In last week's silver update we talked about the Central Bank Gold
Buying Agreement that was originally signed in 1999. It was up for renewal this year and the Central Banks that signed the original agreement decided not to renew it. The reality is Central Banks are no longer selling gold but reading the world situation, the stability of fiat currencies, and today's realities they are gold buyers.
Central Banks collectively hold a huge hoard of gold and their actions can have a substantial effect on the price of gold.
It's important for precious metals investors to understand what the Central Bank Gold Buying Agreement was and what the motivations were for this agreement. If you understand those motivations it will help guide your precious metals investing philosophy.
Although when originally signed in 1999 it was called the Central Bank Buying Agreement it more correctly should have been called the Central Bank Selling Agreement. Why? Because it was really designed to prevent another disastrous Brown's Bottom decision. This decision has gone down in history as one of the most financially disastrous decisions in history achieving fame as Browns Bottom. Gordon Brown, Britain's Prime Minister sold half of Britain's gold reserves 20 years ago at the absolute bottom of the market when others were also selling their gold.
Make no mistake about it, this agreement was designed to serve the best interests of the central banks. They didn't want to be caught selling cheap again. They wanted to coordinate and limit the amount of gold selling at any one time.
I know if you go to the organization that formed and promoted this agreement they will go on about how the did it to stabilize the prices and markets.
If it was done for our sakes to stabilize the markets why was it just formulated and signed 20 years ago? Remember Brown's Bottom occurred about 20 years ago too. Coincidence? I don't think so. Central Banks were burned selling cheap and didn't want it to happen again.
So what does this mean for the precious metals investor? Let's first look at one other decision the Central Banks recently made -the Basell III agreement which raised gold from a tier 3 asset to a tier 1 asset. What exactly does that mean for banks and what benefit is to them? Banks make their money by lending it out. The amount of money they can lend out is based on the reserves they hold. So when an asset is a lesser tier 3 asset like mortgages, the banks can only lend about 50% of the value of that asset. With a tier 1 asset, the banks can loan 100 percent of the value. So with Basell 3 in raising gold from a tier 3 asset to a tier 1 asset the asset valuation has doubled the amount of money banks could lend. In effect very significantly increasing the amount of money banks can make by greatly increasing the amount of mortgages they can make and money they can lend.
So for the precious metals investors basically what this means is that the central banks, who, because of their huge catch of gold have a significant influence on the price of gold can now make a lot more money. Can you ever imagine that once they are given this huge gift that doubles their gold asset base enableing them to double the amount of money they lend and very very significantly increasing the money the banks can make that this decision raising gold to a tier 1 asset will ever be reversed? Can't you just hear the howls from banks who suddenly had their profit potential halved by moving gold back to a tier 3 asset?
The precious metals update is a new shorter version of the Precious Metals Investing podcast. It usually focuses on one issue. I would appreciate your comments and feedback. Send your thoughts and recommendation for future updates to email@example.com
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