India, China and Gold

The Reserve Bank of India in an off market transaction purchased 200 Metric Tonnes of Gold Bullion from the International Monetary Fund (IMF). Several things made this both interesting and market moving.

First, the magnitude of the purchase was surprising. Second was that they were not expected to make the purchase at all, analysts expected a large buy from China and the rest sold in market to the regular IMF Affiliate Banks. Lastly, they paid for it not in SDR’s or Special Drawing Rights as is the common practice when dealing with the IMF but in Hard Currency.

What did each of these things mean to the market and how will they affect the future?

1) The magnitude of the purchase.
Gold rallied over 3% on the day after this announcement. The fact that a sovereign bank was willing to pay top dollar for so much gold was very stimulative to the price.

2) India was not the buyer the analysts had picked for the purchase.
It is likely in light of this other sovereigns will follow, possibly China or some of the other Asian central banks. This will be a significant up force in the price of gold going forward. It is quite likely China, which has expressed an interest in moving away from the US dollar, may take this step. Additionally, political events related to trade conflicts recently may influence China to use this type of move to send a message to the US. The visit next week by President Obama may mitigate or exacerbate this possibility.

3) They paid for it in hard currency not SDR’s
This is much more subtle, and was much more difficult to analyze. The SDR’s are comprised of a basket of currencies as explained in the link in the reference section of this blog. India holds a large position of reserve currency, but it is comprised almost exclusively of US Treasury Securities and US dollars. So essentially they paid for this large cache of gold, which they are going to hold as a proxy for a reserve currency, in US Dollars.

This is tantamount to saying they would rather have gold than dollars. The immediate effect was twofold. First it caused the US dollar Index (USDX) to fall, and the price of the US Treasury securities, primarily the 30yr Bond, to fall. Second it stimulates the other sovereigns to do the same thing to avoid being caught holding a US dollar or Treasury that is declining in value. While this has not as far as we know happened yet (The IMF doesn’t announce the sales until they are completed and the India purchase did not leak out ahead of the announcement) it caused enough fear in the market to cause the dollar to reverse it’s recent uptrend and drop. That drop is continuing.

Broader Market Effects
The value of the dollar effects the value of things that are denominated in dollars. US Treasury Securities, Equities, and Commodities. As the dollar loses value the price of US Treasuries goes down, and Equity and Commodity prices rise. As a result we saw a rise in Crude Oil prices and a large rise in Gold prices. Crude as a result of first order effects (dollar value decreasing) and Gold as a result of first and second order effects (Increased demand).

Longer Term Effects and Price going forward
The price of US equities will see decreasing effects of this event unless another similar event as describe above takes place. The effect on Crude will be subsumed by the normal supply demand effects and/or any disruptive event. The effect on Gold and US Treasury prices will be effected to a greater degree as the up force on gold of such a large purchase, and the implications for US Treasuries of such a vote of “no confidence”, will in my opinion be long lasting, and again should a second or more sovereign banks engage in the same type of transaction there will be an exacerbation of these effects that could be greater than a linear effect.

Some Ancillary Comments
In the research of this piece, I found that the mainstream media either elected not to mention the fact that the purchase was made in hard currency, or in fact stated outright that SDR’s were used, even though the conference call clearly included that statement, and no media outlet I could find stated the makeup of the hard currency that was used. Obviously the market knew the facts or correctly surmised it as the price of gold and equities was positively affected by the news, but the media totally missed what in my mind was the critical factor for the markets.

Disclosure: The author and The Wallingford Trust hold long or short positions or may hold positions in the future in the following:
CL_F And other Gold Futures, Physical Gold Bullion, ZGZ9 and other Crude Oil futures, DXZ9 and other US Dollar Index Futures, ZBZ9 and other 30yr Treasury futures, CVX, XOM, TBT, FPP

Comments

[Roger Knights:]

It's likely, IMO, that India outbid China for this offering, because normally a motivated seller with a large position to unload would have to accept a below-market bid. That's probably what China figured, and offered. I wonder if round 2 will also be sold at a price that mirrors the market, instead of at a discount, as would "normally" be the case.

Nov 05 02:39 PM

[Aiki14:]

Agreed, and I think everyone was surprised at the "Bust out retail" price the RBI was willing to pay. They are up 4.2% on the position so they look smart at this point. If another sovereign buys at todays price it'll be a great ride for gold and a slap again to the greenback. Knowing this I would not be surprised to see China make the play.


On Nov 05 02:39 PM Roger Knights wrote:

> It's likely, IMO, that India outbid China for this offering, because
> normally a motivated seller with a large position to unload would
> have to accept a below-market bid. That's probably what China figured,
> and offered. I wonder if round 2 will also be sold at a price that
> mirrors the market, instead of at a discount, as would "normally"
> be the case.

Nov 05 04:09 PM

[DiggerUK:]

I have been burning my eyes out on the web for a couple of days now, trying to find the process by which the IMF's gold is sold.

Who decides?
What committees decide?
Were in the IMF site is the sales process outlined?
Were are the minutes?

Anybody got a clue, we woke up a couple of days ago to find out the gold was sold to India, and that's it.

Any bets as to who gets the next tranche.
Australia? Japan? S.Korea? Saudi? Brazil?

Nov 05 04:20 PM

[Aiki14:]

If you go to my blog directly I have links to the IMF site that cover the sale.
www.aiki14.com
It was pretty amazing that this didn't leak out at all before the conference call.

As to who gets the rest, my guess would be China. I am working on a detailed explanation of that opinion now and it should be on my blog by morning.


On Nov 05 04:20 PM DiggerUK wrote:

> I have been burning my eyes out on the web for a couple of days now,
> trying to find the process by which the IMF's gold is sold.
>
> Who decides?
> What committees decide?
> Were in the IMF site is the sales process outlined?
> Were are the minutes?
>
> Anybody got a clue, we woke up a couple of days ago to find out
> the gold was sold to India, and that's it.
>
> Any bets as to who gets the next tranche.
> Australia? Japan? S.Korea? Saudi? Brazil?

Nov 05 04:28 PM

[DiggerUK:]

Aiki,
Not exactly what I have been looking for. Got this from IMF site as well.
It doesn't say a lot.

Did India get 1/2 because it bid highest, was anybody else bidding, has anybody else bought, did anybody else want it, did anybody else get a look in?
It's the politics behind it all I'm trying to get to the bottom of.

The IMF gold sale soap opera, has been running for a long time now. And just like a soap it is at the final episode.
But this ain't soap, it's reality. Much more gripping.

Nov 05 04:52 PM

[Aiki14:]

Digger,
The decision to sell was made at the Executive Boards general meeting on 19 Sept 2009. Nobody else has bought as far as they have announced. If they don't get offers on the other 203.3 tonnes they offer it to member banks in "market" sales.
This may offer a little bit more on the basics of the sale and who approved it and when. It also lays out the IMF's executive boards guidelines for gold sales in general.
www.imf.org/external/n...
Under the Fund's Articles of Agreement, all gold sales must be conducted at market prices, including direct sales to official holders. Hence, the Fund will sell gold at the market price when the sales are conducted.
Any of the Sovereign members of the IMF can make offers for off market purchases
www.imf.org/external/n...

Closest thing I could find to minutes is here
www.imf.org/external/p...

On Nov 05 04:52 PM DiggerUK wrote:

> Aiki,
> Not exactly what I have been looking for. Got this from IMF site
> as well.
> It doesn't say a lot.
>
> Did India get 1/2 because it bid highest, was anybody else bidding,
> has anybody else bought, did anybody else want it, did anybody else
> get a look in?
> It's the politics behind it all I'm trying to get to the bottom of.
>
>
> The IMF gold sale soap opera, has been running for a long time now.
> And just like a soap it is at the final episode.
> But this ain't soap, it's reality. Much more gripping.

Nov 05 05:48 PM

[JeffDB:]

On Nov 05 05:48 PM Aiki14 wrote:

> If they don't get offers on the other 203.3 tonnes they offer it
> to member banks in "market" sales.
> This may offer a little bit more on the basics of the sale and who
> approved it and when. It also lays out the IMF's executive boards
> guidelines for gold sales in general.
> www.imf.org/external/n...
> Under the Fund's Articles of Agreement, all gold sales must be conducted
> at market prices, including direct sales to official holders. Hence,
> the Fund will sell gold at the market price when the sales are conducted.
>
> Any of the Sovereign members of the IMF can make offers for off market
> purchases
> www.imf.org/external/n...
>
> Closest thing I could find to minutes is here
> www.imf.org/external/p...

Thanks for the article & the followup info.

I wonder if the price included free shipping & handling? or maybe the use of Ben's Helicopter for delivery. ;)

Nov 05 09:41 PM

[Aiki14:]

If anyone is interested in a little more on this, I was interviewed by Wall St. Media's Doug Estadt on this topic. here's the link:
www.wsmco.com/show.asp...

Nov 05 10:03 PM

[Laurence Hunt:]

I like your attention to detail. This was well done.

I think the trend here is obvious. Those who want cash for gold will sell it as the value of gold rises and the value of cash falls.

Those who prefer gold to cash will accumulate it as the value of cash declines and the value of gold rises.

We know who the long-term thinkers are here.

Will the trend reverse?

Will governments get responsible again with the management of their currencies?

Answer:

Same question.... We don't know yet. But the trend won't reverse until governments get responsible.

I'm not holding my breath.

Nov 06 02:11 AM

[StocksReporter:]

Your link to IMF in the first sentence is pegged to Salomon Brothers Inflation Management Fund (IMF).
The observation about the RBI paying hard cash in US Dollar and not SDRs is right and is indicative of the maverick central bank's stance.

Nov 06 08:56 AM

[auto44:]

I think India wanted to unload cash and protect the value of gold already in it's vaults and also the huge hoard that it's private citizens keep both as adornments and a private store of wealth. It's ironic that Warren Buffet chose to dump his cash hoard for locomotives boxcars and rails on the same day. It seems like the smart money would rather have hard assets than paper even in a tough business environment. The term gold bug may soon stop being a derogatory term.

Nov 06 09:09 PM

[The Recusant:]

OK, so India got rid of some of their U.S. bucks by trading the devaluing greenbacks for gold. Nice, smart move on India's part to start the game of "Dump-the-Dollar". So now IMF has all these souring dollars that it supposedly is intending to loan to poorer countries. Who will be next for the ol' bucks for gold swicheroo? Likely China, as everyone has been guessing for some time. But it doesn't matter much since U.S. dollars will be used to buy the gold adding more fuel to the fire that nobody wants the currency. And the game will continue until nobody holds U.S. dollars except people in the U.S. -- oh, wait a minute, they don't have any either, they've bought gold and Australian dollars. Maybe JPMorgan and Goldman-Saks will have them all and choke on them, I wish!

Nov 07 12:20 AM

[Lum Chang:]

The IMF sold the gold to India because those westerners in IMF do not want the gold to go to China. They want China to keep buying their bonds.

Lum Chang Chai
Hong Kong

Nov 07 10:15 AM

[Lum Chang:]

IMF sold the gold to India because the westerners in IMF do not want China get most of the gold sold. They prefer China to buy their government bonds. You westerners are jealous of the financial strength that China has.

Lum Chang
Hong Kong

Nov 07 10:19 AM

[Aiki14:]

Thanks for your comment.
The link to the Salomon Brothers fund is I think a program effect by Seeking Alpha as I didn't put the link in the article. On my blog at www.aiki14.com I list the references used.


On Nov 06 08:56 AM StocksReporter wrote:

> Your link to IMF in the first sentence is pegged to Salomon Brothers
> Inflation Management Fund (IMF).
> The observation about the RBI paying hard cash in US Dollar and not
> SDRs is right and is indicative of the maverick central bank's stance.

Nov 07 12:24 PM

[Aiki14:]

Thanks for your comment.
While I agree the US would prefer the Chinese to buy their bonds, the IMF offers the gold to it's member states on a first come first serve basis. The announcement of the gold sale was in September and the Chinese have had ample time to purchase the remaining 203 tonnes. I am surprised that they appear not to have done so.
I will note a piece of information supporting your argument that western governments are in fact propping bond sales up by limiting gold sales. In August 2009, the European Central Bank and other central banks announced the renewal of their agreement (Central Bank Gold Agreement) on gold sales, which are not to exceed 400 metric tons annually and 2,000 metric tons over the five years starting on September 27, 2009. The announcement notes that sales of 403 tons of gold by the IMF can be accommodated within these ceilings. This ensures that gold sales by the Fund would not add to the announced volume of sales from official sources.
That agreement can be found on the ECB's website here:
www.ecb.int/press/pr/d...


On Nov 07 10:15 AM Lum Chang wrote:

> The IMF sold the gold to India because those westerners in IMF do
> not want the gold to go to China. They want China to keep buying
> their bonds.
>
> Lum Chang Chai
> Hong Kong

Nov 07 12:36 PM