Speech by Mr Hervé Hannoun, First Deputy Governor of the Banque de France, at a dinner organised by Goldman Sachs on the occasion of the Financial Times Gold Conference held on 26 June 2000.
I. Gold
A. The Banque de France’s view on gold is based on three main pillars:
• We are in favour of gold holding
• We are against gold selling
• We have a very prudent and conservative approach to gold lending
1. Gold holding
The Banque de France is a major gold holder (with more than 3,000 tons). The creation of the single currency has in no way modified our policy and motivations for holding gold, which remains in our view an important reserve asset.
Let us review the reasons why central banks want to hold gold. What is the rationale for holding gold, a non-interest bearing asset, given that there is no more official role for gold since the collapse of the gold exchange standard?
– First, security: the absence of any credit risk is an intrinsic quality of gold: gold offers full security as long as it is properly stowed in central banks’ vaults.
– Second, liquidity: in situations of political turmoil or high global inflation, gold’s liquidity is unchallenged. Certainly, in circumstances of orderly financial markets, gold is not the most liquid of assets (even though it is probably the most liquid of commodities). But its liquid quality becomes apparent and increases as uncertainty grows. In this regard, the absence of a return on gold can be viewed as the price of its “option component”: contrary to most other assets, gold prices go up when things go wrong.
– Third motivation for holding gold: diversification.
Gold bears no interest coupon. If lent, the lending rate is relatively modest. Then there is usually a cost of carry for gold holdings. This is partially offset by the “option component” I mentioned before. But gold is also a very good diversification instrument. Indeed in the long run, the price of gold has shown a very low and even a negative correlation with the dollar (the first-ranking reserve currency) and with US Treasuries. So gold is very useful to build a diversified portfolio as it enables you to improve your risk/return profile.
On the whole, I would say that gold is an asset of last resort par excellence and that recent market developments have in no way altered its intrinsic qualities. There is still a rationale for central banks to hold gold.
2. Gold selling
After having listed all the good reasons for holding gold, you will not be surprised if I reiterate that we have no plans to sell gold!
The leading official holders of gold have not changed their attitude in this respect. Neither the American Federal Reserve System, nor the German Bundesbank, nor the Bank of Italy, nor the Banque de France have any plan to sell gold.
3. Gold lending
Concerning gold lending, the Banque de France, as most of you probably know, is definitely not among the active players in the market. Quite the contrary, alongside the other major holders, it has refrained from an active management of its gold holdings. The Banque de France has always adopted a very prudent and rather conservative approach, acknowledging the fact that the issue of gold lending is a matter of common interest to the major holders.
Two main reasons are traditionally put forward to justify gold lending:
– The first one refers to a question of principle. Foreign currency assets are actively managed. Why not extend this management to gold insofar as gold is considered to be part of a country’s external reserves?
– The second reason is that central banks obviously have to take into account profit and loss account considerations. From this standpoint, gold should provide a return just like other assets.
But the reasons for prudent management of gold reserves by central banks are, in our view, of utmost importance.
Central banks are typically “risk averse” when investing their foreign assets on the financial markets; as far as gold management is concerned, an even more cautious attitude is required because of the characteristics of the gold market.
Central banks must be aware that their deposits may favour the financing of speculative gold sales. In other words, for a speculator (or a producer) who wants to take a position against gold, it would be very easy to be short because he can easily borrow from the official sector, which is a potential lender on this market. The result of this policy then would be a drop in the price of gold.
Furthermore, lending is even more delicate for a big holder: what is the use of lending if, at the same time, you are depreciating the value of your holdings? This question is effectively not the same when you hold 3,000 tons as when you hold 300 tons.
Consequently, our policy regarding gold lending could be expressed as follows: a responsible holder must have a responsible approach to management. This means that the Banque de France has to and does pay due attention to the trade-off between its own interests (ie enhancing the return on its assets) and the impact on the market.
The gold market characteristics described earlier call for a cautious and coherent attitude.
A. The Banque de France’s view on gold is based on three main pillars:
• We are in favour of gold holding
• We are against gold selling
• We have a very prudent and conservative approach to gold lending
1. Gold holding
The Banque de France is a major gold holder (with more than 3,000 tons). The creation of the single currency has in no way modified our policy and motivations for holding gold, which remains in our view an important reserve asset.
Let us review the reasons why central banks want to hold gold. What is the rationale for holding gold, a non-interest bearing asset, given that there is no more official role for gold since the collapse of the gold exchange standard?
– First, security: the absence of any credit risk is an intrinsic quality of gold: gold offers full security as long as it is properly stowed in central banks’ vaults.
– Second, liquidity: in situations of political turmoil or high global inflation, gold’s liquidity is unchallenged. Certainly, in circumstances of orderly financial markets, gold is not the most liquid of assets (even though it is probably the most liquid of commodities). But its liquid quality becomes apparent and increases as uncertainty grows. In this regard, the absence of a return on gold can be viewed as the price of its “option component”: contrary to most other assets, gold prices go up when things go wrong.
– Third motivation for holding gold: diversification.
Gold bears no interest coupon. If lent, the lending rate is relatively modest. Then there is usually a cost of carry for gold holdings. This is partially offset by the “option component” I mentioned before. But gold is also a very good diversification instrument. Indeed in the long run, the price of gold has shown a very low and even a negative correlation with the dollar (the first-ranking reserve currency) and with US Treasuries. So gold is very useful to build a diversified portfolio as it enables you to improve your risk/return profile.
On the whole, I would say that gold is an asset of last resort par excellence and that recent market developments have in no way altered its intrinsic qualities. There is still a rationale for central banks to hold gold.
2. Gold selling
After having listed all the good reasons for holding gold, you will not be surprised if I reiterate that we have no plans to sell gold!
The leading official holders of gold have not changed their attitude in this respect. Neither the American Federal Reserve System, nor the German Bundesbank, nor the Bank of Italy, nor the Banque de France have any plan to sell gold.
3. Gold lending
Concerning gold lending, the Banque de France, as most of you probably know, is definitely not among the active players in the market. Quite the contrary, alongside the other major holders, it has refrained from an active management of its gold holdings. The Banque de France has always adopted a very prudent and rather conservative approach, acknowledging the fact that the issue of gold lending is a matter of common interest to the major holders.
Two main reasons are traditionally put forward to justify gold lending:
– The first one refers to a question of principle. Foreign currency assets are actively managed. Why not extend this management to gold insofar as gold is considered to be part of a country’s external reserves?
– The second reason is that central banks obviously have to take into account profit and loss account considerations. From this standpoint, gold should provide a return just like other assets.
But the reasons for prudent management of gold reserves by central banks are, in our view, of utmost importance.
Central banks are typically “risk averse” when investing their foreign assets on the financial markets; as far as gold management is concerned, an even more cautious attitude is required because of the characteristics of the gold market.
Central banks must be aware that their deposits may favour the financing of speculative gold sales. In other words, for a speculator (or a producer) who wants to take a position against gold, it would be very easy to be short because he can easily borrow from the official sector, which is a potential lender on this market. The result of this policy then would be a drop in the price of gold.
Furthermore, lending is even more delicate for a big holder: what is the use of lending if, at the same time, you are depreciating the value of your holdings? This question is effectively not the same when you hold 3,000 tons as when you hold 300 tons.
Consequently, our policy regarding gold lending could be expressed as follows: a responsible holder must have a responsible approach to management. This means that the Banque de France has to and does pay due attention to the trade-off between its own interests (ie enhancing the return on its assets) and the impact on the market.
The gold market characteristics described earlier call for a cautious and coherent attitude.
B. This Banque de France view is now widely shared by the central banking community
1. Concerning gold holdings:
The ECB’s decision in July 1998 to hold 15% of its reserves in gold, taken from the gold stocks of the national central banks, was generally seen as a positive signal in a market hitherto inhibited by fears that governments might decide upon new gold sales.
This was evidence that gold remains an important element of global monetary reserves.
2. Concerning gold selling and gold lending:
The Banque de France and the Bundesbank have been a driving force behind the 1999 joint statement on gold, which is fully consistent with our traditional position. And I quote:
– “The undersigned institutions will not enter the market as sellers, with the exception of already decided sales.
– The gold sales already decided will be achieved through a concerted programme of sales over the next 5 years. Annual sales will not exceed approximately 400 tons and total sales over this period will not exceed 2,000 tons.
– The signatories of this agreement have agreed not to expand their gold lendings and the use of gold futures and options over the period.” (End quote.)
The so-called “Washington Agreement” has clarified the intentions of the Eurosystem as well as of the Sveriges Riksbank, the Swiss National Bank and the Bank of England with respect to their gold holdings.
First, it has re-emphasised the role of gold in stating that (I quote) “Gold will remain an important element of global monetary reserves”. Second, it has provided the market with some reassuring guidance concerning the sensitive issue of central banks’ gold sales and lending.
Far from destabilising the market, the Washington Agreement brought more transparency to the gold market, and helped foster sounder conditions in the price formation process by reducing uncertainty and overall volatility.
It is true, however, that the initial market reaction to the joint statement was extreme. The immediate impact of the Washington Agreement was all the more dramatic as a number of market participants (gold mines, hedge funds) had accumulated big and, I would say in some cases, excessive, short positions. The fact that the short sellers had to rapidly square their positions induced a brief period of higher volatility, but also created the conditions for a more orderly market and thus, during the last months, gold prices have fluctuated in a relatively narrow range.
On balance, I do think that the joint statement has had a stabilising effect on the gold market thanks to enhanced transparency and clarity concerning central banks’ intentions...."
Source: http://www.bis.org/review/r000725b.pdf?frames=0
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