Bank of England auction highlights decline of gold

Disaster, slump, crisis: the sound and fury that accompanied last week's gold auction in Britain may have suggested that the end of the world was just round the corner. But consider a few facts. Ten days ago, the Bank of England sold 25 tonnes at close to the market price: about the quantity the South African miners ship in a fortnight. So far this year, the price of gold has fallen from $288 (€282) to around $258 (€253) an ounce: a drop of 10.5 per cent.

Over the same period, the euro has fallen by almost 13 per cent against the dollar. Or look at the FTSE 100 index, that bulwark of solid investment.

Since the start of this year, 13 of the 100 Footsie companies have fallen by more than 10.5 per cent. A fall of 10 per cent over six months is not unusual in financial markets.

There are several reasons for the disproportionate fuss made about the gold auction, and the price fall. The metal's changing role has created real uncertainty about where the price is likely to end up. It has been in intermittent decline for nearly 20 years, and falling prices tend to breed paranoia and conspiracy theories. The Bank of England's auction has been a convenient whipping boy. And the pro-gold lobbyists have become unusually vocal and aggressive.

Gold is a metal in transition: it no longer has an official role as money, but is not yet a simple commodity. Like most fundamental changes, this one is creating a lot of uncertainty, price volatility and worry, particularly in the countries and businesses built up around the old certainties. The beginning of the end of gold as money occurred in stages. Until 1968, the official price was pegged at $35 an ounce. Then came a brief two-tier market which collapsed along with the Bretton Woods system of fixed exchange rates.

In 1975, the US allowed its citizens to own gold and, in the second half of the 1970s, both the International Monetary Fund and the US sold substantial quantities, using the auction mechanism. So, governments and central banks, which had been big buyers of gold throughout history, became sellers. The metal was allowed to find its own price level, and speculative investment funds have become important players in the market.

At present, demand exceeds annual mine production, but there is so much of the stuff already above ground (mainly in jewellery, central bank vaults and private hoards) that normal supply/demand sums are inappropriate.

In the late 1970s, the bullion price surged, reaching an all-time peak of $850 an ounce in 1980, thanks to pent-up demand, the second oil shock, several currency crises, wars and near-wars, stagflation, and other little worries that made the yellow metal look a safe haven.

It has been a more sober story thereafter. In the 1980s, the collapse of the dollar, or a sudden crisis, such as the 1987 stock market crash, would at least send people scurrying into gold temporarily. Recently, neither the collapse of large parts of Asia nor that of Long Term Capital Management, the hedge fund manager, provoked so much as a blip.

Miners have tended to blame the falling price on the series of sales by central banks, and the fear of more to come. Some analysts point out that the growth in holdings of other types of investment, including derivatives, have simply marginalised gold.

Nowadays, most gold miners hedge against metal price falls by selling forward.

This year, the Bank of England's pre-announced auctions have given the industry a handy scapegoat. Britain is not a big gold-owner: it scrapes into the top 10 just ahead of Portugal. Its planned disposal of 415 tonnes in total over the next few years is substantially less than the 1,300 tonnes Switzerland plans to sell.

The main reason this rather small auction received so much publicity was the unusual amount of high-profile opposition. The World Gold Council, a lobby group funded by some of the large gold mining companies, has attacked both the British sale and the IMF's planned disposal of 300 tonnes. It has organised a Hold Onto Our Gold campaign.

Several African politicians have accused Britain and the IMF of damaging their economies and putting miners out of work.

The effect could well be to scare any remaining investors out of gold. But even contrary thinkers will have to search hard to find any positive reason for buying gold now.