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.

Reuters

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.