The ECB's gold buying idea is a non-starter

Bullion bulls, desperate for positive news amid prevailing negative sentiment on the gold market, latched onto pronouncements by Yves Mersch, member of the ECB's executive board, earlier this week.

Mensch said the European Central Bank may "theoretically" look at purchasing gold, equities and exchange-traded funds as part of a quantitative easing program as it tries to find ways to stoke inflation and stimulate economic growth.

The economic bloc only just escaped tilting back into recession during the third quarter and price inflation has been well below the 2% target for a considerable time.

On top of that bond yields, as evidenced by the 10-year German Bund, have declined to levels last seen in Genoa during the 15th century.

With all other efforts falling short, including negative deposit rates (paying for the privilege of storing cash at the bank instead of earning interest), the ECB may be forgiven for attempting unconventional methods.

But a new note by independent researcher Capital Economics argues there is a reason using gold as part of a QE program "has not even been seriously discussed at the Fed, Bank of England or Bank of Japan, despite their much bolder policies":

For a start, there simply isn’t enough gold for the ECB’s purposes. Excluding jewellery and other practical applications, the total amount of investable gold worldwide is probably of the order of 60,000 tonnes, or approximately 2 billion troy ounces. At current market prices this global stock is worth around $2.3 trillion, or €1.8 trillion. However, the ECB will probably want to expand its balance sheet by at least €0.5 trillion through QE and perhaps as much as €1.5 trillion. The upshot is that, unless the ECB is willing to become the dominant player in the gold market (and significantly increase its current holdings of around 503 tonnes, worth only €16 billion), it will have to look elsewhere.

What’s more, even if the ECB devoted just a small part of its purchases to gold, it wouldn’t achieve very much. Crucially, very little of this investable gold is held by euro-zone banks. Purchasing gold in the open market or from other central banks wouldn’t encourage private sector lending or portfolio rebalancing towards riskier assets. Nor is there any obvious economic advantage in boosting the price of gold – as opposed to the prices of government bonds, asset-backed securities or even equities. And buying gold would not send such a clear signal about the outlook for monetary policy.

Finally, once the ECB has brought the additional gold, it may have to renegotiate agreements with other central banks in order to reverse the policy at a later date. In May, the ECB and 20 other European central banks signed the fourth Central Bank Gold Agreement, or CBGA, stating that they do not have any plans to sell significant amounts of gold for the next five years.