Gold has traditionally been used to measure the value of goods and was a means of payment in almost every ancient civilization, partly because it is extremely rare in nature and therefore scarce. According to the latest figures some 183,600 tonnes of gold have been mined to date (source: World Gold Council), roughly equivalent to a cube measuring 21 metres on each side. The US Geological Survey estimates that about 50,000 tonnes still remain in the ground and the number of new mines is dwindling. Some of the value of gold stems from its properties (it is ductile and malleable), as well as its resistance to oxidization and chemical reagents, meaning that it does not deteriorate and can be stored for long periods of time.
Gold is an excellent hedge against adversity. Its price tends to rise when operators perceive the level of risk to be high, for instance during military escalation or, more often, financial crisis, when financial instruments, especially high risk ones like shares, plummet in value but gold tends to rise in price. Incorporating gold into a financial portfolio is a way of hedging against high-risk scenarios, however unlikely. This function has been very much to the fore in recent years: in the face of widespread fears about the resilience of the financial system in 2008-09 and the stability of the euro area in 2011-12, gold performed particularly well, adding considerably to the equity revaluation account in which the Bank records increases in the value of its gold reserves.
Another good reason for holding a large position in gold is as protection against high inflation since gold tends to keep its value over time. Moreover, unlike foreign currencies, gold cannot depreciate or be devalued as a result of a loss of confidence. So, when a foreign exchange crisis erupts, central banks can use gold in the same way as their official foreign exchange reserves, to shore up confidence in the national currency; they do so by using gold as collateral for loans or, as a last resort, selling it to buy national currency and uphold the latter’s value. A large stock of gold gives a central bank plenty of room for manoeuvre to preserve confidence in the national financial system.
Of course, gold’s unique properties entail financial costs: the cost of storage and security. Also, it does not offer a return and so owning a large stock means forgoing the interest that would mature on debt securities. Those securities, however, have a fiduciary value that could evaporate in the event of a systemic crisis of confidence, undermining their role in investment diversification. Gold, on the other hand, is not an asset ‘issued’ by a government or a central bank and so does not depend on the issuer’s solvency.
Lastly, part of the gold is held for precautionary reasons, in case the ECB demands an additional contribution of either foreign currency (including dollars and yen) or gold.