BIS 70th Annual Report
24 August 2000
V. Foreign exchange market developments
Developments in the gold market
"...The period under review was an eventful one for the gold market. In the first three quarters of 1999, the price of gold trended downwards from about $291 per ounce in January to a low of $254 in late August (Graph V.9). The remainder of the period was characterised by two major events. The first occurred in the two weeks after the joint central bank statement of 26 September 1999, when the gold price rose by about a quarter. In the following weeks, the gold price surrendered part of its gains in a very volatile market. The second took place on 7 February 2000, when it leaped by about $20 per ounce within a few hours of the decision of a major gold mine to alter its hedging strategies. This change was, however, reversed over the next few days.
Long-term, cyclical and more technical factors weighed on the gold price during the period under review. The global lowering of inflation expectations had reduced gold’s attractiveness as a store of value and dampened its price over the preceding decade. In the last few years, the price of gold suffered in addition from the broad decline in commodity prices and depressed demand in the Asian region. The substantial fall in 1999 can also be attributed to a surge in forward sales by gold producers. In order to lock in current prices so as to gain protection against future declines, gold mines stepped up their hedging sales by more than 4000/0 in the first three quarters of the year, an increase equivalent to about 100/0 of the total annual gold supply. A sharp rise in the gold lease rate in summer 1999 put pressure on banks that would normally buy gold forward from gold producers at long maturities and hedge their exposure by borrowing gold at short maturities and selling it on the spot market. In 1999, gold producers appear to have started to lock in their output prices at longer maturities (10–15 rather than 5–10 years), while banks in response were trying to lengthen the maturity of their gold borrowing beyond three to six months. Although conditions in the gold lease market eased in the autumn, hedging activity also appears to have been behind the temporary rise in volatility in October 1999 and the sharp spike in the gold price on 7 February 2000, when it jumped from $294 to $313.
The joint statement on gold, which pushed up the gold price at the end of September 1999, was issued by the central banks of the Eurosystem, the Bank of England, Sveriges Riksbank and the Swiss National Bank, which together hold about half of total official gold reserves (Table V.5). The signatories agreed to limit gold sales to a maximum of about 400 tonnes a year and to 2,000 tonnes over a five-year period. They also stated that gold would remain an important element in official reserves, that only sales that had already been decided could actually be carried out, and that the signatories would not expand their activity in the gold leasing and gold derivatives markets. The central banks’ agreement seemed to break the declining trend of the price of gold. After the announcement, the gold price rebounded from about $260 to more than $330 in early October. Overall, the gold market has seen a return to calmer conditions since then.
News about sales of official gold holdings by central banks was also viewed as a factor affecting the price of gold during the period under review. While this argument might be justified on the grounds that such sales alter the balance between the current demand for and supply of gold, these sales were relatively small compared to the size of the gold market. A sale of, say 100 tonnes is equivalent to about 40/0 of estimated world annual production and represents around 100/0 of the estimated average daily turnover in the London spot gold market. An alternative explanation for the influence of official gold sales is that, despite their relative size, they provide important signals of future intentions. Central banks are the largest single group of holders together with the IMF, with official gold reserves amounting to about 33,000 tonnes, the equivalent of 13 years’ production: hence, should the market start to anticipate future sales, this would probably affect current prices. Given the impact of the central bank agreement on the gold price, it is instructive to analyse the behaviour of the gold price around all the days on which news about official sales reached the market during the period January 1998–March 2000. While it should be stressed that this analysis focuses on news about official gold sales that reached market participants, rather than actual sales figures, it would be consistent with the signalling argument above that the former is more relevant in determining the market’s reaction and hence the gold price. News events can be classified according to whether ex ante they might have a positive or a negative impact on the gold price. Positive news includes decisions to abandon previously planned gold sales and official comments opposing gold sales. Negative news comprises reports of actual official sales or of increased prospects of future sales. Obviously, this classification is not incontrovertible. News about a previous sale that is only announced ex post might have a positive effect on the gold price, as the market would be encouraged to learn that a sale had been absorbed.
On average the gold price declined on days marked by the arrival of negative news about gold sales (Graph V.14). However, the decrease was very small (no bigger than 0.250/0) and was almost entirely reversed in the days that followed. In the case of positive news, the gold price increased on average, but again only temporarily. It should be noted that this last result appears to have been driven mainly by the central bank agreement of 26 September 1999. When this single item is excluded from the list of positive events, they are on average followed by a small decline in the gold price.
Subject to the caveats mentioned above, this analysis suggests that, over the last two years, while on some occasions news about official gold sales had a substantial impact on the gold price, its average impact was not significant. One interpretation of this apparent puzzle is that, during the period 1998– early 2000, most of this news was backward-looking. That is, it provided market participants with information about sales that had already occurred..."