The Gold Companion

by Timothy Green

Investment in gold covers a broad spectrum from the purchase of a single gold coin by an individual to portfolio holdings by a government investment institution which may amount to 100 tons or more. Investment attitudes to gold also vary considerably from region to region: in Asia it may be physically hoarded, in Europe simply held on metal account or as part of a portfolio in a private bank. But of one thing there can be no doubt: since gold’s last official link with the dollar and the concept of a fixed price was broken in 1971, it is investment demand which has provided the catalyst, the driving force to propel the gold price to new heights. The more conventional underlying physical demand for jewelry and industry provides at best a floor to the price; the appetite of investors propels it up. And its appeal to them has been enhanced because, for the first time in its history, the price of gold is mobile, no longer fixed. So one can, in theory, invest in gold as a way of making money, and not just, as was the traditional case, as a hedge or insurance against losing it.

The decade of the 1970s, beset by oil shocks, inflation and a weak dollar, seemed to show investors how gold could perform; the compound annual rate of return on gold in the ten years to 1980 was 31.6 per cent, compared with 7.5 percent for stocks and 6.4 percent for bonds. Only the performance of Saudi Arabian light oil matched gold.

The 1980s told a different story; gold was $850 an ounce in January 1980 and just less than half that a decade later.

Investment gold in the last decade of the twentieth century is, consequently, different. First, the concept of physical gold coin or bars held or hoarded by an older generation of Europeans, notably in France and Germany, has disappeared. The political and economic uncertainty of two world wars that made them hold gold has gone. The collapse of the Berlin wall in 1989 signaled that clearly. Second, the classic portfolio advice of private Swiss banks that up to 10 percent of a portfolio should be invested in physical gold has given way to a more flexible policy of zero to 15 per cent depending on price expectations. Gold funds in Europe and North America also largely hold gold shares rather than metal; indeed, the expansion of the gold mining industry in the 1980’s gave investors a fresh opportunity for getting to ‘gold’ by simply buying the shares, diverting away much money that might have gone into the metal a decade earlier. Gold bonds and warrants were also variations of options on gold.

The shift in gold investment has been towards Asia, where a degree of uncertainty still prevails in may societies, coupled with new prosperity and, frequently, not many alternatives to gold for investment. For that reason, Asia has taken up gold investment where Europe left off. Hong Kong, Indonesia, Taiwan and Thailand have plenty of investors. So does Japan, where the concept of financial technology, ‘zaiteku’, implied that the Japanese would be as diligent in managing their savings as they had been in making electronic equipment; ‘zaiteku’ could include gold. The Japanese bought rather more than 1,000 tons of physical gold for investment during the 1980s, plus considerable undeclared holdings loco London, Japanese fire and marine insurance companies have also been permitted to put up to 3 percent of their portfolios in gold since 1989, on the grounds that if Japan were struck by a major earthquake, it might so damage the local industries in which they were heavily invested that gold would be a useful insurance asset for such a crises; the classic reason, of course, for buying gold.

The traditional investment attitudes to gold persist, therefore, in Asia, buy much less in Europe and north America. There the investor who is interested in gold has become much more a short term speculator, trading in and out of the gold market on metal account or using futures and options which offer a foothold in gold without actually having to take delivery. That is the key to the investors’ approach; they still like the idea of benefiting from a price rise, but they no longer need to have the metal at home under the bed.

The monetary system with a fixed price for gold, and with gold coin either forming the whole circulation of currency within a country or with notes representing and redeemable in gold, has always been known as ‘the gold standard’. Internationally, completely free import and export of gold was included with all balance-of-payments deficits settled in the metal. The gold standard was supposed to discipline an economy. Gold flowed out of a country in deficit, leaving less for internal circulation, thus controlling prices and making exports more competitive. Equally, a country in surplus imported gold and its economy expanded.

Britain went on to an unofficial gold standard in 1717 when Sir Issac Newton, the Master of the Mint, established a fixed price of E3.17.10 ½ d per standard (22 carat) troy ounce, equal to E4.4.11 1/2d per fine ounce. Although silver, which had previously formed the major circulation in the country, was not officially demonetized, it circulated little after that. Britain adopted a formal gold standard in 1821 at the end of the Napoleonic wars, after the introduction of the Sovereign as the main circulating coin. The rest of Europe, however, remained on a silver standard until the 1870s, when the great flows of old available from the United States and Australian discoveries made it practical for it to be adopted as the main metal circulating. Germany switched to gold in 1871, Scandinavia in 1874, the Netherlands in 1875, France and Spain in 1876 and Russia in 1893. The United States remained on a bimetallic system of gold and silver until 1900 when the Gold Standard Act confirmed the supremacy of gold. Eventually, 59 countries were on the gold standard, with China on silver as the only main exception. Its heyday was short. At the onset of World-War I in 1914, most countries suspended gold payments, preferring to husband their reserves for essential war needs. Many never returned. Britain went off the gold standard in 1919. Although attempts were made to revive the gold standard during the 1920s, gold coin circulation was limited and many central banks began to keep part of their reserves in key currencies, such as sterling or dollars, which they could still exchange for gold. Thus the gold exchange standard was born.

Britain itself went on the gold bullion standard in 1926, which had a fixed gold price (still £4.4.11 1/2d per troy ounce, as in 1717) but notes were not convertible into gold coin and could be exchanged only for 400-ounce good delivery bars. Britain went off this standard in 1931 and most European countries followed suit in the early 1930s. The United States went off gold in March 1933, when private holding and export were forbidden. Only the export of gold recognized central banks and governments was permitted. This created the dollar-gold exchange standard under which dollars could be traded for gold at the Federal Reserve. This system was confirmed by the Bretton Woods Agreement in 1944 and lasted until 1971.

The Bank for International Settlements (BIS) was created in 1930 as a non-political central bank for central banks based in Basel, Switzerland. As a major pillar of the monetary structure of the western world, it has been widely used by central banks to buy and sell gold discreetly on their behalf or to act as intermediary in transfers of gold between themselves. Central banks can also swap gold with the BIS for foreign exchange.
The California gold rush began after the discovery of gold in the tailrace of John Sutter’s mill near the junction of the American and Sacramento Rivers in January 1848. Prospectors quickly tracked the gold back to other streams coming down from the High Sierras, identifying a belt of gold-bearing rock over 100 miles long and up to two miles wide.

The ensuing gold rush, as over 100,000 diggers made their way from all over the world to California, proved a great stimulant in the opening up of the American West. Although output peaked at 93 tons in 1853, when the most accessible alluvial deposits had been worked out, even today several thousand prospectors scour the American and Sacramento Rivers each year, finding small amounts of gold dust and small nuggets.

As a legacy of the gold standard and the gold exchange standard central banks hold over 29,000 tons of gold on their own account, while another 6,000, tons is deposited with official institutions such as the IMF and the European Monetary Co-operation Fund. Not only is this close to one-third of all gold ever mined, but it accounts for between 35 and 50 percent of all monetary reserves, depending on the current price (see graph). Thus gold remains an essential cornerstone of the international liquidity and the action of central banks can be pivotal to the gold market.
However, after 1971 when central banks were no longer able to exchange dollars for gold at the Federal Reserve Bank of New York, their holdings have largely been immobilized. Central banks also ceased to be significant buyer of newly mined gold after the mid-1960s. Between 1948 and 1964 central banks acquired 43.7 per cent of all gold coming on the market, increasing their stocks by 7,897 tons; from 1965-1990 they were net sellers of just over 2,000 tons. The major part of this selling came from the US Treasury and the IMF through auctions in the late 1970s, but other central banks, notably in Canada and Belgium, were also sellers. Central banks, therefore, are not the main clients of the mining industry, as they were in the nineteenth and early twentieth centuries.

The Balance of central bank holdings is also uneven in relation to their other reserves. Over 80 percent of official gold holdings is in the hands of the major industrial nations; but the proportion varies. The United States has over 8,000 tons and Germany nearly 3,000 (excluding its tranche with the EMCF), but Japan has only 754 tons. In the United States gold accounts for over 70 percent of reserves; in France, Italy and Switzerland for over 50 percent; but in Spain and the United Kingdom for less than 20 percent.

Despite some buying by OPEC countries in the early 1980s, and later by Taiwan, little of the reserves of newly rich nations has been switched into gold. Existing stocks are also largely frozen, except in isolated instances such as the central bank in Spain taking up part of the gold when Belgium disposed of 10 percent of its reserves. Unless off-the-market interbank transactions can be arranged, the holdings of such countries as France or German are too large to be disposed of through the market place without undermining the price.

No concerted central bank activity has taken place in the gold market since the gold pool in the 1960s. But a number of individual central banks remain regular participants for a variety of reasons. Central banks in some gold producing nations market local production. In South Africa the mining companies must sell their output to the South African Reserve Bank, which markets the gold mainly through banks and bullion dealers in London, Zurich, Frankfurt, New York and Tokyo. The Reserve Bank increasingly uses the forward and options markets for hedging, and will, on occasion, buy back to support the price. Brazil’s central bank is also active as a channel for local production, as are central banks in Colombia, Ecuador, Venezuela, the Philippines and Zimbabwe. The Bank of England is also a regular participant, both on its own account and on behalf of other central banks. A few central banks are also traders, or lease gold to the market for a modest interest (0.5-3 percent, sometimes paid in gold).

This still accounts for a small part of central bank holdings, which in general are not managed as actively as currency reserves, despite the increasing attention of a younger generation of central bank governors who would like to see gold bring a better return.

The use of gold as collateral for foreign exchange loans was pioneered between Italy and Germany in 1974 to tide the former over a massive balance of payments deficit. That collateralization was between their respective central banks, but this practice has evolved into more complex swap operations between a central bank and one or more commercial banks. Such deals are particularly useful in a short term foreign exchange crises, where the sudden outright sale of the metal might undermine the price. It also enables producer countries, such as South Africa, to hold gold off the market when the price is weak. While terms vary from deal to deal, on most straightforward collateralization the central bank would receive close to 100 per cent of the market price of the gold when the arrangement was made, and would be liable for margin calls if the price fell.
International association based in Washington DC that includes miners, refiners, bullion suppliers, manufacturers of gold products and wholesalers of gold investment products. It was founded in 1976 and has nearly a hundred members from North America, Europe, Japan and Australia. Its aim is to promote the common business interests of the gold industry as a whole by providing members with current statistical data and other relevant information, while alerting them to potential changes in the operating climate for the industry. The institute also provides information on gold to the media and public and acts as an industry spokesman.
The gold pool was an alliance between the central banks of Britain, Belgium, France, Italy, the Netherlands, Switzerland, the United States and West Germany from 1961 to 1968 to try to maintain the gold price at $35 an ounce. The Bank of England operated for the pool through a direct line to the fixing in London, selling from their combined reserves if the price threatened to breach $35.20 and buying back for the pool account when it was weak. The pool finally collapsed in March 1968 when the run on god, after the Tet offensive in Vietnam undermined confidence in the dollar, overwhelmed its resources. The pool lost nearly 3,000 tons of its combined reserve of 24,000 tons, including 1,000 tons between 8 and 15 March 1968, when the London gold market was closed temporarily. When it re-opened two weeks later the pool had been disbanded and gold was left free to find its own level.
The city of Hong Kong is a major regional gold market and jewelry manufacturing center. Gold trading in Hong Kong dates from the foundation of the Gold and Silver Exchange Society in 1910, but it was strictly controlled from 1939 until 1974. Once liberalized it became a significant center in round-the-clock gold trading because huge volumes on the exchange attracted other international bullion houses to establish essentially a parallel market in loco London during Hong Kong’s trading hours. They took advantage of arbitrage between a Hong Kong price quoted in Hong Kong dollars per tael (1 tael = 2.1 ounces) and a London price in dollars per ounce. The international houses do not trade on the Exchange but operate more as wholesalers, dealing in lots of 2,000-4,000 ounces at a time. This alliance between local Chinese traders and the international bullion community made Hong Kong the pacesetter of the early morning price for gold. Hong Kong is also a physical re-export center for both tael bars and kilo bars for China, South Korea, Thailand, Taiwan and Vietnam. Imports are usually 100 to 250 tons a year, but reached a record 460 tons in 1988 due to exceptional demand in mainland China and Taiwan. As a producer of Jewelry, Hong Kong uses upwards of 50 tons annually for gem-set jewelry for Japan and the United States and chuk kam or pure gold jewelry for the local population.
Numismatics is the specialized sector of the coin business for the study and collection of rare coins and other media of exchange, particularly those with archaeological or historic interest. Numismatic dealers are usually quite distinct from banks, trading in more conventional gold coins, although a few, like Bank Leu in Zurich, do have separate numismatic departments. Generally, however, it is the province of firms like Baldwin’s, Seaby’s or Spink’s in London or Stack’s in New York. They belong to the International Association of Professional Numismatists (IAPN), which has 110 members from numismatics firms in 22 countries. Numismatics is not limited to gold and silver coins, but covers everything from cowrie shells to early bank notes that have been used for exchange in some way.

In respect of gold, however, the numismatist’s interest ranges from the first coins of electrum, the natural alloy of gold and silver, issued in Lydia around 550 BC, through Greek, Roman and Byzantine gold coins to the earliest British Sovereigns (struck in 1489 as a symbol of Henry VII’s new Tudor dynasty), Guineas (first struck in 1662 just after the Restoration) and early American Eagles and Double Eagles (first launched in 1837). The rarest coins fetch high prices. A Victoria Gothic gold Crown, dated 1847, sold in 1988 for £113,000; only two examples of this coin were known.

The Singapore International Monetary Exchange Ltd was established in late 1983 from an alliance between the Gold Exchange of Singapore and the International Monetary Market (IMM) in Chicago. It is an open outcry market with a 100 fine troy ounce futures contract quoted in US dollars, deliverable on even months on a one-year cycle. The last trading day is the second last business day of the month preceding the contract month. Under a revised contract initiated in 1990 it is cash settled. On the delivery date the contract is settled in cash against the loco London a.m. fix on the last trading day of the contract. The minimum price fluctuation is US $0.05 per fine troy ounce; the value of one tick is US $5.00.
The United States Mint was established in Philadelphia, Pennsylvania in 1792 and produced the first $5.00 Half Eagle gold coins in 1795. The modern Mint, completed in Philadelphia in 1969, strikes the current Eagle gold bullion coins and other special commemorative coins in gold and silver. The Mint’s bars are acceptable good delivery on the London market. A branch of the US Mint also operates in Denver, Colorado, where it was originally established in 1862 to produce gold coinage from new gold discoveries in the region.
A Geneva-based organization of over seventy gold producers from eleven countries, formed in 1986 to promote gold, and which replaced the International Gold Corporation (Intergold). The jewelry division works mainly with the jewelry trade and industry to co-ordinate promotions and increase direct involvement by the trade in special projects. The investment division has promoted schemes such as gold accumulation plans in Japan and Europe, and the bullion coin market. The Council also seeks to educate mining companies to a full understanding of the gold business.