Financial markets have a nasty habit of proving eminently
logical decisions utterly wrong.
Take the 1999 decision by Gordon Brown, the British Finance
minister at the time, to sell more than half his
governments gold reserves. The right of currency holders
to turn paper into gold at central banks had long since ceased
ending golds special position as a form of reserve
currency and removing an essential reason for governments to
keep it. All things considered, Lenins famous suggestion
that all gold should be melted down to build public lavatories
seemed a tad less absurd than before.
In the late 90s many financial experts agreed that
because governments no longer had a technical reason to hold
gold, it seemed best for them to sell it before its real value
fell even further. Responding to this new view, Brown asked the
Bank of England to off-load 395 tons of it from the
governments vaults, and the central bank won plaudits for
selling slowly to prevent sharp price drops.
But shortly after the bank had finished, the commodity
entered a nine-year bull market. Gold reached a record nominal
high above $1,900 an ounce in early September before dropping
to $1,600 an ounce later in the month. The U.K. achieved an
average sale price of merely $275 from 1999 to 2002. Had it
waited until late last month, the U.K. would have made about
$21 billion six times the $3.5 billion it earned by
selling when it did.
China and India have recently followed the opposite course
to Browns by aggressively building reserves. The Reserve
Bank of India bought 200 tons of gold from the IMF in 2009. The
Peoples Bank of China has increased stocks to more than
1,000 tons since 2003. Both countries have made a notional
profit, as the price has kept climbing. When India bought from
the IMF, the price was still only about $1,045 allowing
India to earn an extremely high return. Gold now
accounts for 8.5 percent of Indias foreign currency
reserves and as high as 88 percent of the reserves of Western
governments that did not sell as aggressively as the U.K. under
Should governments take the bet of buying gold even now,
after such sharp price rises in recent years, in the
expectation that it will resume its upward trajectory? Olivier
Accominotti, a gold expert at the London School of Economics,
says the gold market finds particular strength when interest
rates are low, because this reduces the cost of holding a
commodity that does not earn interest.
Central banks will need to ramp up borrowing costs when
strong economic growth returns especially if global
commodity prices continue to ascend, keeping inflation above
central banks targets.