Why central banks buy Gold

Gold bars and Financial concept,3d rendering,conceptual image.

Gold has been an essential component in the financial reserves of nations for centuries, and its appeal is showing no sign of diminishing, with central banks set to be net purchasers of gold once again this year. Indeed, central banks now hold more than 35,000 metric tons of the metal, about a fifth of all the gold ever mined. But what is it about gold that has made it such a key asset for so long?

One of gold’s primary roles for central banks is to diversify their reserves. The banks are responsible for their nations’ currencies, but these can be subject to swings in value depending of the perceived strength or weakness of the underlying economy. At times of need, banks may be forced to print more money, since interest rates, the traditional lever of monetary control, have been stuck near zero for over a decade. This increase in money supply may be necessary to stave off economic turmoil but at the cost of devaluing the currency. Gold, by contrast, is a finite physical commodity whose supply can’t easily be added to. As such, it is a natural hedge against inflation.

As gold carries no credit or counterparty risks, it serves as a source of trust in a country, and in all economic environments, making it one of the most crucial reserve assets worldwide, alongside government bonds.

Gold’s inverse relationship with the US dollar, another major reserve asset, is an added element to its appeal. When the dollar dips in value, gold typically rises, enabling central banks to protect their reserves at times of market volatility.

The profile of the most active central banks has changed, with the traditional economic powerhouses such as the U.S., Germany, France and Italy no longer buying more gold but instead retaining the substantial holdings they already have. The U.S. possesses the most gold, with over 8,100 tons, which equates to almost 78 percent of its total foreign reserves. That’s more than double Germany’s holdings of more than 3,300 tons, which makes it second on the list and equates to about 74 percent of its reserves.

In their place as purchasers of gold have stepped emerging economies such as Russia, China, Turkey and India. Yet despite the four countries buying substantial quantities of gold over the last decade or so, they still lag behind their Western counterparts, with gold representing just 22 percent of Russia’s reserves, while China’s holdings of just under 2,000 tons represent a mere 3 percent.

More recently, European Union members Poland and Hungary have been making regular additions to their holdings. The statement issued by Hungary’s central bank at the time of its March purchase, which tripled its total gold holdings to 94.5 tons, gave an insight into the asset’s modern-day relevance as well as its enduring appeal. It said that managing “new risks arising from the coronavirus pandemic” played a key role in the bank’s decision, while “the appearance of global spikes in government debts or inflation concerns further increase the importance of gold in national strategy as a safe-haven asset and as a store of value.”

So while the origin of the central banks buying gold may have changed over the years, the reasons for holding the asset have changed little.