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Wednesday, Feb 25, 2004

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Will Asian central banks buy gold?

G. Chandrashekhar

Mumbai, Feb. 24

GOLD producers are incurable optimists. They constantly look for opportunities to expand the demand base. Believers in gold have always been positive about prices and are willing to project a favourable outlook based even on seemingly innocuous statements of policy makers.

No wonder, the Japanese Finance Minister's statement last month about the ongoing discussions relating to positioning of gold in foreign reserves has evoked interest in the market. He was answering a question whether Tokyo would bring its gold reserves more in line with other nations.

India, whose ravenous appetite for gold is well known, has accumulated foreign exchange reserves in excess of $100 billion so far and it is growing roughly at $4 billion a month. However, India's gold holding is rather modest at 357 tonnes.

It is no secret that large Asian central banks have a low proportion of gold as part of their total reserves as compared to European central banks and the US. However, Japan with 765 tonnes and China with 600 tonnes are amongst the top 10 largest gold holders already; and indeed, hold a similar quantum of gold as the ECB (767 tonnes). The difference is of course in gold's share of the total reserves. So, the question that arises is: will Asian central banks buy gold?

A decade of large-scale and widespread gold sales by central banks has generated scepticisms about central banks reversing the trend and actually buying gold.

According to Mr Kamal Naqvi, precious metals analyst with Barclays Capital, low yield, low liquidity, tough exit route and difficulties in building reserves would all have a bearing on the issue. It can be argued that yields on US dollar assets have fallen markedly and hence the opportunity cost of holding gold has significantly reduced. However, gold is not only an extremely low yielding asset but there is also limited lending potential— only around 4,000 tonnes of the total official sector holding of 30,000 tonnes is being lent. The lending market, at present at least, is driven by borrowing demand and this has fallen significantly due to reduced producer forward selling, minimal speculative short selling and depressed physical demand, Mr Naqvi reasoned.

Low liquidity in the gold market vis--vis the foreign exchange market is another reason. Average daily turnover in gold of about $7.3 billion is minuscule as compared with average daily global turnover of $1,200 billion in foreign exchange markets. Also, the difficulties in exiting large physical positions in gold are evidenced by the very existence of the agreement among European central banks on sale of gold in order to reduce their holdings. This itself may discourage other central banks from increasing their gold reserves significantly, the expert pointed out adding that it would be impossible for buying banks to build further reserves without a major price reaction.

``For example, if Japan wanted to match the proportion of gold in its reserves as the ECB (initially) then 15 per cent would equate to a requirement to purchase nearly 6,800 tonnes. Given that this represents 2.6 years' of mine output, such a purchase scheme is virtually impossible to transact in anything other than a massive off-market transaction,'' Mr Naqvi remarked.

But gold market lives on hope. Few would have believed prior to September1999 that European central banks would come together to agree to conduct and contain gold sales as a group— but it happened and fundamentally altered the market.

According to the analyst, if any of the major Asian countries had intention to meaningfully raise their percentage of gold as a proportion of their total reserves, then the next few months are realistically their only opportunity to do so. Before any new European gold sales agreement begins (it is up for renewal in September 2004), it is conceivable that an approach could be made to Europe from one or more Asian central banks to purchase several thousand tonnes of gold in a major `off-market' or `staged' transaction.

Indeed, there may be a number of European central banks willing to offer discount on current spot price so that their excess stocks could be liquidated quickly. While what Japan does remains to be seen, India is most unlikely to increase its gold reserves, it is widely believed. In India's reserves, the share of gold is less than 5 per cent, which is in line with many of the Asian economies and others like Australia and Russia. So far, there has not been any indication that the country wants to raise its gold reserves.

As for management of gold reserves, in its latest Report on Currency and Finance, the Reserve Bank of India (RBI) reiterates the importance of gold held by the bank.

The RBI has a modest gold holding of 357 tonnes of which 65 tonnes or 18.2 per cent are held abroad. The yellow metal provides ample cushion to the reserves of the country as was demonstrated in the critical periods of the foreign exchange crisis in 1991.

However, there is nothing at present to suggest that the RBI would even remotely consider going in for adding to its gold reserves, notwithstanding the burgeoning forex kitty.

More Stories on : Gold & Silver | RBI & Other Central Banks

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