Today VOX has released [9]an engaging report titled "Central banks and gold puzzles" which looks quite simply at holdings of gold by central banks over the past 50 years. It breaks down the two buckets into countries that broadly fall into the Developed World category, and countries that make up the up and comers known as BRICs. The charts serve to merely confirm the latest "decoupling" in the world - that regarding views on gold by the insolvent developed world, and the economic powerhouses that make up true intrinsic global growth.
First: the Developed World
[10]
And compare this to the BRICs:
[11]
Here is how the report's authors frame their findings:
In an era when ‘plastic money’ and ‘electronic money’ gain importance in providing intermediation services, the case of holding, mostly passively, large piles of precious commodity remains an enigma. By revealed preferences, central banks keep viewing gold as a useful part of their portfolio. We compare the patterns of non-gold international reserve to GDP and gold to GDP ratios, applying a prevailing econometric speci?cation for explaining international reserves. Both gold and non-gold international reserves have similar sets of determinants, yet these determinants are not stable over time. There is a strong history dependence of gold and non-gold international reserve holdings, and more volatile reserve positions are associated with higher reserves held by central banks.
In other words: if gold is so useless, who keep holding on to it?
But there's more. The bigger question is why do the economic dynamos of the world, China, Russia, India (oddly Brazil does not fall in this category), not only like their gold, but keep on buying more and more?
While we focus on the OECD countries, we include also the two emerging ‘super countries’, China and India, noting that their recent gold holdings increased in tandem with the sharp rise in their economic power. As of November 2011, China is the 6th largest gold holder in the world, Russia is the 8th, and India is the 11th largest. These patterns are consistent with the desire of ‘super emerging markets’ to signal their economic might, to diversify their reserves, and to insure themselves during the global turbulence.
What is more curious is that willingness of these players to not only accumulate gold, but to do so in secret (most notably China in 2009) and only announce the results well after the fact:
The tendency to under-report gold positions in the conventional international reserve statistics remains a managerial issue that deserves explanation. A possible take on it is that most central banks prefer portfolios offering a stable valuation in terms of the chosen basket of global currencies. Central banks refrain from holding stocks, thereby giving up possible gains from diversi?cation and a higher expected yield (recall that during most of the past 50 years, stocks outperformed bonds, a situation dubbed ‘the equity premium puzzle’). A possible explanation for central banks’ portfolios is that being a public institution, diversi?cation into equities is risky. Central bank managers face the downside risk of being blamed for large declines in a central bank’s portfolio valuation at times of weakening equity markets, while getting very limited gratitude at times of bullish equity markets. These reward patterns encourage ‘loss-aversion’ on behalf of central bank managers, as sizeable equity positions come with the risk of a manager’s job termination during bad times (see Aizenman and Marion 2003 for a further discussion on loss-aversion and central banks).
This leads us to believe that the most recent upward catalyst in the price of gold, namely the previously reported buying of the yellow metal by central banks, is largely underestimating the true extent of the accumulation, especially by BRIC countries:
In these circumstances, the volatility of the price of gold possesses a challenge for international reserves managers. Not reporting the market value of gold as part of the international reserve position may be a working solution for a central bank wishing to maintain a sizeable gold position, while minimising the criticism that may occur at times when the price of gold declines. Similar incentives apply when the central bank is concerned that capital gains associated with gold appreciation may be taxed by the ?scal authority, whereas capital losses associated with gold depreciation would be viewed as re?ecting portfolio mismanagement. In either case, the central bank is exposed.
Finally, we can't find any fault with the paper's conclusions:
To conclude, gold retains its unique stature of a ‘safe haven’ asset at times of global turbulence, where large central banks’ gold position signals economic might.