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Gold in the foreign reserves of the central banks of the world
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Gold in the foreign reserves of the central banks of the world
16.12.2015  | Latvijas Banka

Gold in the foreign reserves of the central banks of the world

Although its role has decreased significantly over the past century, gold representing investment value rather than being merely a commodity or raw material remains a wide-spread financial asset in the global financial markets. What is the policy of national central banks with respect to gold reserve building, i.e. their accumulation or reduction? What trends have been observed over the past decades and during the last global crisis?

Investiciju-zelts

Since the 1990s, the total gold reserves of the central banks have decreased; however, gold still is a significant element of foreign reserves and plays a role in reserve management. During periods of instability in financial markets or when the US or other G20 countries risk a rise in inflation, gold is used as an alternative investment, and its price goes up. This could also be observed during the years of the recent crisis, when the gold price reached a historic high.

The approaches used by the central banks in managing their reserves, including gold, may differ: some countries hold very large gold reserves, while others hold none; some countries purchase gold, while others sell it. Latvia's stock of gold reserves was built as an instrument for ensuring monetary stability at the beginning of the 20th century. Although nowadays the share of gold in Latvia's foreign reserves has decreased substantially, it still remains a component of them.

Any limited larger-amount gold sales transactions are carried out by the central banks of European countries gradually so as to avoid unnecessary gold market disturbances. The transactions are regulated by the Central Bank Gold Agreements. However, it should be noted that over the past few years the advanced economies have refrained from gold sales. Meanwhile, the major central banks of Asia, e.g. those of China and India, have purchased significant amounts of gold. Similarly, the central banks of Russia, Iraq, Turkey and Kazakhstan have also increased their reserves of this precious metal. As a result, the central banks have purchased overall the largest amounts of gold over the last 50 years. This is largely why the price of gold per troy ounce has remained within the range of approximately 1 200 and 1 400 US dollars over the past few years, regardless of the US dollar appreciation.

Central banks' different approaches with respect to gold reserves can be explained both in terms of cultural differences and the nominal level of reserves and their increase: the higher the nominal level of reserves, the higher the probability that gold will constitute a share of such reserves. Despite the fact that during the crisis the gold price reached its historical high, i.e. more than 1 900 US dollars per troy ounce, changes in the gold price have not actively affected central bank activities, since the reserve management is based on a long-term strategy.

Gold is still viewed as an instrument for risk mitigation and investment diversification as well as an investment option in an environment of growing inflation and increasing sovereign risk. Another important factor is that gold is not associated with a particular country as compared to investment in currencies or securities. However, it should be kept in mind that:

* the gold price depends on how much market participants are willing to pay for it at a given moment,
* gold does not yield interest when the rates are close to zero: it could be observed during the years of the recent crisis and also today,
* storage fees are charged for storing gold.

The historic background, i.e. the amount of gold reserves historically stored by the respective central banks, also needs to be taken into consideration. Banks with very large gold reserves cannot sell significant amounts of gold reserves in a short period of time without seriously disrupting the gold market. Considering all the above factors, each central bank chooses its own strategy of gold reserve management.

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