IMF Reserves Sale Could Flood Gold Market, Depress Prices

Consider Britain’s Chancellor of the Exchequer, Gordon Brown, a man who made one of the stupidest financial decisions of the last twenty years.

In May of 1999, Brown sold half of the Bank of England’s centuries-old gold reserves-right at the bottom of a 20-year bear market in gold. Not only did he sell the gold at the bottom, he announced before hand he’d be selling it via auction, which immediately depressed the gold price.

Funny how that works isn’t it? You increase supply and the price falls. Pretty basic for anyone, except, apparently, the man in charge of England’s money at the time.

In 17 separate auctions, the Bank of England unloaded nearly 400 tonnes of gold at an average price of US$275 per tonne-or about $409 less than gold’s closing price in Friday’s New York spot market. Brown’s decision to unload gold at the bottom, before it went up 148%, cost the taxpayers of Britain around two billion pounds (this from the man who may very well be Britain’s next Prime minister.)

We recall the incident because a headline in today’s paper tells us that, “Japan’s Omi Recommends IMF sell gold reserves.” The IMF, at 3,217 tonnes, has the second-largest gold reserves in the world, behind the U.S. government ( 8,133 tonnes), but ahead of Germany (2,422 tonnes), France (2,710 tonnes), and Japan (765 tonnes). The Bank of England has about 300 tonnes left.

The IMF needs cash to cover its operating costs. Normally that cash would come from interest paid on loans by debtor nations. But things have been so good for countries like Brazil and other traditional borrowers that they have paid back their IMF loans ahead of schedule. That’s the bad thing about being a bank. If borrowers aren’t borrowing, you have no way of increasing your income, unless you sell your assets.

You can probably see what our mind is conjuring up now. If the IMF chooses to sell its gold now, or some of it, it would certainly depress the gold price a bit. The difference between now and 1999 is that the gold ETF market exists. This means IMF gold sales might easily be sopped up by increased demand for gold from retail and institutional investors, via ETFs.

But that’s probably a bit of question begging. The real question is whether IMF selling would flood the gold market and depress gold prices…or whether IMF selling, like Bank of England selling in1999, is the chance to load up on gold at a low relative purchase price—right before a great big honking bull market run.

Philip Klapwijk of GFMS thinks gold is going higher this year, and said so when his precious metals research firm released its Gold Survey 2007 last week. “It’s looking pretty certain that the record in terms of the annual average, $614.50 back in 1980, is going to fall this year. It’d also be far from surprised  if this year we saw the market moving above the 2006 high of $725. Quite whether we’d then get close to the all time high of $850 is more doubtful, but I’d certainly expect the upward price trend to continue on into 2008.”

Dan Denning
Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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Surely even Gordon Brown got more than US$275 per tonne for the gold, maybe US$275 per ounce would be nearer the mark.

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