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10:13p ET Sunday, October 3, 2004
Dear Friend of GATA and Gold:
Movements in the price of gold are sometimes "so
enigmatic" and central banks and bullion banks are
so involved with it that the gold market may be
less than free, the deputy chairman of the Bank of
Russia says.
The deputy chairman, Oleg V. Mozhaiskov, made the
remarks in a speech at a meeting of the London
Bullion Market Association in Moscow in June, but
the LBMA and other participants in the meeting
suppressed it, refusing repeated requests to
release a copy. After months of negotiation, the
Bank of Russia last week supplied the Gold
Anti-Trust Action Committee with an English
translation, which is appended.
In his speech to the LBMA Mozhaiskov cited GATA's
work at length, and while not formally endorsing
it, he showed that the Bank of Russia has been
following it closely and knows that much more
has been going on in the gold market than is
widely acknowledged. Likening the central bank
to a giraffe, Mozhaiskov quoted a poem well-known
in Russia: "The giraffe is tall, and he sees all."
The central banker acknowledged that the great
increase in the use of derivatives and central
bank leasing of gold have depressed its price in
recent years.
Mozhaiskov also denounced "the blatant lack of
discipline" of United States fiscal policy and "the
social and economic injustice of a world order that
allows the richest country in the world to live in
debt, undermining the vital interests of other
countries and peoples."
Despite its use as jewelry, gold is mainly a
financial asset, not merely a precious metal,
Mozhaiskov said, and international financial
circumstances are making gold particularly and
hard assets generally ever more desirable for
investment.
GATA is grateful to Mozhaiskov and the Bank of
Russia for their willingness to address gold
market issues openly, and we will encourage
study and discussion of this speech.
CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.
* * *
The London Bullion Market Association
Bullion Market Forum
Baltschug Kempinsky Hotel, Moscow
June 3-4, 2004
Perspectives on Gold: Central Bank Viewpoint
By Oleg V. Mozhaiskov, Deputy Chairman
Bank of Russia
I would like to thank the conference organisers
for this opportunity to share my thoughts on
such a complex, even mythical subject as gold
and the prospects for the near and medium-term.
I assume that the request was made for one
simple reason: that I, as a senior executive of
the Bank of Russia, should know more than
other ordinary mortals.
In general, this logic is flawed, although there is
sense to it: It is necessary to understand the
Central Bank perspective regarding this
precious metal, particularly given that it does
have approximately 500 tonnes of the metal in
its vaults.
It is from this perspective, that of central bank,
that I intend to base my presentation. I hope you
can understand that it is quite a specific topic,
management of gold reserves. This is distinct
from the views adopted by gold prospectors,
industrialists, investors, speculators, and
ordinary purchasers of jewellery.
For the central bank, the gold stock is the
international payment reserve for the whole
country -- for the state authorities, private
companies and corporations, as well as individual
citizens. Like any reserve, it needs to be
conserved, in terms of both actual physical form
and its value. To a lesser extent, we need to be
concerned about its liquidity, or more precisely,
market price developments.
The central bank's duties in managing gold
reserves may therefore not seem particularly
onerous to a commercial trader, who has to
close dozens of transactions daily to achieve
results by the end of the day.
In this there is a grain of truth. The central bank's
specialists do not have to follow real-time price
movements every day and every minute, or react
instantaneously to every little twist and turn in the
market. We are concerned with other, less
immediate problems regarding gold. In a figurative
sense the central bank's attitude can be compared
with that to a giraffe. I have in mind an image of an
animal that suggests certain ambiguity, at least in
the Russian language.
On the one hand, when Russians say that someone
is reacting like a giraffe, they are highlighting that
person's slow reaction. It even suggests a degree
of slow-wittedness. On the other hand, the evident
magnificence of the animal commands respect.
"The giraffe is tall, and he sees all" -- the words of
the Russian bard Vladimir Vysotskii are well known
throughout Russia.
With this allegory in mind, I would like to mention
the issues concerning gold which fall within the
"giraffe category", or more formally, present
concerns of a central bank.
These are several: the volume of actual precious
metal stock, both in absolute and relative terms
(essentially, the optimum component of the metal
in total monetary reserves); methods of controlling
the stock; ensuring both security and availability
for liquidity purposes and at the same time
optimising income-earning potential. All these
issues reflect very practical concerns.
It may seem strange but all bear direct relation to a
problem that is often considered purely theoretical:
What is gold currently, and what will it be tomorrow?
Real money with intrinsic value? A raw material? A
cash commodity that has lost some of its monetary
functions? If so, what are the prospects -- complete
loss of gold's role or a restoration of lost functions,
in one form or another?
There is a wide circle of leading financiers who believe
that pondering on these themes is a fruitless academic
exercise. They are convinced that the heads of the
world's richest countries, who once agreed to abolish
exchange of national currencies for gold at a fixed rate,
have in fact demonetised gold altogether. In their eyes,
the existence of official gold reserves is simply a
remnant of the past, a financial monument to the gold
and gold-currency standards, which will ultimately be
absorbed by the global gold market. This market has
properly organised infrastructure, products, rules, and
procedures, and central banks are merely one of its
clientele. For them, this is the only reality to be
reckoned with.
Is this a true picture for gold in the modern world?
Many people do not think like this; the reality is more
complicated. The contemporary gold market has
emerged as a byproduct of a series of agreements
between governments, initiated by the United States
and supported by the other major powers, in whose
possession the bulk of all gold ever extracted lies.
These agreements (the most important of which were
the Jamaica Agreements of 1976) created ideal
conditions for stimulating international trade by means
of expanding credit facilities in national currencies.
The obligations on debtor countries to pay off the trade
deficits with gold (upon demand of the creditor
countries) severely limited the exporter countries'
opportunities for trade expansion. The importer
countries were made to live within their means,
predicated by their gold reserves. Gold was
therefore considered by a number of economists
and policy makers as an instrument guaranteeing
order and justice in international economic relations,
while others remained convinced that it hindered
international economic progress and development.
The latter, as you know, secured the upper hand.
That brief look back into the past was necessary to
make the following conclusion: The present state of
the gold market and its future cannot be analysed in
isolation from the problems of the international
monetary system.
Some people may question this conclusion because
of the incompatibility of the present volumes in the
respective gold and foreign currency markets. I would
suggest that the volumes do not matter for this
particular purpose. The modern monetary system,
although undoubtedly robust and long-standing, in
fact has a number of flaws and weaknesses. These,
like the birth of the new, can cause health problems
to the participants of the system.
This disconcerting phenomenon occurs because, by
taking gold out of international payments turnover,
people are undermining payment discipline. The
discipline I have in mind is at a macro-level; that is,
the discipline of rich industrial countries whose
convertible currencies have taken the role of an
international trade medium by virtue of their
economic strength and have been accepted by the
world community as reserve units of payment.
Although there are several reserve currencies, the
blatant lack of discipline is demonstrated by the U.S.
dollar. I am leaving aside the main aspects of this
problem, such as the social and economic injustice
of a world order that allows the richest country in the
world to live in debt, undermining the vital interests
of other countries and peoples. What is important for
us today is another aspect, which is connected with
the responsibility of the state issuing the reserve
currency and for the international community
preserving that currency's buying power.
Given the actual behaviour of the dollar on the forex
markets, the problem could be more accurately
termed the irresponsibility of the U.S. government in
relation to the market valuation of its currency in
international circulation.
Today the net debt owed by the United States to the
outside world (the so-called "international investment
position") is in the region of US$3 trillion. To
understand the scale of this figure, let me remind you
that it exceeds the total official currency reserves in
all the world's countries (including the United States
itself). According to the International Monetary Fund
statistics at last year-end, the world pool of foreign
currency reserves totalled Special Drawing Rights
2,013 billion or about US$2,800 billion. The volume
of cash only ("greenback" banknotes) available outside
the United States totals about US$400 billion.
The world has come to a paradoxical situation in which
the creditor countries are more concerned with the fate
of the dollar than the U.S. authorities themselves are.
Thus, the evolution of the U.S. dollar's reserve role in
recent years has given ground to some quite pessimistic
forecasts, based on rational economic theory. No wonder
that the number of people who have held assets in dollars
and now wish to diversify them partly into gold -- the
traditional shelter from inflation and political adversity
-- is steadily growing.
The statistical correlation between the market prices of
dollar and gold is obvious. For the problem we discuss
today it means specifically that gold, in addition to its
unique physical and chemical properties used in
industry, has retained its particular monetary
attractiveness for cautious financial investors, and its
market price is still heavily influenced by the state of
the international monetary system.
This dualism in gold price formation distinguishes it
from other commodities and makes the movements in the
price sometimes so enigmatic that market analysts
need to invent fantastic intrigues to explain price
dynamics. Many have heard of the group of economists
who came together in the society known as the Gold
Anti-Trust Action Committee and started a number of
lawsuits against the U.S. government, accusing it of
organising an anti-gold conspiracy. They believe that
with the assistance of a number of major financial
institutions (they mention in particular the Bank for
International Settlements, J.P. Morgan Chase,
Citigroup, Deutsche Bank, and others), some senior
officials have been manipulating the market since
1994. As a result, the price dropped below US$300 an
ounce at a time when it should, if it had kept pace with
inflation, reached US$740-760.
I prefer not to comment on this information but dare
assume that the specific facts included in the lawsuits
might have given ground to suspicion that the real
forces acting on the gold market are far from those of
classic textbooks that explain to students how prices
are born in a free market.
So even those who stick to traditional economic
theory in analysing and projecting gold market
developments should admit that various factors that
influence gold price interact between themselves in a
constantly changing manner, sometimes in a very odd
way. Here, as in nuclear physics, some factors briefly
disappear or cease to act, and in their place comes a
new dominant market factor. This causes confusion for
the forecasters in their efforts to build a logically
balanced model for the metal price movements.
So I do not even dare shed light on the methodology
of gold price forecasting, but would like to risk outlining
basic factors, which are permanently (and I stress
"permanently") acting on the market. There are four of
them -- two relating to the raw material properties of
gold and two to its monetary qualities.
As an economist educated in the Marxist school, I
believe that the base for gold prices is rooted in the
sphere of the real economy. Like any mineral raw
material, mined gold has its intrinsic value. This value
fluctuates quite significantly depending on the location,
time, and technology of extraction. The market averages
out the individual expenses, optimising them at a level
that is acceptable to the industry that uses the metal
in its production. The absolute values in monetary
terms for this factor fluctuate, although they are the
least mobile element of the price.
The production cost category has its own "floor and
ceiling." The technological particularities of gold
extraction determine the minimum price level at which
production is economically feasible in the industry
as a whole. We think that the worldwide level is currently
about US$200 per ounce. This is the minimum price limit.
With lower prices the industry will plunge into a zone of
catastrophe. So the average costs of gold production in
volumes sufficient to satisfy expected market demand
(over the past 15 years this has averaged 2,500 tonnes
with the upward trend) are the first factor.
The second factor is the real volumes of demand
generated by the consuming industries for physical gold.
The behaviour of industrialists (jewellery is playing the
most important role) is mainly caused by factors
connected with an economic activity cycle. During the
1990s there was a significant but uneven rise of demand
for jewellery: from 2,200 tonnes in 1990 to 3,200 tonnes
by the end of the decade, with a peak of 3,350 tonnes in
1997. The first three years of the new millennium saw a
decline of demand from jewellers; the volume of metal
purchased by the industry dropped down to 2,550 tonnes
in 2003. The fundamental correlation between gold prices
and the volume of demand from industry is normally linear
in character. This correlation cannot be the sole cause
behind the dramatic falls in prices, but can show a vector
for price movement, which can be enhanced or indeed
maximised through the efforts of speculators.
However, even when speculative activity is relatively quiet
this vector is not always clear. There are "anti-phases" in
economic activity in various parts of the world, and on top
of these, various national traditions in demand for the
metal.
A recent example of this occurred at the turn of the
century. After prices reached a 20-year low of US$252 in
May 1999, demand for physical metal increased and
pushed the price temporarily to a new "equilibrium level"
of US$300 by the end of the year. The concept of
"equilibrium" reflects the situation on the market when
its participants believe that they are aware of a balance
between supply and demand. It brings a measure of
price stability to the market.
Such a situation appeared to take place following the
central banks' Washington Agreement on Gold.
However, as soon as demand started to shrink again
and a danger of excess supply arose, prices went
down. This was the beginning of a two-year market
stagnation, with the price waving within a range of
US$270-290. It was not sufficient for the metal
producers, but they were unable to control the
situation. It was investors who made the weather on
the market.
Now the time has come to admit that investment
demand was, and still is, the main driving force behind
price fluctuations on the gold market. The changing
character of demand heavily depends on what is going
on in the international foreign currency and financial
markets.
The investors pay continuous attention firstly to the
dollar rate of exchange and secondly to the level of
interest rates for financial assets. The volatility of
these indicators directly influences investor interest
in gold. Since this interest is realised not through
operations with physical metal but through deals with
gold derivatives on stock-exchange and
non-stock-exchange markets (where gold ismentioned
only as a base asset), the volume of these deals can
exceed the volume of trade in physical metal dozens
of times. Last year turnover with gold derivatives was
about 4,000 million ounces (or 129,000 tonnes), but
physical metal actually sold totalled 120 million
ounces or some 3,860 tonnes. As it is said: Feel the
difference!
It is true that the markets for derivatives linked to
other raw materials also usually exceed the operations
with base assets. The difference in volumes are
incomparably less (five to 10 times). At the same time
the markets for derivatives with foreign currencies and
prime securities as base assets are developing every bit
as rapidly as the gold derivatives.
What can we infer from that?
One conclusion, at least, is clear: Gold is predominantly
a financial asset, not merely a precious metal.
In this capacity gold is competing with other financial
assets on a variety of parameters. Being inferior in
terms of returns, it is far more reliable than anything
else for protection against war-related, political,
financial, economic, and credit risks, and also provides
a high level of liquidity and lower management costs.
However, since the rate of return is the main measure
of success for financial institutions under normal
conditions, investment-related decisions depend
directly on the stability of the international monetary
system, strength (or weakness) of the dollar, and the
level of interest rates on financial markets.
This dependence is not linear in nature. Correlation
factors change from time to time because decisions
are taken by investors individually on the basis of their
market expectations. As a result, investors' reaction
may race ahead or lag behind developments on the
forex and financial markets. If we examine gold price
movements over the last 10-12 years, it becomes
clear that during the first half of the 1990s the
dominant factor was the weak dollar and the market
was still living in hope of a recurrence of the 1980s
"gold fever."
From 1997 onward, as the dollar strengthened, these
hopes were dispelled, investors turned around, and price
fell to the level of support on the physical market. It
seems to us that the depth and duration of this
depressed phase of gold prices were to a considerable
extent caused by the wide use of gold derivatives by
investors. Insofar as these instruments are intended for
protecting banks and their customers against unwanted
and unexpected changes in price dynamics, they can
provoke massive closing of the existing position at a
specific moment. This process may take the form of a
chain reaction. As a result, the price falls below the
level dictated by the sensible interests of investors.
I would also like to note that recently the central banks
have been playing a significant role in the gold market.
Low interest rates in the money markets and revaluation
of gold reserves in line with lower market prices have
exacerbated the problem of the financial efficiency of
gold stock management. To earn some income on the
stock and compensate for "book losses" caused by its
revaluation, a number of central banks have started to
place a part of their reserves into deposits with
commercial institutions -- leasing operations.
Data available to me suggest that these banks deposited
about 1,000 tonnes in 1991, and 10 years later the
volume of the deposits reached 4,800 tonnes. Naturally,
the central banks' activity increased market liquidity and
thus also put downward pressure on the gold price. The
influence of these operations, however, must not be
exaggerated. It is even incomparable with the pressure
that was exerted on the market of gold derivatives.
The same conclusion can be made about the central
banks' sale of some of their gold reserves. All market
participants have been paying particular attention to
these operations since September 1999, when 15
European central banks agreed in Washington on the
orderly sale of 2,000 tonnes of gold from their official
reserves over the next five years.
One month ago the agreement was extended for a
further five years (to September 2009), setting the total
sale limit at 2,500 tonnes or 500 tonnes per year. One
may wonder if these agreements and sales indirectly
indicate that these countries have embarked on a
long-term gold demonetisation programme and if their
statement that "gold will remain an important element
of global monetary reserves" is nothing but a sort of
soothing therapy for the market. Such opinions exist,
although they do not prevail.
I think that the agreements do not give ground for this
view.
First, the participating countries own between them
12,300 tonnes of gold. The share of the metal in their
official monetary reserves has reached 36 percent.
This is significantly higher than the average for all the
world's countries (10-12 percent). So the sales can
be seen as optimisation of the reserves structure.
Secondly, the countries making the sales (France,
Germany, and some others) are currently enduring
budget deficits exceeding the limits laid down by the
Maastricht Treaty. Hence, this may explain the
temptation to solve their budgetary problems without
reducing expenditure or raising taxes.
The current decisions by the monetary authorities in
European countries could therefore be considered
sensible, like the actions of certain Asiatic states that
in recent years increased the gold portion within their
monetary reserves. The internal imperfections of the
international monetary system (which I spoke about
earlier) have already led to a number of regional
financial crises and still carry the danger of larger
upheavals. Under these conditions, the growing
interest of investors in real assets, gold in particular,
is more than justified.
And on that optimistic note, I would like to end my
presentation.
----------------------------------------------------
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