Wednesday, 29 October 2014

Gold: what's happening to the price

Here is a chart of the gold price over the last five years...


The chart shows the spot price of 1 troy ounce in pounds sterling. As you can see the price peaked recently-ish in September 2011 at £1,150 but today an oz will cost you a mere £760 - a nasty loss of a third for anyone who bought at peak. (Obviously you cannot buy at spot price; expect to be paying £50 over, but that's the reference price.)

And yet all the signs are that the world is experiencing massive gold demand. The Chinese as a nation and as individuals are trying to convert their dollar piles into gold before the USA's 16 trillion dollar national debt collapses their currency; the Indians buy gold by instinct, and in the UK there are no end of businesses touting for your old scrap gold.

Back in 2013 the German government got worried about their gold reserves which are mainly held abroad, in London and New York, to make them easier to trade. They initially requested a physical audit of the gold and when that was refused they demanded the gold be delivered back to them in Frankfurt. The Americans said, yes you can have your gold back, but it will take seven years!

Both the Americans and Germans presented this delay as an inevitable consequence of attempting to move 3,300 (approx) tonnes of precious metal. It must be flown across the Atlantic - nobody will insure a ship, and the insurers insist on only one tonne per flight. So naturally it's going to take a while. (At today's price one tonne of gold is worth around twenty-five million pounds.)

But, suspicious minds have wondered if this delay isn't really longer than it needs to be. There is money to be made leasing out gold to people who want to be able to show a big gold pile and maybe the Americans need the delay to get the gold back from whomever they leased it to. (The big problem with gold as an investment is that it returns no yield. The urge to lease it out is strong.)

The leasing market is so active one gets to wondering: how much gold "out there" is actually smoke and mirrors. Leased gold is routinely re-smelted and reformed into different bar sizes and designs and then smelted back on return. No-one can really be sure how much true physical gold exists. If someone demands to see "their" gold in a depository this can be arranged - it wasn't there yesterday, it won't be there tomorrow, but today you can see it. (Hint: touch it, is it still warm?)

Unless of course you want to see 3,300 tonnes - about 2% of all the world's gold - in which case that is too difficult to arrange.

Naturally if the Americans were having trouble scraping together enough gold to give the Germans their gold back neither the Americans nor the Germans would whisper a word of this publicly. If bruited abroad everyone would want their gold back. There would be a buying frenzy which guaranteed the Germans didn't get their metal back. No, far better to keep everything quiet, don't rock the boat, let the Americans return it slowly but surely. Nearly 3,000 tonnes of new gold is mined every year - as it becomes available it can be bought up and given to the Germans.

A gold shortage should be a self-correcting problem that time will solve. Wait long enough and everyone can have their gold back.

The important thing is to keep everyone calm during the wait. This means the gold price must not be allowed to run wild. If it spikes up people will get antsy about where their gold is, or worse, try to sell it and need it back so they can deliver it to the new owner. A significant fall could also trigger selling.

There is a long history of the gold price being manipulated. Back in the 1960s there was a secret agreement known as the London Gold Pool. This was an agreement between the Central Banks of various Western governments, including the USA and UK, to keep gold between a lower and upper bound. The Americans were particularly concerned to keep gold steady as they were committed to redeem foreign-held dollars in gold (although they had long before dropped the domestic gold standard.)  So the participating Central Banks watched the gold price and when it fell below the agreed lower bound they purchased gold to raise it, and when it soared above the upper bound they sold from their reserves to bring it back down.

Needless to say, the small number of people who actually knew about this agreement could make fortunes. They could see the price break its bounds and know with certainty that major buying or selling was about to occur and forward trade on that knowledge.

As history relates, by the 1970s the CBs completely lost control of gold and the USA was obliged to break all links between gold and the dollar in 1973, which resulted in aggrieved Arabs, who were holding big dollar reserves, pushing the oil price sky-high and causing the major economic slumps of the late 1970s. Gold was $36 per oz in 1970 and over $600 per oz in 1980; a 16x jump, the investment of the decade if you were holding.

What we don't know, is if there is some secret agreement in force at the moment. But the way the gold price is defying the laws of supply and demand makes it look like there is. It looks like the old firm is holding the price down to keep everything on a steady keel, basically trying to keep a lid on the price until production brings the "physical" supply in line with the "paper" supply.

If they fail, it could be spectacular.

Readers in the UK may be interested to know that there is no VAT on the sale of pure gold; and certain coins - Sovereigns and Britannias - because they are notionally legal tender, are also exempt from Capital Gains Tax. Just saying.

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