Why Central Banks Store Gold?

Why Central Banks Store Gold? The London Bullion Market was closed for two weeks in 1968. The world’s largest precious-metal market had run out of gold, drained by a five-month run by European central banks on America’s reserves. The crisis signaled the end of the Bretton Woods system, which had kept the dollar pegged to gold and other currencies pegged to the dollar since 1944.

Central banks are once again buying gold in a frenzy (see chart). 400 tonnes were added to their reserves in the third quarter alone. This has increased the total from January to September to 670 tonnes, a rate not seen since the Bullion Market meltdown. Turkey purchased nearly 20 tonnes in a single transaction in May.

India and Qatar are also hungry. The metal now accounts for two-thirds of Uzbekistan’s reserves, despite the country’s intention to reduce gold reserves to less than half. Kazakhstan is also stepping up its efforts.

This is due, in part, to the fact that gold, which is overlooked in good times due to its lack of yield, regains its luster during times of volatility and high inflation. In the long run, it is regarded as a store of value and, because it is not tied to any specific economy, appears immune to local political and financial turmoil.

Central bankers may also believe they are getting a good deal. Despite holding up better than most, the metal’s price has dropped 3% this year. Gold investors expect a rebound.

Buying gold bars, like in the past, is a good way to get rid of some cash. Except that this time it is emerging markets, not Europe, who are complaining about the dollar. They require dollars to cover imports and external debts.

However, the majority of their reserves are made up of treasuries rather than actual banknotes. And, as the Federal Reserve raised interest rates, boosting yields, the value of government debt fell. Lesser central banks have used this as an opportunity to exchange them for precious metals rather than betting on the Fed taming inflation.

There are also murkier motives at work. Here comes an interesting part, Gold allows Russia to avoid Western sanctions, as much of its reserves have been frozen since March and its banks have been largely disconnected from the dollar-based international payment system. Roubles are almost never held as foreign-currency reserves by central banks.

Gold provides an alternative, albeit clumsy, means of exchange for countries that have traditionally done a lot of business with the Kremlin, ranging from Turkey to Turkmenistan. This diverse group of emerging markets has been among the most active buyers of gold this cycle.

There isn’t much the West can do about it. Russian gold is prohibited on the London market, but no one has access to its gold reserves, which are primarily sourced from its own mines. Furthermore, Russia’s central bank no longer reports the amount of gold it owns, making swaps impossible to track.

Moving physical metal is a logistical nightmare, but it keeps transactions off the West’s digital radar, which is advantageous for those who play both sides, such as Qatar or Turkey. According to the World Gold Council, unidentified buyers account for a large portion of this year’s bonanza.

The fact that no other currency is gaining ground is a small consolation for the dollar. This year, the proportion of global foreign reserves held in yuan has stalled. The euro, yen, and pound are also treading water. Central banks may be obsessed with gold, but no regime change is on the horizon.

Feel Free to comment below and share your thoughts with me. I read all the Comments.