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Why Do Central Banks Around The World Buy Gold?

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Why Do Central Banks Around The World Buy Gold?
 

Central Banks of countries are collectively said to be holding the largest quantity of gold bar stockpiles in the world. Their possessions can individually be measured in tonnes.

While it is common knowledge that gold forms as an important part of a central bank's reserve assets, which also includes foreign currency assets (like US dollars or Japanese yen) and IMF Special Drawing Rights, there is more significance to the metal that what meets the eye.

  • Firstly, central banks hold any kind of asset on behalf of its nation and not for their own purpose. So, the asset portfolio is diversified to curb the effect of as many uncertainties a nation can face.
  • Gold is considered highly liquid. Its is a commonly understood and historically significant asset of value. In a crisis, the central bank can pledge the gold it holds as collateral or sell it, to raise liquidity in foreign reserve currency. In fact, top banks place their gold in various international locations (like London) where gold can be easily traded without having to transport it. The strategic placement of these gold bars at various locations is also part of the a central bank's risk-aversion criteria.
  • Gold is free from credit risk that other categories of assets hold. Credit risk is the exposure a certain kind of asset faces from another asset's performance. For example, in equity, the returns from the stock depends on the performance of the company, the sector that the company associates with, the economic conditions in the country that the company main runs its operations, etc. The recession of 2008 taught the nations how important it was to limit credit risk exposure and how a country could go bankrupt if not dealt with correctly.
  • Another important feature of gold that makes it attractive in times of crisis is that it is independent from the performance of any economy. For example, the attractiveness of the US Treasury bonds or the Indian government bonds depend on the interest rates set by the central banks of the respective countries, which is inturn dependent on the country's economic performance. The US-China trade war showed us how political agenda changed the trade policies of a country, which hurt the performance of these economies and also the underlying industries whose businesses were dependent on the demand and operations in these markets. Gold has nothing to do with economic performance.
  • Central banks need to hold gold to maintain a stability in their balance sheet with the diversification. Since gold and currency reserves follow different patterns in their value generation, the combined value of gold and currency reserves is more stable than holding the two separately.
  • In terms of returns on investments, gold has shown a consistency in its growth in value and sometimes even out performed other financial assets.
  • Traditionally, the metal has been considered precious not only because it is scarce, but because it is highly durable and almost imperishable when kept in storage.
  • Its high value allows the storage of a higher value within limited size.
  • The recent trend

     

    In its note on Tuesday, ANZ Banking Group said that despite the current record high gold prices, central banks are on a major buying spree of the precious metal. "In the current environment, where uncertainty in emerging-market currencies is high, we see good reason for countries like Russia, Turkey, Kazakhstan and China to continue to diversify their portfolios," it said.

    At a time where global economic and consumption growth have slowed down amid geopolitical tensions, official purchases by central banks now account for about 10 percent of worldwide consumption, according to ANZ. Further, according to World Gold Council's data, central banks have added 374.1 tonnes in the first six months of 2019, helping push total bullion demand to a three-year high.

Read more about: gold central bank gold bars
Story first published: Tuesday, August 27, 2019, 12:44 [IST]
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