Russia's Big Lesson For Gold Investors

December 30, 2014

Russia's giant gold reserves have done nothing to protect Russian savers from the collapse of the ruble.


This article first appeared on BullionVault and is republished here with permission.

Russia  has been the world's biggest central-bank buyer of gold in 2014, taking its national holdings into the top five worldwide.

But Russia's huge central-bank gold demand has done nothing to stop its currency and economy crashing, an awkward truth for hard-money fans in the West who think central-bank buying always signals strength and vigor.

Now some traders fear Moscow could dent the gold price and related ETFs like the SPDR Gold Trust (GLD) by selling some of its hoard to raise dollars and euros, and then selling them to buy rubles and try to support the currency's FX rate. Indeed, it seems one overexcited translation of a Russian website has even led a professional bank analyst to say it is "possible the Central Bank of Russia has started to sell off some of its gold reserves in December."

In reality, the CBR was still adding gold in November, and the odds are very slim that it will dare sell any gold yet, much less report it to the world: 1) because there is another state-owned stockpile of precious metals to get through first—palladium; 2) because even cold cash is unlikely to trump the political value of Russia's gold reserves.

It was late in 2005 when President Vladimir Putin publicly approved a plan from the Central Bank of Russia (CBR) to double Russia's state gold holdings. He set the target at 10 percent of total reserves by value, a level lost after the 1998 ruble crisis as Russia first sold down its gold holdings near 20th-century lows, and then as it hoarded up dollars and euros thanks to the surge in energy prices.

Putin in 2005 also noted how, alongside the country's huge underground reserves of crude oil and natural gas, Russia is rich in unmined gold. Proposing government support for new projects and refining plants, he told reporters, "I believe the role of the state in this field should be rather significant."

Moscow's "significant" role in gold came to the fore in 2014, both globally and for the domestic mining business. Today the CBR lags only the central banks and Treasurys of France, Italy, Germany and the United States in the gold reserves it reports to the world. Holding some 1,188 tonnes, now worth more than $45 billion at current prices, the CBR holds Russia's largest hoard since the last Romanov Tsar topped 1,200 tonnes, right before the outbreak of WWI and the Bolshevik revolution that killed him.

But while the CBR, Russian media and Western gold-bug websites have trumpeted this year's doubling of Russia's central-bank gold buying from the pace in 2013 (both 2009 and 2010 were bigger, however), the jump also came as Western sanctions over Ukraine and Crimea hit some Russian banks. That in turn effectively shuttered the world market to much of its gold mining output, now the third-largest after overtaking the United States' gold mine output for the first time in a quarter century.

Some 175 tonnes of gold were newly mined in Russia during the first nine months of 2014. Moscow meanwhile bought 114 tonnes, and word among Western bullion bankers is the two are closely related. Indeed, should sanctions be eased, one predicted in November, Russia's gold buying would likely pause too. Now in December, some Western gold traders think the CBR will start unloading metal as it sells down foreign reserves to try and bolster the ruble. Because, to quote the CBR, things are "critical".




In the third week of December, Moscow put $7 billion of its $373 billion in foreign cash reserves on the slate, and analysts think a further $70 billion of dollars and euros could be readied to sell for rubles. The plunge to five-year lows in crude oil—which together with natural gas accounts for three-quarters of Russia's exports and half of all government revenues—meantime shows no signs of reversing any time soon. State-owned energy giant Gazprom might fire 15-25 percent of its 450,000 staff. Yet Moscow has said it doesn't plan to cut the nation's 2015 oil output targets, joining the OPEC oil-cartel states in leaving the market oversupplied for next year.

With interest rates now hiked to 17 percent—the highest since 2003 (but still way off the spike to 150 percent following Russia's 1998 bond default)—Moscow is also taking the next classic step in a currency crisis and applying exchange controls, despite Russian Prime Minister Dmitry Medvedev hinting Wednesday that the CBR wouldn't try to stem capital flight. Many large corporations owe his boss and rival, Vladimir Putin, a favor or three. Now they're being told to swap the euros and dollars they own for rubles from the central bank. Western sanctions are also helping slow the outflow of money, a perverse outcome for Western politicians.

Stuck inside the rocky Russian currency, Russian citizens—who have now been here three times in 20 years—are taking their cue to buy whatever they can grab with spare cash before it sinks in value again. Cartier watches, the cheapest iPhones in Europe from Apple (NASDAQ:AAPL) and mispriced goods from Ikea have all flown off the shelves. For the speculator who can raise a loan, real estate will also appeal, as it does in any currency collapse.

Private Russian gold buyers don't need telling that Moscow's huge state reserves have done nothing to defend private savings so far. Don't expect that hoard to be used for defending the ruble any time soon either. Far more likely is the sale of whatever palladium now sits in government stockpiles instead.

Palladium is primarily used in catalysts to reduce emissions from automobile engines. It has no history as money, and 91 percent of annual demand today comes from productive and industrial uses, rather than investors or jewelry consumers. Russia is the world's largest palladium mining nation, and the government holds untold quantities, bought from domestic miners but unreported in public. Trying to guess how much is held by Gokhran, Russia's 'State Precious Metals and Gems Repository', analysts and traders had thought Moscow's government stockpiles were run down near zero after that secretive agency's annual sales fell from 31 tonnes in 2010 to just 5 tonnes last year.

This September Russia's largest palladium miner, the privately held Norilsk, said it was in talks to buy palladium from the government, meeting with the central bank rather than Gokhran and putting the "opportunity" at $2 billion—some 80 tonnes at current market prices of $795 per ounce.

"Palladium is not a gold and currency reserve," Norilsk's CEO Vladimir Potanin had already told reporters this spring, ahead of the proposal. "It should be sold rather than bought by the state. We could help, and not only by buying those volumes, but by marketing the deal."

The CBR needs foreign currency to sell in the FX market to try and defend the ruble. Whatever palladium it apparently holds has already found a ready buyer in Norilsk. Selling palladium also offers the advantage of taking a 10 percent gain in US dollar terms for 2014, with prices at the highest year-end level since the huge spike of 2000.

Selling gold, in contrast, would mean selling a prestige asset—the ultimate "crisis money" as former US Fed chairman Alan Greenspan put it this fall—near five-year lows in dollar terms. That would signal that this ruble crash is indeed the ultimate crisis for Putin's Kremlin, as well as denting Moscow's claim to be "leaving the Dollar dictatorship" which rules global trade by pricing near-everything in US money. That in turn could tarnish Putin's "strong man" image and huge approval rating at home as well.

Fact is, Moscow's gold strategy over the last decade has made the metal a key symbol of Russia's revived strength and stability. The political power of today's huge CBR gold reserves is worth far more to the Kremlin than its cash value. The lesson for Western investors expecting gold to protect their money, meantime, is to buy it themselves. Even record-high central bank holdings won't help.

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