Everything you'd like to know about gold in Poland, but are afraid to ask p. 2

In our new series, we aim to focus on the subject of gold in Poland. We hope to cover all gold related aspects and try to answer important questions of who, where, when, why and how much. And we aim to do that deeply, so our esteemed readers could use those analysis as a compendium of facts for years to come. In second part of this series, we continue on thoughts about Poland’s official gold reserves, this time in modern times.

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Modern evolution of Poland’s gold reserves

It is 1989 usually being used to mark end of communism in Poland. Democracy enabled more transparency to economic and financial data. Hence, statistical data for 1990 shows us that Poland’s official reserves were composed that time of 4.5 bln USD in foreign currencies and approx. 0.5 mln troy ounces which would be 15-15.5 t. of gold. Each ounce was worthy nearly 385 USD as per average yearly NY exchange price, which would mean polish gold equalled about 4.3% of overall reserves at a time.

In 1998, after years of introducing great economic changes as a part of introduction of free market, and after undertaking denomination of polish zloty, NBP spotted possibility for gold purchase to be made and made its decision in May. That happened upon spot prices being low and basically just before Bank of England started selling its gold reserves in an event known as Brown’s Bottom. As a result, level of Polish gold reserves reached 102,9 t. and stabilised on this tonnage for quite a long time. For further purchases we had to wait until 2018 and 2019. In the period of July-October 2018, 25.7 t. in total were added, followed by another 100 tonnes purchased in between May-July 2019. NBP explained this move by need to re-balance its asset diversification. On the interesting note, 1998 purchase was made during a local price bottom (Brown’s bottom), 2018 on local price drop and 2019 purchase just before gold broke-out from established in 2013 horizontal price channel, commonly referred in sector as the 'Maginot Line'. And it was to reach new nominal price records just year later. Good price timing of these purchases gave rise to industry banter that NBP "has a nose for gold purchases". This, in the context of recent purchase of 14.8 t. made in April and then 20 t. in May of 2023 and overall promises to add extra 100 t. to official reserves (which we described in part one of this analysis), should really give us some serious material to consider.

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In addition, between May 2021 and January 2022. NBP kept buying and selling relatively small volumes – in between 0,3 to 3.4 t. monthly, effectively ending market activities at net zero. However, especially these sales divided domestic financial commentators in very politically polarised country. Some political opponents of President of the National Bank of Poland, who was at the time seeking for re-election and was considered as supportive to ruling coalition, even compared sales carried out at a time to these made by communist authorities. Since then, mentioned 34.8 t. has been purchased in 2023, effectively making polish gold reserves to reach 263.5 t.

In the context of domestic gold reserves, on 5 October 2021 in an interview, NBP President Adam Glapinski stated:

"[...] in order to further increase the financial security of Poland's financial security, we will continue our existing policy, we will certainly strive to increase our gold reserves. However, the scale and pace of purchases will depend, among many, on the dynamics of changes in official reserve assets and current market conditions".

On this and several other occasions, NBP confirmed its intention to make a purchase of additional 100 t. in 2022. To great disappointment of many local commentators, this didn’t happen fully yet, but it seems NBP is in the flow. For certain period of time, elevated gold purchases made by central banks in H2 2022 allowed to speculate whether Poland was among them. We were considering that in our ‘Central banks bought nearly 400 tonnes of gold in Q3 2022’ analysis from November 2022. At this moment promise remained mostly unfulfilled, however this could be explained by market conditions keeping price of gold elevated until very recently.

Official Poland’s gold holdings are being managed by NBP and are being split between two main locations. It appears that 104.9 t. are being kept in Poland with remaining 123.8 t. being kept in London. These figures however don’t include said 34.8 t. of 2023 At this moment we don’t know whereabouts of said latest purchase. They may remain abroad or be soon transferred to Poland. We could only assume based on past occasions and geographical proximity they had been purchased at London’s gold market and currently are being held there, however that is not backed up by any official press release.

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So-called repatriation of approx. 100 t. of gold to Poland took place during the autumn of 2019, and has been aligned with overall celebrations of 100th anniversary of Polish independence held at a time. This volume has been added to 4.9 t. held previously in Poland and is being kept in several vaults of NBP’s branches. Although exact locations and breakdown are unknown, it is assumed that gold bars are stored in Warsaw and Poznań. Reason for such split lies in a fact that ‘central vault’ that could hold whole volume simply doesn’t exist in Poland. In the past, upon discussing repatriation of Poland’s gold, such idea was being discussed. It was however abandoned due to the fact that Polish gold was at the time located nearly entirely in the United Kingdom at LBMA market serving as an asset for collaterals and swaps, hence generating profits, and no plans were being made for its return. Additionally, its transfer to Poland would incur storage costs. Need also to remember, market conditions and macro environment during most of last decade, were simply less troubling.

It is doubtful, that current 263.5 t. with above split will remain unchanged for years to come. As stated by NBP’s press releases, NBP declares:

• intention to bring back home from LBMA another 50 t.
• make purchases of 100 t. (approx. 35 t. already made).
• and possibly diversify some remaining on LBMA volumes towards Comex.

Reasons for repatriation and market participation

So, what has changed that polish gold eventually found its way home? We believe it was mostly security based as in 2019 we could already observe strong volatility and systemic risk and overall financial markets (i.e. on REPO market). Repatriation luckily occurred before the outbreak of pandemic, fuel crisis of 2021 and war in Ukraine, which increased pressures on financial markets several-fold. Having reserves stored in close proximity allows direct un-interrupted access, hence owner may sale volumes easily if liquidity needs to be quickly acquired. That may also happen in less formalised way as it would occur via LBMA. Earlier repatriation carries much lower risk than if attempted during financial crisis, when there could be high volume of similar requests making market extremely tight and chances of timely deliveries lower.

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In last couple years, we experienced interesting activities concerning delays in return of various gold reserves. Reasons for such vary. Just to mention few:

· We have mentioned about Turkish repatriations of 2017 and 2018 in our ‘Is Türkiye Abandoning Gold Buying?’ analysis. Reason for that lied in political insecurity that they may be frozen due to conflict between Ankara and Washington.

· Banque du France acted in similar but very covert way between 2013 and 2016. Paris aims to become local gold trading centre.

· Bundesbank was first to announce such move in 2013, repatriating its gold from France and New York, quoting cost efficiency, security and liquidity. Process of transferring 3.4k tonnes of German gold from New York started in 2016 and has been ongoing for several years as this was significant volume used in swaps and as collateral of numerous transactions.

· In case of Venezuela, Bank of England - depositary of Venezuelan gold - has refused to release its volume, contesting legitimacy of Venezuelan President Nicolás Maduro's authority.

Additionally, we could speculate, if historical issues related to polish gold (described in previous part) didn’t determine NBP’s approach in the matter. After all, during war it has been withheld by Vichy France authorities and later by allies. But what supports repatriations is fact, that upon issues on debt repayments, creditor may eventually request freezing certain gold volumes belonging to debtor.

Repatriations come with costs, as it also should be remembered that gold itself does not generate interests but opposite as maintenance of infrastructure and security system in vaults away from gold market will generate costs. Profit generation, on the other hand, is made possible by lending precious metal or benefiting from its price volatility. But for that, gold has to be present on liquid precious metals market, and the best time to have it there is peaceful time of prosperity. Therefore, decision to repatriate gold cannot be taken ad hoc, but must be result of pros outweighing cons for such action.

In our geographical latitude and also in the world, it is LBMA serving as the most important market for transactions on physical gold. Due to its location, it is the Bank of England being top regulator and depositary. It is stored in the vaults of one of the oldest central banks in the world, where remaining volume (123.8 t. confirmed and possible 34.8 acquired in 2023) that belongs to NBP is being kept in a form of gold term deposit with foreign financial institutions and with interest paid in USD. Exactly as volume kept in polish vaults, this one is being kept in the form of bars, following guidelines of London Good Delivery applicable to the LBMA market. These include purity 999.9 standardised weight of 400 troy ounces (12.44 kg) and appropriate dimensions and shape for each bar.

NBP’s gold at the Bank of England used on LBMA is kept in allocated account. That is type of account where depositary bank holds physical gold on behalf of the client and acts as its custodian. Depositary bank (in this case BoE) has no right to deposit, does not record it on its accounting balance sheet and formally acts only as a well-paid accountant and custodian. Customer (in this case, NBP) is entitled to receive exactly same - in terms of minted numbers and weight – bars, as recorded on the inventory list made at the time of making deposit. Upon any issues NBP’s deposit should remain intact with no 3rd party having claims on it.

Above is in contrast to the more popular type of account, which is unallocated, and which until recently accounted for 95% of accounts active on LBMA. Here client only holds claim on gold, and i.e. bullion bank, has a debt to customer of same value. The word ‘unallocated’ takes on the meaning of ‘outstanding debt’ and just gives market exposition with possibility of physical settlement. Of course, as it is simply balance sheet-based account, cost of operating such is much lesser than in case of allocated account that requires security, physical vault, appropriate handling while storing (don’t forget that pure gold is rather soft metal, prone to scratches). And of course, in case of unallocated accounts, upon insolvency of account holder, assets on it belong to creditors.

NBP’s deposit at LBMA can be lent in various forms, for example, as a swap or collateral, just like other currency assets. Generally:

· NBP is in need for i.e. USD, so gold serves as collateral of loan. Upon dept maturity, NBP pays loan and interests back in USD, and gold is returned to its balance sheet.

· NBP loans gold to entity that needs certain volumes as backing up its transactions. At a time of maturity, entity returns gold to NBP, paying fees and interests.

When making a loan to a bullion or investment bank which i.e. wishes to open position requiring gold collateral, NBP gains from reduced storage and collateral costs and earns in the form of leasing and deposit fees. Of course, belonging to NBP bars are not being moved to different vaults, they physically remain exactly where they were. What only changes is name of the owner in the system. Answer to parliamentary interpellation no. 26867 gives exemplary financial data on our gold, for the first half of 2014. 98 t. of Polish gold held at a time on LBMA (remaining 4.9 tonnes were stored in Poland) generated maintenance cost of 143k PLN at the same time generated profit of 4.2 mln PLN. It is possible that keen readers could find more actual examples, however our purpose was simply to show financial aspects of why polish gold didn’t have to find its way home for such a long time.

Withdrawing bullion from the LBMA market in physical form during the contract would be a breach of the agreement and potentially put reputation of NBP at risk, but also other side of agreement to significant financial losses. After all, since gold has been lent out, it can be subject to further transactions between other market participants.

NBP’s gold related policies and books

It seems that NBP decided to be present on both directions – to repatriate, and to remain market participant. Why is that? To answer that we’d have to dig deeper onto policies and overall functions of central banks. What functions does NBP maintain? In short: on polish territory, it is bank of banks, issuer and bank of the state, supreme director of finance department and accountant. More detailed:

• It is a bank of banks, i.e. it organises and participates in the settlement system.
• Regulate commercial bank activities, although this often overlaps with the prerogatives of the national legislature.
• Support national and international banking settlement system.
• Issue cash and credit money - fiat money carries the name of the issuer.
• Influences amount of money in circulation (i.e. through interest rates, QE, QT policies and other market interventions).
• Determines value of money and pursues it by creating supply, rate and exchange rate.
• Serves the state budget, i.e. acts as the country's supreme accountant.
• Maintains country's bank accounts, including deposits in securities, foreign currencies and gold.
• Carries out statistical and information activities.

Market activities undertaken by NBP, mean that as an entity it may report profit or loss on its financial results. Upon being profitable, 5% is being saved to NBP’s reserve fund and rest has to be transferred to Poland’s budget. Hence for 2021 overall profit was at near 11 mln PLN, but in 2022, due to adverse market conditions it had loss of nearly 17 mln PLN. Losses affected many European central banks including Swiss National Bank and Czech National Bank.

Gold is subject of such market activities maintained by NBP. On one hand, it wants to have gold in Poland, for security reasons, just in case. On the other it is capable to generate profit from the volume held abroad on gold term deposits. According to financial statements for 2022 published by NBP, its income generated from gold related activities made in 2022 was 14.4 mln PLN, in comparison to 3.3 mln PLN of profit at 2021.

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How NBP calculates its valuations in USD and PLN related to gold? Financial instruments in gold are recognised in the books of the NBP at the transaction price. Transaction price of an ounce of gold in USD is exchanged into PLN at the average NBP exchange rate on this pair on the transaction date. Gold assets constitute gold resource for which the average cost is being determined. This average cost is eventually used to calculate revenues and costs resulting from the sale of gold and to determine balance sheet valuation effects. At the balance sheet date, gold is valued at the market value of an ounce in USD, exchanged into domestic currency at the average NBP exchange rate for the US dollar. No distinction is made between the effects of exchange rate valuation and price valuation of gold, but are treated together as differences from the valuation of the gold resource. Costs not realised, included in the financial result at the balance sheet date, change the average cost of the of the gold resource.

Fact that NBP holds gold among its reserve assets shouldn’t surprise. Especially when taking under consideration that we experience ongoing net purchases made by collective central institutions since 2010. Trend is your friend after all. But what may be considered as supportive to having gold is Basel III. It is set of regulatory rules, developed under the auspices of BIS, including 28 most important central banks of the world and other advisory institutions. In theory, they are designed to apply prudential regulation developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector. Application of said set of rules is theoretically voluntary, but in European Union its requirements are brought together in the EU Capital Requirements Regulation and similar local directive (CRD IV), being in force for all EU Member States since January 2014. Rules are being implemented gradually with expected deadline of 2025. NBP is not counted among project proponents, but in 2021 its representatives signed a letter of intent, along with a number of European banks confirming the confirming willingness and necessity to implement the proposed regulations.

Prior to 1st of April 2019, Basel III framework defined three types of groups of assets that banks could hold. Each level applied to different classes and defined the degree of risk in each group. For example, level three was considered speculative assets, while level one was treated as risk-free. Furthermore, the relationship between the different levels was established proportionally. Namely, the value of tier three assets should not exceed 250% of level one assets. This was also reflected in the books of the central banks, as the assets of the most risky third group could only be declared as 50% of their value. Before mentioned date, currencies and bonds were the only tier one asset, with gold being consider as tier three assets. However mentioned date marked reclassification which resulted in gold being placed in group one. This would simultaneously imply three types of benefits for central banks in the context of gold holdings:

· Increased value of assets held, by being able to report their full value on balance sheets.

· Increased value of gold in reserves through the price appreciation of gold in H2 2020, culminating in setting of new nominal price records.

· Expanding liquidity capacity with the simultaneous expansion of the safety buffer by adding a new asset with zero credit risk and high liquidity.

And we still discuss an asset that central banks were already buying. Hence Basel III acknowledged already existing approach in this matter.