Central Banks Starting to Buy Gold?

By: Mark_OByrne

Gold  rose yesterday  despite continuing dollar strength and falling oil prices ( gold closed at $880.80  up $6.80 while s ilver  closed at $12.71 up 53  cents ).  Once again in  after hours trading there was determined selli ng which pushed the price as low as $862/oz in Asia  prior to rallying  in early European trade to over $870 /oz.

There  appear to be good  support  in the  $850/oz to 860/oz  region but  given the unprecedented nature of the  volatil ity in global  financial  markets anything is possible in the short term and leveraged trading is not advisable .

I nterbank  pressures remain elevated with a further rise in three month rates led by dollar Libor rising 4.15% and premiums for European bank bonds are now at record levels.   Thus, financial and  systemic risk remains elevated which will support gold. But w ith gold up significantly in the last 3 weeks it  may need to consolidate between $850 and $910 prior to rechallenging $1,000/oz in the coming weeks.

EUR and GBP gold remain very firm as the euro and British pound weaken as financial and economic woes are becoming more pronounced in the Eurozone and the UK.

Western Central Banks Curtailing Gold Sales and  Other Central Banks Buying Gold
Western central bank gold sales continue to fall while Russian and other large creditor nations such as China and OPEC nations with huge dollar denominated reserves and assets are believed to be increasing the percentage of gold that they hold in their currency reserves.

Contagion in the financial markets and U.S. dollar vulnerability are bolstering gold's reputation as the central monetary anchor within the international monetary system.

Gold sales by European central banks (the largest holders besides the Federal Reserve of gold in the world) under the Central Bank Gold Agreement (CBGA) in the year to September 26 were provisionally estimated at a record low 357.2 tonnes, the World Gold Council said on Wednesday. Sales in the final year of the pact could be lower still, the WGC added. Under the terms of the CBGA, signatories can sell up to 500 tonnes of gold per year. With the advent of the euro, European central banks began diversifying their reserves which were overweight in gold.

The gold sales were the lowest since the central bank gold agreement in 1999.

Financial market instability , concerns about the  dollar  and huge systemic risk are making gold more attractive as a reserve asset for central banks .

Governments and central bankers who sell their gold are likely to be asked very hard questions in the coming years. Already Gordon Brown's decision to sell much of the UK's gold in 1999 at near record low prices has been criticised. Some have even suggested that the sales have weakened the UK's monetary position and increase risks to the vulnerable pound.

The German Bundesbank and the Swiss National Bank confirm ed this week  that they will not be selling any more of their gold reserves. The SNB said it doesn't plan a further reduction of its gold reserves, which now stand at 1040 metric tons.

Recently, the Bundesbank reaffirmed its belief in the importance of retaining significant holdings of gold bullion in their monetary reserves. The Bundesbank has said that financial and political uncertainty make the gold reserves even more important than before. The Bundesbank is the world's second-largest holder of gold after the US Federal Reserve, and has sold just 20 tonnes out of total reserves of over 3,000 tonnes in the past five years.

"National gold reserves have a confidence and stability-building function for the single currency in a monetary union," the Bundesbank said.

China is the elephant in the room and it holds the world's largest foreign reserves, worth 1.81 trillion U.S. dollars followed by Japan and Russia with 996.7 billion U.S. dollars and 581.6 billion U.S. dollars, respectively. India is fourth with 295.3 billion U.S. dollars.

China only has some 1% of it's reserves in gold whereas Germany's Bundesbank , the world's second-largest official holder of gold with 3417.4 tons, has 66.3% of its reserves in gold.

Even a small increase in central bank diversification into gold is likely to see markedly higher prices in the coming years.

By Mark O'Byrne, Executive Director

Gold and Silver Investments Ltd. have been awarded the MoneyMate and Investor Magazine Financial Analyst of 2006.

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