-- Posted Thursday, 14 June 2007 | Digg This Article
This morning we have inflation data out that is considerably higher than had been expected by economists with PPI numbers showing a 0.9% increase for May versus expectations of a 0.6% increase. This was led by gasoline prices that were over 10% higher during the month. Keep in mind that the higher PPI number today means a higher CPI number in future reporting periods as the cost increases work their way through the supply chain.
But more important for the gold market this morning is news out of the Bank of Switzerland that they will be kicking off a new gold sales program and begin selling 250 tonnes over the next two and a half years of the remaining CBGA II. Even with this inclusion of sales, announced sales still sitting out in the market by ECB member banks will fall significantly short of the total sales allotment over the next few years. As we've seen with the increases in the months past, sharp increases in sales can impact prices considerably, but over the long term, if the sales are still short of quota, the market will be dealing with less and less supply.
Announced sales over the next 28 months of the CBGA II by France, The Netherlands, Swiss, Sweden and Austria total 620 tonnes. There are 1,220 tonnes of allotted sales that can take place during that time period. We will likely see periods when more sales hit the market than in other time periods, causing temporary price weakness, but over the long haul, ECB banks will be well short of their CBGA II allotment.
Supply, or rather, lack thereof, will be the key for this market to continue heading higher as we move forward. It's always important to keep an eye on the dollar, inflation, interest rate moves, etc. but over the last five years, it has been the contraction in supply via less mine production, increased dehedging and lower central bank sales that have led to prices increasing. Let's not forget that the largest mining country is creeping closer and closer to heading offline….
Below is part of our recent supply side analysis of the market on Central Bank sales. I have the full supply side analysis if you would like to have it emailed.
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CENTRAL BANK SALES
Legacy holdings of gold in central banks, specifically the gold held in reserve by European banks, has been a major source of supply for the gold market via outright sales and loans/swaps into the market. This is the one source of supply that has been as dependable as any other sources in the market as the ECB banks banded together and signed the Washington Agreement in 1999 (now referred to as the Central Bank Gold Agreement or CBGA).
In the first five-year agreement, the ECB banks agreed to limit sales to 400 tonnes of gold annually. In the second five-year agreement, the banks upped their quota to 500 tonnes of sales. For the first time in the life of the first or second Central Bank Gold Agreement, European Central Banks failed to sell their full, allotted quota into the marketplace.
The failure to sell the 500 tonne quota, missing the mark by over 100 tonnes, or twenty percent, has started the speculators talking (present company included). Understanding the flexibility of this supply in the marketplace will, in our opinion, be the key to positioning an investment for the coming lack of supply from this source into the market in the near future.
There's been plenty of conjecture of late about ECB sales, Spain's activity in the market, and what will be happening going forward. Here's our take.
The Bank of Spain has sold 25% of its gold reserves into the market in 3 months. A best guess here is a best guess, but we think this action could portend some serious fiscal problems in the Spanish economy in the near term. Maybe some cracks in the fiat currency situation? The Spainish government has got every asset out in the yard like a garage sale right now, gold, t-bills, bonds, etc. so this is not a diversification story, it's an attempt to save the economy from breaking. If Spain's banking and housing sectors are the reasons behind the cash raise, the rest of the ECB will soon feel the effect of the fallout. On June 6th, Spain's Finance Minister stated the sale was done to move reserves into fixed instrument assets.
The ECB umbrella organization sold another 37 tonnes into the market in the last two months. These sales, unlike the Bank of Spain's sales, have not yet shown up in ECB reports. That means in three months, 170 tonnes of gold were sold into the market, the largest set of sales by ECB banks in the history of both CBGAs. The market has weathered this storm quite well.
So what about moving forward? While no one had any expectations of Spain selling 25% of their reserves into the market, we can look at what should be expected via announced sales programs.
The Bank of France announced their intentions to sell 500-600 tonnes of gold in the CBGA II. To date (Sept. 2004 to May 2007) France has sold 350 tonnes, leaving them with 150-250 tonnes to dispose of over the next 28 months.
Sweden has another 27.3 tonnes of announced sales to complete in the remainder of the CBGA II.
The Netherlands has 33 tonnes of remaining sales to complete in CBGA II.
Austria has about 60 tonnes left of sales remaining in CBGA II. (Austria sold 90 tonnes in CBGA I and announced sales of less than 90 tonnes will take place in CBGA II, to date they have sold 30 tonnes in CBGA II, so the assumption is a high side number).
Germany has announced no sales will take place in 2007 and has yet to decide about 2008.
Italy has sold no gold in the life of either agreement.
Switzerland and the UK have completed announced sales programs. The Bank of England did not sign on as a signatory to the CBGA II.
UPDATE: The Bank of Switzerland announced that they will now be selling 250 additional tonnes into the market over the next two and a half years.
So if we start with what can still be sold into the market via ECB member banks, we've got figures of 220 tonnes remaining in the 2006-2007 fiscal calendar and 500 tonnes each in the remaining two years of the CBGA II. All told, there are 1,220 tonnes of gold sales allowed under the remainder of the CBGA II. Assuming the high end of announced sales takes place the remaining CBGA II, there are 620 tonnes of sales that should be expected.
While one should never, ever assume what central banks will do, current announced sales should be 50% short of the allowed quota the next two and a half years unless other entities such as Portugal, Germany, and Italy become major sellers while Spain continues to be a major seller on the market.
There is no other segment of the supply side market that has this potential for a major correction in relation to past levels. Central bank sales have, on average in the last decade, composed between seven and sixteen percent of annual supply into the market. If the market sees anything even approaching a 50% reduction in this supply component in the next three years, demand could remain static and prices will still climb. We believe that there will be some new announced sales programs potentially showing up in the ECB market, but only after gold prices have made that climb to loftier levels than the present ca $650 per ounce level.
High prices will more than likely scare some more supply out of the central bank vaults, but that's in the future. (Looks like the future is now with the Swiss Bank announcement)
One thing has held true since the Bank of England, Bank of Australia, Bank of Canada, Bank of Switzerland and numerous others began selling off massive amounts of gold into the market, it's been a buying opportunity always followed by price increases when the sales have finished.
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