Hey, big spenders
Central banks have certainly been splashing the cash recently. As Bloomberg recently reported, China’s People’s Bank raised gold reserves to 60.62 million ounces in March, up from 60.26 million the previous month. It’s the fourth month in a row that the bank has bought in the yellow stuff.
But China isn’t the only big player to be buying gold. Over in Russia, Putin increased reserves by 145.5 tons between January and March. That’s in addition to the 274 tons Russia stockpiled in 2018, making it the year’s top buyer.
And according to the World Gold Council (WGC), plenty more central banks are choosing gold – traditionally a safe haven in troubled times. They added 651.5 tons of bullion in 2018 – that’s the second-highest total on record, the highest being back in 1967.
So why do central banks love gold so much? Quite simply, it’s an essential part of their function to keep wealth diverse, especially in uncertain times. As the 2018 WGC report says: ‘Heightened geopolitical and economic uncertainty throughout the year increasingly drove central banks to diversify their reserves and re-focus their attention on the principal objective of investing in safe and liquid assets.’
Central banks are responsible for many of the practical aspects of managing a country’s financial system – issuing money, overseeing and operating monetary policy. But they are also the lender of last resort to their respective governments, and to their country’s commercial banks.
Following the 2008 financial crisis, for example, Russia’s government gave $100bn in extra liquidity to the banking sector. Iceland nationalised all three of its banks, while the Swiss government gave UBS $54bn.
Keep the faith
So central banks need to have sufficient assets stockpiled to keep an economic system shored up. And they need to make sure that the population has faith in the strength of their banking system. If people feel that a bank is weak and their money is at risk, they’ll rush to take it out. This uncertainty caused the run on Northern Rock in 2007 – the first run on a British bank in 150 years.
In short, central banks need those safe haven assets, such as gold, as valuable collateral in case things go wrong – plus, gold can also improve risk-adjusted returns. A World Gold Council and YouGov survey in 2018 found that 71 per cent of central banks believed these two aspects of gold were relevant to them.
In a recent BullionStar survey, which asked central banks why they hold gold, Greece’s central bank responded that “the two main reasons central banks, including the Bank of Greece (typically prudent-oriented organisations), choose to include gold as a reserve asset on their balance sheets, are: 1) its recognition as a safe haven asset during periods of markets’ unrest and 2) the ability of instant liquidation in case of emergency.”
And Austria’s national bank said: “Gold is an essential part within our strategy for crisis prevention and crisis handling and is held as liquidity reserve but is also a means to diversify our investments.”
The chart below provides a timeline for gold purchases by the US federal reserve:
But there’s another reason why central banks such as China, Turkey (the second-biggest buyer in 2018 with 125.8 tons) and Russia might be buying up gold reserves. The theory, posited by Rick Mills at aheadoftheherd.com: these are all countries who don’t get on with the US. Are they looking to undermine the dollar – and capitalise on its fall?
The US dollar, of course, is the foreign currency of choice. That suits the US just fine and gives it a lot of power. It can borrow more cheaply, and governments all over the globe like to buy US Treasury bonds because they’re stable. The US’s financial sector makes a huge amount of money selling dollar banking services. And oil, of course, is only sold in ‘petrodollars’.
But that might be about to change, Mills points out: OPEC members are, for the first time, threatening to sell oil in non-dollar currencies, while China and Russia have signed energy deals conducted in rubles and yuan. To avoid US sanctions, Iran and the EU have agreed to set up a new payments system.
If the dollar falls, says Mills: “It would make the financial crisis of 2008-09 look like a mere stock market correction… In light of these risks, is it any wonder central banks are bulking up on bullion?”
Important disclaimer: this document is not an official research report and the views expressed in it are those of the authors. The authors are not registered research analysts and there is no assurance the trends mentioned will continue or that the forecasts discussed will be realised. Gold as a commodity is not a specified investment for the purpose of giving advice under the Financial Services and Markets Act 2000, therefore, this it does not give rise to rights to claim compensation under the Financial Services Compensation Scheme.