Select Committee on Public Accounts Minutes of Evidence

Examination of Witnesses (Questions 120-140)



  120. Can I take you on finally to the assets you hold. How much do you hold in cash? You have to intervene in the market every so often, so presumably you have to do that in cash terms?
  (Mr O'Donnell) No.

  121. Do you hold cash in any significant quantities?
  (Mr O'Donnell) No.

  122. So you are given time to realise your assets?
  (Mr O'Donnell) We can intervene, given the expertise of the Bank who would do it for us, very quickly. It is possible to generate funds which can be used for intervention very quickly, given the funds we hold which are not cash but interest-bearing.

  123. I wanted to come back to this 40:40:20, which I understand is long-term and that seems sensible in terms of Government policy. How often would you review that position in relation to the changing fortunes of the economies involved in each of those currencies? We know Japan had and continues to go through some difficulties. The American economy may be going into difficulties. The European economy may be coming out of difficulties, we do not know. How would you balance those judgments and how often do you review the overall proportions of the percentages you hold in each currency?
  (Mr O'Donnell) We certainly are in continuous touch with the Bank in terms of what is happening to the overall foreign exchange account. We publish monthly what is happening, there are monthly meetings between the Bank and the Treasury, and in particular we have six monthly meetings where we look at more long-term strategic issues.

Mr Campbell

  124. I have a couple of questions following on, very much from the point of view of the layman. I want to take you back to this question of significance, because I recall some months ago if one had listened to some commentators one would imagine the sale of gold would have led to the economic roof falling in, and actually the NAO Report demonstrates this clearly is not the case. If you look at Figure 16 on page 20, and you look at the price which would have been attained using the London Gold Fix compared to the auction price, the significance is something like 1.6 per cent. Not only is that not statistically significant, it is not really significant at all, is it?
  (Mr O'Donnell) No, I agree. The point being, it is very useful we have a benchmark here we can look at. It is one of the best benchmarks one can have but we know we are auctioning at the same time they are doing a Fix, so we can look at the differences between the two. That is what the NAO have done and those are the numbers. I would have been surprised if they had shown big differences.

  125. Similarly, something else which has come up quite a lot this afternoon, what has happened to the money which was gained from the gold sales—40 per cent into dollars, 40 per cent into euros, 20 per cent into yen? If one takes a longer-term view of that, that is not significant either, is it? I may be naive in this but if money is going away from the dollar, it is going into something else, probably into euros or probably into yen, so actually it is not going to do us very much harm wherever the money is going, unless something fundamental happens.
  (Mr O'Donnell) Two points I would make about that. One is that is precisely why we diversify the portfolio, so we are not putting all our eggs in one basket. If it was all in dollars and the dollar went into long-term decline, we would have a problem. The second point to note, of course, is that the one thing we are doing is moving out of an asset which basically has an interest rate of around half a per cent into interest-bearing assets in the old currencies.

  126. That is the third point I wanted to raise with you. Looking at Figure 1, the really significant thing is what has happened to the price of gold over a period of 20 years, and if one was looking for good value for taxpayers one would have to say that as those 20 years have progressed better value was found outside gold as opposed to holding large amounts of gold. Is that broadly true?
  (Mr O'Donnell) With hindsight that is true. The question is, could you have predicted that in advance.

  127. But you used the phrase earlier, I think, that it was a good bet, and history has demonstrated—and again hindsight is a wonderful thing with regard to history—that gold has not really been a very good bet over the last 20 years or so, has it?
  (Mr O'Donnell) Its price has fallen substantially from that peak, but if you look back to the 1970s you would find a period of gold price rises. So you have to be careful about which periods you choose.

  128. We have heard a great deal this afternoon about transparency and fairness and the idea that the UK has been leading the way on this. What, in your view, has been the downside of that? What has been the cost of being so transparent and going out of our way to be fair? Has there been a cost?
  (Mr O'Donnell) I do not think there is a cost in being transparent. I think what transparency does is enhance your reputation, for us as big operators potentially in the market, big owners of large foreign exchange reserves, markets know we will operate in an open, transparent and predictable fashion, and that reputational gain spills over into other areas. It means, for example, we can borrow money from the markets, if you go out to 20 or 30 years, more cheaply than any other country, as far as I know, with the possible exception of Japan which is a special case, I have to say, and maybe Switzerland. Compared to, say, Germany, the United States, France, we can borrow money more cheaply, so our reputation matters a lot to us and openness and transparency, although you cannot pick it up in any one particular area, generally feeds through and enhances the reputation of the authorities, and I think that is useful.

  129. I am sure there are many people wanting to bend your ear at the outset with very good advice, but paragraph 3.23 says that over half the members of the London Bullion Market Association were concerned that their experience was not sufficiently used in the route that was taken. Should we read anything into that or would they have said that anyway?
  (Mr O'Donnell) We went down the route which was basically auctions, where the Government is selling it, so in a sense I am not completely surprised by that statement. But it is important for us to listen to the markets and there are at the moment on-going consultations with the LBMA about reviewing our processes, so we talk to them a lot.

  130. In Figure 15 I am interested in the idea of game playing, the idea that the volume of gold trading might be reduced prior to an auction. Is there evidence, from what you have seen now of ten auctions, of prices being artificially depressed before an auction?
  (Mr O'Donnell) Interestingly not. We can compare what happens in the gold market with what happens when we auction bonds, which we do very regularly, and one can see the differences in the market shorting position before an auction and what happens in the auction price. Paul might be able to give you the numbers on that.
  (Dr Mills) Coming at it from my experience of the gilt market where you generally see some cheapening up of the bond before the auction because you have to attract buyers and market makers are pre-selling it forward, you do expect the price to fall somewhat because effectively that is the equivalent of your underwriting fee. You are asking the market to take the supply and they essentially require a small incentive to do that. This does not seem, as yet, to have occurred that much in the gold market and on the whole the losses on the swings are outweighed by the gains on the roundabouts and there does not seem to be a clear-cut pattern that gold necessarily cheapens up just before an auction. Sometimes it does and sometimes it does not. We have a wide variety of auction results just from the ten. There does not seem to be a clear-cut pattern. To me that is as good as we can expect if not better than we anticipated. I would have thought that auctions would have under-performed the Fix because to sell this amount of gold you would expect the price to cheapen up a little bit before the auction relative to the average Fix price, and that does not seem systematically to happen. If we were to be selling through the Fix, of course, the Fix price is likely to be the same or lower and it would only be the same if all the demand that came through auctions went through the Fix. As that may not have occurred you would have expected the Fix price to be lower anyway if we had not auctioned. I am quite surprised how well it has gone.

  131. My final question is on figure 13 which is on page 18. I am not sure whether you have been asked this and answered it before, which is the significance of the bid cover ratios for future auctions. First of all, is there any significance in that figure and what would happen in the future if not all the bids were fully covered?
  (Mr O'Donnell) On your first point bid cover ratios is something you would normally put out after an auction to give an idea you were selling X tonnes but there was five X number of bids. It gives you an idea of how much demand there is. You have to be careful about that because some of the bids could be ridiculous bids and that is why there is a potential for this ratio to be manipulated. If, for example, you are a player in the system and you wanted to give the impression that there was enormous demand for this auction you could put in a really big bid but at a ridiculously low price. You would not get any gold but the cover ratio would not show that up. In fact, that has not happened and that is not the way things have operated. The bid cover ratio has been a reasonably good guide and it shows there has been fairly clear demand.

  132. What would happen if all the bids were not fully covered?
  (Mr O'Donnell) That is one of the things we would have to consider in the light of our operating. We retain certain options. What have we precisely said?
  (Dr Mills) No government which auctions bonds or gold says, "We are going to fill every bid that comes along even if we do not get up to 25 tonnes." So we do not tell anyone what it is but we have a reserve price, and we do not necessarily then fill every bid that comes in if we do not get cover. The point to note is that this is a uniform price auction. That means that we will fill all the bids up to 25 tonnes and everyone pays the same price. That means that the marginal bid sets the revenue for the whole of the auction. If we do not get up to 25 tonnes then the marginal bid could be very low and if we pre-committed to taking every bid, our revenue could be very low. So, for instance, we had one uncovered auction in index-linked gilts about two years ago where we did not allocate all the bids because that would have reduced total revenue if we had done so. If that happened here it would depend on what the bidding pattern was. We might take all the bids if they were reasonable. We might reject some if they were too low.


  133. I have one or two follow-up questions for you. Firstly, I was interested in Mr Mills' comment about the absence of game playing in the market prior to auctions. Could we have a note on that? In that note can you pick up the apparent propensity of the market to leap up shortly after the auction on more than one occasion[4]. I can think of some tactics that might cause that. Secondly, you would not believe the amount of free advice I have had about this hearing from people with conspiracy theories in the back of their mind. Can you let me have for the record the indication that the only purpose of this exercise was to get a value-for-money improvement in the risk profile and no other[5]?

  (Mr O'Donnell) Exactly.

  134. Thank you very much. The third point is the 40:40:20 basis, is that based on our world trade balance or something else?
  (Mr O'Donnell) We look at a whole range of possible reasons for holding currencies, but one of the things we look at is trade, yes. That is part of it.

  135. Anything else?
  (Mr O'Donnell) You would not want to hold a whole range of currencies, because that just becomes messy. We do not, for example, hold any roubles, as was suggested earlier, even though we do have trade with Russia.

  136. We would encourage that!
  (Mr O'Donnell) We keep it to a small number which can be highly liquid and transferred to different currencies if we wanted to. Having said that, we look to roughly get in line with trade patterns.
  (Dr Mills) It would be worth adding that if you look at the composition of the basket of the SDR, the Special Drawing Right, that has got sterling in as well, but if you take sterling out the composition of dollars, euros and yen is not too far away from 40:40:20

  137. The reason I ask is that I can imagine circumstances where—and let us say that the trade weighting is the primary driver—two variables run away from you. If one is that the American economy is very successful, and continues to be successful for 20 years more than the other two you are talking about, you would probably see that as an appreciation in the dollar and a significant change in the trade weighting at the same time. My question is a rather mathematical one really, how would your risk minimisation deal with that? Could you write the Committee a note on that because it is not a point which is particularly easy to debate around the table[6]. Do you take the point?
  (Mr O'Donnell) I do, yes.

  138. The fourth one is a simple question, do we have statistics on how much gold we bought or sold unannounced in the pre-1999 years?

  (Dr Mills) We have sold only gold coins as far as I know in small quantities. We had roughly 715 tonnes in the early 1970s, maybe a little more than that, and we have sold some for investment purposes in gold coins.

  139. Trifling sums really?
  (Dr Mills) Yes.

  140. The final point is something a member of the Committee asked as well, and it relates to Figure 10 on page 16, when did Switzerland announce its very high level of sales and what happened to the price of gold at that point? Was it the same sort of 10 per cent drop we got when we announced our sale?
  (Dr Mills) I think the early indications for Switzerland were after our sales but they went through a more protracted process because they had to have a referendum to clear the sale.
  (Mr Plenderleith) It emerged in stages because there have to be local referenda to approve it through their system. The full realisation of the scale of the programme came shortly after ours but the market was expecting that, and indeed part of the reason the market softened after our announcement was the recognition that there was this substantially larger Swiss sale to come on top of it.

  Chairman: I will not ask you to do an analysis of the effect of referenda on it. Thank you very much for that. It has been a very interesting session, the only disappointment has been no free samples! Thank you.

4   Note: See Evidence, Appendix 1, page 18 (PAC 00-01/107). Back

5   Note: See Evidence, Appendix 1, page 18 (PAC 00-01/107). Back

6   Note: See Evidence, Appendix 1, page 18 (PAC 00-01/187). Back

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