Why are Central Banks Buying Gold? Exploring the Trend of Record Highs
Central banks buying gold is a rising trend that has taken the investment world by storm. Over the years, central banks have been accumulating gold at an unprecedented rate. Between 2010 and 2019, they purchased over 5,000 tons of gold, the highest level of net purchases since the end of the gold standard. What is driving this trend and what are the implications for investors? In this blog post, we explore the reasons behind central banks’ gold purchases and the impact on the global economy.
Geopolitical Tensions
One of the key drivers for central banks buying gold is geopolitical tensions. Geopolitical uncertainties have eroded confidence in the US dollar, causing central banks to reduce their dependence on the currency. As tensions between the US, China and other countries continue, central banks are hesitant to hold all their assets in US dollars for fear of backlash. Instead, they are diversifying their reserves by purchasing gold, which is seen as a hedge against political and economic risks.
Several countries like Russia and Iran are using gold as a tool to diversify their portfolios and establish financial stability. Russia purchased 158 tons of gold in 2020, whereas Iran purchased around 6.5 tons in the same year. This is a perfect example of how central banks use gold as a hedge against geopolitical instability.
Economic Instability
Central banks are also purchasing gold as a defense against economic instability. During times of economic uncertainty, gold prices increase because it is considered a safe haven asset and is less volatile compared to other assets such as stocks and bonds. This has prompted central banks to increase their gold reserves as part of their risk management strategy.
The COVID-19 pandemic has created further economic uncertainty and fear, leading central banks to question the longevity of the current financial policies. Banking giants such as the European Central Bank have adopted negative interest rate policies to spur economic growth, leading to a surge in central banks buying gold. In 2019, central banks purchased a record-breaking 650 tons of gold due to negative interest rates and economic instability.
Diversification of Reserves
Central banks also see gold as an important component of their reserve portfolio diversification strategy. Diversification reduces the risks associated with volatility, currency fluctuations, and default. Gold has no credit risk, and it is a liquid asset that can be sold quickly when needed. As emerging market economies become wealthier, they are increasing their gold holdings to diversify away from their US dollar-dominated portfolios.
In 2019, China added a total of 100 tons of gold to its reserves in a drive to increase diversification of its foreign exchange reserves. This highlights the importance of diversification and why central banks are increasingly turning to gold as a crucial component of their portfolio management.
Conclusion
Central banks buying gold are driven by geopolitical tensions, economic instability, and the need for diversification. As these trends continue, it is very likely that central banks’ demand for gold will continue to increase. For investors, gold provides a hedge against economic and geopolitical risk that is not present in other assets.
If you want proof of central banks’ gold purchases, refer to the data from renowned institutions such as the World Gold Council. According to their Q1 2021 report, central banks purchased 95.5 tons of gold in Q1 of 2021, marking the strongest first quarter in a decade. The International Monetary Fund (IMF) also keeps track of gold reserves by central banks around the world.