Commodities & Futures: Dutch gold sale could mean the end of the affair

GOLD bugs were stunned last week by the news that the Dutch central bank sold 400 tonnes of its gold reserves last year.

Prices plumbed seven-year lows as professionals tried to digest what sounded like a Western government's clear vote of no confidence in the precious metal. Why would the Dutch central bank sell that quantity of gold unless it had lost faith in its value, the market asked.

If the Netherlands is doing it (following big gold sales by Belgium in 1990 and in June last year) why should not other Western central banks follow suit? And if they do, won't the gold price collapse?

The Swiss central bank said on Friday that it had no plans to sell gold reserves, and was legally restricted from doing so. But experts were still nervous. '(The Dutch sale) doesn't augur well for what other central banks may do and it doesn't augur well for the gold price,' Philip Crowson, mining analyst at RTZ Corporation, said.

Speculation abounded last week about how the central bank might have sold dollars 4.3bn of gold right under the market's nose, leaving no clue. Did it have help? And who bought it from the Dutch?

By Friday, gold trading in London and New York was at a virtual standstill with investors unwilling to take new positions because of the uncertainty.

After all the fuss, prices fell only about dollars 2 on the week, closing in London on Friday at dollars 327.50 compared with dollars 329.25 last Friday.

The panic showed that, even though gold has gone out of style as a financial investment in the past few years and has done nothing but disappoint its fans, it continues to fascinate.

Yet it is impossible to say whether gold will ever be the darling of the markets again, as it was in 1980 when it touched dollars 850.

The financial deregulation of the past 10 years has awakened potential investors to a huge new variety of investment alternatives that promise returns when gold cannot. Gold must compete with bonds, shares, unit trusts and derivative markets such as futures and options, to name a few.

Mr Crowson said: 'With deregulation, positive real interest rates and a weak inflation outlook, there is no reason people should be interested in physical assets when they are going to make more money in paper assets.'

Andrew Smith, precious metals analyst with Union Bank of Switzerland, believes gold's 10-year price fall reflects a transformation under way in the market.

In the mature gold market of the 1990s, 'investors are spoilt for choice', Mr Smith says. Private investors have liquidated some 40 per cent of their holdings in Europe since 1987.

Jewellers are tapping the developing world for business, rather than the high mark-up accessories market in industrialised countries that provided a rich seam in the 1980s.

Producers, formerly reluctant to hedge gold, are comfortable with a range of financial market hedges. Demand and supply are more responsive to price today, and mines will cut output if it is not economic.

Central banks, which used to sit on their piles of reserves, are selling. They have 35,500 metric tons of gold at their disposal, some 15 years' mine output.

During the inflationary 1970s, European central banks bought thousands of tons of gold from the US after it abandoned the gold standard. They wanted to build up reserves at a time when international currencies were depreciating. Now, EC central banks are holding about 14,000 tons of gold earning low returns.

After the Netherlands' sale, it has about 40 per cent of its reserves in gold, compared with 59 per cent in April 1992. The EC average is 35 per cent, with Britain on the low end at 16 per cent, and Italy and France at around 57 per cent, International Monetary Fund figures show.

Some analysts predict that last week's announcement could have a profound psychological effect on the gold market, at least initially.

Producers may hedge further into the future to lock in prices and sell immediately prices rise. Investors and speculators may stay away.

Certainly, the uncertainties surrounding the Dutch sale and its settlement will continue to preoccupy the gold market in coming weeks. Participants will be looking for signs of a counter-party to the deal buying gold.

But for those readers still enamoured with gold, never fear. Though the West may have ended its love affair with the precious metal, much of the rest of the world still adores it. Double-digit inflation, war and political strife in many countries mean that many would still like to hide a bar or two under their mattresses.