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The case for Australia to restore its gold reserves

Despite the fact that gold has increased in price from below AUD450 an ounce to over AUD1700 an ounce since the turn of the century, investors in developed markets remain reticent to invest in gold today.

In the late 1990’s, gold was languishing below AUD500 an ounce, having suffered a near double decade bear market. No yield, ongoing storage costs, and significant opportunity cost does not a happy investor make.

It wasn’t just investors, with central banks net sellers of the metal from the late 1980s until the onset of the GFC, divesting close to 6,000 tonnes over this 20-year period. One of those central banks was the RBA, which in 1997, sold off roughly two-thirds of Australia’s national gold reserves, netting some AUD2.4 billion in the process.

What was the RBA thinking?

The rationale for the RBA gold sale was in a detailed memorandum prepared in December 1996. The memo noted that gold represented some 20% of foreign exchange reserve assets, and that there was considerable cost of holding this reserve, especially in terms of income foregone. When looking at the outlook, the memo noted that “it would be optimistic to expect sizeable increases in the price of gold in the near term”.

It also included the table below, which contains the returns on physical gold vs. US Treasuries.

Compound annual returns (percentage)

This analysis was partly used as justification for the gold sale, with the memo stating that:

“The value of $100 invested in US Treasuries in 1900 would now be about $3,700 (assuming all coupons were reinvested), which is about twice the value of a similar investment in gold.”

Whilst the data is accurate, the insight drawn was questionable at best, for the memo itself noted the gold price was fixed until 1971. Had the 70-year period where gold prices were fixed been removed, then the return comparison of gold versus US Treasuries would show that the yellow metal’s performance was double that of Treasuries.

Impact of the physical gold sale

Those 167 tonnes would be worth close to AUD9.4 billion today. The decision to sell at an almost double-decade low has cost some AUD7 billion in capital gains foregone. In fairness to the RBA, we must acknowledge the growth of the proceeds they received for the gold sale. Given the duration profile of their assets, and the countries they invested in, the return on 2-year US Treasuries between March 1997 and March 2018 would give an annualised return of 2.54%. The proceeds of the gold sale would be worth some AUD4.1 billion by now, meaning the decision by the RBA to sell back in 1997 has likely cost the nation back closer to AUD5.3 billion.

Make Australia gold again

RBA gold holdings currently make up less than 5% of our foreign reserve assets, a number that is alarmingly low compared to the holdings of other developed market nations, as the chart shows.

There is now a lack of income being generated on our portfolio of foreign exchange assets. The latest RBA Annual Report includes the following chart, which highlights the fact we earn less than 1% on our assets.

Given the RBA actually earns roughly 0.20% on its gold loans (contrary to popular opinion, one can earn a yield on gold), the opportunity cost of holding gold is now far less.

A central bank (or any investor) might look to trim their gold holdings if they could earn over 4% in ‘real’ terms investing in low-risk, low-volatility financial assets, but we are not operating in that environment today, and likely won’t be for years to come.

The deterioration in public sector balance sheets across the developed world will almost certainly result in higher inflation in the coming years, adding weight to the argument that the RBA would benefit by topping up our physical gold reserves.

Central bank gold buying is a global trend

Since the GFC, central banks have turned net buyers of physical gold. Collectively, they’ve purchased the better part of 3,000 tonnes of gold in the past eight years with total official gold reserves now back to where they were in 1999.

The buying has been spearheaded by emerging market nations, including China, India, Russia, Kazakhstan, and Turkey, many of which are likely to be accumulating for some time too, as on average, they still have less than 8% of their reserves in gold, far below that of the United States and many European nations.

Since the GFC, Austria, Belgium, the Netherlands, and Germany, have all either moved, or are taking steps to move some of their gold holdings back within their own borders. Central banks are in no doubt as to the importance of holding gold, and the RBA should take note.

Time to move back to 1997

Given the paucity of yield on offer in sovereign bonds, the prospect of higher inflation and gold’s unique attributes as a monetary asset, now is the time for the RBA to begin increasing our gold reserves. A 15-20% weighting would be appropriate, in line with our holdings prior to the 1997 gold sale, and roughly equivalent to the proportion of foreign reserve assets that gold constituted when the ECB was formed back in the late 1990s.

A significant portion of these reserves should be held within Australia. Australia is a politically stable, AAA-rated sovereign. There seems little point in mining and refining physical gold in Australia, only to have all of our national gold reserves held offshore.

Storing national gold reserves locally would also send a positive message to Asia, where gold is seen as money by both citizens and central banks alike. Provided it was leveraged the right way by the private sector, it could grow our banking and financial services links with the region.

Rebuilding our national physical gold reserves will better balance out the RBA’s reserve assets for what may be some rough years ahead.

 

Jordan Eliseo is the Chief Economist for ABC Bullion, Australia’s largest private bullion dealer and precious metal depository. This article is in the nature of general information only and not intended as investment advice.

 

10 Comments
John
January 29, 2022

The current level of reserves is judged to be sufficient for achieving the Bank’s policy objectives in the current environment, particularly as Australia also enjoys robust and credible institutional frameworks and flexible markets that help mitigate the effect of economic and financial shocks. 2012. ..... and now? where is the Prince to kiss the sleeping Cinderella? Every other Central bank disagrees with academics in the RBA.

Ben
July 02, 2021

Great article. It really highlights the short-sightedness of our financial decision-makers. RBA should be looking for reasonable entry-points in gold spot price and increasing its reserves. It is interesting that Australia is touted as one of the largest gold-holders in terms of unmined deposits, but our government agencies are so short-sighted that we have some of the thinnest gold reserves (of actual mined gold) in the world.

Edward
October 19, 2018

It appears that RBA has sold some gold. The gold reserve has gone down to 68.7 tons. Instead of buying more gold, RBA has sold some....

https://tradingeconomics.com/australia/gold-reserves

Would someone please get in touch with RBA and understand why they have to sell our national gold reserve?

I would rather see RBA increase their gold reserve rather than sell them.

SMSF Trustee
October 19, 2018

Because they're not needed. We only need reserves if we have a fixed exchange rate. See my previous comment on this topic.

Martin Carter
April 13, 2020

Absolutely correct - Gold and foreign currency reserves are a relic of the Breton Woods fixed exchange mechanism. Unless the RBA or any Central Bank or Currency Board intends to conduct a dirty float the RBA should transfer all those assets to the Futures Fund for investment . Incidentally , since fixed exchange rates were abandoned , is there a need for the IMF , an organisation set up after Breton Woods , to lend foreign exchange & stabilise currencies within the agreed exchange rates .

Peter Sheumack
November 04, 2018

We dig so much gold up on our own land , why get rid of it ?
Build our gold reserve up for bad times in the future , come on work it out you're the one that is suppose to know all the in & out of these things

James Chan
October 18, 2018

Thank you Jordan Eliseo for the most predictable article of 2018.

Back to reality, we have RBA reserves to balance the sometimes wild economic swings.

In 2008, 2009, and 2010, when things were a bit crazy, the RBA lost or gained +$5 billion in each of those years. But Jordan is very excited about that happening once with gold last century.

The RBA reserves aren't there to make a profit. The idea that more gold should make up for the "paucity of yield on offer in sovereign bonds" and so on, reveals a fundamental lack of knowledge about the RBA and why central banks hold reserves.

SMSF Trustee
June 12, 2018

There are false assumptions stated or embedded in this article about why we have foreign exchange reserves. They're not earning income - so what? It's preserving their capital value and their liquidity that matters most. We need to hold more reserves for 'rough times' - why? so we can stop the currency falling and thus helping us through the rough times? No thank you.

Try reading this article from 2012 for a more complete understanding of what foreign reserves are there for and why more gold serves almost none of the requirements.

http://www.rba.gov.au/publications/bulletin/2012/dec/pdf/bu-1212-7.pdf

Ben
June 08, 2018

Great article today. Just wondering your thoughts as to whether or not the RBA make take this on board and perhaps even act on it, in the hope of therefore not even pondering the thought of increasing the cash rate, hence our mortgage interest rates? Of course the cash rate isn't going to increase 'til late 2019... but to nip it in the but by increasing our Gold Assets surely our economy is to benefit?

Felix Huxley
June 07, 2018

I think you are missing the deeper point about Central Banks offloading gold. It is no longer "money" in any practical sense. When it was "money" it was responsible for severe boom/bust cycles in European and US economies, deflation and a significant contributor to depressions, recessions, stagnant living standards and high unemployment, including the 1930's.

Ditching physical gold as money as well as the gold standard has liberated modern economies to target sufficient inflation to keep economies growing and we would not be enjoying our living standards had we maintained the fixation on tying our economic capacity to the supply of a shiny metal used primarily for jewellery.

The fact that Central Banks missed out on appreciation of value shortly after reducing their holdings in the 1990's is irrelevant because capital appreciation is not and should not be the purpose of reserves or money.

 

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