Why Are Central Banks Buying Gold?

Gold reserves at central banks currently stand at a 31 year high as banks lower their exposure to the United States dollar and increase the gold reserves they hold.

Unlike the dollar, gold is not dependent on the economy of a nation and does not expose the holder to risks that other financial assets do.

Why is Gold Emerging as a preferred Asset?

With years of low-interest rates, and money printing in the United States, the value of the dollar against gold has fallen over time. The supply of the US dollar has grown manifold over the last 50 years. Gold supplies increase at a very low pace, due to various factors, ultimately outstripping gold’s demand.

In 1971, Richard Nixon ended the gold standard, that is, the dollar would not be backed by gold. Over decades gold has served as protection against various macroeconomic troubles.

Major buyers of gold are the central banks of several emerging markets. Several of these economies lag behind their developed counter parts in terms of gold reserves. These economies have also seen currency depreciation – hence, lowering dollar reserves while increasing the share of gold can be helpful.

According to Hungary’s central bank, the decision buy large a quantity of gold from the markets was prompted by the need to manage new risks in the global economy. In addition, Hungary’s central bank also believes that increasing global debt and inflation would require a hedging instrument - gold.

“The appearance of global spikes in government debts or inflation concerns further increase the importance of gold in national strategy as a safe-haven asset and as a store of value,” the Hungarian central bank’s press release had said after the purchases were made.

The Polish central bank had given similar reasons for buying 100 tonnes of gold in 2019.

Catalysts to the Adoption of Gold

According to a survey by the World Gold Council, for the first time in years the top reason behind emerging markets’ central banks buying gold has been the performance of gold during crisis situations.

In addition, unlike dollar gold does not face any political risk issues. For example, the dollar has seen pressure in the past as countries like Russia shifted to gold due to political issues.

The Great Financial Crisis has been a catalyst in the shift to gold as well. Once the issues in the financial system were exposed, central banks began exploring ways to reduce the dependence on the US dollar – resulting in increasing adoption of gold by emerging market central banks.

These banks have been net buyers of gold since 2010 from 29,962 tonnes in 2010 to 35,527 tonnes in 2020. Until before the great financial crisis and the rise of China, US had been the sole dominant economy and had consequently dollar denominated assets, and the US dollar itself attracted the interest of central banks of other countries.

The China Factor

Clearly, the focus on buying gold is a turn from the policy of being net-sellers since the 1970s, when the US dollar was taken off the gold standard. Russia and China, two countries with several political issues with US, have been the largest buyers of gold, followed by India.

The shift in power from the US to China has been another factor affecting the move away from the dollar. Over the last few decades China’s economy has grown at a rapid pace, becoming the largest on a purchase power parity basis. It has a large manufacturing base, a large export market, and a large internal consumption market.

With the People’s Bank of China taking proactive steps to increase the adoption of renminbi, it is likely that a larger percentage of international trade would be concluded in Chinese currency, slightly reducing demand for the dollar.

However, increasing foreign exchange reserves could be another reason behind gold buying as central banks look to balance portfolios.

While buying had tapered off during the pandemic period from late 2019 and 2020, buying had resumed in 2021. Thailand bought 90 tons of gold, while India bought 70 tonnes of gold in the current fiscal. China and Russia have slowed on their respective buying sprees so far.

While 2020 had been a great year for gold, peaking in July, the yellow metal did not perform well in calendar year 2021 markets in the current fiscal.