Gold's Future Role in the Monetary System

• The opening statement of the signatories to the Washington Agreement stated, "Gold will remain an important element of global monetary reserves".
• The second, equally specific and clear on future intentions was that the signatories, "would not enter the market as sellers, except with the exception of already decided sales". This certainly seems to us, as not a simple reduction of sales but indicative of a decision to sell no more, with the exception of sales already decided upon. It would therefore be reasonable to assume that this was a termination of decisions to sell over and above sales already agreed. The emphasis being on the termination factor! As if to clarify this, we noted that Italy, France and Germany enlarged their Reserves by between 400 and 500 tonnes, each, in 1998 just prior to the Agreement, albeit by way of returning swaps to their vaults.
• Thus the W. Agreement laid the foundation for an Orderly Market Restructuring.
• Consequently, gold has to rise to realistic price levels for it to have a 'credible' role in the Monetary System.
• In view of the history of gold no rigid, formal role will be defined for gold - but it would function in a pragmatic support role to the Monetary system world-wide. [Our next article in this series will demonstrate the practical application of this]

What has been the impact of the Washington Agreement?

This is best seen as a reaffirmation of gold's continuing monetary role and a halting of the attack in actions and posture on gold. Such a move had to precede gold's re-acceptance. The structure of the gold market in 1999, simply would not have borne the pressures bought to bear on it, had the change been made silently.

Just as a massive oil tanker turns in the ocean, the forces brought to bear on these structures, geared as they were to only a falling gold price, were such that a turn in the direction, would have taken massive distance and time. Just as were it to turn on the spot, a tanker would break up, so too the structure of the Gold Market.

Had sales been halted in September 1999 - suddenly -the price would not have stopped at $330. It would have just not stopped. The derivatives market, focussed on a persistently falling gold price, would have collapsed in a horrendous pile of major bank - gold producer - and derivative market bankruptcies.

The short covering needed - simply would not have been possible. The gold producers would have been caught with their pants down on their hedge positions, requiring Bullion banks to become producers, if they survived. Central Banks would have had the unthinkable on their books, bad debts and the need to write off reserves.

Orderly Market restructuring

So it was vital that an orderly restructuring of the market take place, to enable a rising price to be accommodated. Amongst the necessary adjustments to be made were, the Bullion Banks and the Producers needed to have time to unwind their hedge positions, actions that have accounted for well over 365 tonnes of gold purchases by producers, or deliveries of gold into hedges - thus directing that gold away from the Gold Market - by the end of June 2002. This unwinding of hedge positions may well account for 500 tonnes of gold in total this year.

Please note that it has been these same Gold Producers who have been responsible for accelerated sales of gold for two decades, this year alone.

Counter Party risks in the derivatives markets needs time for realigning and reduction of their positions. The re-positioning of this market has been adjusting steadily too. After nearly a decade as "short" position speculators. Speculators are long to neutral.

We sincerely hope that the mines Put-Option positions of 2,480 tonnes will be realisable. This will then keep them in a healthy state.

Once the supply of gold from the reserves of the Central Banks cease - the market structures will be able to bear a rising price. Once the price of gold is rising, the value of the gold reserves rises - without a word, from the monetary authorities.

It is a small technical step to revalue the price of gold reserves to market price, as should - and we believe will - be done by the IMF.

Gold's 'Reserve Asset' role although still silent and seemingly in the shadows - will then - be fully recognised as an effective one. Now that this has happened, any rise in the gold price will not be seen as a threat to currencies, but an enhancement to all currencies with gold in the vaults.

The Rise in the Gold price

No credible, even silent role, for gold can be effective, except at a much higher price level than at present. Current price levels are so low that new exploration and production are falling off, so clearly, that the supply of gold is dropping dramatically from its 70, 000, 000 ounces per annum level. This drop in supply alone is enough to guarantee a rising price.

No one can say the production will fall off because of the low gold price as the very nature of demand supply will push the price up. The question remaining will be how long before the rising price impacts on production levels?

How high will the price rise? Good question? We would agree that there will be a time when the Dow Jones and the Gold price will be the same level. Depending on whether Deflation or Inflation dominates - so the price level will be determined. There is no doubt that the deflationary forces have been underestimated and the politicians will do all in there power to ameliorate the impact of deflation through monetary expansion. However, please remember that it was the horrendous shortage of cash that precipitated the worst excesses of hyperinflation in the Weimar Republic. The ride to that point cannot be determined yet, so we would rather wait until the direction we are headed in defines itself more certainly.

No Formal Role for Gold

The concept of a formal role for gold, such as a partial or full 'Gold Standard' is out of the question and will not be resurrected. Were this to happen the spectre of gold, as a judge would be raised again, a prospect few of the World's governments would be happy to see, or their currencies able to bear. No, they will not allow the profligacy of fiat money, which has been seen in the last thirty years, to be highlighted willingly. Gold will have to fit in with the goals of the main protagonists. With the prospect of a $50 + Oil price possible in a war torn Middle East, we believe these goals are to see the gold price rise in silent support of currencies.

Is this necessary, you may ask? The prospects, that lie immediately ahead are being described dramatically. 9'11 showed clearly just how low the optimism tolerance levels in the States really are. Since then, with efforts going full blast, to promote further U.S. growth, producing little or no impact, the potential collapse of the equity market and the Dollar are being touted. The silence on whether the strong Dollar policy has been changed or not is speaking volumes and a possible fall of up to 40% in the Dollar from its peak is being extrapolated. The prospect of a Depression and or rampant Inflation or a combination of both, is real again. Whether this happens or not, does not detract from the prudence of allowing an environment in which a higher gold price will persist.

With the Dollar playing such a consuming role in the World's reserves, the prospective weakness of the currency will have such a detrimental effect on world monetary reserves that there is a great need to prepare for difficult days, days when gold serves in its role of wealth preservation, again. The near future could be a time when not only the Dollar but also other fiat money will need all the support it can get.

With so much of the world's monetary reserves not simply in the Dollar, but under the control of the US Authorities, a widening of the available choices of effective reserves is an urgent matter. We note that the recent purchase by China of 105 tonnes took its holdings over 500 tonnes in total.

The contemplated military onslaught against ostensibly Iraq - but seen by many Islamic countries as an attack on Islam highlights the certainty gold can and will provide currencies - in uncertain times.

Conclusions

Politicians do not get kudos paid for solving problems - only crises.

The time for the formal adoption of gold in any role, is not right - nor do we see it in the near future. We believe the lessons of history will not be ignored [We will highlight these in the final part of this series].

As to timing, crises in great proportions are looming in the very near future. Gold will slip unobtrusively back into a key position in support of fiat money. Just as there is no formal monetary system at present, gold will have no future formal role. Its re-integration will be seamless.

Effective use of Gold in the Monetary System have already been demonstrated by India, who settled debt with gold in the recent past and in the case of Brazil and Mexico who sold gold to the I. M. F. Despite the protestation that this sale was an exceptional "one-off" process, it was a successful example of an 'Official' gold transaction in a monetary role and as they re-occur in the future gold's monetary role will be reconfirmed!.

No doubt should the need arise further "exceptions" will be made to establish this aspect of gold's role in the system. In times of stress we have no doubt that the market price valuation of gold in the I.M. F. will cease to be an obstacle as contemporary and growing global stress assert themselves.

The open market - gold's unofficial role - having developed extensively in the last twenty plus years, has more than sufficient instruments - both from history, such as the Rente Giscard and Rente Pinot, the old gold price related bonds and those now existing in the Derivatives market - to satisfy the non-official markets. These are already tried and tested and part of life. There is no reason why the two markets [official and open markets] should now clash as they did before.

Should our assessment of the Central Banks attitude to gold be correct, the cessation of Official Gold sales by the signatories of the Washington Agreement, the U.S. and the I. M. F. will be confirmed, when it comes up for review in 2004 - provided stability reigns in the various gold markets.

Hence, Gold's role will be a pragmatic one suited to the needs of the day. But, for sure, the Washington Agreement has confirmed a continuing role for gold and at a far higher price. Hindsight, however, in the forthcoming turbulence, will define the complete details of gold's future role.