefore the report didn’t question the wisdom of selling the gold in the first place, or shed any new light on why the government proceeded with an auction that was opposed by most of the British public.

The WGC also expressed surprise that the NAO used the afternoon fix, rather than the morning fix, when it compared the achieved price in the nine auctions staged to date. After all, the afternoon fix takes place after the auction and is, therefore, influenced by its result. The WGC cited two occasions when the difference between the auction price and the morning fix was significant. Last July, for example, the auction achieved US$3.10 per ounce less than the morning fix, whereas in September of last year, the auction under-achieved the fix by US$1.40 per oz. This represents an implied loss to the U.K. of US$2.5 million and US$1.1 million respectively — small potatoes for the government perhaps, but it would be a major scandal if any reputable financial institution ignored more than US$3.5 million of potential profits while carrying out transactions that involved the public interest. Clearly the country did not get as much value as it could have received had the government handled the gold sale in a more astute and discreet manner.

Sadly, the limited scope of the investigation means that most questions about the gold sales will remain unanswered. British citizens still have not been provided with any compelling reasons for the sale, other than the nebulous claim that they were prompted solely by “reserve asset management policy.” Public confidence suffered as a result, and declined further when it was learned that 40% of the proceeds from gold sales were used to invest in the euro. In the absence of a reasonable explanation, the British government is sending financial markets the message that it no longer believes in gold as a reserve asset the way it once did. Its plan to reduce gold reserves to a mere 300 tonnes will bring it on par with the gold reserves of Albania in percentage terms — a sad state of affairs for a nation once perceived as an economic and financial powerhouse. In the process, it has undermined the continuing role of gold as a strategic reserve asset, while harming an industry that provides jobs and economic benefits for many poor and developing nations.

Gold bugs can only take heart that the United States remains the largest holder of gold, accounting for 57% of its currency reserves. Many other nations continue to value the precious metal as a reserve asset, though Canada is way down the list, with a mere 1% of its total reserves held in gold.

History has proved the wisdom of holding gold as a reserve asset, but central bankers seem to believe that this time-honoured practice is no longer relevant or warranted. As the old saying goes, those who cannot remember the past are condemned to repeat it.