Central banks sit on their bullion reserves

Falling gold sales and loans provide price support; IMF has 400 tons to unload.

The world's major central banks, which hold more than 15% of global gold stockpiles, are expected to reduce their sales or lending of their bullion reserves this year, potentially restricting supplies and putting a floor under gold prices.
Several precious metals consultancies and the industry's main trade group anticipate total sales from major central banks such as France and Switzerland will decline again this year. One estimate projects sales could tumble to their lowest level in at least a decade.
Fewer sales mean gold supplies, which have been retreating in recent years as mining production has weakened, are likely to keep falling short of demand.
As long as investor appetite stays strong - and that's a big question mark, of course - this trend should support prices over the long term.
"Falling central bank sales have been a part of the gradual improvement in the overall balance between demand and supply in the gold market," said George Milling-Stanley, managing director of the official sector at the producer-funded World Gold Council.

"There are a whole bunch of reasons why the [gold] price has been going up, and I think that lower supply has been one of those reasons," he added.
Jon Nadler, senior analyst at Kitco Bullion Dealers, said falling central bank sales "might put a floor of some kind under gold, near $500 or so."
Analysts also anticipate official holders such as central banks will lend less of their reserves, keeping with a trend of recent years. Some analysts say central banks' loans of their reserves to mining companies and private banks contributed to a slump in gold prices in the second half of last year.
Another important milestone for the supply of official gold this year is the International Monetary Fund. The organization has said it plans to sell more than 400 tons of gold to diversify its revenue and strengthen its balance sheet.
Some investors are worried that the IMF sales could pressure gold prices, although the fund has said it plans to coordinate closely with central banks to minimize the impact of this large gold sale.
The IMF's plan could provide a boost in getting central banks to extend an agreement expiring in September to limit how much gold they will sell every year. That deal, called the Central Bank Gold Agreement, has helped restrain central bank gold supplies over the past decade.
In Tuesday's trading, the London afternoon gold fixing, an important benchmark for gold prices, stood at $923.75 an ounce. That's $88 lower than the record high above $1,000 hit about a year ago.

Bank of England's shocker
Central banks sell gold to rebalance their reserves portfolio by reducing the portion of gold. By selling gold, a country can switch into assets with higher return and better liquidity.
For example, Switzerland, which had held the most gold reserves per capita in Europe in 1999, has sold more than 1,300 tons of its gold reserves. Other major sellers in the past 10 years included France, the Netherlands, and the U.K.
Countries like France, where monetary policy is now set by the European Central Bank, still maintains its own central bank. The U.S. hasn't sold gold.

In the past, abrupt selling has sometimes depressed gold prices. The Bank of England's announcement in early 1999 that it was selling part of its reserves helped gold prices slump to a 20-year low. Gold traded at just above $250 an ounce by the summer of that year.
But efforts to coordinate those sales have reduced those shocks. On Sept. 26, 1999, 15 European central banks, led by the ECB, signed the first CBGA to take concerted moves on gold sales.
The banks agreed that in a five-year period, they will cap their total gold sales at around 400 tons a year, with sales in five years not exceeding 2,000 tons. The CBGA was renewed in 2004 for another five-year period. The second CBGA raised annual ceiling to 500 tons and the five-year limit to 2,500 tons.
"There is a general consensus in the gold market that the two successive CBGAs have been a success for the whole market and for central banks in particular," said WGC's Stanley.
Sales slip, slip some more
In the past 10 years, almost all the official gold sales have been from signatories of the CBGA. Their sales have fallen in recent years and are likely to fall further this year, analysts say.
VM Group, a precious metals consultancy based in London, estimated that selling under the CBGA will fall to 150 tons in the year ended Sept. 26. If realized, this will be the lowest number since 1999, when the first CBGA was signed.
The World Gold Council and CPM Group, a New York-based precious metals consultancy, also anticipate official gold sales will fall this year.
Central bank gold sales declined to 279 tons in the 2008 calendar year, more than 200 tons, or 42%, lower than a year ago, according to data collected by GFMS, a London-based precious metals consultancy.
The fall in official sales is a major contributor to the decline in global gold supply in 2008, GFMS data showed. Meanwhile, the portion of official sales in total gold supply also fell to 8% in 2008 from 14% a year ago.

"Central banks that wanted to reduce their gold holdings have sold most of the gold they wanted to sell by the middle of this decade," said Jeffrey Christian, managing director at CPM Group.
But further selling could come from countries that still hold a big portion of gold in their reserves, such as Germany and Italy, according to analysts at VM. Earlier this year, politicians in Germany were talking about selling gold to fund the country's stimulus package.

Borrowing and hedging
Aside from selling gold, some central banks also lend the metal to miners, big banks and funds. Miners borrow gold to sell forward in order to lock in their future revenue. Funds and banks sometimes sell borrowed gold to invest the proceeds in other markets.
Gold borrowed for these two purposes used to have a dramatic impact on the market because it was immediately sold in spot markets, said WGC's Stanley.
VM estimated that total outstanding balance of central bank gold lending was at 2,345 tons at the end of 2008. That's more than the year's total mining production, the major source of gold supply.
Nonetheless, this balance has shrunk consistently since the late 1990s, reducing its impact on the markets. The balance in 2008 fell almost 50% from 2004's more than 4,300 tons, according to VM.
"Gold mining companies have largely stopped selling production as a hedge, and the hedge funds have largely abandoned the practice of selling gold forward as a speculation," said Stanley.
Miners reduced forward sales by 1.54 million ounces in the fourth quarter, the smallest amount for the year, according to GFMS. Gold producers still had 15.52 million ounces left in hedging at the end of the year.
Still, in the short term, gold borrowing can make a shift in prices.
From last August, when the global credit crunch hit the financial industry, bullion banks borrowed "as much gold as was available and executed gold swaps to raise liquidity," VM analysts led by Carl Firman pointed out in a yearly report released earlier this month.
The activity had an "immediate and very marked affect" on gold by holding prices back, even in the wake of strong retail demand for physical metal, Firman wrote in a report.
Gold prices slumped nearly 30% from July's high to below $700 in November. See related story.
By lending gold, central banks can earn interest on it. Unless central banks can lend out their gold, it earns nothing, and the stockpile in fact is a cost in terms of storage and insurance, said VM's Firman in a telephone interview.
Despite some wild speculations, all evidence indicates that the U.S., the biggest gold holder, is not lending gold, said CPM's Christian.
"The people, the gold conspiracy theorists who claim evidence, twist the truth like Uri Gellar twists spoons," said Christian.
More than half of the 8,133.5 tons of gold held by the U.S. is stored in Fort Knox, Ky., according to the Treasury Department. Gold is also stored in West Point, N.Y., and Denver, Colo.

IMF has 400 tons to unload
The second CBGA is expiring in September. Stanley said he expected a new agreement will be signed. William Lelieveldt, an ECB spokesman, declined to comment on the potential renewal of the agreement.
One of the beneficiaries of a third CBGA will be the IMF, which is considering coordinating with central banks to sell 403 tons of gold.
The fund, which holds more than 3,200 tons of gold, ranking the third in the world after the U.S. and Germany, is facing a widening deficit. With the majority of its income coming from interest payment of the fund's loans, the IMF has been looking for other revenue sources.
One of the plans is the creation of an endowment, with major financing for the endowment coming from the proceeds of gold sales.
The IMF acknowledged drawbacks of gold sales, but also said that the sales could "form part of a package approach" and should "subject to strong safeguards to limit their market impact," according to the plan.
The sales "need to be coordinated with the existing and possible future central bank gold agreements," the committee said in the report. By coordinating with the CBGA framework, IMF gold sales "should not add to the announced volume of sales from official sources."
The WGC's Stanley said the IMF is likely to help push through a third CBGA.
"The proposal was designed not just to plug the income gap, but also to put the IMF's finances on a more diverse, sustainable and stable footing for the longer-term, and less subject to the ups and downs of the world economy," wrote Matthew Turner, an analyst at VM, in a report.