Perspectives 2020-2021 Public Sector

Citi Perspectives for the Public Sector 46 47 • The opportunity cost of holding gold is minimal in the current low or negative interest rate environment. A large proportion of central banks are limited to short investment tenors. Given the short- dated nature of their bond holdings, the yield of the bonds they hold is typically low or negative. While gold is non-interest bearing it is highly liquid, making it a potentially attractive alternative. 6 • Adding gold to a portfolio has a diversification effect. Its low correlation with other assets makes it very effective in enhancing portfolio diversification and therefore reducing risk and volatility. 7 • Gold is a long-term store of value and generally has a role of reinforcing trust and improving stability in times of uncertainty. 8 How gold reserves are managed When managing portfolios, the key objectives of reserve managers are safety, liquidity and return on investment. For most central banks, gold is held for safety and liquidity; returns are less of a priority. 9 As in previous crises, gold has demonstrated its defensive and stabilizing properties from a portfolio perspective during COVID-19: in most markets, gold outperformed the respective domestic stock market. Positive returns tend to encourage the further building of international reserves. Gold as a reserve asset combines the characteristics of a currency with some features of a commodity. While the official benchmark price for gold is the immediate (spot) delivery of the metal in London, there are many alternative ways of owning and taking delivery of the yellow metal in different types of accounts, various locations and with different sizes and purities of bars. Bars can also be acquired via listed futures contracts on the CME exchange in New York, again with different specifications compared to metal traded in other locations. Why reserve managers hold gold What is driving CBs’ gold purchases in recent years? There are multiple reasons for reserve managers to invest in gold: • Gold has no credit risk as it is nobody’s liability, and its value cannot be controlled by any institutions or governments. 3 • Gold is negatively correlated against the US dollar making it an effective hedge against dollar-denominated assets. It has posted fresh nominal records across all G10 FX crosses and major EM pairs this year, most recently in Q3, benefiting from USD weakness. This boosts financial demand for gold as a currency hedge or portfolio overlay. 4 • Gold is very liquid , especially in stress situations and its trading volumes and market size are higher than several bond and stock markets. 5 All these factors have an impact on the relative value of specific gold holdings versus the London price benchmark and can have implications in terms of safety, liquidity and return. Therefore, reserve managers should consider diversification of how they hold their gold in order to achieve their objectives. Account types: A question of credit exposure Investors can choose between unallocated or allocated custody in terms of account types. In an unallocated account, the account holder has a claim against the custodian over a pool of gold as opposed to owning specific bars. Therefore, the metal has some credit risk as it sits on the balance sheet of the provider. An allocated account is backed by specific bars held in segregated custody in the name of the account holder and therefore does not carry any credit exposures. Typically, transactions between allocated accounts result in physical movements of bars, unless both buyer and seller hold their metal with the same custodian and the movement can be done simply by book entry transfer. 10 Leveraging the New Gold Rush: How to Extract Greater Value from Gold Market value of negative yielding debt (global; $m) Central bank gold holdings* (2000-2020) Gold futures prices across G10 FX (December 1, 2018 = 100) Source: Bloomberg, Citi Research Source: IMF, LBMA, Citi Research, *allocated reserves Source: Bloomberg, Citi Research 3 LBMA Alchemist 57: Paul Mercier, The Eternal Question of Gold in the Official Sector 4 Citi Research: Going for GOLD and why the current bull cycle still has legs https://www.citivelocity.com/t/r/eppublic/1ty33 5 WGC: A Central Banker’s Guide to Gold as a Reserve Asset 6 WGC: A Central Banker’s Guide to Gold as a Reserve Asset 7 WGC: A Central Banker’s Guide to Gold as a Reserve Asset 8 LBMA Alchemist 97: New Golden Age, Building up Gold Reserves 9 LBMA Alchemist 97, New Golden Age, Building up Gold Reserves 10 LBMA The Guide, An Introduction to the Global Precious Metals OTC Markets Adding gold to a portfolio has a diversification effect. Its low correlation with other assets makes it very effective in enhancing portfolio diversification and therefore reducing risk and volatility.