Signs of fear and uncertainty: gold’s price and deposits at the European Central Bank

Back on the 13th of May I took a look at the gold price and gold market and gave some thoughts on the subject. Since then the price of gold has remained reasonably firm and as of yesterdays close the front month for Comex gold futures closed at US $1205. There is a lot of debate over why this is so and there have been some new interventions in the debate that I think are worthy of note. It is of course a subject that often leads to passionate debate as you could almost summarise the debate as you either love it or hate it and both extreme camps tend to view the other as simpletons and fools!

Warren Buffett

Some time ago the Sage of Omaha gave his view on gold.

“Gold gets dug out of the ground in Africa, or someplace,” he said. “Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

So I think that we can safely assume he is not a fan.

A Ponzi Scheme?

An article in the Wall Street Journal recently advanced the view that the gold market operates as follows. Over the past decade or so the price of gold has risen approximately fivefold. This rise has been because there have been more buyers than sellers. But according to data from the  World Gold Council, an industry body, there is no shortage of gold at all.Over the last decade the world has produced—or, more accurately, recovered—far more gold than anyone actually wanted to use. Since 2002, for example, total demand for gold from goldsmiths and jewelers, and dentists, and general industry, has come to about 22,500 tonnes. But during the same period, more than 29,000 tonnes has come on to the market. So there has been a surplus of 6500 tonnes of gold since 2002,according to these figures.

Most of the new supply has come from mine production. Some, though a dwindling amount, has come from central banks. And a growing amount has come from recycling with old jewelry and the like being melted down for scrap.  So if supply has consistently exceeded user demand, how come the price of gold has still been rising? In a word, hoarding. Gold investors, or hoarders, have made up all the difference. They are the only reason total “demand” has exceeded supply. Lots of people have been buying gold in the hope it would rise. But the only way it can rise is if still more people buy it, hoping it will rise still further. And so on.

What do we call an investment scheme where current members’ returns depend entirely on new money brought in by new members? A Ponzi scheme.


The argument is actually quite seductive but I feel that there are some points which are relevant.

1. Over the past few years has seen a reduction in investors faith in fiat money. It would appear that the main central banks of the world are willing to engage in Quantitative Easing (which many people other than gold bugs see as printing money) on a scale which is unprecedented and only recently the European Central Bank has started on this road. So there are genuine fears of inflation should such action be repeated or carried on.

2. I am always cautious about statistics and wonder how accurate the numbers from the World Gold Council actually are.

3. Calling holders of gold “hoarders” may be inaccurate after all many seem to believe it has value and may have no intention to sell in these times. Only time will tell if it proves to be a better store of value in this century than the last one.

What is actually occurring?

Well the various mints around the world are seeing an increase in orders. Back when I wrote my previous article on gold there was talk of a lot of gold buying from Germany and Austria. It turned out that the Austrian Mint sold 238,000 ounces of its Vienna Philharmonic coin last month, six times the volume in May 2009. In another example The US Mint sold 190,000 one-ounce American Eagle coins in May which was nearly treble the sales of a year before, and the highest since January 1999, when gold was trading at less than a quarter of its current price. This demand has carried on as the Rand refinery in South Africa, which produces the world’s most popular gold coin, the krugerrand last week increased production by 50 per cent to keep up with demand. Whilst consumption of coins and small bars makes up a relatively small part of overall gold demand, it is clearly showing signs of being a leading indicator of investor sentiment.

Central Bank Sales and Brown’s bottom

Over the past decade central banks particularly European ones have been sellers of gold. Exact figures have been hard to find and I even heard a story of a journalist being fired from his job for trying too hard to track down the numbers but in the end these things always leak. Anyway it is estimated that  central banks in France, Spain, the Netherlands, and Portugal followed the UK’s 1999 example and sold large chunks of their gold reserves when gold prices were around US$280. They sold around 3,800 tonnes of gold for around $56 billion, according to estimates in the FT. If  they’d kept those gold reserves and not bought government bonds with the proceeds, those banks would be $40 billion better off.

Brown’s bottom

The example which they followed was when Gordon Brown back in 1999 decided to sell off some of the United Kingdom’s gold reserves. He sold 395 tonnes at an average price of US $275. He then reinvested the money in foreign currencies in the ratio 40% US dollars, 40% Euros and 20% Yen. At current prices the sale of the gold makes a loss of just over 11.5 billion US dollars. It is not easy to estimate the interest we would have received on the money but I estimate that at around 2.5 billion US dollars. So Brown’s bottom currently has an opportunity cost of around US $ 9 billion by my reckoning.

Last year central banks sold only 246 tonnes of gold according to the FT which was the lowest for some time. Sadly it means that they are heavy sellers at low prices and minor sellers at high prices. It is fortunate for them that they do not have to make a living doing this,although of course it is very unfortunate for their respective taxpayers.


I still feel as I did back on the 13th May that fear and uncertainty are the main drivers behind the advance in the gold price. The recent additional spur was the fact that the ECB began sovereign bond purchases which meant that no-one really believed anymore that it was a spiritual follower of the policies of the German Bundesbank. In case you were not sure on this count the fact that it appears that the current Bundesbank chairman Axel Weber voted against the move should make it clear. So as people lose faith in other investments they cling again to gold. For mankind as a whole if you accept my analysis the rise the price of gold is something of a defeat.

The European Central Bank deposit facility

Euro zone banks are parking record sums overnight at the European Central Bank in the latest sign of fear and uncertainty across the 16 countries which make up the euro zone.Use of the ECB’s deposit facility rose to 316.4 billion Euros this week which  even exceeded levels seen after the collapse of Lehman Brothers in September 2008.

What does this mean?
It means that banks in the euro zone are turning down potentially higher interest rates from other banks because they are afraid of counter-party risk. I wrote on the rise in Libor rates on the 28th May  which is another function of this environment but this rise in deposits at the ECB is a clear sign that banks are nervous of other banks exposure to sovereign debt in the euro zone. So instead they get less interest but a safer counter-party.

Another Problem

The ECB is supposed to be unwinding its extraordinary monetary stimulus measures during this summer. But we can see that there are still problems within the euro zone banking system. Of course it Securities Market Programme (QE)  is an extension of extraordinary monetary measures as is the resumption of swaps arrangements with the American Federal Reserve. It also recently weakened its collateral rules. These are not quite what I would call an unwinding!

Also there are issues for the ECB’s bond buying programme to address. You see the ten-year bond yields of Greece (8.23%),Portugal(5.13%) and Ireland(5.11%) have started to move higher again. It would appear that the moment the ECB stops buying these bond markets are rather friendless. This of course only adds to sovereign debt fears.However something worse has also happened as Italian and Spanish ten-year government bond yields have risen to 4.30% and 4.56% which is virtually where they were on May 7th before the new euro zone rescue schemes began. As I wrote in my articles on her on the 24th and 31st of May there are particular worries for Spain and her banking sector. This poses a new problem for the ECB as of course the Spanish (and the Italian) government bond market is much larger than Greece Portugal or Ireland’s.

A curious fact

I discovered recently from watching the BBC programme QI that mobile phones are now recycled for the gold in them as the rising price makes this economic. The curious fact is that pound for pound there is more gold in a mobile phone that there is in gold ore according to the programme.


10 thoughts on “Signs of fear and uncertainty: gold’s price and deposits at the European Central Bank

  1. What I always find peculiar is that so many people buy gold as they (reasonably) fear for the integrity of fiat money.But then they rejoice that their golds is worth more dollars.

    I think these holders of gold miss the point that the yellow stuff is the ultimate barter metal.However there may be better barter items to hold.Maybe farmland maybe tobacco?

    • Cigarettes have been a well-known barter item in prison and during times of hyperinflation I am told. Nicotine is a powerful motivating factor.
      Farmland sounds promising too, but it needs water, which is difficult to store in the needed quantities. Let alone labor power.

      I drive a Corolla and I have always been mystified by those who prefer, say, a Camry. I guess people place value in all kinds of stuff for all kinds of reasons. Paintings, sculptures, tulips, why not gold.


      • Once you start choosing something to replace (fiat) money it is not so easy is it? Andy’s point of land is good in many ways but you can’t carry it with you and as already pointed out it needs water and labour. Cigarettes I agree have been used but as a non-smoker I would be a pure trader and not a consumer! Economists when searching for measures to use for purchasing power parity for exchange rates have measured things in Mars bars and Big Macs for example. But again there are weaknesses as Mars bars in the desert? And you can hardly store Big Macs… John’s Corolla could be used as the most common car but it is hardly divisible.

        I think some time ago Abba traded some of their albums to Russia in return for oil maybe it will turn out they were well ahead of events.

  2. Gold has little intrinsic use and value.This is purely fear-of what though ?inflation.
    All the signs suggest that at least in the short to median term disinflation is the main concern
    When this occurs, and I choose my words guardedly,reactive action will lead to subsequent inflation.
    IMOP Sell Gold now-buy later when the central banks start cranking up

  3. I see you mention Gordon Brown’s sale of the UK’s gold reserves.

    What needles me is that this is the same Gordon Brown that approved, and wanted extended, quantative easing a.k.a. printing money.

    This means he swapped a tangible asset of which there is a finite amount for something that could be created by flick of an electronic pen to an unlimited degree by World governments/central banks. And he knew it.

    This is almost criminal stupidity.

  4. in your post you say
    “Gold investors, or hoarders, have made up all the difference. They are the only reason total “demand” has exceeded supply. Lots of people have been buying gold in the hope it would rise. But the only way it can rise is if still more people buy it, hoping it will rise still further. And so on.

    What do we call an investment scheme where current members’ returns depend entirely on new money brought in by new members? A Ponzi scheme.”

    also the arch critic of gold warren buffet in fact made no small part of his fortune.from trading its sister metal silver.whose price is essentially a deriavative of the gold price.

    my point is that in essence all markets ie stock markets,currencies etc .are in essence ponzi schemes whereby the price rises are produced by drawing in new money(purchasing power) to purchase at ever higher prices.
    .in the essence we end up returning to the question as discussed previously of what is money and wealth.(would like to hear more thoughts on this)
    money i would argue is essentialy acceptable purchasing power as measured or accepted by both purchase and vendor.i would argue that physical gold or silver is the most widely accepted purchasing power around the world and throughout history in the event of widespread ” bublisation ” and possible failure of fiat much is the brazilian cruizeiro worth now.i actually own physical gold and silver and hedge using the paper markets.this has worked ok up to would be good to hear how others would seek preserve money and wealth by universally acceptable means.
    i cannot see land or tobacco as better or more practical forms of money or purchasing power as gold or silver or other rare portable metals or items or substances of a societal breakdown.

    • Hi Chris sensemakesnonsense, it is interesting to see you also commenting re being interested to see more discussion particularly concerning money and wealth.

      As I understand your comment, you seem to be querying the statement “Gold investors, or hoarders, have made up all the difference. They are the only reason total “demand” has exceeded supply. Lots of people have been buying gold in the hope it would rise. But the only way it can rise is if still more people buy it, hoping it will rise still further. And so on.

      What do we call an investment scheme where current members’ returns depend entirely on new money brought in by new members? A Ponzi scheme.” .. and I would agree with your query. I do not believe that those buying gold value in one form or another at present do so because they hope the price will rise as in a classical Ponzi scheme.

      I believe that more people are buying gold at present out of fear – the fear that fiat money and some other previously perceived wealth forms (such as equities) are about to plummet in value; i.e. hyperinflation and Depression. The basis of this is really no different from that of paper money and currency backed by a gold standard. Since the gold standard and Bretton Woods agreement were dropped then fiat money has been dangerous, since politicians could debauch their currencies at any time they chose. The fractional reserve banking system has made those dangers much worse.

      So I do not believe that purchasing gold or silver can in any way be seen as a Ponzi scheme. Many are rushing into such purchases as a desperate effort to preserve their wealth, not because gold or silver will increase in value, but that they will not fall in value as fiat currency and equities will. The principal problem with such precious metals is storage and security of course. This iwhy some are purchasing gold or silver value in form rather than as actual metal.

  5. But Drf don’t you have to convert back into a currency to do any real spending or will we see gold ingots being used for food purchases? We might as well be using coloured pebbles off the beach! Doesn’t really matter what is used within the system as long as it is quantifiable or has that illusion! I think we are missing out on a real chance for deep structural change within society, financial sector and wealth measurement being only one part. The system is protecting the profligate not the prudent and will inevitable be shown to be baseless.

  6. Hi Mac, Normally I would agree that the value preserved in gold and silver would be converted back to another form of wealth eventually when the precipitating crisis had subsided. However, it depends how bad things get and how long things stay bad. If there are serious collapses in fiat currency value then you could again see gold and silver itself being used as money, or even as in Germany before, coffee and cigarettes; anything with perceived intrinsic value in fact.

    I agree that society has missed out on the potential for deep structural change; it always does; but of course the changes perceived as optimal by each person tend to be different and subjective. Socialism promised Utopia for example, but has failed to deliver because it is conceptually flawed. That is why Zanu Labour in the UK tried to patch it up, but unfortunately they still held to many serious flaws without change.

    I agree entirely that the present status quo is protecting the profligate – not the prudent, but that was not always so until recent times. I believe that what we face, and what politicians have been attempting to avoid and continue to attempt to avoid, but have only delayed and made worse, is a significant Economic correction. It is a bit like water finding its own level; you can try to keep it at a different level, but if there is a feed of more water you will eventually lose the battle, and water will win. The natural Economic forces will ultimately win. It can be summarised by the statement “You can in the long term only have and enjoy the wealth which you actually earn or plunder. In the short term delusion may seem to last, but it will not do so for ever.”

  7. hi to the other posters.interesting discussion.about wealth ,money and silver cannot be be a ponzi scheme unless we are about to witness a historic precendent.that being gold and silver end up in the future being of no value or utility worth nothing .if prices fall and gold is cheap i am sure there are many more industrial uses that could be found as for silver it is already widely used industrially.
    . in a ponzi scheme many investors lose is interestg that until relatively recently silver and copper was used in our coinage it was removed when the valuable content of the coin became worth more than its face value owing to inflation indeed in hyper inflation it may be possible that iron content of the coin may become worth more than the coin..deflation or disinflation is always going to be a short term phenomen
    to be avoided by the majority prolifigate.fear is a powerful motivator.

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