Heavily indebted euro zone nations such as Italy and Portugal could come under pressure to put their bullion reserves to work as a result of plans for Cyprus to sell gold to meet its financing needs.
A European Commission assessment of what Cyprus needs to do as part of its European Union/International Monetary Fund bailout showed Cyprus is expected to sell in excess gold reserves to raise around 400 million euros.
Other struggling euro area countries may be pushed to take note. Between them, for example, Portugal, Ireland, Italy, Greece and Spain, hold more than 3,230 tonnes of gold between them, worth nearly 125 billion euros at today's prices.
The lion's share of that - 2,451.8 tonnes - belongs to Italy. But Portugal and Spain also hold hundreds of tonnes and gold is currently trading around $1,558.95 per ounce in spot terms, or 1,189 euros.
The metal makes up more than 90 per cent of Portugal's foreign exchange holdings, and 72.2 per cent of Italy's. India, by contrast, holds less than 10 per cent of its reserves in gold.
Gold sales on their own would be far from a magic bullet to solve euro zone financing problems: Italy's entire gold reserves, for example, are worth less than 95 billion euros, against outstanding debt of around 1.685 trillion euros.
But the Cyprus situation shows that even a relatively small gold sale may help address severe debt problems. Cyprus' gold sale would allow it to easily come up with around 3 per cent of what it must contribute to the bailout.
It is something that has the market somewhat concerned given that a big sale would push down the price. Central bank gold buying was one of the few areas of demand to increase last year at a time jewellery, coin and gold-bar buying was on the wane.
Indeed, spot gold posted its biggest one-day drop in nearly two months on Wednesday after news of the planned sale broke.
"Cyprus may be a one-off, (but) the market's concern will be that it isn't, and that other countries will be invited to sell their gold," one senior gold trader said.
"It's a potential game-changer for the market," he added. "Given we know that Portugal rejected the most recent austerity plan, and they have over 90 per cent of the country's foreign exchange reserves in gold, does this mean that Portugal perhaps will be asked to sell some of its gold?"
PROHIBITION
Despite this, potentially hefty barriers lie in the way of central banks making sales to meet financing needs. Article 7 of the Protocol of the European System of Central Banks, for instance, guarantees central bank independence and freedom from government influence.
In other words, if a central bank doesn't want to sell its gold, in theory it can resist.
The European Central Bank issued an opinion against an Italian government proposal to levy a 6 per cent capital gains tax on the central bank's balance sheet, apparently including its gold holdings, in 2009.
The ECB noted at the time that the monetary financing prohibition within the Treaty "is of key importance to ensuring the primary monetary policy objective of price stability, which must not be impeded", GFMS senior analyst Rhona O'Connell said.
"We can't rule out the possibility of other banks trying to find a way of mobilising gold, but history is against it," she told the Reuters Global Gold Forum on Thursday.
"The Bundesbank has had a number of run-ins with the Bundestag on this issue and the bank has always won. So I suspect there would be heavy political pressure, as well as legal difficulties, that would preclude such activity."
CAP ON SALES
There is also the issue of how much central banks are actually allowed to sell even if they want to.
The Central Bank Gold Agreement, originally signed in 1999 and currently in its third incarnation, caps gold sales by signatories at 400 tonnes a year.
Disposals have fallen well short of that in recent years, with just 4.2 tonnes of bullion sold so far in the current year of the pact, which runs from last September. Central banks have been net buyers of gold since 2010.
With the exception of some small sales, chiefly for coin minting, no large-scale disposals have been made by euro zone central banks since France sold 17.4 tonnes of gold in the first half of 2009.
But if central banks in troubled euro zone states started to sell, that could quickly change.
Leveraging gold does not necessarily have to mean selling it, of course.
Central banks can also swap gold for cash with other central banks or other institutions through a simultaneous sell spot/buy forward transaction, with a view to redeeming it later.
The World Gold Council says methods other than selling may offer better returns for gold holders.
"It is important that Cyprus explores all the options available to it and outright sales are not the only one,2 a spokesman for the WGC said. "We believe that the most effective way for countries to benefit from holding gold is to leverage its gold as collateral for sovereign issuance."
"A gold-backed bond could raise four or five times the value of Cyprus' current total gold reserves - more than 2 billion euros in today's money."
That doesn't mean, though, that troubled countries won't look at their gold and see a quick fix.
Copyright @ Thomson Reuters 2013
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