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Central Bank could provide support to gold prices

Posted by fairval on November 5, 2009

Article by Quantum on RBI’s gold purchase

International Monetary Fund (IMF) announced on its website that India has bought 200 tonnes of gold from a total of 403.3 tonnes that they had planned to sell. This transaction was completed during the period of October 19th – 30th 2009 with daily purchases at the prevailing market prices.
The point to note is that not only has the Reserve Bank of India (RBI) purchased gold – but it has done so at a price that was not at a discount to the spot prices.

The reason for buying
According to a Reuters report, an IMF official quoted that the sale took place at an average price of about $1,045 an ounce. The payment for the same would be made in “hard” currency – and not in SDRs, the currency of the IMF.
This means that the purchase of nearly $6.7 billion of gold would be made from RBI’s dollar reserves.
The message: the RBI is diversifying – it is moving some of its money from US dollar paper notes to gold.
The RBI says: “This was done as part of the Reserve Bank’s foreign exchange reserves management operations.”
Hmm… The RBI, as a central bank, is the fund manager of India’s reserves. Given the uncertainty surrounding the dollar, the RBI seems to think that it is prudent to diversify some of its dollar reserves to gold.

Learning from the past
During the balance of payment crisis in 1991, India mobilized its gold reserves to serve as collateral against a $400 million loan from the Bank of England. India shipped a total of 47 tonnes of the country’s gold reserves to the Bank of England as collateral. It also leased a further 20 tonnes of confiscated gold to Union Bank of Switzerland with a six month buyback option to raise a $200 million loan. The funds were used to help India meet its short-term debt obligations – and its rising import bill.
A central bank of a country serves as a lender of last resort. We saw this happen in the severe financial crisis of 2008. But, as seen above, gold has many a times served as an asset of last resort for these central bankers – just like it did for India in 1991.
Central bankers see gold as the ultimate currency and have often in the past acknowledged this fact by words and by actions.
The debasement of currencies by central bankers around the world – especially in the U.S and in UK – has led to an erosion of confidence in paper currencies. This has ignited a need to diversify reserves away from the US Dollar. Countries like Russia, China and the Middle East have often voiced their concerns and were amongst the likely nations to grab the IMF gold for sale.
India buying almost half of IMF’s available gold for sale has come as a surprise to many. Especially since, the gold markets never placed India anywhere near the top of the list of prospective buyers. Also, this has come at a time when prices are ruling near record highs.
India’s total forex reserves have grown significantly over the years whereas gold holdings (in tonnes) were unchanged. This led to a steep fall in gold reserves when expressed as a percentage of total reserves. India’s gold holdings declined from more than 8% of total forex reserves at the beginning of 2000 to less than 4% before this purchase from IMF.

This purchase of 200 tonnes of gold will lift the proportion of gold expressed as a percentage of total reserves to almost 6%.

Who’s next?
India has moved swiftly. China and Russia were considered more likely to grab the IMF gold.
There are chances that China might rush to grab the remaining gold for sale by the IMF, without any further delay. China’s gold reserve as a percentage of total reserves stands at 1.6%. While China has huge dollar reserves which are increasing each day, it has also voiced its concerns regarding the uncertainty surrounding the U.S dollar.
This potential sale of gold by the IMF was one of the lingering threats for gold prices. Now we have real takers for the IMF gold: 50% swallowed by India in one gulp. This will certainly lift the sentiments amongst those that believe in gold as the ultimate form of currency.
(A Quantum MF article)

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