India dumps dollars for IMF gold - is China next in line?

The news that the IMF has sold virtually half the gold it has approved for sale to India surprised some observers although the growing Asian giant is, on reflection, a logical purchaser.

LONDON -

The IMF announcement yesterday that it had sold virtually half of its planned 403.3 tonnes of gold, destined to increase its resources for lending to low-income countries, to India came as something of a surprise to the market. Not perhaps that a Central Bank had made the purchase, but the hard money had been on China to do so, not India.

Indeed, the market seemed, in retrospect, little affected by the news of the sale, which apparently involved daily sales that were phased over a two week period during October 19-30, with each daily sale conducted at a price set on the basis of market prices prevailing that day. It reached around $1,066 an ounce before falling back initially this morning in Europe to just below $1,060 at the time of writing.

However, once the North Americam markets opened there has obviously been a different take on the Indian purchase with the goldprice moving up sharpl to hit a new record over $1,080.

One suspects that when the news really sinks in it will be positive for the gold price with at least a part of a significant prospective overhang being taken out of the marketplace. It would also seem likely that the IMF is negotiating with other Central Banks for the sale of the remaining 203.3 tonnes of gold. The IMF said in its press release that it "is standing ready for an initial period to sell gold directly to Central Banks and other official holders that may be interested in such sales." Under the Fund's Articles of Agreement, all gold sales must be conducted at prices based on market prices, including direct sales to official holders as in the case of this transaction.

Perhaps surprisingly, among observers Chris Powell of GATA expresses some caution over the sale. In a note he says "But whether the Reserve Bank of India will use the gold for market intervention, open or surreptitious, is another question, and such use must be suspected. After all, India is the biggest market for gold, and the transfer of IMF gold to India could facilitate the dampening of that market if the Reserve Bank of India is inclined to try intervention to support the rupee or the U.S. dollar."

In effect though the sale may actually undermine the dollar in the short term. Reuters reports that an IMF official said that the sale was concluded at an average price of about $1,045 an ounce and that the transaction would be paid in hard currency and not in IMF Special Drawing Rights. This effectively means US dollars as India's reserves are reportedly mostly held in U.S. Treasuries. Given the perceived continuing weakness of the U.S. dollar this would seem a logical move by India where the gold proportion of its $285.5 billion gold and currency reserves had slipped back to only 3.7%. 15 years earlier gold had accounted for 20.86% of the country's reserves. Even with the addition of the 200 tonnes - at this morning's gold price - the country still only holds about 6.3% of its reserves in gold. For a country where gold ownership is built into the national psyche this seems a very small proportion.

What faces the market now is what will happen to the remainder of the IMF gold overhang. There have been unconfirmed reports that China is in discussions with the Fund, but also speculation that there are a number of other countries which might also be interested in boosting their reserves by purchasing all, or some, of the remaining amount scheduled for sale. No other countries keep anything like the proportion of their reserves in gold that the U.S. and some key European countries do. With a growing distrust of paper currencies it would be logical for others to follow India's lead.

Given both China and India are both allowing state institutions to peddle small gold bars and coins to the general populace as a good investment (see: China pushes silver and gold investment to the masses and In India even the Post Office sells gold coins) supporting the market in terms of gold purchases would seem to be a sensible move, particularly given both economies are relatively strong, while the West and Japan remain in economic turmoil. China may be quietly building its own reserves anyway through purchasing domestically mined gold - it is now the world's top producer. It may also make sense for other countries - mainly in the Far East and Middle East, where gold has always been an important element in wealth preservation among monied individuals, to follow suit - not only by buying from the IMF, but also building holdings by small and steady purchases in the open market. This may already be happening given the considerable support being seen for gold every time it dips back a little from its recently much higher levels.