Against a backdrop of continued global economic uncertainty, central banks have begun to reduce reserve portfolio allocations to U.S. dollars and euros while increasing purchases of traditional assets such as gold and new alternatives including Chinese renminbi, a report issued by the World Gold Council said on Wednesday.
Declining credit ratings and economically unsustainable debt-to-GDP levels -- issues shared by many advanced economies -- are “long-term structural issues that are unlikely to go away in a short time frame,” Ashish Bhatia, Manager for Government Affairs at the World Gold Council, said by phone.
“Many central banks are already far along the way of diversifying their reserves, while others are just getting started,” he added.
The official reserves of global central banks have grown from $2 trillion in 2000 to more than $12 trillion in 2012, according to the report.
During this same twelve-year period the data revealed significant shifts away from the U.S. dollar -- with dollar-denominated assets as the U.S. dollar’s share of total reserves declining from 62 percent to 54 percent -- while the share of “other” currencies in reserve composition has tripled in absolute terms since 2008.
During this same twelve-year period the data revealed significant shifts away from the U.S. dollar -- with dollar-denominated assets as the U.S. dollar’s share of total reserves declining from 62 percent to 54 percent -- while the share of “other” currencies in reserve composition has tripled in absolute terms since 2008.
The report assumes that central banks will reduce their combined allocation to U.S. dollars and euros from the current 74 percent down to 65 percent. In 2000, allocations to U.S. dollars and euros amounted to 78 percent.
The Canadian dollar (CAD), Australian dollar (AUD), Swiss franc (CHF), Danish kroner (DKK) and Chinese renminbi (CNY) are among the currencies in which emerging market central banks are increasingly investing. These assets have produced strong returns in recent years and are supported by healthy economic fundamentals.
China’s rise in the global economy has forced central banks to seriously consider renminbi-denominated assets.
As of now, the global statistics compiled by the IMF, also commonly referred to as the “IMF COFER data,” do not show the breakdown of renminbi. But it is widely understood that the allocation to renminbi is not very large.
Despite the attraction of the Chinese renminbi market, it currently remains difficult to access.
Foreign investors must be part of the Qualified Foreign Institutional Investor (QFII) program, which currently consists of approximately 13 central banks and sovereign related entities. Participation by individual institutions is limited to $1 billion, which is too small to provide adequate scale for central banks, the report said.
“While the Chinese debt market is $1.5 trillion large, the availability of that asset is quite limited, at around $200 billion,” Bhatia said.
Hence, after taking into account market size and access constraints, the WGC concluded that in an optimized portfolio, gold should receive a prominent 8 percent allocation, surpassing the 4 percent allocation to renminbi and 3 percent to Australian assets.
“We found that as these countries diversify away from the dollar and euro, gold is both a practical and quantitatively sound solution,” Bhatia said.
For one, gold has a deep and liquid market with no credit risk. Due to the large size of the gold market, approximately $3.2 trillion, central banks have sufficient access to gold for large investments.
For another, gold does not move in tandem with other assets and in particular tends to move in opposite directions as the risky assets, which central banks are eager to stay away from.
In line with this trend, central bank gold buying in the fourth quarter of 2012 marked the eighth consecutive quarter of net purchases by the official sector and the highest level since 1964.
They bought 534.6 metric tons of gold last year. Net purchases by central banks accounted for 12 percent of overall demand in 2012, compared with a 10 percent share in 2011. That’s also higher than the average of a four percent share over the past five years, the WGC said.
Until about four years ago, central banks as a whole have been a net seller of gold for 15 years. They became net buyers of gold in the second quarter of 2009, and have added 1,100 tons to global gold reserves since then.
The past year saw a number of new joiners added to the list of institutions building their gold reserves. Brazil and Paraguay were two such countries, and both made significant purchases during the year, according to the WGC.
“One thing that’s important to know is that trends in central bank positions take many years to play out,” Bhatia said.
IBT
