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CENTRAL BANKS’ GOLD SALE AGREEMENTS AND GOLD-USD INVERSE RELATION


In 1997–1999, several central banks from Western Europe sold substan-tial amounts of their gold in an uncoordinated manner, with the principal aim of realizing substantial capital gains in the gold holdings they had pur-chased several decades earlier. Those gains helped beef up national bud-gets and state finances. The 11 European nations that first joined the Euro-zone had to abide by strict fiscal conditions requiring that budget deficits not exceed 3 percent of GDP. The gold sales helped erode the value of the metal by 25 percent between 1995 and 1998, and lifted the U.S. dollar against the Japanese yen and deutsche mark by 84 percent and 36 percent respectively.

CENTRAL BANKS’ GOLD SALE AGREEMENTS


Central bank gold sales were particularly punishing for the precious metal in 1999 as both the Bank of England and Swiss National Bank stepped up their selling. In May 1999, gold’s decline began after the an-nouncement from the UK Treasury that it planned to sell 415 tons of gold. The announcement triggered a massive wave of producers’ hedging activ-ity and front-running speculation. A month later, the Swiss National Bank (SNB) decided that gold was no longer an integral part of monetary pol-icy making and announced the sale of half of its 2,590 tons of gold re-serves over the next five or six years. The central banks’ announcements led to a 13 percent fall in gold to $252 per ounce, the lowest level in 20 years. Without any systematic limits on volume and frequency of the sales and no coordination, central banks were free to dump gold at their own choosing, creating sharp declines in the metal, and rapid moves in currency markets.

The resulting price action in gold ultimately paved the way for the first central bank agreement on gold sales, which provided the framework for subsequent gold sales by the Swiss National Bank, the European Central Bank (ECB), and 13 European national central banks. Under the agree-ment, the SNB sold 1,170 tons, which accounted for the bulk of the total 2,000 tons in sales by all participating central banks. As gold prices accel-erated their fall, the European central banks sought to boost confidence in the metal and stabilize the plummeting value of their newly created euro currency by establishing the Washington Agreement on Gold. On Septem-ber 26, 1999, 15 central banks (the ECB plus the 11 founding members of the Eurozone, Sweden, Switzerland, and the United Kingdom) announced a collective cap on their gold sales at around 400 tonnes per year over the next five years.

When the Washington Agreement on Gold expired in 2004, a new agree-ment was reached for the 2004–2009 period, called the Central Bank Agree-ment on Gold. The new arrangement raised the amount of annual gold sales to 500 tonnes from 400 tonnes set in the original agreement. The higher threshold of gold sales would help stabilize the value of the U.S. dollar, af-ter the currency had lost 22 percent between 1999 and 2004 and the metal rallied 60 percent over the same period. As of 2007, central banks held nearly 20 percent of the worlds’ aboveground gold stocks as a reserve as-set, with individual nations holding approximately 10 percent of their re-serves in the metal.

please read also : RECENT EXCEPTIONS TO THE INVERSE RULE AND USING GOLD TO IDENTIFY CURRENCY LEADERS AND LAGGARDS


One of the most widely known relationships in currency markets is per-haps the inverse relation between the U.S. dollar (USD) and the value of gold. This relationship stems mainly from the fact that gold serves as an inflation hedge through its metal value, while the U.S. dollar holds its value via the interest rate commanded by it. As the dollar’s exchange value falls, it takes more dollars to buy gold, therefore lifting the value of gold. Conversely, when the dollar’s exchange value rises, it takes fewer dollars to buy gold, thereby dragging down the dollar price of gold. Unlike cur-rencies, government bonds, and corporate stocks—all of which are deter-mined by demand and supply as well as the issuing power of central banks and corporations—gold is largely dependent on demand and supply and is therefore immune to shifts in monetary and corporate policies and the new issuance of equity, debt, and currency.
GOLD-USD INVERSE RELATION

While gold’s distinction from fiat currencies maintains an inverse re-lation with currencies other than the U.S. dollar, the negative correlation remains most striking against the U.S. dollar due to the currency’s dom-inance in central bank currency reserves. Figure 1.1 showed the inverse relationship between gold and the dollar from 1970 to 2008. Figure 1.3 illus-trates the highly inverse relationship between gold and the dollar between January 1999 and May 2008, highlighting a −0.84 correlation.


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