Central banks bought more gold than ever in 2022, adding over 1100 tonnes of the yellow metal. World Gold Council’s Shaokai Fan explains why.
In the face of the war in Ukraine and rampant inflation around the world, some might think it is only natural for central banks, alongside many other investors, to load up on gold.
While these factors may have figured in the minds of central bankers, their thinking towards holding gold has evolved considerably in the past two decades.
While 2022 was a historically strong year for central bank gold buying, it is the latest in a 13-year stretch of net buying by these institutions.
A slow evolution
Central banks have long been familiar with gold as an asset class.
Through variations of historical gold standards, central banks came to accumulate large gold reserves initially to back their paper currencies. The implementation of the Bretton Woods system after WWII continued to place gold at the heart of the international monetary system.
The US dollar would be pegged to gold with guaranteed convertibility at a fixed rate, while all other currencies would be pegged to the US dollar. However, skyrocketing US budget deficits in the subsequent decades led to a breakdown of the Bretton Woods system until the US finally suspended the convertibility of the dollar to gold in 1971, effectively ending the metal’s formal role in the international monetary system.
For several decades after the end of the Bretton Woods system, central banks found themselves managing large gold reserves despite the fact it no longer had any formal function in backing currency. This led to a sustained period of central bank gold sales, in particular from Western European central banks.
For many years, central banks were net sellers of gold and it seemed like the metal would never regain its prominent role as an international reserve asset. But the 2008 global financial crisis abruptly reversed this phenomenon, as the advent of quantitative easing by many central banks sparked fears of currency debasement and the spectre of hyperinflation.
Western European central banks ended their gold sales, as they found value in the metal as a strategic asset amid a quickly changing monetary environment. More significantly, however, central banks in emerging markets began to accumulate large quantities of gold reserves as they saw their large US dollar holdings come under threat from quantitative easing.
Central bank gold buying after 2008
In the years since the global financial crisis, attitudes towards gold has been defined by several major phenomena: Western central banks have ended sales but are unlikely to add gold; central banks in emerging markets have risen as the driving force behind new gold buying; and central banks in countries that produce gold have developed programs to add reserves through domestic production.
Among these phenomena, buying from emerging markets has largely reshaped the story of gold as a central bank reserve asset.
The central banks in Russia, China, India, Turkey, and many other larger emerging economies have added significant quantities to their reserves since 2008. Furthermore, many other emerging markets’ central banks, including Thailand, Brazil, Hungary and Poland, have made notable purchases.
These central banks started with a very low level of holding compared to their advanced-economy peers. The drive to diversify reserve assets from market-driven and political risks has naturally led many to choose gold.
In addition, central banks of countries like Kazakhstan, the Philippines and Mongolia have tapped domestic gold production. This can be advantageous as it allows a central bank to pay using local currency, whereas buying internationally would require exchanging a hard currency (like the US dollar) for gold.
Central banks break gold-buying records in 2022
Several factors may have driven last year’s record central bank gold-buying.
Russia’s invasion of Ukraine has re-focused attention on other global hotspots like the Taiwan Straits or the Korean peninsula.
Strong Western unity against the invasion of Ukraine has strengthened ties between Russia and China, while many non-aligned countries are precariously balancing relations between these two camps. This has prompted a wave of de-globalisation and heightened tensions.
From a central bank perspective, the rapid imposition of sanctions against the Russian foreign currency reserves was new and unexpected. While some central banks have faced sanctions before, none approached the size and importance of the Bank of Russia. The freezing of its offshore foreign currency reserves proved that the US dollar could indeed be wielded at a large scale.
The sanctions against the Russia may have prompted a re-thinking of the nature of political risk and the accessibility of a central bank’s foreign currency reserves that are domiciled overseas.
Gold, if stored domestically, is immune from seizure. While a country facing international sanctions would have difficulty using gold for cross-border transactions, its very existence provides a level of comfort within a domestic economy and financial markets.
This may have prompted the large-scale gold buying in 2022. For example, China’s central bank reported gold purchases for the first time in several years. Large gold purchases also came from the central banks of Iraq, Egypt, Turkey, and the UAE in 2022.
Will central banks continue to buy gold?
Central bank investment trends can be difficult to assess. Their investment decisions are not purely based on market factors, but usually involve elements of political and strategic calculation as well.
It is therefore difficult to say whether central bank gold buying will continue, and whether it will continue at the blistering pace we witnessed in 2022. That said, the trends continued into the first quarter of 2023. China continued to report gold buying, while Singapore announced a 51-tonne gold purchase in the first two months of the year.
The reasons that drove central bank gold-buying last year persist. In fact, recent discussions have increasingly focused on the long-term role of the US dollar in the global economy and whether alternative currencies or arrangements should displace its supremacy.
Most analysts predict that the US dollar will remain the unparalleled currency of international trade for years to come, but its position will face steady erosion that may be accelerated by the weaponisation of the dollar in recent years.
What this may mean for gold as a reserve asset is still unclear; however, the central bank of Hungary may have provided some insights.
After a substantial gold purchase in 2019, the Hungarian central bank took the rare step of detailing its rationale, suggesting it added gold because it foresaw disruption during a period of transition in the international monetary system, highlighting gold’s role as a risk-mitigator.
With so much uncertainty clouding the global outlook, perhaps gold can still shine as a beacon of stability.
This feature appeared in the June–July edition of Australian Resources & Investment.