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Russia's Central Bank Buying Gold Isn't Quite What You Think It Is

This article is more than 9 years old.

The Russian central bank has been buying more gold this year. This could be taken as some form of support for the price of gold, could be taken as simply the bank deciding that the price has plateaued and thus the yellow metal is a good investment. That's certainly how some people are taking it. But it's more likely that it's to do with a small financial detail, a little wriggle in Russian public policy about precious metals sales. The combination of that little detail with the current sanctions meaning that the central bank doesn't really have much option but to purchase in domestically produced gold.

Here's Zero Hedge telling us about the purchases:

Russia's central bank Governor Elvira Nabiullina told the lower house of parliament about the significant Russian gold purchases. She is an economist, head of the Central Bank of Russia and was Vladimir Putin's economic adviser between May 2012 to June 2013.

This announcement is unusual and to our knowledge has not happened before. The announcement by the Russian central bank governor was likely coordinated with Putin and the Kremlin and designed to signal how Russia views their gold reserves as a potential geopolitical and indeed financial and currency war weapon.

Gold currently constitutes for around 10% of the bank's gold and forex reserves, she added. Official purchases were about 77 tons in 2013, International Monetary Fund data show.

We might, as above, take that to be a strong signal for the gold price. That isn't quite the way that I would read it though. The always excellent Craig Pirrong adds a little more to the story:

Russia’s central bank has been forced to step up its gold buying this year to absorb domestic production that Western sanctions are making it hard for miners to sell abroad, and to boost liquidity in its foreign reserves, sources said.

Most Russian gold mine production is sold to domestic commercial banks, such as Sberbank or VTB, which can then sell the metal on to either the central bank or to foreign banks.

This year, sources say, foreign banks are holding off buying Russian gold after Western powers implemented sanctions against the country over the Ukraine crisis.

And as Pirrong points out, the central bank can pay for that gold in rubles meaning that it can simply print the money to boost those reserves.

However, there is one more little wrinkle in the way that precious metals are treated under Russian law. Miners themselves aren't allowed to export them (my information is a little old but I'm almost certain that this is still true, I was working in Russia in the metals business when this system was set up). They must be sold by the miners, at market prices, to a select few domestic dealers in those metals and the central bank has the right to purchase at or near the market price. Certain of those dealers are allowed to make export contracts which is what is referred to above. But some of those dealers are being affected by the financial sanctions imposed which is what makes the western banks wary of contracting with them for the export.

If the miners were allowed to export directly, as most precious metals miners can in most jurisdictions, then the problem simply wouldn't occur. Because they would export directly and thus sidestep those sanctions affected intermediaries. At least part of this is therefore to do with the fact that the Russian state has promised to purchase, at market prices, all domestic production in return for which domestic producers must offer their production for sale through those approved channels. And if those channels get blocked, as they seemingly are, then the Russian state is obviously going to end up purchasing more domestically produced gold.

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