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Peter Grandich again tells ROB-TV: Murphy and GATA are right
Let's Cut the Bullion About Holding Gold
By Alan Wood
The Australian, Sydney
Saturday, February 11, 2006
http://www.theaustralian.news.com.au/common/story_page/0,5744,18106836
%255E31478,00.html
Has the Reserve Bank [of Australia] made a costly blunder in its
management of Australia's international reserves, a task that is
surely a litmus test of a central bank's financial acumen? Why ask
this question now?
Well, for the past few weeks the world gold price has been bouncing
around 25 year highs. Although it is off its peak of $US572.15 an
ounce on February 2, it was still around $US564 the last time I
looked.
The highest gold prices for a quarter of a century set a neon sign
flashing in my head that reads July 1997. What happened on July 3,
1997?
Let me remind you. On that day the Reserve Bank of Australia put out
a short press release headed "Official sales of gold." Here is the
opening sentence.
"Over the past six months, the Reserve Bank has sold 167 tonnes of
gold, reducing its holdings from 247 tonnes to 80 tonnes." It said
the RBA planned no further sales, but that didn't stop it hitting the
gold market like a bombshell.
Gold shares plunged, the stock market fell, and the gold price, which
was already on a long slide that began in 1980, tumbled. In New York
gold hit its lowest level since 1985, at $US325 an ounce.
The RBA was accused of betraying the local gold miners and doing long-
term damage to the gold price and the Australian economy. The Prime
Minister and Treasurer both defended the bank and its governor, Ian
Macfarlane, but through gritted teeth.
There were dark mutterings in ministerial offices about the dangers
of RBA independence, and the Treasurer rang Robert Champion de
Crespigny of gold miner Normandy to square off, denying he said gold
was anachronistic.
This was all more than a little overdone. Other central banks had
already been selling down their gold holdings, notably the Dutch and
the Belgians. Even the Swiss were talking about doing it and the
International Monetary Fund was considering gold sales.
What particularly upset the World Gold Council, it said, was that
Australia was the first central bank to sell gold primarily to
improve the return on its international reserves -- tantamount to
saying gold was a bad investment.
The bank didn't quite say so in its original press release. It said
its principal reason for the sale was that Australia had plenty of
gold reserves in the ground and high annual production, so there was
negligible diversification benefit from holding a significant
proportion of its international reserves in gold. However, stung by
the savage attack on the gold sales, Macfarlane made it clear that he
did regard gold as a poor investment. He said taxpayers were losing
about $150 million a year in potential investment income.
He pointed out that the bank's gold holdings were not earning it any
income, particularly with the gold price falling. Better to sell the
gold and invest the proceeds in income-earning assets. The bank made
some $2.4 billion from its gold sales.
After the sale the price of gold continued to fall, hitting a 20-year
low in August 1999 of about $US256 on the back of Bank of England
gold auctions. It then began a bumpy ride up and in March 2002, with
gold at $US294, a gold bug wrote a letter to a newspaper suggesting
Australia would have been better off by $600 million if Macfarlane
had held off selling the gold until then.
It was angrily denied by Macfarlane, who said far from losing money
the RBA was well ahead from selling the gold and investing the funds.
The bank's annual report for 2002 gave the detailed figures.
It showed that if it had held on to its gold it would have made a
return of $787 million, compared with its cumulative return on its
investment of the sale proceeds of $1.4 billion -- better off by $625
million. Since 2002 the bank hasn't published any figures.
So what's the story now, with gold at a 25-year high? On my
calculations the difference between the value of the gold holdings if
the bank had retained them and the cumulative return on the sale
proceeds it invested is about minus $600 million. It would be $600
million better off if it had held on to its gold. The RBA confirms
this figure is ballpark.
Was the central bank wrong to sell the gold? I don't think so. Over
the long term, say 20 years, its returns on its investments are odds-
on to beat gold, and central banks are long-term investors.
The chart shows how equities and government bonds have outperformed
gold over 200 years in the US. The dollar amounts show the cumulative
after-inflation return from investing $US1 in 1802.
The relative return story would be much the same here over any
extended period. And since 1997, for all but the last four months,
the RBA's investments were ahead of gold.
Nor can the profit on gold be realised without selling it, and in
what circumstances might a central bank do that? With a floating
exchange rate, international reserves play a much less important
role, needed as a buffer only in extremis.
In Australia's case that translates as plunging commodity prices,
falling terms of trade and a falling exchange rate. In those
circumstances the price of gold, another commodity, would be falling
too.
Don't forget the RBA's original justification for its gold sales --
gold offers negligible diversification risk in Australia, with its
large gold reserves and high annual production.
Putting that in investment terms, Australia is long on commodities,
including gold. Why should the central bank increase our exposure by
holding its reserves in gold?
The mistake our central bankers made was not selling gold in 1980,
when they could have got out comfortably at well over $US600 and
ounce, even after the price collapse of January that year. I have
heard it was discussed over coffee, but Treasury, expecting the price
to double, wanted to hang on. Gold prices fell for the next 20 years.
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