GOLDCeylon | GOLD NEWS | 26.03.2024
As part of the World Gold Council Central Bank Gold Reserves Survey in 2023, central banks all over the world were asked for the major factors at play in their decision to hold gold. The five most popular responses – and therefore the biggest reasons why central banks buy gold were:
• Historical position
• Performance during times of crisis
• Long-term store of value/inflation hedge
• Portfolio diversifier
• No default risk.
Let’s examine some of these factors in more detail.
Historical position
Gold is one of the oldest and most universally valued assets. People from all cultures, all across the world, have revered gold since ancient times. Royal treasuries, temples, and other important authorities hoarded gold as a way to assert their economic stability and power. There are many reasons for this:
• Scarcity: Gold is rarer than other metals, such as iron or copper, but not so rare that it’s unfeasible to use it.
• Durability: From a chemical perspective, gold is a solid metal that doesn’t rust or corrode when left exposed to the elements.
• Malleability: Gold is extremely soft and malleable, making it easy to mold to different shapes and stamp for gold coins.
Gold’s value today stems from its past use as a currency and object of value, giving it a strong historical position. Should the financial system as we know it crumble, it’s likely that the world will turn back to gold as an asset. If this were to happen, central banks with gold reserves can maintain their position as economic powerhouses.
Performance during crisis
Gold has proven itself to be a safe-haven asset that maintains its value – and even increases in value – during periods of instability and crisis. Whether its political turmoil, economic instability, or a global financial crisis, gold tends to hold its value regardless of what’s happening in the world. This is why it’s often called the ‘crisis commodity’.
These two examples highlight gold’s ability to skyrocket during periods of crisis:
• USA in the late 70s: At this time, interest rates were over 15%, inflation was at 14%, and the world was experiencing the Cold War, Soviet invasion of Afghanistan, and an oil embargo. During this time, gold’s price increased by 721% between 1976 and 1980.
• Early 2022: In the wake of the Russia-Ukraine conflict and the global uncertainty that followed, a similar situation occurred where gold prices increased by 6%.
Essentially, gold’s continuing performance during a crisis allows central banks to confidently navigate economic uncertainties and geopolitical tensions. The Dutch central bank, De Nederlandsche Bank (DNB), sums up its perspective on the matter succinctly:
“A bar of gold always keeps its value. Crisis or not. That gives a safe feeling”.
Long-term store of value/inflation edge
Besides its ability to perform well during a crisis, gold has shown itself to act as an effective inflation hedge and long-term store of value. While paper money is known to depreciate in value over time, gold is a limited-supply asset. This means it cannot be produced at will.
Its scarcity, combined with its intrinsic value, makes gold resilient to the effects of inflation and helps retain its purchasing power in the long-term.
Portfolio diversifier
Another reason why central banks buy gold is to diversify their reserves. The value of a country’s currency is likely to fluctuate in value depending on the state of its economy. In dire situations, central banks might need to print off more money to prevent economic collapse. This results in currency devaluation.
Unlike fiat currencies, gold is a physical commodity that cannot be printed on demand. This helps add a layer of diversification to central banks, reducing overall risk, increasing resilience, and optimizing their potential for long-term returns. Having gold reserves allows central banks to weather economic storms and maintain a balanced portfolio that won’t collapse in situations where paper money loses value.
On top of that, gold tends to move in opposition to conventional financial assets like stocks and bonds. When these assets depreciate, gold’s price tends to increase. This makes gold a reliable anchor and diversifier in central banks’ portfolios.
No default risk
Another key reason why central banks hold gold is the absence of default risk. Unlike other financial assets, like bonds or loans, gold doesn’t rely on a third party to make good on contractual obligations or promises.
Once acquired, gold is a tangible, physical asset with intrinsic value that does not depend on a third party. This means that central banks holding gold can be confident that their investments will remain secure, stable, and reliable into the future.
Other reasons why central banks buy gold
While the factors outlined above play the biggest part in central bank gold buying, there are other reasons why they may choose to do so. These include:
• Anonymity: Amidst heightening geopolitical tensions, the Society for Worldwide Interbank Financial Telecommunications (SWIFT) payments system has imposed sanctions on countries like Iran and Russia. Countries weary of sanctions can trade their US dollar assets to the more anonymous gold.
• It makes them safer: In an uncertain world, gold purchases can help make central banks look (and feel) more stable and secure. Should there be any financial crisis or decline in a country’s currency, these countries can rely on their stores of gold to weather the storm.
• De-dollarization: Many countries buy gold to diversify their reserves from US dollar over-concentrations. For example, BRICS nations – Brazil, Russia, India, China, and South Africa – are in talks of developing a new currency as part of a de-dollarization strategy. They’ve hinted that new currency may be backed with gold and other metals with intrinsic value. Should this process develop further, it would be no surprise to see more central banks flocking towards gold.
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