Central Bank Gold Buying — a Global Trend

Central Bank Gold Buying — a Global Trend

Increasing national gold reserves, should the RBA decide to, wouldn’t happen in isolation from a central bank perspective.

That’s no different to the RBA’s decision to sell a large portion of physical gold reserves in 1997. Which it did alongside sales by many other central banks.

Since the GFC hit, central banks have turned net buyers of physical precious metals. Total holdings have grown every year since 2009.

Collectively, central banks have purchased the better part of 3,000 tonnes of gold in the past eight years. That’s equivalent to roughly one year of total annual gold production. Official gold reserves, as measured by the World Gold Council, now total more than 33,000 tonnes.

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The chart below plots total central bank gold holdings in tonnes over the past 18 years. As you can see, holdings are now basically back to where they were in 1999.

It’s likely no coincidence that it was the onset of the GFC that caused central banks to re-evaluate their gold reserves. As a result, they decided to increase holdings — in the process turning from net sellers to net buyers.

Central bank gold buying over the past few years has been spearheaded by emerging market nations. Included in that are China, India, Russia, Kazakhstan and Turkey, as well as a handful of countries in South East Asia.

In many cases, these nations gorged themselves on developed-market debt for much of the last 20 years.

But with rising geopolitical risks, escalating debt levels and exceptionally low yields on sovereign paper, they are now looking to build their physical gold holdings. That way, their reserve assets will be more appropriately diversified.

This desire for reserve diversification at central bank level is not only limited to their vast accumulation of physical gold over the last decade. It’s also seen in the stabilisation in the total holdings of US Treasuries owned by foreign central banks.

Those holdings, which had largely risen uninterrupted for decade, have not grown at all since 2013.

The chart below makes this clear. It shows that total foreign central bank holdings of US Treasuries are at just over US$4 trillion.

In simple terms, emerging market central banks want less paper and more rocks.

Alan Greenspan, ex-Chairman of the Federal Reserve, explained why central banks are looking to build national gold reserves in a 2014 piece titled ‘Golden Rule — Why Beijing Is Buying’.

Greenspan discussed China’s accumulation of gold, though the rationale extends beyond the Middle Kingdom.

Greenspan noted (emphasis mine):

Gold has special properties that no other currency, with the possible exception of silver, can claim. For more than two millennia, gold has had virtually unquestioned acceptance as payment. It has never required the credit guarantee of a third party. No questions are raised when gold or direct claims to gold are offered in payment of an obligation.

Today, the acceptance of fiat money — currency not backed by an asset of intrinsic value — rests on the credit guarantee of sovereign nations endowed with effective taxing power, a guarantee that in crisis conditions has not always matched the universal acceptability of gold. If the dollar or any other fiat currency were universally acceptable at all times, central banks would see no need to hold any gold.

Emerging market central banks are likely to be accumulating physical gold for some time. After all, their foreign exchange reserves are still overwhelmingly comprised of developed market government bonds.

This can be seen in the chart below, which plots gold as a percentage of reserves in the BRIC nations (China, India, Russia and Brazil), as well as Turkey, the Philippines, Thailand and South Korea:

As you can see, none of these nations has a physical gold holding of greater than 22% of total reserve assets. Turkey’s holdings, at 22%, are boosted by commercial bank gold reserves held with their central bank.

On average, these nations have less than 8% of their reserves in physical gold, which is less than one-tenth of what the US holds. It’s also less than one-seventh of the average physical gold holdings for developed market nations in the Europe.

Gold repatriation

While the lion’s share of central bank gold buying has taken place from emerging markets, they are not the only participants worth paying attention to.

In the post-GFC environment, there has been a growing movement among central banks of developed nations, especially European ones, to repatriate national gold reserves.

Since the GFC hit, Austria, Belgium and the Netherlands have all either moved or are taking steps to move a portion of their physical gold holdings within their borders. The same is true of Hungary, Turkey and Venezuela.

Owing to economic calamity and hyperinflation, Venezuela has since sold off their gold reserves. President Nicolas Maduro has instead tried to make do with a state-sanctioned cryptocurrency.

The most high profile of these gold repatriations was the decision by the Bundesbank to bring its gold stored in France and the US to Frankfurt.

As the second largest nation state holder of gold, Germany owns nearly 3,400 tonnes of the precious metal. It built up the bulk of its reserves between the 1950s and early 1970s.

Carl-Ludwig Thiele, executive board member of the Bundesbank, has discussed the role and the importance of physical gold in the central bank’s portfolio of reserve assets.

He recently noted: ‘The availability of reserve assets like gold strengthens public confidence in the stability of a central bank’s balance sheet.

There’s no question…

Whether it’s a noticeable uptick in the purchasing of physical gold…

Or the repatriation of existing holdings to home shores…

There’s only one logical conclusion to draw from observing all this activity:

In the precious metals space, central banks are in no doubt as to the importance of holding this unique monetary asset.

The RBA should follow suit!

With the benefit of hindsight, the RBA would probably have been better off ignoring the December 1996 memorandum and holding onto all of its physical gold reserves.

But the past is the past, and the sale ‘made sense’ at the time. The most important thing is getting the composition of our reserves best structured for the coming years.

For a number of reasons, now is the perfect time for the RBA to begin increasing our national physical gold reserve.

There’s a dearth of yield on offer in sovereign bonds.

There’s the historical inevitability of higher inflation.

There are the strong returns of gold during this cycle.

And there’s also the fact that gold has unique attributes as a monetary asset.

How much physical gold should the nation hold as a position of reserves?

We believe that a 15–20% weighting would be appropriate for Australia. That number is in line with our holdings prior to the 1997 gold sale. And it’s roughly in line with the proportion of foreign reserve assets that gold constituted when the European Central Bank was formed in the late 1990s.

As a proportion of total reserves, a 15–20% allocation would still be well below the amounts held by some European nations and the US.

Crucially, we believe a significant portion of these physical gold reserves should be held within Australia. That’s preferable to having it held in either London or New York.

After all, not only are we a gold mining powerhouse, but Australia is a politically-stable, AAA-rated nation with a sophisticated banking and financial services sector.

Given this, there seems little point in mining and refining physical gold in Australia only to have all of our national gold reserves held offshore.

Storing national gold reserves locally would also send a positive message to Asia. Across the continent, gold is very much seen as money by both citizens and central banks. And, provided it was leveraged the right way, could even help grow our banking and financial services links with the region.

Furthermore, while it shouldn’t in any way influence its policy, a decision by the RBA to purchase large quantities of physical gold bullion in the months and years ahead would also have an additional benefit in that it would provide de-facto support for Australia’s gold mining industry.

Australia’s physical gold industry is the second largest in the world in terms of annual production. We make some 300 tonnes of gold valued at over AU$15 billion.

Gold remains a key component of our national economy. It employs approximately 25,000 people directly and up to 50,000 indirectly.

What’s more, gold is the lifeblood of many small mining towns, particularly in Western Australia.

Most importantly, rebuilding our national physical gold reserve will better balance out the RBA’s reserve assets.

It will also help to hold Australia in good stead through what may well be some rough years ahead.


Jordan Eliseo,
Chief Economist, ABC Bullion
For The Daily Reckoning Australia