Innovative Reserve Management: Leveraging Gold Futures to Bolster Nigeria’s FX Reserves

By Chinedu Okoye 




Introduction:

This paper discusses the prospects of using innovative means to prop up the Naira by diverting some of its reserves into gold. This stems from our view on the value of the precious metal and the need to strengthen the Nigerian local currency.

Gold has seen a meteoric 38% rise in the past year. With global central banks piling into gold for over three years, we make a case for diversifying and growing reserves by gaining exposure to gold. This builds on thoughts expressed in an earlier paper on central bank reserve asset diversification.



Paper Thesis:

Last year, we conceptualized the idea of the Central Bank of Nigeria (CBN) diversifying its reserve assets via currency swaps, aiming to reduce dependence on the USD.

Having come to terms with the limitations that existed then—and still linger (FX supply constraints)—we have resorted to a different idea: increasing reserves by trading in precious metals (gold) in the short term as a way to diversify FX sources and bolster reserves.

We foresee an upward trajectory in gold. Since the CBN's reserves are somewhat limited, committing a percentage of FX to going long on gold futures could strengthen reserves. The bank could realize gains from exposure to the metal through futures trading rather than holding physical gold.


Benefits of the Strategy;

This strategy has the potential to; increase reserves, realize short-term gains from  
shadow diversification into Gold through its exposure to futures price movement, and unlike physical gold bars, it is highly Liquid as positions could be closed instantly in the event that the committed funds are needed.

Increases Reserves:
As shown in the chart below, gold has risen 38.12% year-on-year. If the CBN had committed 10% of its reserves a year ago (approximately $3.4 billion out of $34 billion), it would have realized a return of $1.4 billion from this commitment.


Highly Liquid:
Unlike physical gold bars, gold futures are highly liquid. In the event liquidity is needed, the bank can easily close its positions, limiting losses or future gains, but making funds available when necessary.

Shadow Diversification with Immediate Gains:
By gaining exposure to price movements in precious metals, the apex bank essentially diversifies its reserves in an indirect way. This introduces an additional component to the reserve assets.

For the duration gold remains part of the reserves, its rise in value would influence the Naira similarly to how fluctuations in gold prices impact the Yuan. Unlike the PBOC’s long-term gold holdings, which are not for sale, the CBN’s gold futures positions would be closed for profit-taking at the right moment.


Making the Most of FX Reserves:

The Central Bank is in a stronger position now, with foreign reserves having increased by over 11% in the past year, reaching $38 billion. The substitution of imported petroleum products (PMS) with locally refined products eliminates 40% of the country’s import demand, potentially provides a major relief to import burden on foreign reserves.

If the NNPCL can ramp up production to meet OPEC quotas—and preferably exceed them—it could satisfy both local and international demand for Nigerian crude. Given that Bonny Light commands an almost $3 premium to the Brent benchmark, the CBN could commit a percentage of its reserves to gaining exposure to rising gold prices.

This leads to an updated thesis on CBN reserve management as Nigeria faces ongoing FX supply challenges and urgently needs innovative solutions to consolidate reserves.



New Zero Equilibrium Propositions on FX Reserve Management:

Foreign exchange sources such as FPIs and Diasporan remittances, which have been the major drivers of reserve increases, provide the apex bank with the flexibility to commit a portion of reserves to this venture.

This could be managed through the Nigerian National Investment Bank, where a special fund could be created and funded by the CBN. A representative from the CBN would sit on the board to supervise and direct the investment of these funds.

We suggest using a tenth of the reserves to trade the XAU/USD pair, calculated based on the 30-day moving average to derive the 360-day moving average. This would be the metric for determining the total investible sum.

Once gold hits a target price, say $3,000 within a year, positions could be closed, and profits realized. This strategy would allow the CBN to capitalize on upward movements in gold prices against the dollar, increasing reserves once profits are realized and inadvertently strengthen the Naira.

Comments

Post a Comment

Popular posts from this blog

US China Trade War, Winners and Losers, and Implications for the Global Economy

Image
- By Chinedu Okoye    Summary: Winners and losers in this conflict can't be measured in monetary terms as both sides lose in that regard. The real differentiation lies in long-term economic positioning. The Trump administration seems to miss the transition of the US economy, and this moves could actually stall and take way the focus from long-term sustainability to short-term (political) gains. Ironically the US needs these deficits to maintain the balance of payments surplus it runs from gigantic inflows it receives from foreign investors into private and government securities. The trade war and threats to "isolate China" has sever implications for US position and influence in the global economy as it is basically strongarming allies, and giving China more leverage.   Introductory Remarks: Trump is going aggressive as China is gently forging ties, whilst issuing stern warnings of US collusion. Bot...
Read more

Zero Equilibrium Revised 12 Month Naira Outlook:

Image
By Chinedu Okoye  Spot Rates Strengthens Beyond ZE Expectations: Spot USD/NGN is currently N1,490.33, reflecting continued relative strength of the Naira against the USD and other majors.  At the time of our last  ZE Naira outlook : The Naira was selling for N1560/$1. And at the N1500/$1 - N1600/$1 range, was as “relatively strong”. This just inside the strong case zone in the earlier ZE Outlook where it was state that; below N1500 - N1400/$1 as a strong case scenario; N1500-N1600/$1 as the baseline level, and; above N1700+/$ as the most bearish scenario. Given the economic developments on the global economy (a range of monetary policy decisions and forward guidance, changes in the Oil market, and CBN monetary policy) since our last Naira outlook earlier in the year, for FY 2025. Going NGN/USD 12 Month Forward Rates: Data from @Investingcom showed Forward points from Investing.com translate into 1-year forwards at N1,703 (bid) and N1,783 (ask), implying a +...
Read more

Government Spending, Debt and Growth.

Image
- By Chinedu Okoye  Synopsis: Fiscal authorities act as a stabilizing mechanism in the goods and services market in periods of high uncertainty and slow or even negative output growth. However a level of efficiency is required if the expansion is to yield the intended benefits. Tis is because, indiscriminate deficit spending with no distinct purpose could be hyperinflationary. A prioritized budgetary allocations according to value added on a cost-benefit basis should be the none of any effective fiscal expansion. Not doing so could lead to erratic spend and income redistribution that creates economic imbalances and Stokes inflationary pressures, rather than provide economic stability. Fiscal expansion must be more about stabilizing and supporting the markets, with job creation as an inevitable consequence, such that the jobs created as a result add value to society. The effects of a crowding-out of private investment is more likely to occur when deficit spending c...
Read more