Gold is commonly seen as a good investment in uncertain times. No one would call the current times certain, and gold is duly rallying.  

Part of the momentum seems to be driven by central banks, which are hoovering up gold. According to the World Gold Council, central banks globally added 37t to reserves in July, a 206% m/m increase. Poland’s central bank led the buying spree, its appetite for the metal unabated. The Polish central bank added a net 14t to its reserves, increasing its holdings to 392t. 

The recent WGC data shows a continuing appetite for the metal among countries that have recently bought gold. The data show that the Reserve Bank of India has added gold to its reserves every month of 2024, with estimates indicating the RBI added 5t to its reserves in July. 

Turkey has also been consistent in its uptake of gold, with 14 consecutive months of net buying.  The latest data shows a rise in its net reserves of 4t, with its official gold reserves rising to a record high of 589t. 

The Central Bank of Kazakhstan was the only net seller in July, reducing its reserves by 4t to 295t. After two successive months of buying, Uzbekistan has gone from net seller to net buyer (the Central Bank of Uzbekistan bought 10t in July). 

A hedge against volatility …  

On the face of it, the turn to gold isn’t surprising. Inflation has been a concern globally, and geopolitical risk is high. In this environment, gold is often seen as a safe investment amid uncertainty. 

Unlike fiat money, which devalues as governments increase supply, gold is a physical commodity, the supply of which cannot be rapidly altered. It is thus seen as an effective store of value. (Indeed, some commentators point out we shouldn’t underestimate declining supply as a factor in rising gold price historically.) When countries are printing money, it thus may be sensible to increase gold holdings. 

Gold is also highly liquid and not subject to counterparty risk – so the credibility of the authority holding the asset is not a factor in its valuation.  

… but does volatility create the hedge? 

Gold’s high liquidity also makes it useful as a medium of exchange when your own currency becomes persona non grata in global trade.  An IMF paper by Barry Eichengreen and others finds evidence that central banks have an increased propensity to buy gold when they are faced with the prospect of sanctions. Gold is a stable and liquid asset that can help states operate outside of the US dollar system. When faced with the prospect of sanctions, nations turn to gold.  

The paper finds that “many of the largest year-on-year increases in individual central banks’ gold holdings occur at times when those central banks are or have reason to think that they may be subject to financial sanctions.” Remarkably, they conclude that “fully half of the largest year-over-year increases in central bank holdings of gold reserves since the turn of the century were associated with the risk of sanctions.” 

Central bankers’ appetite for gold is not a temporary phase. The authors show that central bank gold buying has, in fact, been reverting to pre-Global Financial Crisis norms.  

Chart Source: IMF Working Paper: Gold as International Reserves: A Barbarous Relic No More?, 27 January 2023 

Global coordination and the gold price  

For most of the 1960s, the price of gold was stable and consistent: 35 USD per troy ounce. That wasn’t an accident or a fluke of the markets. Under the Bretton Woods system, there was coordinated global action to defend the gold price. Once Bretton Woods collapsed, the price of gold rapidly soared. 

Today, a different type of coordination is arguably pushing gold in the opposite direction. Interestingly, the IMF paper found that the scope of sanctions influences the scale of gold buying.  The authors see evidence that multilateral sanctions by the main reserve-issuing countries leads to an even more dramatic increase in gold buying. That makes sense, as under those conditions, the sanctioned state cannot simply convert its currency to an alternative reserve currency. 

Rather than coordinating to preserve an integrated monetary order, multilateral exclusions (i.e. sanctions) from the club of favoured trading nations drives central bank towards gold, pushing up the value of the metal.   

The world economy is complex and interconnected. Sanctions, even multilateral sanctions, don’t remove a nation from the world economic system. One scholar has gone so far as to suggest producers need to increase gold supply to drive down the price and thwart Russia war economy. What that all means for investors’ portfolio is another question. 

Simon Shear

Content Writer at Finalto

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