Last month, the IMF announced it would be putting for sale progressively on the market some 12.97 million ounces of gold. Although gold has lost the allure it held during the reign of the Bretton Woods agreement, it still features on the balance sheet of central banks throughout the Middle East.
Gold played a vital role in the international monetary system until the collapse of the Bretton Woods structure of fixed exchange rates in 1973. Currencies started to be linked to a basket of currencies instead of gold, which reduced the importance of the precious metal as a mean of exchange.
Nonetheless, gold remains a central asset in the reserve holdings of central banks in a number of countries. The IMF is one of the largest official holders of gold in the world with 103.4 million ounces, equivalent to 3,217 metric tons of gold, that by the time this issue went to print amounted to almost $100 billion. According to analysts, the news of the IMF decision to put some of its gold for sale will certainly affect the bullion market on the shorter and longer run.
Everybody’s precious metal
Gold holdings vary significantly in the region. According to a March 2008 report by the World Gold Council, Lebanon comes first in the region’s classification of major gold holders, with 286 tons representing 39.5% of its total foreign reserves, calculated by the council using the end of January 2008 gold price of $923.25 per troy ounce, followed by Algeria with 173.6 tons, Libya with 143.8 tons, Saudi Arabia at 143 tons and Kuwait with 79 tons, closely followed by Egypt at 75 tons.
“In the eighties, the ounce of gold witnessed a rally and reached about $850, which currently equals about $2,200 if adjusted to inflation, before it plummeted to 330$ in 1985/86,” explained Lebanese economist Ghazi Wazni. “Throughout the 1970s and early 80s gold was considered a safe haven, especially when inflation showed double digit figures. To this day, gold is an asset that is not undermined by inflation,” he said.
But is this enough to account for the central banks holding on to the precious metal?
One of the many answers to this question can be found in any “Business 101” book. Diversification has always been dubbed by financiers as one of the keys to a sound financial approach. According to the World Gold Council gold may also be used to hedge risks and limit volatility in spite of its price variation.
Another factor playing in the decision to retain gold is that the price of the precious metal follows the law of supply and demand while the values of currencies and government securities are also linked to government’s economic approaches and the variations in central banks’ monetary policies. “The price of gold therefore behaves in a completely different way from the prices of currencies and exchange rates,” states the World Gold Council Report.
A dependable asset
By being able to maintain its value in terms of real purchasing power in the long run, gold tends to be particularly well suited to contribute to central bank reserves, especially in contrast with paper currencies, which depreciate over the long term.
Liquidity of gold assets is another factor that pushes some central banks into hiding it deep in their large vaults. “Nonetheless, in Lebanon, gold is considered a sterile asset. Half of our gold holdings are sitting abroad in American and Swiss vaults, which incurs an expense for the Lebanese central bank,” said economist Marwan Iskandar who believes that gold needs to be well managed and fructified to be considered an actual real asset on the central bank’s balance sheets. But Lebanese laws limit the central bank’s margin of maneuvering when it comes to gold, as any operations involving the precious metal require a parliamentary vote. “If the central bank had the freedom to properly manage its gold stock and the possibility to mortgage it out, this could translate in significant revenues of about $100 millions yearly,” added Wazni.
Often described as a non-income-earning asset, gold can, however, generate substantial profits if it is lent on the gold market. “Speculations on the price of gold have certainly affected to a large extent current prices, which are also linked to an increase in productions cost in South Africa due to the surge in fuel prices,” Wazni pointed out. The economist underlined that speculation might account for 70% of the current high price of gold.
Damaging events such as wars, an unstable regional context, an unexpected surge in inflation, or a generalized economic crisis — all of which prevail today — have certainly pushed investors toward gold as an asset class.
Regardless of market trends, the IMF’s Executive Board has recognized that its own holdings of gold give a “fundamental strength” to its balance sheet. The same might just apply to central banks.
