Picture: Part of German Gold Reserve
We can hear you think “yeah right, the ECB buying gold…”, but the title of this article did not fall from the sky; it is based on recent statements from a prominent member of the European Central Bank [9], Yves Mersch, who did not beat around the bush. The man from Luxembourg underlined that the ECB could start buying different types of assets to stimulate the economy when necessary. Not just government debt or mortgage-backed securities, but also stocks or ETFs. The Bank of Japan is already doing this today; buying into Japanese stocks and ETF's. Mersch also pointed to other assets that fulfill a monetary role on the central bank’s balance sheet, such as gold.
Purchasing gold is not such a crazy idea for the central bank when you think about it. Contrary to the US central bank, the gold reserves of the ECB is marked-to-market on its balance sheet. Coincidence or not, but the balance sheet of the ECB went downhill from the moment gold got stuck in a downtrend.
Source: ECB / Stockcharts
The two charts above – the ECB balance sheet on the left and gold (in EUR) on the right – are so similar, that we started digging a bit deeper. The detailed balance sheet of the ECB, which we found on their website, clearly shows that gold carries a lot of weight compared to other assets. On a total of 597 billion euros, the value of the ECB’s gold position is 329 billion euros, which amounts to 55%. The contrast with debt securities (160 billion euros) or equity and/or investment funds (360 million euros) is huge. We annotated the table below to point out these assets on the balance sheet.
Source: ECB
According to Mario Draghi’s recent statements, the European economy has to pick up steam and to accomplish that, inflation needs a little push. A higher inflation rate is synonymous with expanding the central bank’s balance sheet, however, which is what Draghi implicitly mentioned to expect. The market presumes, however, that this balance sheet expansion will be the result of buying debt securities but, as you can see on the table above, there are other ‘line items’ that can achieve the same result, including the purchase of gold.
Ultimately, we expect the ECB to mix up its purchases. In southern Europe they would love the central bank to buy up their worthless bonds at par, but that is not what Germany is hoping for, for example. The Germans are fans of minimizing risk and gold indisputably is a big part of a safer approach. We would not be astonished, as a consequence, if the ECB soon surprises friend and foe with a unique expansive policy that includes both debt securities and physical gold.
The recent repatriation of Dutch gold reserves from New York [10] could serve as a catalyst in that regard. Germany also wants to get part of its gold back, but they did not get the same service as the Dutch. If the ECB starts buying gold then, it could be a brilliant counterstrike that calms down the Germans at the same time. It would also create a lot of upward price pressure on the gold market, moreover, pushing the gold price and the value of the gold position on the ECB balance sheet upward. Two birds with one stone.
It would also end gold’s downtrend. Admittedly so, we did not expect the bottom formation process in gold to take this long and the fact that the gold price is still running in place is remarkable, ultimately, in a financial system where the balance sheets of central banks have grown beyond control with no end in sight (look at Japan for example).
Despite the fact that the trend in gold has not turned yet, it would be wise not to ignore the yellow precious metal. We are watching the central banks like hawks and their message is clear: inflation will rise at whatever the cost. There is no doubt in our minds that these central banks will do everything in their power to achieve their goal, even if it means buying gold and pushing the gold price higher. Thus, gold remains an important asset in every diversified portfolio. The analysis of the gold positions of central banks speaks louder than words at least.
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