With the G-20 meeting wrapping up in Pittsburgh, there is much talk about the dollar and whether it can maintain its role and vitality as the world's leading currency and reserve asset. Surely, gold's role in the international monetary system -- and its value to private investors -- is evolving favorably for the yellow metal.
Countries like China -- while talking tough -- have a strong interest in maintaining a stable dollar and an undervalued yuan to support exports to the U.S. and a growing economy with high employment at home. At the same time, China -- and a number of other major countries -- are interested in gradually diversifying reserves into gold and other currency reserve assets.
I believe we are now at a key turning point in the modern history of gold as an official reserve asset. After years of persistent net sales by central banks in the aggregate, the official sector may soon become a net purchaser of gold from the market.
In fact, if we include sovereign wealth funds -- which are non-central bank government-owned investment institutions -- the official sector may already be a net buyer of gold. On average, the central banks of the world hold about 10 percent of their international reserves in gold but there is great disparity countries and regions.
The major European nations together hold about 55 percent of their assets in gold. In contrast, the Asian nations -- including China and India -- as a group hold only about two percent of their reserves in gold. China has about one and a half percent of its reserve assets in gold and Russia holds about four percent in gold.
For the past three decades beginning in the mid-1970s, gold has been under the threat of massive sales by the world's gold-rich central banks and by the International Monetary Fund as well. In fact, the official sector has been a net seller of gold each and every year since 1989. At times, official sales -- and the threat of more to come -- have contributed to negative sentiment in the marketplace with the price typically falling whenever one or another central bank announced a sales program.
This was seen most dramatically in 1999 when, much to its recent embarrassment, the Bank of England sold over half its official gold reserves at an average price of about $275 an ounce!
Other European central banks -- among them Switzerland, France, Italy, Spain, Portugal, and the Netherlands -- followed Britain, together selling about 3900 tons in total over the next 10 years.
Realizing that their gold sales were having a considerable disruptive affect on the market and the metal's price, the European central banks announced in September 1999 their agreement to limit future gold sales to no more than 400 tons per year over the next five-year period.
This first Central Bank Gold Agreement (also known as the Washington Agreement) was followed by the second Central Bank Gold Agreement, which limited sales by the European signatory nations to 500 tons per year for another five years.
This summer, the European Central Bank and 18 other central banks announced a third Central Bank Gold Agreement that caps the group's aggregate sales now again at 400 tons per year for another five years.
All of this may prove to be irrelevant because the European central banks have not been inclined to sell much gold this past year -- and my guess is that they will not sell much at all during the next few years.
For one thing, the pattern of sales in recent years suggests that those central banks most eager to sell have already done so. For another, many central bankers are bullish on the metal and don't want to sell an appreciating asset. Moreover, central banks that have sold large quantities of gold in the past decade look foolish indeed as the metal's price has moved higher and the value of their U.S. dollar reserves has declined.
I believe the decline in gold sales by the European central banks reflects a renewed respect for the yellow metal as a reserve asset and reliable store of value.
The European Central Bank, in announcing the latest Agreement said, "Gold remains an important element of the global monetary system."
The Swiss National Bank, a signatory to the Agreement, added that it "has no plans for any further gold sales in the foreseeable future."
Germany and Italy, the two biggest holders of official gold after the United States and the IMF, have both implied they have no intention to reduce their gold reserves.
And, perhaps a harbinger of things to come, the European Central Bank also reported recently that one of its members (and a signatory of the Central Bank Gold Agreement) recently purchased gold, going against the trend of the past decade.
The International Monetary Fund has also made news with its plans to sell 403.3 tons of gold to support lending to the poorest countries. IMF membership is expected to approve these prospective sales before its annual meeting this October.
IMF strategists have suggested sales might occur gradually over two or three years. Others believe all 403 tons may be sold "off the market" directly to one or a few central banks - with China, Russia, India, Brazil, or the Gulf states mentioned as possible buyers.
Importantly, the new Central Bank Gold Agreement incorporates these sales by the IMF, even though the Fund is not a signatory.
More specifically, the Agreement "recognize(s) the intention of the IMF . . . and noted that such sales can be accommodated within the (Agreement) ceiling." In other words, total sales by the European central banks and the IMF cannot exceed 400 tons per year or 2000 tons over the five-year term of the Agreement.
To a large extent, gold sales by the IMF are already anticipated and factored into the current price. However, direct sales - off the market - to one or more central banks would be confirmation that central bank attitudes are shifting in favor of gold and would likely have a positive effect on the metal's price.
The big news of the past year has been announcements from both China and Russia that they have been buying gold from their domestic mine production - importantly demonstrating that large central banks can gradually buy gold without disrupting the market.
As the G-20 ends today member nations will leave the Steel City knowing the gold reserves they're building up are going to continue to climb in the long term with international pressure on the dollar. The smart American investors will do the same.
Jeffrey Nichols of American Precious Metals Advisors is the Senior Economic Advisor to Rosland Capital LLC, a precious metals sales firm that provides advice on precious metals asset management.
