Fundamental analytics

Why did the Central Bank Gold Agreement collapse?

An agreement among European central banks to restrict the sales of gold was concluded in 1999. The main objective of this agreement was the coordination of European central banks to manage the gold reserves. In fact, the central banks of European countries refused to sell their gold reserves in excess of the limits set by the agreement. Also, European central banks actually “agreed” in 1999 to limit the volume of free trade in gold in order to exclude the mass exchange of the young and untrusted Euro currency for gold. Thus, the banking system supported the new single European currency and at the same time, further strengthened the influence of the London Gold Fixing. Subsequently, the CBGA was extended three more times. However, on September 26, 2019, the next extension of the agreement did not take place. What conclusions should experienced traders draw?

 

To answer this question, the FortFS analytical department draws the attention of traders to the fact that over the past 30 years, the most significant influence on gold has had a «weak» or «strong» USD policy pursued by the US Federal Reserve. The policy of central banks from other regions, including the EU, had a weak effect on the prices of yellow metal. Therefore, the key to the question must be sought in the prospects of the US economy and the current position of the FED.

 

The global problem the Fed is facing right now is that, on the one hand, the ISM Manufacturing Index fell to its lowest level in 10 years, which clearly indicates an impending recession, and on the other hand, the country's unemployment rate is at a record low level and the economy of the non-productive sector continues to boost. In such an ambiguous situation, a subsequent reduction in rates will lead to an even greater increase in unsecured obligations debt, an increase in risks in the stocks, assets and debt markets and an even greater imbalance between the manufacturing and non-manufacturing sectors of the economy, that will certainly lead to a systemic financial crisis. At the same time, both Donald Trump and investors are waiting and demanding from the Fed decisive action to reduce rates. According to the futures, market participants laid down almost a 90% probability of a rate cut at the Fed meeting in October. The most acute and unpleasant fact is that the current rate level is already slightly lower than it should be and it must be adjusted! However, such an adjustment will lead to the inevitable collapse of the financial markets. In fact, the Fed faces the most difficult task - to choose the lesser of two evils and subtly manage this process.

 

Having such complex and unpredictable situation around the US economy and politics, it is not surprising that the central banks of Europe want to rely on their gold reserves in case of a global economic crisis. This means that the leading economies of Europe are seriously considering scenarios of the global economic crisis and the possibility of selling gold to maintain their financial system. Therefore, any restrictions on gold transactions under the CBGA are unacceptable to European bankers. The mechanism of London gold fixing is also weakened, which gives gold even more freedom in determining its fair price on the market. This situation not only frees gold from artificial price limits, but also increases the role of gold as a universal reserve and means of payments during periods of economic turbulence. Respectively, in the global perspective, we will not be surprised if the price of gold will gradually rich $ 2000-3000 per ounce.

 

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