In the 1990s, gold was an unloved asset among central banks. Reserve managers lent or sold their gold, particularly in Europe, and the gold price fell to a low of US$250/oz. Years of persistent selling triggered the Central Bank Gold Agreement of 1999, under which signatories agreed to limit collective sales to 400 tonnes per annum, put a cap on gold leasing and take a disciplined approach to gold futures and options.
The Agreement delivered two clear benefits: it helped to stabilise the gold price and increased transparency around central bank gold sales. Today, however, sentiment towards gold has been transformed and gold has regained its status as a valuable and highly regarded reserve asset.
Key changes
A glance back over the past 20 years highlights some of the key changes in central bank behaviour.
First, central banks have rapidly and consistently added to their foreign exchange reserves since the Asian crisis of 1998. Reserves are a crucial element in a country’s armoury, providing protection against both domestic and external shocks and acting as a show of confidence to the outside world. Emerging market economies led the charge in this respect, sending worldwide foreign exchange reserves from around US$3 trillion (tn) in 2000 to approximately US$13tn in 2014. Purchases have plateaued over the past five years but still stand at some US$13tn today.
The dollar is the most widely held reserve asset but, according to International Monetary Fund statistics, gold comes third, accounting for 11% of global reserves. Having been net sellers until 2000, central banks have been net buyers ever since. In 2018 alone, central banks bought 651 tonnes of gold, up 74% compared to 2017 and the highest level since 1971. Over the past decade, central banks have purchased more than 4,300 tonnes of gold, taking their total holdings to around 34,000 tonnes today. The trend has continued in 2019, with net purchases reaching 90 tonnes before the end of the first quarter.
Notably too, central bank buying has been geographically diverse. Russia has been the most committed purchaser of gold – acquiring almost 275 tonnes in 2018, the largest amount ever purchased in a single year. China has been consistently adding to its reserves as well, but many other emerging market countries have been accumulating gold over the past year and more, including Hungary, Poland, Egypt, Kazakhstan and India.
The drivers
What is the rationale behind this renewed interest in gold? First, heightened uncertainty about the global economic and geo-political outlook and second, gold’s intrinsic value as a reserve asset.
Ten years after the Global Financial Crisis, the macro-economic outlook remains fragile and hard to read. In April, the IMF outlook highlighted weakening GDP growth, with risks skewed to the downside. As IMF Chief Economist Gita Gopinath explained, the global economy is at “a delicate moment”. Advanced economies are predicted to grow by just 1.8% in 2019 and 1.7% in 2020, while growth in the Euro area is expected to be even lower, at 1.6% and 1.5% respectively. The emerging market growth trajectory is more solid (4.4% in 2019 and 4.8% in 2020) but risks remain tilted downwards.
Trade tensions are a major unknown. They have already had a negative impact on growth and if the US and China do not reach a genuine truce, the global outlook may worsen further. Fears of retaliation and escalation may hit business investment, supply chains may be disrupted, and productivity may slow across the world stage. The Euro area faces specific challenges too. Business confidence is low, especially in Germany due to the introduction of new fuel emission standards in the auto industry. Fiscal policy is affecting Italian sovereign and commercial bank spreads. And, of course, uncertainty about Brexit persists, particularly as the exit date has now been postponed to October 2019.
Furthermore, global geo-political risks have not abated and may have a negative impact on economic activity. Idiosyncratic risks are increasing too, such as the rise of populist governments in Latin America and across Europe.
Gold advantages
All these uncertainties accentuate negative market sentiment and drive central bank investors to reallocate their portfolios away from risky assets to safe haven assets.
This is where gold comes into its own, as it fulfils central banks’ three core objectives: safety, liquidity and return.
Gold is well known as a safe haven asset. It carries no credit risk, has little or no correlation with other assets and the price generally increases in times of stress. As such, it offers valuable protection in times of crisis.
Gold is highly liquid too. It can easily be traded in global market centres, such as London and New York. It can be used in swap transactions to raise liquidity when needed and it can be actively managed by reserve managers.
Gold can also enhance the risk/return profile of a central bank portfolio. Its lack of correlation to other major reserve assets makes it an effective portfolio diversifier and, over the long term, it delivers higher returns than many other assets.
