Central bank transactions in the gold market

In the past five years, central bank activities in the gold market have increased significantly. There are currently more than 80 central banks active in the gold market. Indeed, central banks are an important component of the marketplace; without them, the marketplace would run into severe liquidity problems.

The ability to mobilize gold through gold loans, swaps, and so on (as opposed to outright sales) is needed not only by central bankers but by institutional investors and the mining industry for forward hedging and derivative products. Because of the high degree of gold mobilization, the gold market has been able to handle huge supply shocks and still function in an orderly manner. Even during the peak of central bank sales by the Belgians and the Dutch, it was not possible to push gold down more than a dollar an ounce.

Outright gold sales from central banks have been well-publicized. The most recent were from the former Soviet Union in the late 1980s and early 1990s, and countries like Canada, Holland and Belgium. Sales from these countries have exceeded hundreds of metric tons. At times, this has sent shock waves into the bullion market, creating rumors that other central banks would also sell their gold reserves.

Central bank sales are not always responsible for sudden swings in the gold price. Very often, they are made scapegoats when there is large, unexplained selling in the marketplace. The Russians, for example, were often made the scapegoats, even on days when they were not in the market and had no gold reserves left to sell. Central banks, however, have been responsible for compensating some of the mine supply shortage over recent years. The mining industry, too, has had its fair share of criticism recently. Many miners were taken to task for an aggressive hedging policy. Hedging is a proven risk management tool for the miner. It acts very much like an insurance policy and gives a miner guaranteed income in times of distress-level prices. In the late 1980s, it was very difficult to be positive about the price of gold. We saw increased central bank selling and an explosion in mine supply. However, now we can be more optimistic. Gold supply-demand fundamentals are becoming more favorable and miners are unlikely to be aggressive hedgers until the price exceeds the $400-per-oz. level.

— This article is a summary of a presentation given at the Central Bank Workshop, held Jan. 20 in New York and sponsored by the World Gold Council. Ian MacDonald joined Credit Suisse in July, 1983, and is a much quoted commentator on the gold market.