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The U.S. Treasury’s Hidden $350 Billion Asset
“We are in the vicinity of Fort Knox…In fact, on a warm night, you can smell the gold… There’s something about the soil in and around Fort Knox that gives a magic quality to gold. The gold radiates a powerful influence throughout America. It activates assembly lines in Detroit, it makes skyscrapers sprout from the gutters of New York, and it produces a bumper crop of millionaires.”
– Finian McLonergan, from the 1968 movie version of the 1947 Musical “Finian’s Rainbow”
After World War II, the U.S. held most of the world’s central bank gold. Many of the major nations in Europe also chose to store their central bank gold in America for safe-keeping in case another World War broke out – specifically, a widespread fear of Russian tanks rolling west from Soviet-run East Germany.
The 1947 Broadway musical Finian’s Rainbow captured the popular fascination with U.S. gold stored at Fort Knox. That play was quickly followed by two popular gold-centered movies, “The Treasure of Sierra Madre” (1948) and “The Lust for Gold” (1949). In that same year (1949), the volume of gold in the U.S. Treasury peaked at 701.8 million ounces, worth a then-significant $24.6 billion, based on $35 per ounce.
In 1950, the Treasury began to hemorrhage that gold, slowly at first, then too rapidly for comfort. Due to the costly Korean War and the ensuing Cold War, the U.S. began running deficits while some other rising industrial powers, including former foes Germany and Japan, began running trade surpluses, resulting in a growing glut of U.S. dollars. Nations began redeeming those dollars for gold. That was their right, as the post-war Bretton Woods global financial system made the U.S. dollar convertible to gold at $35 an ounce.
From 1957 to 1968, America suffered a run on gold. The volume of Treasury gold was cut in half, from 653 million ounces in 1957 to 311 million ounces in 1968, when Richard Nixon was elected President.
U.S. Treasury gold kept declining until 1971, when President Nixon closed the gold window and revalued U.S. gold at $42.22 per ounce – a lowball figure that still determines the official value of Treasury gold!
As it turns out, closing the gold window in 1971 was the best investment move the Treasury ever made. Without that bold move, U.S. gold would eventually have disappeared, but now we hold 261.5 million ounces, worth $350 billion at $1,338 per ounce, but only valued at $11 billion on the books (at $42.22).
I’ll repeat that: U.S. gold is valued at $11 billion on the books, but it’s really worth $350 billion. That’s a great investment! Good things tend to happen when you stop selling your nation’s greatest financial asset.
Since 1971, the U.S. has held at least 260 million ounces of gold. As of the latest accounting, the U.S. holds exactly 261,498,926.23 Troy ounces of gold, or about 8,134 metric tons (each ton contains 32,150 Troy ounces, or 2,205 pounds). According to the Treasury accounting of August 31, 2016, most of that gold (over 147 Troy ounces) is held in Fort Knox, Kentucky, followed by West Point, New York (54 million ounces and Denver (44 million ounces). Most of the rest is stored at the Federal Reserve of New York, 80 feet below the street level, 50 feet below sea level and 30 feet below the nearby subway line.
Central Banks Mostly Sold Gold when it was Rising
(and Bought Gold after it First Reached $1,000 per ounce)
Even though the gold standard is officially dead and buried, around 20% of all of the gold ever mined is held by the central banks of the world. The U.S. remains the #1 holder of central bank gold by a long shot, holding more than twice as much gold as second-place Germany (at 3,378 metric tons), but the nations rising fastest in central bank holdings are #6-China (over 1,820 tons) and Russia (1,500 tons).
Central banks – like many other investors – tend to sell low and buy high. The total of all central bank gold peaked over 50 years ago, in 1965, at 38,350 tons, eventually sinking to barely 30,000 tons in 2009, when gold first penetrated the $1,000 barrier. Since October 1, 2009, gold has traded above $1,000 every day for nearly seven years, so all of the net central bank gold purchases since then – about 2,800 tons – have been at prices over $1,000 per ounce. As the chart (below) shows, central bank gold sales peaked in 2005, when gold averaged $445 but central bank gold purchases peaked in 2013 at an average $1,411/oz.
Entering Gold’s “New Age” of Central Bank Accumulation
A report by the Official Monetary and Financial Institutions Forum (“Seven Ages of Gold,” September 19, 2016) covered this central bank gold story in more detail. These seven ages cover 200 years. The latest period (VII) began after the financial crisis in 2008 with the return of gold to favor among central banks. Since then, OMFIF said, “central banks in both developed and developing countries have shown a new fondness for gold, rebuilding its importance as a bedrock of most countries’ foreign reserves.”
In short, the rich (“developed”) nations have been holding on to their large gold hoards, while a select few developing countries have been building up their gold reserves, gradually at first and faster since 2011, a year when the U.S. narrowly avoided a crisis of confidence in Treasury debt after S&P downgraded U.S. bonds and America narrowly avoided a government shutdown due to an impasse over the debt ceiling.
Since 2008, central banks have bought a net 2,800 tons of gold. The total official holdings of central bank gold as of mid-2016 stands at 32,805 tons – about 15% less gold than they held in 1965. That gold has entered private hands. Although there is no official gold standard, the tug of war between central banks and private investors keeps a floor under the price of gold. In particular, gold buyers in the two primary gold demand markets – China and India – are price-sensitive, buying more gold whenever the price falls.
Coming up to the present, central bank purchases were sub-par in the first half of 2016 – totaling 185 metric tons (a 340-ton annual rate), about one-third below the average pace of the previous five years – but we have some indications that the pace of central bank gold buying is picking up in the second half.
In its latest announcement, the Russian Central Bank said that it added 700,000 Troy ounces of gold in August, raising its total holdings to 49.1 million ounces (1,527 metric tons). August marked the largest single monthly increase of Russian gold in 2016. So far in 2016, Russia has purchased over 3.6 million ounces (113 tons) of gold, up slightly from the 109 tons it bought through the first eight months of 2015.
Last year, Russia accelerated its purchases in the final four months of the year, buying almost as much gold (99 tons) in four months as it bought in the first eight months (113 tons). If that pattern holds for the last four months of 2016, that should add to other favorable seasonal factors in the late-2016 gold market.
We’re Right on Schedule to Start “The Golden Season”
So far this September, gold is up 2.2%, from $1,309 on August 31 to $1,338 on September 23. As we reported here earlier this month, the fall months mark a time of major gold accumulation in India due to its festival season, including Diwali (in late October) and the ensuing wedding season. This year, Indian farmers are likely to buy a lot more gold due to a healthier rainy season during this summer’s monsoon.
In addition, Chinese jewelers will soon start accumulating gold for its New Year season, coming earlier than usual, on January 28, 2017. We haven’t heard much about China’s central bank gold buying lately, but they have been consistently adding more gold in recent years and they currently hold only 2% of their exchange reserves in gold, leaving a lot of room for more gold buying in advance of a yuan devaluation.
On the negative side of the ledger, Venezuela has had to sell about 100 metric tons of gold since last December to help feed their starving population. That drain on net central bank gold buying may be over, as it looks like Venezuela has sold no further central bank gold (so far) in the third quarter of 2016.
Speaking of central banks, the U.S. Federal Reserve’s decision not to raise interest rates at its latest meeting of the Federal Open Market Committee (FOMC) last week gave a boost to gold prices, as we predicted in May and August. This is a predictable short-term trend: Gold goes up when the Fed delays rate increases and it tends to go down when Fed governors talk up the likelihood of a new rate increase.
In other fundamental factors, we have a coming election in America which should boost the price of gold, no matter who wins. If Donald Trump stages a surprise victory in November, gold could rise far more rapidly than under the more predictable Democratic candidate… but that’s another story for another day.