In Russia’s Sovereign Wealth Fund, the Dollar’s Out and Gold Is In

In Russia's Sovereign Wealth Fund, the Dollar's Out and Gold Is In

The tale of Russian gold purchases has taken yet another interesting turn that might, at first glance, be difficult to decipher. After spearheading central bank gold purchases year after year in an almost boastful fashion, as if to remind Western interests that sanctions imposed on the nation can only accomplish so much, it ceased all purchases last March.

Its central bank gave a vague statement and has made no official purchases since then, only making two small sales. It was quite the shift from purchasing gold bullion in double-digit tonnage every month, but nonetheless left the country with the fifth-largest sovereign gold stockpile in the world, amounting to 2292 tons.

Russia’s National Wealth Fund

When people talk of sovereign gold stockpiles, they almost invariably refer to the amount of gold owned directly by a national central bank. Yet just as Russia so often blurs the line between public and private business, it appears that the same effect is happening with its national fund allocation. The $185 billion National Wealth Fund (NWF) is the latest edition of Russia’s state wealth fund. It has changed names since its introduction in 2004, but its focus was always on having a diverse portfolio that would protect Russia’s state budget against oil price fluctuations and secure the nation’s pension fund.

In December 2019, Russia’s Finance Minister Anton Siluanov made a statement that the fund should invest in gold due to the metal’s reliability. In November, the Russian government came up with a proposition that would allow the NWF to buy and store gold, and on May 21, an official announcement was made that the fund was greenlighted to do just that. The gold, unsurprisingly, will be stored with Russia’s central bank.

Where does the money come from?

The NWF is similar to the sovereign wealth funds owned by many nations who enjoy budget surpluses. Norway, China, and Abu Dhabi currently place in the top 3 for fund balances. The concept is simple: money in a sovereign wealth fund gets invested like a pension or an endowment, with profits accruing to the fund (and, by extension, the nation).

Like Norway’s and Abu Dhabi’s funds, the Russian sovereign wealth fund takes its seed capital from the nation’s oil industry. Any Russian oil revenue that isn’t allocated to the federal budget goes to the NWF, and the NWF spends it on a wide variety of assets.

Perhaps the worthiest of mention here are foreign exchange and foreign debt securities, which will likely lessen in favor of gold and precious metals over the following months and years.

Last year, gold officially become a bigger component of Russian reserve assets than U.S.-dollar denominated assets. It has since continued to de-dollarize amid risks of sanctions from both the U.S. and the European Union.

Gold’s popularity as an asset

Various nations that have purchased gold officially over the past few years cited the metal’s utility as a tool for sovereign influence and a universally-accepted store of value, despite having no immediate threat of sanctions unlike Russia.

In short, the new legislation means Russia can continue hoarding gold and dumping dollars under the guise of sound portfolio management. While the NWF issues supposedly accurate allocation reports, the same can’t be said of the State Fund of Precious Metals and Precious Stones, another government branch that does not publish reports on its gold reserves. As sovereign nations open up about the importance of owning gold to maintain clout on the global stage, Russia now has three different investment vehicles through which it can increase its bullion stockpile and lessen dependence on foreign assets.

Big Gold Purchases By Central Banks: Bad News for U.S. Dollar?

Central Banks Buying Gold - Bad News for U.S. Dollar?

According to data published by the World Gold Council, global central banks haven begun adding to their gold stockpiles. In February, the following nations added to their reserves:

  • India (11.2 tons)
  • Uzbekistan (7.2t)
  • Kazakhstan (1.6t)
  • Colombia (0.5t) 

The only notable sale of central bank gold reserves was from Turkey at 11.7 tons.

Why did Turkey’s central bank sell gold?

Nations hold gold reserves as a sort of collateral against their sovereign currency. Turkey’s currency, the lira, had a horrible day on March 22 and lost 20% of its value. In response, Turkish President Recep Tayyip Erdogan made an appeal:

I ask my citizens to invest their foreign currencies and gold in various financial institutions and bring [those assets] into the economy and production.

via BalkanInsight

Put simply: if his people listened to Erdogan’s plea and swapped all their U.S. dollars and euros and precious metals for lira, demand for lira would increase. And therefore prices would increase. It’s reasonable to assume the Turkish central bank sold gold in order to buy lira in an effort to prop up the beleaguered currency.

Note that even after this sale, Turkey has a respectable 716 tons of gold reserves.

What other central banks are buying gold?

More recently, central bank gold purchases have been in the news.

This month, Hungary announced its intention to triple its gold reserves “to help stabilise the economy amid the COVID-19 pandemic, inflation risks and rising debt.”

Back in March, Poland decided to buy 100 tons of gold.

The Reuters article even hints at a possible explanation…

Over the last decade central banks, particularly in Eastern Europe, the Middle East and Asia, have stepped up purchases of gold, often seeing it as a way to reduce reliance on assets such as the U.S. dollar.


Is central bank gold buying a bad sign for the dollar?

Not necessarily. Most central banks around the world hold a combination of foreign exchange reserves (a collection of the world’s most-used and/or most-stable currencies) in bonds as well as gold or other precious metals.

So, in a sense, any government that issues bonds is competing for central bank customers. For the most part, only the most common currencies are considered useful as foreign exchange reserves. According to the IMF, the top five are:

  • U.S. dollar
  • euro
  • China’s renminbi
  • Japan’s yen
  • U.K.’s pounds sterling

So anytime the U.S. Federal Reserve, the Bundesbank or the Bank of England issues a bond (a promise to pay later for cash now, or an IOU), there are other global central banks who are potential customers. Along with them, what you might think of as the “traditional” customers for bonds like pension funds, insurance companies, individual savers, etc. also want bonds. More customers means more demand, and more demand means higher prices.

But what if some of that central bank demand is diverted out of bonds, into gold?

That means a diminished demand for bonds. That means a slight upward pressure on the interest rate issuing banks must offer to attract buyers. Which makes deficit spending more expensive. Sovereign bonds can also lose value to inflation.

Further, as mentioned in the Reuters article, gold isn’t subject to counterparty risk. There’s always the chance, however small, that a nation might choose to stop paying its bond-holders. (This is called a default, or a sovereign debt crisis, and they happen fairly regularly.)

There’s zero chance of physical gold defaulting. Once those gold bars are locked up in a nation’s central bank vaults, it serves as a permanent store of value.

In an important sense, when a central bank chooses to add to their gold reserves, the decision says, “We’re diversifying our country’s savings out of currencies we don’t control, into an asset class that we can trust.”

Why Central Banks Are Increasingly Buying Gold

Already consistent buyers for decades, why has there been a groundswell of renewed interest among nations in recent years? Find out their motivations here.

On the face of it, central banks might not seem all that interested in gold. Barring a select few economies, one will rarely hear central banks praising gold as a cornerstone of their nation’s prosperity. Yet a closer look into who’s buying gold bullion, along with the why, tells quite a story about the interest central bankers have in hoarding the metal.

While the gold market may come off as driven by investor and retail purchases, it is in fact central bankers that have been the strongest under pinners of gold’s price over the past decade. Since 2010, central banks around the world have turned into strict net buyers, purchasing bullion by the ton on a monthly basis.

Central bank purchases of gold have taken center stage in 2018 and 2019, when the official sector bought an annual record of 650 tons of gold during each respective year. The ramped-up purchases were especially curious to market watchers, as various countries that have either been absent from the gold market for years or haven’t shown much interest in it suddenly jumped on the train with multi-ton purchases.

As GraniteShares’ CEO Ryan Giannotto recently noted, central banks now own an astounding $2 trillion of gold bullion. According to experts like Max Castelli, head of global strategy at UBS Asset Management’s Global Sovereign Markets team, and Leigh Goehring, managing partner of natural-resources investment firm Goehring & Rozencwajg Associates, different central banks have different reasons for accumulating bullion.

The case of Russia’s double-digit tonnage purchases on a monthly basis has been well documented. Russia’s desire to move away from the U.S. dollar and shield itself from possible sanctions by acquiring an asset with no counterparty risk is a matter of public domain. And while Russia has been spearheading central bank gold purchases by a wide margin for years, it has recently been joined by China, which not only became a regular buyer but also overtook Russia in terms of purchase weight. Not coincidentally, China’s reemergence in the gold market happened right as trade relations with the U.S. plummeted and threats of levies and sanctions became prominent.

Goehring believes that Turkey, another persistent top buyer, is also spurred to hoard gold due to deteriorating relations with its Western allies. However, Turkey has an additional powerful motive to buy gold, as it is currently in the midst of a currency crisis.

In a broader sense, the reasons for central bank gold buying are fairly straightforward. While nowhere near as strong as in the case of Russia, a desire to move away from the dollar has been made clear by central banks around the world. For many nations, especially emerging markets, owning heaps of gold serves to legitimize their own currency. And, as has often been stated, gold hoards have historically served to solidify a nation’s footing on a global stage, perhaps best exemplified by the Federal Reserve’s massive gold reserves that far outweigh those of gold-loving Russia and China.

As Castelli and many other experts noted, with their long-term outlook, central banks also view gold as a bargain purchase at current prices. Gold’s price bottomed out in 2018, the very same year when official-sector purchases began to double. And, despite gold’s recent climb above a new all-time high, Castelli and his firm believe that the trend of central bank net buying is one that will stick around for some time.