Asset Protection Strategies, STAFF NEWS & ANALYSIS
The New Era in Gold Repatriation Will Affect Everything
By Staff News & Analysis - March 05, 2013

Mexico to audit its gold holdings at the Bank of England … The Mexican Government Audit Office has issued an official statement, criticizing the Bank of Mexico for not auditing the gold it has supposedly bought and stored at the Bank of England. The auditors ask the Central Bank of Mexico to "make a physical inspection with the counterparty that has the gold under its custody, in order to be able to verify and validate its physical wholeness and compliance with the terms and conditions of dealing with this asset." – Voice of Russia

Dominant Social Theme: Trust us. Just trust us.

Free-Market Analysis: The move toward auditing gold holdings is getting more pronounced as we can see from this demand by Mexico in the above article excerpt. German officials have asked the US government for gold repatriation and so has Venezuela. Now it's Mexico's turn to start the process.

The old era in which central banking trust was ingrained in the system is gone now – and the ramifications are many even though they have not yet been felt. Central banks and bankers rely on joint programs and coordinated currency approaches. Without trust, strategies are difficult to create and programs are hard to implement.

This is not a hypothetical observation. As gold prices have moved up and Western currencies have looked increasingly subject to a currency competition, the pressure on politicians to assure gold reserves has increased. Couple this with the overseas storage of much gold reserves, and the situation becomes combustible.

In the case of Mexico, questions have been raised about the country's off-shore storage of precious metals and its ability to take possession if necessary. These concerns have been magnified by Germany's experience. Germany's Bundesbank intends to repatriate a large portion of gold reserves abroad and by 2020 seeks to have at least 50 percent of its total gold reserves at home.

This amount includes 300 tons from the Federal Reserve – which the US Fed may or may not have available. It is unclear, as the Fed refused to submit to an audit of Germany's gold. The apparent tension was compounded by the slowness of the repatriation. Germany will get its gold but not for seven years.

As for Mexico, well … there is a good deal of paperwork that must be sorted out – and Mexico is in much the same shape as Germany regarding overseas holdings of assets. Mexico's central bank owns gold but it might be considered "paper gold" as the actual physical holdings are not available. Here's more from the article:

The Government Audit Office has concluded that 95% of the gold reserves of the Bank of Mexico are stored abroad and 99% of this gold is stored with the Bank of England. However, the Mexican central bank has never inspected the gold it bought, has not performed purity tests on it and doesn't even have a list of all the gold bars stored in London. In their current state, Mexico's gold reserves are no more than "paper gold" in the meaning that the Bank of Mexico doesn't have any physical gold, but mere "claims" on a certain amount of gold supposedly held by the Bank of England.

Bill Gross, the Chief Investment Officer of PIMCO (the world's largest bond fund) has recently said that "Central banks distrust each other". The pending audit of the Mexican gold reserves is not a singular case of actions that show a high level of mutual distrust among central banks. The latest move of the Bundesbank, which demanded the repatriation of its gold holding from Bank of New York, Bank of England and Banque de France, is another sign of distrust in the world's financial system. It is quite probable that after the audit, Mexico will decide to repatriate its gold holdings, possibly prompting other countries to follow suit.

It is the distrust – increasingly in evidence – between central banks and governments that makes the issue of gold repatriation even more contentious. In a market environment increasingly marked by currency competition, government officials and bankers can be polarized by a lack of communication and difficulties in locating assets.

This is only bound to exacerbate tensions that are currently manifesting themselves in what are called currency wars. These currency wars are not going to subside any time soon and will probably expand in scope and vehemence as stresses and strains on the world's financial system continue.

The driver of these currency wars is exports. Countries want to export goods and services efficiently and inexpensively compared to global competitors. The easiest way to accomplish this is to debase currency. As a currency-volatility article posted at MoneyMorning points out, "Driving down your home currency relative to the currencies of the buyers of your products is a way of implementing a 'cover all bases' export growth strategy."

MoneyMorning also points out that the result of this maneuvering will lead to "disruptive volatility in stocks, commodities, and bonds." Multinationals will not necessarily do well in such a combustible environment. The translation from foreign currency back into dollars can inflate the bottom line in ways that are not realistic. MoneyMornings makes the case as follows:

When a foreign country's currency is higher and rising versus the dollar, it buys more dollars. That means you can have a situation where a company's sales overseas are flat or negative (which would be a warning sign) but because the money was earned overseas and then translated (for accounting and reporting purposes) into dollars, it looks like their earnings were higher.

MoneyMorning presents the idea that the dollar may be the best bet in a volatile currency environment. We're not so certain about this. If it turns out that the Fed itself does not have access to as much gold as it maintains, then the dollar, too, could be drawn into a prolonged debate over paper gold and reclamation of precious metals.

It is not yet clear who possesses how much gold in the murky world of central banking holdings. But as these issues are sorted through, the impacts on currency valuations will likely be significant. Issues of gold holdings and repatriation are interlinked with currency valuations and both bear watching.

After Thoughts

The old era of central bank trust has waned. The new era will be significantly more contentious, or so it seems.

Posted in Asset Protection Strategies, STAFF NEWS & ANALYSIS