There are many doubts surrounding physical gold in the form of coins and bars, and one of the most prominent is the role that central banks play in the sector through their gold reserves. These represent some of the main gold claimants and in their vaults, they keep more than 34,000 tons of gold.
Central bank vaults typically have long rows of racks stacked with 400-ounce gold bars. This means having numerous custody and surveillance resources to protect the gold. Why do global central banks hoard gold bullion and what do they use it for?
Reasons Why Central Banks Hold Physical Gold
Gold is a haven asset in times of crisis that offers great liquidity, as well as a long-term store of value. It must be taken into account that the price of gold usually increases in times of crisis, which provides great protection in times of uncertainty. In addition, it does not imply credit risk for banks and has almost no correlation with other asset markets.
It is important to think of liquidity as one of the main reasons for accumulating gold, since it is very easy to negotiate the sale of gold bars in the main global markets, such as London or New York, for example. In this way, it is very easy for banks to obtain short-term liquidity when it is needed by actively managing gold through its reserves by carrying out different types of transactions.
In conclusion, the physical gold that banks accumulate offers greater security than other assets in difficult times, great liquidity, and more long-term profitability than other assets, thus allowing them to meet their main strategic objectives.
An increase in central bank demand for physical gold reflects current global political, geopolitical, and economic conditions and changes.
How Do Central Bank Gold Reserves Work?
The gold that is kept in the reserves of the central banks, is it simply stored, or is there activity? The first thing that must be made clear is that it is not a question of patrimony that must be immobilized in the vaults, but that these international reserves must be made up of gold or convertible currencies to be able to be used simply in times of crisis such as the one we are currently experiencing due to the COVID-19 pandemic.
Central banks thus choose the assets that are going to form part of their reserves based on their credit quality, liquidity, and what they contribute to the risk profile of the investment portfolio. Gold is one of the strategic assets most used by bank reserves to manage short-term liquidity, or as a long-term store of value.
What does this all mean? That this type of financial entity actively manages its reserves. How do they do that? They use gold as collateral for deposits, through loans, or financial swaps, also known as swaps, with other international banks, for example. To be able to carry out this type of management with the reserves, the gold must be adapted to the relevant legal agreements and international standards, as is the case of banked bullion with a Good Delivery certificate. In this way, it is easier to move quickly in times of crisis.
Central banks can also buy or sell gold when needed as part of their routine balance sheet adjustment operations.