In the last few weeks, gold has been gently rising, approaching the USD 2,000 level. Historically, because gold yields no income, it has tended to perform better during periods of uncertainty. These periods might include the latter stages of the business cycle, say, in a recessionary environment with low and falling interest rates, or periods with rising uncertainty driven by geopolitical concerns, or during environments of economic overheating with high and rising inflation and lack of confidence in major currencies. Indeed, it is difficult to be too emphatic about what drives the gold price up or down.
Source: Financial Times
But one factor we can be a little more certain about is the relationship between central banks and gold. Central banks choose what reserve assets to hold, and select assets mainly for liquidity and stability, rather than returns. That is a key reason why central banks own US government bonds. Recent years have elevated another priority for central banks, however – diversification to protect against geopolitical shocks.
Russia’s annexation of Crimea in 2014, and then the 2022 invasion of Ukraine, resulted in an increasing number of Western sanctions on Russian assets, including its central bank reserves. This triggered a renewed focus on reserve diversification, especially by Russia and countries doing business with it. They wanted to shift reserves away from US dollar-denominated assets, as well as from assets of US allies that might be inclined to implement similar sanctions.
Note that China has a long way to go in building up its gold reserves
Source: World Gold Council, Financial Times
Looking at the year ahead, there are positive factors that could help the gold price to rise further. Central banks have suggested they intend to add more gold to their reserves, and China’s central bank in particular has room to do so. The ongoing property deleveraging in China, weighing down on the country’s economy and domestic assets, may keep Chinese households looking to gold as a preferred store of wealth. Investors generally may want to increase gold allocations as a hedge against an unusually busy political calendar that could exacerbate an already unsettled geopolitical backdrop. Next year, 2024, will see a record number of political elections and there is a great deal of uncertainty about outcomes, as we’ve seen recently in the Netherlands.
Gold provides a relatively liquid, stable asset that can be used outside global payment systems (notably Swift) and historically has performed well in periods of heightened uncertainty. In 2022, central banks purchased a record 1,136 tonnes of gold, according to the World Gold Council, with another 800 tonnes bought in the first three quarters of 2023. Gold buying was led by emerging economies, notably China and Turkey.
China has been the largest buyer of gold for central bank reserves this year by far with purchases of 181 tonnes in the 9 months to September 30, taking total holdings to 2,192 tonnes. But it has room to increase gold holdings far more. Gold represents only around 4% of its total reserves, near the low end of allocations by larger central banks.
For comparison, Russia’s gold reserves are just under a quarter of the country’s total, while Turkey’s gold represents 26% of total reserves. Australia holds around 20% of its reserves in gold. The US and Germany have about two-thirds of total foreign reserves in gold. A survey by the World Gold Council released in May found that 66% of emerging economy central banks and 39% of developed economy central banks expected to increase gold holdings over the next five years to 16% or greater as a share of total reserves. That suggests that gold probably has further room to rise.
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