Explained: Why are central banks accumulating gold in large quantities?

Gold prices have been breaking record highs in recent months, defying analysts' estimates as the demand for the yellow metal continues to surge worldwide. A year ago, the price of spot gold was trading at $2000 per ounce, while the same is now valued at $2294 per ounce, a rise of 14% and it touched a new peak of $2431.52 per ounce during mid-April. 

Over five months, domestic gold prices surged from ₹60,000 per 10 grams to ₹71,132 per 10 grams. On April 12, they touched a record high of ₹73,958. 

This unprecedented surge in gold prices indicates heightened global uncertainty, driven by factors such as trade tensions, financial conflicts among global major powers, record-high interest rates in advanced economies, and ongoing wars, particularly in the Middle East.

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Amidst these uncertainties, investors seek refuge in "safe haven" assets, with gold being a traditional choice. Gold's status as a safe haven is rooted in its historical resilience during economic instability, geopolitical crises, and market downturns.

For centuries, gold has been prized for its scarcity and intrinsic value. Unlike fiat currencies susceptible to inflation and government policies, gold tends to maintain or appreciate its value over time. Consequently, investors often turn to gold as a reliable investment during periods of uncertainty.

Moreover, the surge in record equity market valuations is indirectly driving demand for gold as a portfolio diversifier. Recent years have witnessed a significant uptick in gold purchases, driven by robust buying from institutional investors, the retail segment, and central banks globally. 

Institutional investors are acquiring gold in anticipation of a potential interest rate cut by the U.S. Federal Reserve.

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Gold is renowned for its resilience as an investment. In periods of falling interest rates, gold prices typically ascend, as investors find bullion more attractive compared to income-paying assets such as bonds.

Furthermore, there is a noticeable increase in jewellery demand across major gold-consuming nations like India, supported by the country's sustained robust macroeconomic environment. Similarly, domestic demand in China is also trending upward.

Central bankers are actively accumulating substantial quantities of gold to diversify their foreign exchange reserves, reducing their reliance on the U.S. dollar. The influx of gold purchases by central banks is currently propelling gold prices to unprecedented levels.

In this article we will explain the central banks' significant gold acquisition, highlighting the key reasons behind it.

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Shifting away from dollar dependency

Central banks worldwide are increasingly turning to gold as a means to diversify their reserve portfolios, aiming to reduce dependency on the dominance of the US dollar, which is enjoying the status of the 'reserve currency'.

Incorporating gold alongside foreign currencies and other assets helps mitigate risks linked to currency devaluation and geopolitical instability.

Gold serves as a stable asset for central banks, offering a safeguard during financial crises to stabilise economies. Its inherent liquidity and value make it a sought-after asset in times of currency volatility or market turbulence.

Moreover, gold serves as a valuable asset during a balance of payments crisis, as evidenced by its utilisation during the 1997-98 Asian crisis. In such situations, gold can be employed to cover crucial imports or stabilise a domestic currency. Additionally, it can function as collateral for securing loans.

However, the pace of gold accumulation by central banks surged dramatically since 2022. After years of playing a secondary role, central banks took center stage by purchasing 1,082 tonnes of gold in 2022, more than double the previous year's acquisitions, according to HSBC's report citing IFS data.

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The surge in central banks' gold acquisitions stemmed from the aftermath of the United States' imposition of sanctions on Russia. These sanctions, triggered by Russia's invasion of Ukraine, included freezing Russian reserve dollars and imposing restrictions on crucial commodity trades such as crude oil. The global repercussions of these measures were profound, exposing vulnerabilities within Western financial institutions.

The limitations placed on Russia's reserve access by Western financial entities led to a widespread erosion of confidence in these institutions. As a result, central banks worldwide began to view gold as a strategic asset for diversification and risk management. 

China's aggressive buying spree

The People’s Bank of China (PBoC) continued its streak of gold purchases for the 17th consecutive month in March, marking its longest buying spree to date as it looks to diversify its reserves away from the dollar and hedge against currency depreciation.

In February, China divested an additional $22.7 billion in U.S. Treasury securities, as per the latest Federal Reserve data, reducing its total holdings to $775 billion. Despite this decrease, China retains its position as the second-largest foreign holder of U.S. debt.

This strategic move by China reflects a deliberate effort to reduce its dependency on the dollar. Chinese policymakers are responding to concerns over the use of the dollar as a tool for foreign policy leverage.

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Meanwhile, China is not the only country that is currently diversifying its forex reserves, other countries are doing so, especially emerging market banks. 

As reported by the World Gold Council, the PBoC acquired 224.88 tonnes of gold in 2023, following a previous acquisition of 62.1 tonnes in 2022. In the first quarter of the current calendar year, an additional 27.06 tonnes of gold were purchased, bringing the total gold reserves to 2,262 tonnes, accounting for 4.6% of total foreign exchange reserves.

China’s gold reserves have risen by 314 tonnes since November 2022, the time at which the PBoC resumed reporting. During the same period, foreign exchange reserves rose by 5% in dollar terms, and official gold tonnage holdings jumped by 14%, with their total value surging by 44%.

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Although China mines more gold than any other country, it still needs to import a lot, and the quantities are getting larger. In the last two years, overseas purchases totaled over 2,800 tons—more than all of the metal that backs exchange-traded funds around the world, or about a third of the stockpiles held by the US Federal Reserve, as reported by Bloomberg. 

Amidst the challenges in local property and equity markets, gold assets have garnered increased interest among investors. Chinese gold ETFs have witnessed consistent monthly inflows throughout Q1 2024, amounting to RMB2.8 billion (US$386 million). 

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India resumes gold buying momentum

Meanwhile, other central banks, such as Poland, Singapore, Libya, and the Czech Republic, collectively purchased nearly 260 tonnes of gold in 2023. Turkey, which acquired 147.60 tonnes of gold in CY22, exhibited a slight slowdown in 2023 but resumed purchases with an additional 30.12 tonnes in the first quarter of the current fiscal year, according to data from the World Gold Council.

India saw an uptick in gold purchases, acquiring 19 tonnes in Q1 FY24, surpassing its entire CY23 purchase of 16 tonnes. In CY22, India added 34 tonnes to its reserves, and in CY21, the Reserve Bank of India (RBI) bought 77 tonnes of gold, marking the highest yearly addition since 2009, when it acquired 200 tonnes.

Also Read: India's gold demand rises 8%, RBI buys 19 tonnes in March quarter: WGC

Overall, the RBI currently holds 822 tonnes of gold, which is an all-time high and accounts for 8.98% of the entire forex reserves. 

In terms of countries with the highest gold reserves, the U.S.A. leads with 8,133 tonnes, followed by Germany, Italy, France, and the Russian Federation with 3,366.49, 2,451.84, 2,436.01, and 2,271.16 tonnes of gold, respectively. India ranks ninth in terms of gold reserves held by a country, as per the World Gold Council.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before making any investment decisions.