On three principles Central bank guiding!
WGC published, ‘Gold and central bank reserve management during the Covid-19 pandemic’ report says, Central bank reserves are typically constructed according to three guiding principles: safety, liquidity and return. The Covid-19 pandemic has reinforced the significance of these principles and, by extension, the importance of smart and sustainable reserve management.
But, in order to deliver effectively against this mandate, central bank reserve managers need to understand how different assets perform during stress periods. Only in this way, can they develop portfolios that are robust and resilient in the face of market stress, while aligning with the three core principles of reserve management.
Looking back over recent weeks, financial markets have deteriorated at an almost unprecedented rate and central banks have been forced to deploy their reserves to ensure both currency stability and financial system liquidity. Traditionally, assets such as US Treasuries and G-10 sovereign bonds comprise the bulk of central bank reserve portfolios.
But gold is widely held too, with one of the main reasons being that it tends to outperform other assets during periods of market stress. Indeed, gold has generated strong returns this year, increasing in value by 10.91% from 1 January to 17 April. Some central banks have already put their gold into action: the Banco Central del Ecuador, for example, swapped US$300 million of its gold holdings to raise liquidity in March.
However, while nearly every central bank holds some gold, the majority maintain a relatively low allocation, particularly those from emerging economies. Recent market behaviour prompts a re-examination of gold’s role compared to other traditional reserve assets. To gain a better understanding of gold’s role as a core central bank asset, we have reviewed gold’s performance as a reserve asset during the recent financial strife.
We have also assessed how different gold allocations would have affected the performance of total reserves in this crisis period.
In concluding the WGC said, the economic, social, and financial fallout from the Covid-19 pandemic will almost certainly continue for a prolonged period. It is impossible to predict the exact course that financial markets will take as the pandemic continues, but gold has certainly reacted in a predictable way to date – preserving value and providing financial safety as risk assets sell off.
During this crisis period, a typical central bank total reserve portfolio would have performed better with higher allocations to gold than a portfolio without gold, preserving more financial firepower to support currency stability and market liquidity. Central bank reserve managers are already aware of gold’s strategic value and resilience. Its performance in recent times highlights the benefits of these attributes.
Looking ahead, the financial turmoil unleashed by Covid-19 is yet another test of reserve managers’ ability to strike the right balance between safety, liquidity, and return in their portfolios. Now, as in previous crises, gold remains an indispensable central bank reserve asset.
