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, primarily because 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.