Will the IMF Gold sale plan work?

St. LOUIS (ResourceInvestor.com) -- On Saturday, the Group of Seven (G-7) approved the sale of gold by the International Monetary Fund (IMF) from April as part of a broad reform of its budget. But this isn’t the first time gold sales have been approved and subsequently blocked, which raises the question of how this proposal would be any different.

With an annual deficit of about $400 million and a looming global economic slowdown, it stands to reason why the IMF wants to sell some of its gold. The fund is spending $1 billion a year but only bringing in $600 million, while holding 103.4 million ounces (3,217 metric tonnes) of gold worth about $92 billion at current prices - up from $23 billion just 5 years ago.

Italian Economy Minister Tommaso Padoa-Schioppa, also the head of the IMF’s steering committee, said at the meeting between Britain, China, France, Germany, Italy, Japan and the U.S. that “there was an acceptance among the G-7 that resources should be raised by selling gold ... the current gold price means a flow of income can be ensured.”

He said the agreement would be finalised in April and would complement spending cuts being drawn up by the IMF under new Managing Director Dominique Strauss-Kahn. But any sales of the IMF's gold must be approved by 85% of the organization's total voting power.

The United States, as the largest single member nation, and the largest single contributed of the IMF's gold, holds a crucial 17% of that 85% voting power and can effective veto the proposal. The U.S. previously blocked an attempt to sell IMF gold to the market formally in 1999 and informally 2005.

Matt Turner, metals analyst for VM Group, said the G7 meeting basically implies that the administrations of the countries involved are happy with the plan, but the “U.S. Congress is yet to give its authorisation.”

“So it's not clear whether it will pass Congress - for various reasons they might not agree,” he added.

In 1999, for instance, the U.S. Congress blocked on-the-market gold sales for debt relief citing concerns about the impact on the gold price as well as a broad belief that the gold belonged to the members and any surplus should be returned to them. Some were even against any IMF funding, preferring the Fund to be slimmed down or closed entirely, according to Turner.

As a result, in December 1999, the Executive Board authorized off-market transactions in gold of up to 14 million ounces to help finance IMF participation in the Heavily Indebted Poor Countries Initiative. Off-market transactions involving a total of 12.9 million ounces of gold were carried out between the IMF and two member nations, Brazil and Mexico.

This weekend’s announcement follows a recommendation in late January by an esteemed group of eminent persons, including former Fed Chairman Alan Greenspan and current President of the European Central Bank Claude Trichet, advocating on-the-market sales of up to 400 tonnes of gold by the IMF as means to finance ongoing costs.

In a report submitted to the IMF Executive Board today, the Committee, headed by Bank of International Settlement head Sir Andrew Crockett, concluded that the IMF's current income model, which relies heavily on the interest it earns from loans to member nations, is “no longer appropriate.”

At that time, the fund estimated gains about $6.6 billion in revenue with the sale of 400 tonnes (12.9 million ounces) at $500/oz. Investment of the proceeds would yield approximately $195 million per year, assuming a real rate of return of 3%, according to the committee. At $900/oz gold, revenue would increase to about $11.5 billion.

However, the Committee made clear that it wanted the gold sales to be limited to 400 tonnes sold in a way that didn't disrupt the market, much like gold sold consistent with the European Central Bank Gold Agreement (EGA), which limits sales to 500 tonnes per year.

“So the assumption was that they would have a bit of Germany's unused quota, or it might spill over into another EGA,” said Turner.

So far in the fourth agreement year of the EGA, European signatories have reported sales of about 118.6 tonnes, although some January sales have yet to be posted. Current estimates suggest gold sales through January total a little more than 131 tonnes. But minus sales by Germany and Italy again this year, most analysts agree that banks will fall short of the 500-tonne quota.

Dennis Gartman, editor of The Gartman Letter, told subscribers in today’s Letter that the IMF needs the income and “we are not surprised by the announcement, although we suspect that others are.”

He noted that the agreement would not be finalized until April, “so the real pressure upon gold shall not come until then ... for the moment we have to report that the market has ‘taken’ this news very, very well indeed.”

This morning, New York spot gold prices opened only marginally lower, showing a $1.40 loss at $921.90 after having traded in a band of from $920 to $928 overnight. Currently, spot gold is trading down $1.60 at $921.60.

James Moore, precious metals analyst for TheBullionDesk.com, said in an e-mailed market update this morning that dip buying is expected to provide ongoing support in the market. He expects gold to challenge the metal’s $936.80 high, “although the approval of IMF gold sales by G7 members may dampen some of the metals bullishness.”

Jon Nadler, senior analyst for Kitco Bullion Dealers, said it is a bit too early to call the issue a win or a loss for gold since the precise size, timing and methodology of the disposals is still unknown.

“Opinion remains divided as to whether the proposed sale will or will not impact gold market prices and/or psychology at a time when the yellow metal is trading within $10 of its all-time peak,” said Nadler.

He suggested that readers continue to watch the U.S. dollar and equity markets as prime movers for the precious metal, however, added “we will not ignore the developments on the IMF front and consider them ‘case closed.’”