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THE EVOLUTION IN CENTRAL BANK AttITUDES TOWARD GOLD About The World Gold Council The World Gold Council’s mission is to stimulate and sustain the demand for gold and to create enduring value for its stakeholders. The organisation represents the world’s leading gold mining companies, who produce more than 60% of the world’s annual gold production in a responsible manner and whose Chairmen and CEOs form the Board of the World Gold Council (WGC). As the gold industry’s key market development body, WGC works with multiple partners to create structural shifts in demand and to promote the use of gold in all its forms; as an investment by opening new market channels and making gold’s wealth preservation qualities better understood; in jewellery through the development of the premium market and the protection of the mass market; in industry through the development of the electronics market and the support of emerging technologies and in government affairs through engagement in macro-economic policy issues, lowering regulatory barriers to gold ownership and the promotion of gold as a reserve asset. The WGC is a commercially-driven organisation and is focussed on creating a new prominence for gold. It has its headquarters in London and operations in the key gold demand centres of India, China, the Middle East and United States. The WGC is the leading source of independent research and knowledge on the international gold market and on gold’s role in meeting the social and economic demands of society. 1 The evolution in central bank attitudes toward gold Contents Introduction 3 Central banks and gold: advantages and challenges 4 The era of net selling 5 Changes in attitude take effect 5 Growth in foreign exchange reserves required some rebalancing 7 Concerns over other major currencies 9 The crisis has underlined the need for stability and public confidence 10 Additional factors also argue for gold 10 Conclusion 11 3 The evolution in central bank attitudes toward gold The evolution in central bank attitudes toward gold Jill Leyland, World Gold Council Introduction During 2009 central banks and official institutions addition to countries such as Russia and Belarus as a whole became net buyers, rather than sellers, who have been adding to their gold reserves for of gold (see figure 1). Net annual sales for the year some years. India, Sri Lanka and Mauritius together as a whole, at 44 tonnes, were a small fraction of bought over half of the gold the IMF had available those of previous years. Since 27 September 2009, for sale. China announced in April 2009 that it had the start of the third Central Bank Gold Agreement, added 454 tonnes to its gold reserves since 2003, a the only significant seller to date (April 2010) 76% increase. The Philippines, whose gold reserves has been the International Monetary Fund (IMF), fluctuate as it buys up domestic production and although the Fund’s sales of 212 tonnes of gold later sells on the market, was a net purchaser in both in 2009 were completed in off-market transactions 2008 and 2009, as it was in most years before 2003, with central banks, and therefore did not constitute in contrast to being a net seller in the years 2003 net selling to the private sector. IMF statistics for to 2007. Venezuela, which also periodically buys February 2010 show a decline in the Fund’s gold domestic production but for many years had used holdings of 6 tonnes, marking the beginning of it in ways which did not entail increasing its formal on-market sales within the ceiling set by CBGA3. gold reserves, was recently reported on Bloomberg Among signatories to CBGA3, Germany has sold a as intending to buy more domestic production and small amount for coin minting. In contrast a number also adding to its gold reserves. of purchasers have emerged on the buy side in Figure 1: Net official sector sales (tonnes) Tonnes 180 160 140 120 100 80 60 40 20 0 -20 Q1 06 Q2 06 Q3 06 Q4 06 Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09* Source: GFMS. * Provisional 4 The evolution in central bank attitudes toward gold Our previous publication, Structural Change in Set against this background, each reserve asset Reserve Asset Management 1 looked in more detail presents its own particular advantages and at how official sales, primarily from European central challenges. For example, the dollar is the world’s main banks, have declined in the last two to three years trading currency, offers a huge range of financial and how purchases, notably from emerging market instruments and has excellent liquidity; against this countries, have risen, setting this into historical its worth is susceptible to US economic policy, it has context. This publication looks at the reasons this lost value over the last decade against both the euro shift has occurred and how the events of recent and gold and, if there are political issues between years, in particular the financial crisis, have tipped the country concerned and the US, this can affect the balance away from net official sector selling the attitude towards dollar assets in ways not always towards net buying. consistent with optimal reserve asset management. Central banks do not always publish the reasons for Gold is no exception to this rule and has its own set of their reserve management decisions – and when advantages and challenges. Gold is no one’s liability; reasons are publicly announced they are unlikely fully unlike any currency its value is not dependent on any to reflect the long deliberations that develop policy. one country’s economic policies; it has a reputation Nevertheless based both on information in the public as a safe haven, and indeed often acts as one. As a domain, and on the regular discussions executives result of these attributes it can be considered as a of the World Gold Council have with central banks, defence against unknown contingences. All of these it is possible to deduce the main reasons underlying are clear advantages. A further advantage is that the evolution in central bank attitudes which have led including gold in a currency portfolio normally brings to this shift in outcomes. diversification benefits since returns on gold tend to have a low correlation with other assets typically Central banks and gold: advantages and invested in by central banks. Citizens generally challenges like the fact that their country holds gold reserves – gold’s long history, its physical presence and its Central banks manage their foreign reserves reputation all contribute to this. Thus the existence carefully. They have a responsibility to their citizens of gold reserves can increase public confidence in and government for the prudent management of a central bank. For countries where gold is mined, what is part of the wealth of the nation. Not only gold holding or purchasing by the central bank can must the reserves cover day to day needs for foreign be viewed as supporting a local industry. exchange but their value must be preserved, as far as possible, even during times of turbulence. On the other hand challenges include the cost of Objectives in reserve management typically include holding gold (vaulting, insurance, shipping and stability, liquidity, the furtherance of exchange rate settlement costs when traded) and the need for and other national policy goals, the avoidance of specialist management skills since the gold market is disruption to financial markets and financial return. different from currency markets. Another problem is The relative importance of these goals will vary over the fact that decisions on gold holdings can be more time: stability and liquidity, for example, have been politically sensitive than those on currency holdings of particular importance during the financial crisis and therefore cannot always be taken on purely while changes in exchange rate policy, eg from a professional grounds, potentially causing opportunity fixed or pegged to a floating rate, will have immediate costs. Reserve managers can find that decisions on implications for reserves management. Fashions gold have to be referred upwards whereas equivalent also vary. For example, during the 1990s there was decisions on managing currency reserves would be increased pressure on a number of central banks to left to them. Gold, while a less volatile asset than stock obtain a financial return or yield from their reserves exchange indices, can be more volatile than major whereas in earlier times stability and prudence were reserve currencies; its price can also appear more considered more important. Finally the needs of volatile due to the volatility of the currency in which its each central bank will be individual according to price is quoted. This can pose accounting issues and the circumstances of their country, economic policy potentially harm the central bank’s reputation if there goals, political considerations, and the central bank’s has been an apparent or real loss on gold in any one own mandate. period. Interest that can be earned on gold if it is lent 1 By Natalie Dempster, November 2009. Available on www.research.gold.org/research 5 The evolution in central bank attitudes toward gold out tends to be lower than that which can be obtained terms started in 2001 it was not until 2005 that a from currency assets. Finally, some central banks clear upward multi-currency price trend (including may find that their mandate forbids certain actions in the price in euros) started. respect of gold (for example there may be constraints on lending) to which other currencies are not subject; In particular, CBGA selling continued at around or occasionally there may be legal restrictions.

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