The coming run on central bank gold

They called for an audit of their holdings, and while that still has not taken place, the intermediate resolution was to have 10% of their gold repatriated over a period of seven years.

There has been no explanation of why it takes seven years to get such a small portion of the gold returned, which leaves a lot of unanswered questions. However, while Germany has chosen not to be more aggressive in demanding its gold, that does not mean the situation has been resolved. In fact it only serves as more impetus for a potential gold run on the Fed – as well as the Bank of England, the second-largest custodian of sovereign gold.

There are few people (if any) who know exactly how much gold is in the Federal Reserve or Fort Knox. Former Congressman Ron Paul called for an audit to no avail. And there is uncertainty about whether the gold that is physically present has been leased out, since the central banks do not distinguish between gold and gold receivables on their balance sheets.

Of course when a request for an audit is refused the public is only left to wonder why that would be. One would like to believe that the accounting is solid and things are in place. But what is a rational person expected to think when an audit is refused and there is never even an explanation of why? The track record of the banking system over the past decade makes it difficult to take a non-response as an indication of security, and returning 10% of Germany’s gold over seven years does little to resolve this concern.

While many mainstream commentators felt that the acceptance of these terms by Germany resolved the issue, that line of thinking misses an important market dynamic. Even if Germany does not make further demands for repatriation, the incident did not occur without notice. Casey Research quite correctly pointed out this development has now led other central banks to wonder about the security of their own holdings.

Based on the incredible amounts of currency being printed around the globe the probability of another country demanding their gold continues to increase. In 2011 Venezuela had their gold shipped back home from London, and it is likely that others will make the same demand. Indeed, this could yet turn out to be the late Hugo Chavez’s most effective move against “western imperialism”.

This is the type of trading and market dynamic that politicians are for the most part unable to understand. Free market competition keeps prices in check because when things get out of line there is an incentive for someone to act. As any trader, market maker, or even average consumer can attest to, the farther out of line a price gets the more incentive there is to be the first one to act. If there is only one of a certain item available, you can wait for it to get cheaper in hopes of getting a better deal. However, other participants can see this too and while you are waiting for the 10% discount someone else might think 5% off sounds great and take it before the price ever falls to the level you were waiting for.

Given the current inflationary policies around the globe, the frightening precedent set in the handling of the Cyprus crisis, and the continued lack of clarity regarding central bank gold holdings, it is likely just a matter of time before another party acts and the central bank “gold run” starts in earnest.