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Are central bank actions the reason for gold purchases?

The sequence of events that have been escalating since the onset of the coronavirus pandemic, geopolitical tensions, and the renewed financial crisis are having a profound impact on our lives and relationships. The impact is also felt strongly in our attitude towards assets, which are losing real value in times of inflation. The shift towards safer investments such as gold is a logical consequence of past and future events. Central banks have long been preparing intensively for this situation, including by buying gold.

Important events from 2020

Let’s take a look at the key events that have taken place over the last three years:

  • The biggest pandemic in 100 years.
  • A record global financial “stimulus” of 11,000 billion US dollars.
  • The highest interest rate hike in history.
  • Highest inflation in more than 40 years.
  • Extreme volatility in energy prices.
  • The most unaffordable real estate in history.
  • The 3rd largest bank failure in US history.

 

Things seem to be escalating well into 2023. Volatility and uncertainty have become the new ‘normal’ and part of our everyday lives. In the light of what is happening, a mental leap in the search for asset protection is extremely important and must replace the greed that has run rampant in the financial markets in the past. The money that has been ‘generously’ given to us since the pandemic in the form of financial aid is now being taken out of the market and ‘directly’ out of our hands in a big way.

 

Troubles for the banking system again?

 

Recently, events have begun to unfold that have sown the seeds of doubt in people’s minds about the “viability” of the US and European banking systems. The balance sheet of the Federal Reserve increased by almost 400 billion US dollars in the month of March, over a period of two weeks. In this way, in just 14 days, the FED has reversed by more than 50% all the “effort” of quantitative tightening that it had been carrying out for almost 300 days.

 

Figure 1: FED’s balance sheet total, 2021-2023

 

What actually happened? The increase in the balance sheet was caused by the sudden failure of three US banks, which “forced” commercial banks to start borrowing short-term from the central bank to cope with their illiquidity. The rapid “pumping” of money by the Fed prevented the sudden collapse of any of the smaller banks, which found themselves in trouble because of higher interest rates and an inverted bond curve. The reason is that the Fed is trying to bring down inflation by raising interest rates intensively and, at the same time, “pumping” liquidity out of the system by selling bonds. This has recently led to a liquidity shock, which the Fed has resolved by buying bonds from financial institutions. This raises the question of the intensity of this activity in the period ahead, its impact on the US dollar, and the global confidence of people in the existing banking system. As a point of interest… According to the US Federal Deposit Insurance Corporation (FDIC), the failure of Silicon Valley Bank is estimated at USD 20 billion and is one of the most expensive bank failures in US history.

 

Of course, all is not calm in Europe either. In the last five months, €214 billion has been withdrawn from banks in the euro area. That is 1.5% of the total of €14,000 billion held by banks in the euro zone. It is the job of the banks to calm things down and to reassure people of their capital adequacy. Nevertheless, in view of past events, we can be sure that we will hear more about banking problems in the future, which will, of course, test people’s confidence in the existing monetary system, a system based on debt.

 

Central banks have been buying gold since 2008. What about us?

 

With all the problems in the financial systems, it is very interesting to note that, very soon after the last financial crisis in 2007/2008, many central banks started buying gold again. Given that the largest central banks have significant leverage over the functioning of economies around the world, we could traditionally turn to them for advice too, but with the following strategy: “Don’t listen to their words, but watch their actions”. The intensity of central-bank gold purchases has been increasing in recent years, with record purchases in 2022, when they bought the most gold since 1967. They bought 1,136 metric tons of gold, and the volume of purchases exceeds those of 2021 by 152%. This was not announced or widely advised by central banks, but the actions are undeniable.

 

China and Russia are the record buyers of gold

 

Gold is becoming very interesting for one of the key countries of the world in 2023, namely China and Russia. These two countries are sending a clear message to the world about the “strength” of their integration and partnership in practically all areas. As much as 2/3 of their trade turnover is already in Russian roubles and Chinese yuan, and they are winning countries from Latin America, Africa, and Asia to their side. We can all see the economic power that is growing in these countries, and this is particularly evident in their purchases of gold.

 

Russia bought one million ounces (31 tons) of gold after the invasion of Ukraine in 2022. In February 2022, it had 73.9 million ounces, and in March 2023, it already had 74.9 million ounces, worth USD 135.6 billion. The increase in Russian reserves of 31 tons seems very large, given that many analysts were discussing some time ago how much gold Russia would be forced to sell in order to hide its budget deficit. But this has not yet happened.

 

On the other hand, China has “officially” bought even more gold, as much as 100 tons, during the one-year period mentioned. They have increased their official gold stocks from 1950 tonne to 2050 tonne in the 4 consecutive months to February 2023. While these figures only show China’s official purchases through official imports, we should not ignore how much of the world’s gold enters China via Hong Kong and how much gold remains in China, extracted through the mining process. China is the world’s largest gold producer.

 

The following table of gold purchases between 1999 and 2021 provides particularly shocking data: purchases by the central banks of Russia and China accounted for 51% of all gold purchases by the world’s central banks during this period. This left the other “competitors” far behind. The closest country from the “Western world” was Poland, but China’s purchases were 14 times larger than Poland’s.

 

Figure 2: Central banks’ largest gold purchases between 1999 and 2021, by country.

 

The joint cooperation of Russia, China, and other countries sharing the above-mentioned “hunger” for gold clearly indicates that countries want to improve the “quality” of their foreign exchange reserves, increasingly move away from the dollar, and hedge their currencies with gold. De-dollarization is in full swing, and gold is playing an important and crucial role. In the 1970s, countries’ global reserves in gold represented well over 70% of total assets. Today, gold assets account for just under 20%. Given the trend we have experienced in recent years and the increasingly difficult inflationary times, compounded by other uncertainties, the percentage of gold reserves may rise again and sharply. From the information available to us, gold is undoubtedly making a comeback as an asset of central banks and will play a major role in currency hedging.

 

The above is also a pointer to all of us that we should also consider increasing our gold reserves, as the current situation and the importance of asset protection require us to do so. If this makes sense and is important to central banks, why should it not also make sense for a part of our assets and portfolios? Finally, I would like to dwell once again on the admonition that, when it comes to financial institutions and decision makers, it is better than their words to observe their actions and what they themselves do. If we can infer from the actions of central banks, then this is all the more reason to be ‘protected’ for the uncertain period ahead, even with gold.

 

Peter Herman

Peter je finančni svetovalec z več kot 15 leti izkušenj na področjih plemenitih kovin, bančništva, zavarovalništva, delnic in skladov. S celovito podporo in strokovnimi nasveti podpira vlagatelje do pravih odločitev na visoko zahtevnih finančnih trgih.

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