Saturday, December 11, 2010

Saudi Arabia's Gold Reserve Doubles

The World Gold Council in its June 2010 update of World Official Gold Holdings increased the gold reserves held by the Saudi Arabian central bank to 322.9 tons (10.38 million ounces).  This is more than double the previously reported 143 tons of reserves.

In a footnote to this report, the WGC states “Gold data have been modified from First Quarter 2008 as a result of the adjustment of the SAMA’s gold accounts.”  It is possible that the total amount of gold held by the Saudi Arabian government has not really changed, but has merely been reclassified from other accounts.  However, initial attempts to gain further information on this point were not immediately successful.
With the new reported gold reserves, Saudi Arabia’s central bank now ranks 16th, ahead of the United Kingdom, Spain, Austria, Belgium, Singapore, and Sweden. Only 13 other national central banks, the International Monetary Fund, and the European Central Bank have higher reported reserves.

This development has almost certainly contributed to the price of gold reaching an all-time high on June 18, as it demonstrates continuing strong demand from central banks to add to their gold reserves (Russia and the Philippines have been especially prominent in adding to their reserves so far in 2010). Coupled with the almost complete cessation of reported central bank gold sales, this shift in demand and supply will almost certainly help push up gold prices over the next year or so.

This report has even more ominous implications.  In April 2009, China admitted that it had acquired 454 tons (14.6 million ounces) of gold reserves from 2003 to 2009 without making any changes to their stated gold reserves as acquisitions were made.  It is quite possible that the Chinese central bank has continued to acquire gold since that report, but the stated reserves have not changed in the past 14 months.

The question becomes how many central banks are adding to their gold reserves without revealing their acquisitions.  There is a strong incentive to make purchases quietly, so as to avoid spooking the market and seeing the price jump “too soon.”

This is exactly the opposite of what has apparently happened for years, where some central banks (especially the U.S.) are suspected of surreptitiously leasing and selling their gold reserves to the market to help hold down gold prices.  Almost a decade ago, analyst Frank Veneroso used four different methods to calculate how much of the claimed central gold reserves were no longer held by them.  His conclusion then was that 25-50 percent of all reported official gold reserves were gone. In the years since, this percentage has only increased.

This problem was compounded by a reporting rule imposed by the International Monetary Fund, where central banks were required to report leased gold as still being in their vaults whether or not it was there. In addition, the central bank that might actually be holding the first central bank’s gold was also required to report it as reserves, even if this second central bank didn’t actually own it.

The increase in the price of gold so far in 2010 definitely is influenced by continuing strong demand. However, it seems a safe bet that central banks are having greater difficulty trying to sneak their gold reserves onto the market – perhaps because the vaults are near empty.

Gold mine output has been declining, despite the ever higher spot prices, which seems counterintuitive. It is not. Costs of new mine development have soared.  The average time to take a mine from discovery has stretched out from about three years to maybe 10 years. Rising costs and longer time frames make lenders less willing to finance risky projects that would only pay off if prices stay at or above current levels.
There was a huge spurt in gold recycling in the first quarter of 2009, but volumes have fallen dramatically since then, even at current record-high prices (ignoring inflation).

In sum, gold demand, both official and private, is strong and growing. Gold supplies from central banks, mines and recycling are stable to declining. The expected result should be much higher prices in the future.
I would not be surprised to see gold and silver prices suppressed until after the COMEX silver options expiration on Thursday, June 24. You may have a bargain buying opportunity for the next couple of days. What are you going to do?

On June 19, the Chinese government stated that it was going to allow the value of its yuan float. Don’t for one minute believe that it will be allowed to trade freely. Pretty much everyone expects the yuan to appreciate slightly, then be managed to be stable, as has happened for almost the past two years. Chinese officials probably realize that they need the currency to appreciate against other currencies in order to help combat local inflation. However, letting the yuan appreciate more rapidly could be interpreted as the Chinese accepting orders from the U.S. government. Chinese officials would rather absorb greater domestic problems than seem to be obeying U.S. President Obama. The bottom line is that the value of the U.S. dollar is almost certain to fall against the yuan, which also means that the price of gold in U.S. dollars will continue to rise.

Demand for gold sovereigns in Europe (especially in Greece and the United Kingdom) remains so strong that American supplies are being shipped over to Europe. American wholesalers, partly to protect themselves from market fluctuations and somewhat to try to increase profit margins, have not raised their relative bid prices to the same degree as their selling prices. My previous anticipation that sovereign owners might be able to eventually swap their coins at a high enough premium to get lower premium coins (increasing their total gold position without having to pay out any funds) has not developed. There has been increased interest in liquidating sovereigns of late, so I am doubtful that the opportunity of a profit-making supply squeeze will develop this year.

The U.S. Mint has released 2010-dated fractional gold American Eagles much earlier than it came out with the 2009-dated issues.  At the moment, dealers have ample supplies at fairly reasonable premiums. I expect both the ready availability and reasonable premiums to be temporary situations. However, if premiums do rise well before the end of 2010, I anticipate that the Mint will release enough additional supplies to make them more affordable. It could easily happen that fractional gold Eagles could be an erratic market for the balance of the year.


Patrick A. Heller owns Liberty Coin Service in Lansing, Mich., and writes “Liberty’s Outlook,” the company’s monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com/. Other commentaries are available at Coin Update (http://www.coinupdate.com/) and Financial Sense University (http://www.financialsense.com/).  

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