Gold as a reserve asset

Central banks held 34,000 tonnes1 of gold, as of Q1 2019 according to IMF data, making gold the third largest reserve asset in the world. Gold is generally considered to be a strategic asset that can be deployed for both short-term liquidity management and as a store of value over time. It is an asset that is well suited to meeting central banks’ strategic objectives of: safety, liquidity and return.  

Recent central banks gold trends

In 2018, central banks bought more gold than at any time under the existing international monetary system.  The vast majority of demand has come from emerging and developing country central banks. 19 individual central banks bought more than one tonne of gold in 2018, giving rise to total purchases of 651 tonnes. Even the European Union re-emerged as a net buyer, due to substantial purchases from Poland and Hungary. 

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The increase in central bank gold demand reflects a combination of factors: 

  • Rising economic and political risks associated with other reserve assets. These include, but are not limited to: growing global inequality, which is fuelling social unrest, the rise of populist politicians and the increasing polarisation of political parties; ageing populations and deteriorating budget deficits; ongoing trade disputes and an upsurge in protectionist policies; challenges to central bank independence and the threat of debt monetization; and the risk of currency wars.
  • Negative real and nominal interest rates: The total value of negative yielding debt increased to US$13.19 trn, as of 19th July 2019 according to the Bloomberg Barclays Global Aggregate Negative Yielding Debt index. This has reduced the opportunity cost of holding gold.
  • Structural changes in the international monetary system: 39% of emerging and developing country central banks said that anticipated changes in the international monetary system were relevant to their decision to hold gold, in the 2019 Central Bank Gold Reserve Survey. Such a change could be both destabilising and dollar negative. Gold can serve as a hedge against both.2
  • A de-dollarisation policy: 17% of emerging and developing country central banks said their decision to hold gold was part of a de-dollarisation strategy, in the same survey. 

Safety

Gold is the only reserve asset that is free from political and counterparty risk. It does not depend on a sovereign’s ability to repay. Nor can the value of gold be de-based by the printing presses or by extraordinary monetary policy measures. These characteristics of gold are particularly attractive in today’s environment of heightened political risks, growing threats to central bank independence and fears of debt monetisation and currency wars.

Safety can also refer to the way in which an asset performs during times of crisis, when a central bank is most likely to have to sell assets or raise liquidity. Precisely because gold has no credit risk, it often experiences safe-haven inflows during times of financial crisis, leading its price to rally. Gold returns were positive during eight of the last nine periods of systemic risk, highlighting gold’s ability to preserve capital during times of crisis.

Liquidity

The gold market is deep and liquid with central banks able to transact in large sizes. The value of “financial gold” (gold held by central banks bank plus investment gold) is currently estimated to be US$3tn, suggesting that the financial gold market is similar in size to major sovereign debt markets.

The gold market is also characterised by strong trading volumes. Gold trades between US$50bn and US$80bn per day, through over-the-counter spot and derivatives contracts. Gold futures trade US$35–50bn per day across various global exchanges. Gold-backed exchange-traded funds (ETFs) offer an additional source of liquidity, with the largest US-listed funds trading an average of US$1bn per day. This makes gold one of the most highly-traded financial assets. 

Gold is universally accepted and therefore serves as valuable collateral during times of crisis. There is also an active gold swap market.  Of the third of central banks that said they actively manage gold in our 2019 Central Bank Gold Reserve survey, 38% said they are active in the swap market. 

Return

Although safety and liquidity are the most important objectives of international reserves, return is also a consideration, as positive returns contribute to building international reserves. 

Since 1971, when gold began to be freely traded following the end of Bretton Woods, the price of gold has increased by an average of 10% per year. This means that gold’s long-term returns have been comparable to stocks and higher than bonds or commodities.

Central banks can actively manage gold to generate additional returns. Of the third of central banks that said they actively manage their gold reserves in our 2019 Central Bank Gold Reserve survey, 62% said they have gold on deposit. 

1IMF International Financial Statistics, ECB, Weekly Financial Statement, national sources, World Gold Council

2A Central Banker’s Guide to Gold as a Reserve Asset 2019 edition (pdf)