World's banks keep a hold on their gold

Nicki Bourlioufas | April 02, 2008

CENTRAL banks around the world are major holders of gold, but over time, their holdings are falling as they diversify their reserve assets out of gold into income-producing investments.

Central banks and international organisations such as the IMF hold around one-fifth of global above-ground stocks of gold as a reserve asset.

Although a number of central banks have increased their gold reserves over the past decade, the sector as a whole has been a net seller, contributing an average of 562 tonnes to annual supply flows between 2001 and 2005, according to the World Gold Council.

Historically, central banks have held gold to put value behind a country's currency. But today, it has largely lost that role and market forces determine a currency's value rather than any peg to gold.

So, with gold losing its role as a reserve, some central banks, including many European central banks, have moved their reserves into income-producing assets such as US Treasuries and other government bonds.

Gold, a commodity, does not pay an income, so it has been sold off, says Brian Redican, senior economist with Macquarie Group.

Central banks are limited in their gold sales to 500 tonnes a year under international agreements. But still, not all central banks are sellers, including the world's biggest.

The US is the world's biggest official holder of gold, at 8135 tonnes at the end of 2007, and it hasn't been selling.

Unlike most central banks, the US Federal Reserve holds the bulk of its official reserves - or close to 80 per cent - in gold. That's because it can't hold its own US dollar assets as official reserves.

The second biggest holder of gold is Germany (3417 tonnes at the end of December or 66 per cent of its reserves), followed by the IMF (3217 tonnes), France (2622 tonnes or 56 per cent of its reserves) and Italy (2452 tonnes or 67 per cent of its total reserves).

On average, countries hold 10 per cent of their reserves in gold, although the proportion varies widely from one country to another.

The Reserve Bank of Australia holds just 80 tonnes of gold, or 6 per cent of its total foreign reserves.

The bank sold down its gold holdings in 1997 and its reserves are now largely held in US Treasuries and other government bonds. The reserves are used, when required, to keep the Australian dollar steady "in times of volatility", says Macquarie's Redican.

Like the RBA, the central banks of Europe, including the European Central Bank, have been net sellers of gold.

Germany, France and Italy have been diversifying out of the commodity into income-producing assets, though they are still big holders, says Justin Smirk, senior economist at Westpac.

Other reasons to cut gold assets are holding costs: vaults need to hold the commodity and security guards need to protect it, says Redican.

Just this month, reports said the IMF could sell down its gold reserves, with the US backing such a move. The sale of the gold by the IMF requires US congressional approval and an 85 per cent majority vote of the IMF's board of member countries.

On the other hand, Asian countries and the central banks of developing economies have been buying up their gold to diversity their reserves out of US dollar or euro-denominated assets, says Smirk, who adds that Saudi Arabia has also been a buyer of gold.

At the end of last year, China was the world's 10th biggest holder of gold at 600 tonnes. But that amounted to just 1 per cent of the country's reserves.

"It makes sense for China to diversify their (reserve) investments and that might include buying up gold," Redican says.

Asian countries historically have held less gold as a reserve. Compared with developed countries, their percentages of gold in foreign exchange reserves are still small.

Japan's gold reserves of 765 tonnes form just 2 per cent of its overall foreign reserves.

The Indian Government holds 356 tonnes of gold, or just 3.4 per cent of its total reserves.

"The Indian population, however, are one of the largest holders of gold and the Indian domestic market is one of the biggest consumers of gold," says Charles Dowsett, head of commodities trading at ABN AMRO.

"Historically, they have used it because of the lack of a national banking infrastructure. The actual gold reserves held by the Indian population would far exceed the official reserves held by the Indian Government."

But in recent times, gold sales by some central banks have been slowing and quotas have not been filled, says Dowsett. With the US dollar falling to record low levels, there are concerns that central banks around the globe could be holding too much of their reserves in US dollar assets.

"Gold has regained some status as a reserve asset in recent times and selling has slowed," Dowsett says.

The US dollar has hit record lows against the euro this year and China's currency has also gained quickly in value. Further falls in the greenback could continue to place question marks over holding US assets as reserves, says Dowsett.

Other reasons to hold gold as a reserve include rising inflation, which erodes the value of any money, he says. Gold has been traditionally used as a hedge against inflation.

"Gold is not the liability of any government or a company, therefore unlike currencies, bonds and shares, it does not run the risk of becoming worthless due to the collapse of the issuer or country," says Dowsett. "The gold price is not determined by any single government, nor is it influenced by any one country's monetary policy. That's why it is valued as a reserve asset."