According to a story published by Bloomberg, several German lawmakers are urging Portugal to sell its sovereign gold reserves as a part of any deal to bail out the debt stricken nation. Meanwhile, the London Financial Times reports that the Mexican central bank has just purchased nearly 100 tons of gold in the months of February and March.
The combination of these two news events is incredibly bullish for gold prices because it illustrates the current psychology of creditor nations, their increasing attempts to diversify away from the U.S. dollar and their desire to do so with gold. At first glance, the potential sale of Portugal's remaining gold reserves seems like bearish because any time a large quantity of gold is sold, it may impact the market by increasing the supply. However, once you think a bit deeper, you will realize that this news is actually bullish also, because Portugal doesn't have much gold left to sell.
At a hearing in the U.S. House of Representatives, held on July 18, 2003 (a copy of the transcript can be found here), it was revealed that the Portuguese central bank had leased or swapped out 70% of its then 433 ton gold reserve. That gold is almost certainly gone now, having been bought and safely hidden in a few hundred million Indian houses, made into coins or adorning the necks of women all over the world. Between 2001 and 2011 there is every reason to believe that, needing cash, the Portuguese government would have leased or swapped even more of that nation's gold.
Let's consider what would happen if they tried to sell gold to a third party. The first thing they would have to do is stop renewing loan or swap agreements and that would require a huge, multi-billion dollar cash payment to bullion banks. But, let's say they come up with the cash because Germany lends it to them. That means that the bullion banks must return the gold. How in the world are they going to come up with 303 tons of gold, even assuming that not a ounce of additional gold was swapped or loaned out over the last 10 years. Trying to meet such a demand, given the current market conditions, would surely bankrupt the banks.
The price of gold to leap to $2,500/$3,000 or more in a matter of weeks. So, it isn't going to happen. Not one ounce of Portuguese gold is going to hit the market to satisfy German demands relating to Euro bailouts. In fact, even if they were not in the peculiar situation of having already transferred their gold, few nations give away gold voluntarily when pressure is applied to force them to do so. The U.S.A. is a case in point. It never sold its gold reserves during the 1970s, even though it was technically bankrupted by the gold demands of European trading partners. Instead, Nixon broke then-existing international laws and repudiated the right to exchange dollars for gold.
Why should Portugal behave differently? Nations normally prefer to default on their debts, as the U.S. once did, than to give up sovereign gold supplies under pressure. We think that the Portuguese would rather default than give up what little gold the nation actually has left. However, the German request illustrates a return to gold as the ultimate means of satisfying debt. That is, essentially, the gold standard. The value of gold is now on the minds of policy makers and those who formulate the laws.
From a psychological standpoint, this is all incredibly bullish for gold prices going forward. The fact that nations like Mexico are buying shows the interest of sovereign nations that are net creditors. They want more gold, not more paper dollars or dollar denominated Treasury bonds. Gold prices are going to head strongly upward. As they do that, they will drag other precious metals upward also. In fact, to some extent, with respect to metals in near shortage already, the extra investment and jewelry demand that will spill over from gold may cause them to soar upward faster than the yellow metal itself.
As central banks buy, heavy price appreciation is placed upon the small yearly mining production of gold, causing gold to rise, regardless of economic conditions, Indian wedding seasons, and world jewelry demand. What happens as the price of gold and platinum converge? As the two prices approach, platinum becomes more and more desirable, because it has always been more expensive and more prestigious than gold. We remember back in 2008 when we mentioned to a lady at a jewelry store that gold and platinum had reached the same price. She immediately began pressing the store clerk to show her ONLY platinum jewelry.
Continued movement of gold back into the monetary system, which is inevitable, will propel all precious metals upward. Let's assume a 20% drop in gold jewelry demand because of a renewal of the deep economic slump in the United States, and secondarily in the rest of the world. But, the gold demand from central banks continues to drive the gold price mildly but inexorably upward. If even 5% of the remaining 80% of current gold jewelry demand gets shifted into platinum, it means 69 metric tons worth of increased demand. Set that against a 214 ton total yearly mining supply. Platinum will move back to its normal pricing relationship to gold. If gold reaches $2,000, after a period of some delay, platinum will eventually move to $4,000. If gold gets to $5,000, platinum moves to $10,000.
Disclosure: Long precious metals.