Thursday August 7, 11:02 AM Expiration Of Bullion Sales Pact Hangs Over Gold Market
By Nicholas Sinclair
Sydney, Aug. 7 (Dow Jones) - Earlier this week, Pierre Lassonde, noted gold bull and president of Newmont Mining Corp. (NEM), warmed the hearts of delegates at a mining conference in Australia when he predicted bullion would hit $450 an ounce in the next 12 months.
Lassonde argued that strengthening demand from China coupled with further weakening of the U.S. dollar would catapult gold from its current price of about $350. But Lassonde's prediction was made even bolder by his statement that the so-called Washington Agreement governing central banks' gold sales in Europe was not needed anymore, since the banks "were no longer unconditional sellers."
Whether the remark was merely a case of bravado, or if Lassonde has become truly indifferent about the accord, is undoubtedly a matter for much speculation. But he and his fellow mining executives may indeed soon have to operate in a market where central banks can once again sell as much bullion as they please. That's due to the fact that in just over a year - September 2004 to be precise - the five-year-old Washington Agreement will expire.
Essentially, the deal was designed to prop up the sagging gold price by restricting massive and disorderly sales. Thus, 15 European central banks agreed to limit aggregate gold sales to 400 metric tons a year for five years.
The signatories - which included Germany, Britain, Switzerland, France, the Netherlands, and the European Central Bank - devised an auction system to allow members to sell bullion in a measured and orderly fashion.
Now, with 13 months to go before its expiry, the Washington Agreement is increasingly on the minds of miners, analysts, and presumably, central bankers.
In fact, Deutsche Bundesbank president Ernst Welteke kicked off the speculation in March, when he said it was "open" as to whether the Washington Agreement would be renewed in September 2004.
Analysts Acknowledge Potential For Uncertainty
Nonetheless, views are mixed regarding the possible terms under which the deal may or may not be renewed. But one way or another, most experts agree the ramifications for the price of gold could easily be negative.
In a note to clients this week, Macquarie Bank (A.MCQ) updated its gold price forecasts for 2003 ($340) and 2004 ($310). Coming in below the consensus view of other analysts, and well below Lassonde's prediction, Macquarie said one of its considerations was "the uncertainty ahead of the possible renewal" of the Washington Agreement. The bank was nonetheless careful to note that it believed renewal was "probable".
Similarly, Australia's Westpac Institutional Bank says that as "we get closer to September 2004, (speculation about renewal) could help cap the market."
While Westpac doesn't expect a massive sell-off leading up to the expiry date, a commodities analyst with the bank foresees "mildly negative" implications.
Recently, economist Frederic Lasserre with SG in Paris suggested that the persisting soft economic conditions in the euro-zone economies were raising doubts about the likelihood of the accord being renewed.
"The three signatory countries with the largest gold reserves are also those whose financing requirements are the most critical in the short term," said Lasserre, in reference to Germany, France and Italy.
Based on the ratio of gold to total reserves, he has estimated that each country has about 1,500 tons of gold to sell - in other words, significantly more than can be unloaded under the current parameters of the Washington Agreement (unless they are content to sell over a long stretch of time).
One analyst who clearly thinks the Washington Agreement should disappear is the well-known and ultra-bearish Andy Smith of Mitsui Global Precious Metals.
"It's a protection racket," he said, describing the accord that the mining industry fervently lobbied for in 1999, but which he believes damages the rationale for holding gold in the first place. "If you handcuff the banks, gold ceases to be a reserve asset, and you perversely undermine the investment case for gold." He added that the day the accord was signed was the day "that gold as a reserve asset ended."
Smith agrees with SG's Lasserre that the current economic environment in Europe is liable to bolster the banks' urge to sell bullion.
"Given the fiscal pressures in Europe, you'd think anything would be done to avoid raising taxes," Smith said.
Furthermore, Smith believes Europe's monetary union is an additional factor that weakens the case for the accord.
"Back in 1999, they were central banks that issued money," he said of the individual euro-zone central banks. "Now they're only asset managers, and they must make their portfolios of assets perform," Smith argued, adding that "whenever they talk about portfolio diversification, they inevitably mean selling gold."
He further ridiculed the idea of extending the Washington Agreement:
"What sort of a hedge is gold if you can't realize a capital gain on it because you have to queue in order to sell it?"
Possible "End-Game" Scenarios
Despite his total distaste for the gold sales cap, Andy Smith, like others, isn't positively certain what will happen next September.
While he openly wonders what the upside to renewal is for the banks, Smith said they likely won't seriously discuss the accord until "the last minute."
"They certainly won't give it the thought that the gold market is," he said.
When pressed, Smith said his "guess is (the banks) will do the least strenuous thing and search for words that offend the least number of people." Perhaps prophetically, he added that the "queue (to sell gold) has not diminished since 1999, it has lengthened."
But others believe some form of structured agreement is likely to carry forward beyond September of next year. Westpac's commodities team agrees with fellow-Australian bank Macquarie that a new agreement is probable. The bank argues that letting the agreement lapse would trigger a plunge in the gold price, thus diminishing the returns Europe's central banks could realize by continuing to sell gold in smaller, gradual increments.
"I would have thought the incentive (to renew) is where the gold price is today versus where it was four years ago," said a Westpac commodities analyst. Prior to the announcement of the Washington agreement, spot gold languished between $250 and $260 an ounce in August 1999.
The analyst added that the banks would only want to accelerate their bullion sales "if they thought they could get away with it (without causing prices to collapse)."
For his part, SG's Lasserre offered two scenarios for September 2004 under which France, Germany, or Italy might force a new, looser version of the original deal.
"If one of the three countries unilaterally places 1,500 tons for sale, with a 2,000-ton limit (under the current agreement), the other two countries will be forced to wait 5 or even 10 years to review their participation in the gold sale program," Lasserre said.
"A decision by all three countries to sell their gold as of September 2004 would not reduce the time it will take for the market to absorb 4,500 tons, but would enable a fair distribution of the total volume," he said, describing the second scenario.
While the latter would mean more downside impact on prices, Lasserre said either of these "solutions" would be better than outright non-renewal of the Washington Agreement.
"(That) would imply that the candidates failed to reach agreement on the distribution of volumes and that we will once again see disorderly and, most importantly, massive gold sales."
