On the heels of record buying in 2018, gold holdings of central banks continued to grow by nearly 145.5 tonnes (t) in the first 3 months of 2019…outpacing purchases of 86.7t over the same 3-month period in 2018.1
Amid plenty of market and geopolitical uncertainty, the growing demand for gold by global central banks—especially emerging market central banks—sits as one more potential piece of good news for gold investors. Central banks sit center stage when it comes to a country’s monetary policy—managing interest rates and inflation—along with maintaining reserves that buoy the underlying commercial banking system. So, when central banks make a move, the world tends to notice and ask why.
Today, central banks around the globe hold approximately 33,200t—or 17%2 of the world's above-ground gold. And that has grown steadily since 2010—hitting an annual total of 651t in 2018—the largest annual net purchases since 1967.3 For two decades prior to 2010, central banks were a net source of supply for the gold market. But that changed in 2010, with central banks functioning as a net source of demand, making up 10% of annual demand on average between 2010–2017, a figure that increased to 15% in 2018.4 See below.
And the decade-long buying trend appears to have some staying power, with net purchases in Q1 2019 increasing 68% over Q1 2018. Notably, the gold buying was highly concentrated among emerging market central banks, making up approximately 93% of the 145.5t purchased in Q1 2019.5 See below.
The anatomy of global central banks: Two discrete camps
Central banks’ gold buying is not singularly focused on current market volatility. Instead, it is the result of policy decisions by two discrete central bank camps, where—at a practical level, over time—reserves have taken on some very different shapes and forms.
The first camp is the economic titans of North America and Western Europe that were financial powerhouses during the heyday of the gold standard from 1870–1970. Historically, these countries accumulated gold to back their currencies. But despite that no longer being the case, these developed countries continue to hold large volumes of gold, which collectively amounts to 70% of today’s reserves.6 Interestingly, data confirms that they have all but stopped any sales (except for coinage purposes),7 following a period of net selling during the 1990s and early 2000s. This highlights the relevance that gold has played in managing their monetary policy, despite their currencies not being backed by gold any longer.
The second camp is the rest of the world, primarily emerging markets—some large, like Russia or China, and others far smaller, like Colombia or Thailand. These smaller and developing nations have historically lacked the financial strength to accumulate large gold reserves, and by the time they started to develop further, the US dollar had established itself as the global reserve currency. As a consequence, these countries do not have large legacy gold reserves—notably under 1-2%8—with many holding a high percentage of US dollar-backed securities, like US Treasuries, which are backed by the full faith and credit of the US government.
The reserve reshuffle
But following the Asian debt crisis in 1998-1999, with the intervention of the International Monetary Fund (IMF), emerging market central banks began to diversify their reserves. And by the mid 2000s, gold started to play a more important role for these smaller banks as they looked to strengthen their domestic markets and currency. Further, policies intended to strengthen regional links among Asian countries and their emerging market trade partners have also supported diversification away from the US dollar. Based on its return, diversification and liquidity characteristics, gold has been a natural choice for these central banks, especially since the 2008-2009 financial crisis. And a recent survey of global central banks sheds some light on the multiple objectives that gold buying supports for these institutions.
Positive implications for gold investors?
Despite it being an easy leap to link the exponential increase of central bank gold buying exclusively to heightened geopolitical turbulence, it is clearly not the sole reason for greater gold demand. There are some greater and more established forces at play. In fact, based on both supply/demand trends and data regarding central bank sentiment about gold, a more likely explanation of their longer-term moves suggests a strategy focused on safety, as well as diversification of their reserves, given their large exposure to the USD.
As central banks reposition their portfolios and have continued to diversify portions of their reserves into gold, we believe it is likely that this will continue to support the demand for gold. Investors should welcome this trend—it has the potential to spur further positive implications for gold demand, price and investor returns—especially as central banks' buying patterns and currency reserve strategies continue to evolve on an increasingly turbulent world stage.
As central banks have upped their ante to gold, investors searching for ways to optimize portfolio outcomes might ask if they could potentially benefit by taking a page from the central bank playbook—using gold to diversify their own portfolios.9
1World Gold Council, March 31 2019.
2World Gold Council, Goldhub: Monthly Central Bank Statistics; International Monetary Fund, COFER Tables, March 2019.
3World Gold Council, Goldhub: Monthly Central Bank Statistics; International Monetary Fund, COFER Tables, March 2019.
4World Gold Council, Goldhub: Monthly Central Bank Statistics; International Monetary Fund, COFER Tables, March 2019.
5World Gold Council, Goldhub: Monthly Central Bank Statistics; International Monetary Fund, COFER Tables, March 2019.
6World Gold Council, Goldhub: Monthly Central Bank Statistics; International Monetary Fund, COFER Tables, March 2019.
7World Gold Council, Goldhub: Monthly Central Bank Statistics; International Monetary Fund, COFER Tables, March 2019.
8World Gold Council, Goldhub: Monthly Central Bank Statistics; International Monetary Fund, COFER Tables, March 2019.
9Gold has demonstrated a -0.01 and 0.06 correlation to the S&P 500 Index and Bloomberg Barclays U.S. Aggregated Bond Index, respectively, since the 1970s, based on annual returns. Bloomberg Finance L.P., and State Street Global Advisors, 01/01/1970-03/31/2019.