By Tim Wood –
NEW YORK (ResourceInvestor.com) — A frank speech by Dr Philipp M Hildebrand of the Swiss National Bank has taken the lid off the country’s controversial disposal of 1,290 tonnes of gold at the turn of the century.
Hildebrand addressed the Institute for International Economics on May 5 in Washington, D.C. on the largest financial transaction in the SNB’s history.
A bullion expert consulted by Resource Investor described the speech as “amazing after-the-event transparency.” He also noted that followers of the gold price suppression conspiracy would be delighted at the timing and structure of the sales which contributed to lows in the gold price.
The expert said that whilst it was clear from the SNB’s Annual Reports that it had used options for its gold sales, it “will be news to almost all.”
The proceeds of the sale amounted to Sfr 21.1 billion. By July 14 of this year, one third of the money will be in the hands of the Swiss federal government, and two-thirds goes to the cantons.
Mostly through astute currency hedging, Switzerland’s central bank was able to realize $17.20 per ounce more for its gold than the average London fixing price between May 2000 and March 2004. The premium was broken down to show $13.40 an ounce attributable to currency hedging and $3.10 per ounce to rising gold prices. 70 cents an ounce was lost to option programmes, spot sales and sales through the Bank for International Settlements.
Switzerland sold down its gold reserves because the national bank thought the 1999 position of 2,590 tonnes was too long at 30% of U.S. reserves. Referencing the Group of 10 nations, Hildebrand said, “Switzerland held more than five times the amount of gold on a per capita basis than the second-ranked Netherlands. Similarly, its gold holdings as a proportion to imports also far exceeded those of any other G10 country. In light of this extreme position, it is legitimate to ask why the issue of gold sales did not arise much earlier in Switzerland.”
The answer to that question was public opinion holding “gold in high esteem as a symbol of monetary stability” and Switzerland’s complex process for reforming the monetary system.
What irked the SNB was the fact that the Swiss franc represented a “relic of the gold standard”. That meant the SNB was legally compelled to trade in gold at a fixed parity of SFr4,595 per kilogram. The current gold price in Swiss francs per kilo is SFr18,043. It averaged SFr14,776/kg in 1999, 3.2 times higher than the parity rate.
Bankers wanted to deal with this imbalance by first amending the Swiss Constitution as well as the Swiss Coinage Act, but it was only in the 1990s when Switzerland’s public finances deteriorated that it became possible.
Hildebrand relates that the in February 1997 the die for demonetising gold was cast after a committee representing the lower chamber of the Swiss Parliament greenlighted it. “Two months later, against the backdrop of mounting international criticism about Switzerland’s role in WWII, the President of the Confederation proposed to allocate some of the gains in the likely event of a gold revaluation to fund a Swiss Foundation for Solidarity which would provide assistance to persons in needs in Switzerland and abroad. According to this proposal, the initial contribution to the foundation would be in the form of a 500-tonne gold donation by the SNB.”
Building on that, a panel of experts delivered a report in October 1997 finding that 1,300 tonnes of gold “were no longer necessary for monetary purposes and could therefore be withdrawn from the SNB’s balance sheet and used for other purposes.”
This required a Constitutional revision which was ratified by Swiss voters in April 1999. In May 2000 legislators adopt a new federal law to replace the old Coinage Act.
Make no mistake, the SNB was in a hurry to offload its gold as Hildebrand tells it, “The first gold sales by the SNB were promptly executed the day after the new law came into force.”
It was badly timed with the central banks of Argentina, Austria, Australia, Belgium, Canada, Luxembourg, the Czech Republic and India all selling gold, alongside attempts to get the IMF to sell its gold. “The market feared that once the European Monetary Union came into force, the participating central banks or governments would lose their inhibition about selling off parts of their 12,000 tonnes of total reserves. In May 1999, the announcement by the UK Treasury that it planned to sell 415 tonnes set a new wave of producers hedging activity and front running speculation. The gold price dropped by 10% to 252 USD/oz, a 20 year record low,” said Hildebrand.
This explicit linkage between central bank sales and producer hedging will scare up a lot of clamour, but Hildebrand is describing a market response rather than collusion. Producers, faced with declining prices, saw a clear rush for the exits, and went for cover.
The September 1999 Washington Agreement governing gold sales put a floor under this pessimism by giving the market certainty “about the behaviour of the holders of 85% of the world’s official gold reserves. Second, the planned annual total sales (400 tonnes) compared favourably with the sales and increases of gold lending activity of the previous years (700 tonnes).”
The SNB was especially pleased with itself since the WAG stopped the runaway train and allowed the Swiss to sell 1,170 tonnes out of its 1,300 tonnes quota within the the 2000-tonne total sales limit for the first Washington Agreement.
Hildebrand said: “In other words, the SNB ended up being the main beneficiary of the agreement. Formally, the initiative for the Washington Agreement did not come from the SNB. Nonetheless, the SNB’s unilateral announcement in June 1999 of its intention to sell 1300 tonnes of its gold reserves certainly contributed to setting in motion the process that led to the September 1999 joint statement issued by the fifteen European central banks.”
Tools and agents
Central banks were not allowed to hedge their gold price risk for the full five-years of the first Washington Agreement, but they could do it on a yearly basis, and there was no limit on currency hedging.
So the SNB employed forward sales and option arrangements for its annual gold sales. Initially, 20% of the expected proceeds in dollars was hedged, which in December 2000 rose to 35% for the remainder of the sales programme.
The Bank for International Settlements was employed to dispose of Switzerland’s gold until April 2001 when the SNB had, apparently, staffed up to do the sales in-house without paying any commission. “The SNB now had the necessary professionals, know-how, trading resources and contacts to the international gold market to trade directly,” said Hildebrand.
Interestingly, the SNB didn’t just sell gold, it bought it too in a very structured programme. That would have been done to being an obvious target for under-bidders (hello, Gordon Brown!).
For three and a half years after April 2001 the SNB sold 730 tonnes directly in the spot market. It used 25 counterparties on four different continents. Settlement was managed through the Bank of England.
350 tonnes were sold through option programmes. Hildebrand said, “In a typical program, the buyer committed to buy 50 tonnes of gold spread evenly over several months and to pay the daily average AM and PM London Fixing plus a premium. In order to increase this premium, the SNB accepted to fix a cap to the maximum selling price. In other words, the programs were based on the idea of selling gold on a spot basis and writing out-of-the-money call options. In an effort to obtain competitive premiums, each program was allotted in an auction between three major dealers. Considering the high variance of the bids we received, this auction procedure proved suitable.”
The SNB realized premiums between $1.4-$3.5 per ounce. “These modest premiums reflected the SNB’s prudence in choosing the caps. At the time of the relevant auctions, these were far above the market price. This explains why, despite an overall bullish market, the strike levels were only attained on two occasions, namely in February 2003.”
Offering advice to proponents of IMF gold sales, Hildebrand said, “the decision to sell official gold holdings should be made separately from any consideration on how to use the proceeds.” He noted that it took two years to agree to sell the gold versus eight years to agree on how the proceeds should be used.
Therein lies the weapon of greatest effect for opponents of IMF gold sales.
Hildebrand said a third gold disposal agreement was critical to avoid destabilizing the market when the present agreement expires. He also said that any IMF sales should be incorporated within the “existing framework.”
He said transparency in a sales programme was also crucial to avoid destabilizing rumours. He also ascribed the success of the sales to a clear mandate and disciplined adherence to it.
He concluded: “Contrary to initial expectations, the SNB was able to conduct its gold sales in a relatively favourable market environment. A former FED governor once said that the recipe for successful monetary policy is one part skill, one part art and one part luck. Presumably, there was nothing artistic about the SNB sales. On the other hand, good fortune may have indeed played a role. I will let you be the judge of whether or not the SNB conducted its sales skillfully.”
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