If you are planning to invest in gold to minimize volatility in your portfolio through diversification or to create a stable and secure asset pool for your retirement or for any other reason, you should learn more about the IMF effect on gold prices and plan your strategy accordingly.
Due to golds characteristic as the safest investment option in the world today, its prices are influenced not just by demand and supply but by policies of Central banks of sovereign nations and international organizations like the International Monetary Fund as well.
The IMF holds around 2814 metric tons of gold, which is worth, at current prices, around $144 billion. Now this huge amount of gold enables the IMF, if it so wishes, to influence not just current prices but the long-term movement of gold prices in the futures market as well.
Reasons Behind the IMF Effect on Gold Prices
How did the IMF end up holding so much gold in the first place? Until the early 1970s, gold served as the currency for all transactions between sovereign nations and international institutions.
A quarter of the quota subscriptions payable by countries had to be made in gold. All interest and principal repayments had to be made in gold and countries could also sell gold to the IMF to buy a foreign currency. All this led to a steady accumulation of gold in the hands of the IMF.
In 1978, the obligatory use of gold in transactions with the IMF came to an end. The Second Amendment to the Articles of Agreement of IMF prohibited the institution from managing gold prices or dealing with it at a fixed price. Further, the IMF was prohibited from buying further gold and using its gold holdings in transactions that did not involve permanent change in ownership. All this contributed to the IMF effect on gold prices as the institution now became a holder of gold that could be disposed off through only an outright sale.
IMF Gold How Does it Work?
Let us look at how the prices of gold in the market can be affected by the IMF.
Firstly, any decision by the IMF to sell gold will have a dampening effect on gold prices. This was seen in 2009-10 when the IMF decided to sell 400 tons of gold to implement a new income model and put its finances on a firm footing. Despite deciding against disrupting the market, gold prices suffered a hit when traders realized that gold supply will increase by 400 tons.
The fact that the IMF cannot lease its gold or carry out any transaction that does not involve permanent change of ownership means that any decision related to gold will invariably result in a drastic increase of supply of gold in the market.
The fluctuation in the prices can affect the overall value of your gold holdings; it can also represent a wonderful trading opportunity for decisive traders. A temporary slump in prices can be used to increase your gold holdings and reduce overall cost of acquisition through averaging. This will leave you in a position to enjoy better returns when the inevitable increase in prices once the increased supply is factored in by the market.
Secondly, the IMF does not operate in a vacuum. It is a global body with sovereign nations as its members and may step in to bolster the global economy through more gold sales if such a move with benefit its members. Apart from selling gold as a strategic move, the IMF can resort to such sales as a tactic to boost the sagging global economy. Of course, such a decision will not be arrived at lightly but such a move is not impossible either.
Hence, gold investors cannot afford to ignore the possibility that the IMF may use its gold reserves as a safety valve to give a boost to the economy if such a move is considered necessary by all its members.
Thirdly, decisions by the IMF can affect profits and share prices of gold mining companies, valuation of gold ETFs and the prices of all gold-based derivatives and securities even though the IMF does not have any direct connection with such entities and financial instruments.
Increase in supply of gold will reduce the profitability of gold mining companies, thereby affecting their share prices negatively. The sale of gold by the IMF may not have a direct impact on the quantity of gold mined by such companies. Yet, the perception of increase in supply can and does have an impact on share prices of gold mining companies.
Gold ETFs and other gold-backed derivatives too may see fluctuations in their prices. For example, India purchased 200 tons of the 400 tons put up for sale by the IMF in 2009-10. Investing in gold-based ETFs in India can help you boost your gold holdings in a short period of time as the excess supply can cause price variations in India as compared to other countries that have not purchased gold from the IMF.
In such a scenario, switching to physical gold assets or diversifying your gold portfolio to include securities from different countries may be a good move. If you are long term investor, then increasing your holding in physical gold as well as gold derivatives will help you earn good returns in the long run.
In the long run, the fact that gold is the safest store of economic value may result in reduction in price and volume volatility. However, the short term impact of a decision like sale of gold by the IMF can make a huge difference to your investment strategy.
On the whole, the fact that the IMF has so much gold at its disposal and enjoys the right to put it up for sale as and when it desires cannot be ignored by gold investors when planning their gold investment strategy. Hiring a reputed firm to manage your gold portfolio and relying professional advice when investing money in gold will ensure you are in a position to take advantage of any change in the gold market brought forth by participants like Central banks and the IMF.