THE GOLD RATE OF THE OIL FUND

The last few years have seen an unprecedented increase in demand for gold and a related rise in the price of this precious metal around the world. The roots of this trend lie in investors' departure from dollar and euro assets, which are becoming cheaper because of the unresolved debt problems in Europe and the USA. In these circumstances, our country is also interested in gold, the price of which continues to grow. Already in 2010, gold assets were included in the structure of the reserves of the Central Bank, and in February of this year, the State Oil Fund of Azerbaijan (SOFAR) also started to purchase precious metals.

The global trend

On 8 March this year, in the course of trading at COMEX, a division of the New York Mercantile Exchange, April gold futures were sold at a price of $ 1,683.9 per troy ounce (31.1 grams). Although in comparison with last February, the price of this precious metal was lower, the situation at stock exchanges, however, clearly promises a rise in price. It is expected that no later than June this year, a price of $ 1,800 or more per ounce is quite realistic. Such forecasts are quite justified, considering that in the last two years alone, gold has risen in price by 60 per cent, and prices for the metal have been increasing for the fifth consecutive year, which is the longest period of growth, at least since 1920.

According to authoritative analysts and stock traders, the increase in gold prices will be the predominant trend in the next five years. In particular, contracts for the purchase of gold today are nearly one hundred times greater than its actual physical volume on the market. This means that, in fact, another bubble, which only in theory is secured with precious metal that has yet to be produced and cast in ingots, is being inflated on the gold futures market. According to medium-term forecasts, the price of gold will hit $ 5,000 per troy ounce by 2016. Thus, because of its apparent scarcity, physical gold will rise in price by at least three times in the next four years.

Such an increase in the price of gold is prompted, above all, by its use as an instrument for hedging against inflation risks, political instability and the weakening of the monetary policy of leading countries. In fact, the jump in gold prices is connected with the speculative demand, which is due to panic-stricken flight to safe investment assets with a steadily rising trend. As for the long-term appreciation of precious metals, it is related to the fact that the prospects for global economic recovery continues to remain uncertain on the global market. Moreover, gold has almost zero correlation with other investment assets, i.e. it is a great tool of diversification not only for central banks and large state companies, but also for ordinary investors.

The stock of the Central Bank

It is noteworthy that for a quite long period of time since Azerbaijan gained its state independence, the government and the Central Bank of the country have maintained a cautious and balanced approach to the issue of keeping gold reserves. Gold was believed to be quite a risky asset for diversifying the foreign exchange reserves of the state on a long-term basis. Only in 2010, did the Central Bank of Azerbaijan decide to include a new asset - precious metals - in its currency basket. Moreover, the Central Bank did not acquire gold on world markets, as did other states, but only accumulated gold extracted at Azerbaijani mines that are being developed under several PSA contracts, in particular in Gadabay District. Since mid-2009, the operating company Anglo-Asian Mining PLC has been engaged in industrial development here, and gold has been shipped to Switzerland for refining. Some of the ingots sold on the world market under the Ayrim brand arrive at the CBA for storage under a production sharing agreement. At the end of last year, the gold reserves accumulated by the CBA reached 513.6 kg, and their market value is estimated by the Ministry of Finance at $ 28.4 million.

In less than three years, Anglo-Asian Mining PLC produced about 2.408 tons of gold in our country. Eventually, after investors recover their costs, the government of Azerbaijan will receive 51 per cent of the profits from the gold mines. If production remains at the current level, the country's revenues will exceed $ 321.5 million when the maximum price forecast of $ 5,000 per ounce is achieved, and most of them will be the government's share. As annual production increased to five tons per year, the revenues will total approximately $ 803.8 million, i.e. reach the maximum level and approach 10 per cent of the country's total oil revenues.

However, for the time being, the volume of physical gold accumulated by the CBA is very low and is unlikely to exceed several tons over the next two or three years. Many nations have somewhat different approaches to the issue of keeping gold. The past two years have seen a marked increase in the number of central banks and other funds and government agencies with similar powers, which seek to increase the proportion of precious metals, primarily gold, in the structure of their foreign currency reserves. For example, according to the World Gold Council, during 2011 the total gold reserves of central banks of the world grew rapidly and on average, the share of the precious metal in the structure of foreign exchange reserves now exceeds 12 per cent. In general, by the middle of last year, the amount of physical gold accumulated by the central banks reached 25,700 tons.

It is noteworthy that in recent years, this trend has been dominant not only in developed countries such as the USA, Germany, Italy and France, which traditionally accumulate significant stocks of precious metals. In these countries, the share of physical gold has long ranged from two-thirds to three-quarters of total foreign exchange reserves. In general, we can say quite confidently that there is a "gold parity" between the US and the euro area, whose total gold reserves and, accordingly, the hypothetical "gold security" of the US dollar and the euro are comparable with each other. The structure of the gold reserves of the world's largest countries is extremely heterogeneous, but for large economies, it correlates quite well with the gross domestic product of the top ten countries. The only exceptions are China and Japan, which have an extremely low share of monetary gold reserves.

Meanwhile, the developing countries of Asia, Africa, South America and many of our CIS neighbours have begun actively buying gold in recent years. And the issue is not only about keeping gold produced in developing countries, some of which is handed over to the government as a share from the development of natural resources by foreign and local gold mining companies. It is not only dynamically developing countries such as India, Thailand, Venezuela, Iran and other oil-producing states of the Persian Gulf and North Africa, which have an excess of foreign exchange, but many other countries that cannot boast economic growth. For example, in January of this year, Kazakhstan, Turkey and Belarus, which bought more than 538,000 troy ounces together, had an interest in buying precious metals.

The main drive

According to the World Gold Council, last year, the central banks of major countries became net buyers of precious metals. At the beginning of the year, our country also decided to follow the world trend. However, in the case of Azerbaijan, the function of the main accumulator of precious metals belongs not to the Central Bank, but to the State Oil Fund.

In order to diversify the investment portfolio and increase its profitability, on 1 February this year, SOFAR started investing in gold. The State Oil Fund buys gold ingots from banks and other organizations that are market makers - members of the London Bullion Market Association. The Association includes the largest banks, gold miners and transport and refining companies specializing in the market of gold and silver ingots.

According to a presidential decree published in December last year, the fund is allowed to invest up to 5 per cent of its total investment portfolio in gold. Given that the average investment portfolio of the fund for 2012 is set at 23 billion manats ($ 29.258 billion), on this basis, within the framework of the five-per-cent quota, SOFAR can buy gold for about $ 1.462 billion, which is equivalent to about 27 tons of gold in the current prices ($ 1,683.9 per troy ounce). Of course, the actual amount of precious metals purchased will be slightly lower, because filling the five-per-cent quota of SOFAR will not be a one-off deal, but stretch over a relatively long period of time. We should also take into account that gold prices will only increase this year, and respectively, the amount of precious metals, which the State Oil Fund can buy for the designated amount, will decrease.

Nevertheless, even taking a decision to purchase gold on world markets, the Azerbaijani government continues to maintain a very cautious approach to this very risky backup tool. Its share in SOFAR assets is limited to five per cent, and our state is unlikely to decide on mass purchase of gold on world markets in the coming years or fundamentally change the structure of the State Oil Fund's currency reserves.

Such caution by our government is justified, as the unchecked rise in gold prices makes many experts cautious, and they believe that the excessive investor interest in gold is largely fuelled by stock speculators. Thus, according to New York University Professor Nouriel Roubini, the world economy has no fundamental reasons, for example hyperinflation, for such a jump in gold prices. In fact, the current increase in prices for precious metals is caused by the fear of investing in debt assets due to the risk of defaults and fears of recession in the economy. There is a psychological stereotype - the majority of investors believe that gold is the safest asset. In the same way, three years ago, they believed that oil prices would never fall, and property prices would always rise. However, in practice, any speculative growth for a particular commodity or asset ends sooner or later, and often with unexpected bursting of the bubble. Therefore, many analysts believe that the same will happen with gold - there is a difference of opinion only about the maximum level of prices for this precious metal and the date of the end of the gold rush.