Gold prices had a strong year. In addition to the prospect of interest rates falling again, massive purchases of gold by many Asian central banks may also have been a decisive factor in the price gains. Why is gold so attractive for the central banks of China, India & Co.?
• Asian central banks significantly increased their gold reserves in 2023
• US sanctions against Russia increase desire for diversification
• Expert: Despite “de-dollarization” tendencies, the US dollar remains the measure of things for the time being
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The price of gold actually suffers from high interest rates. High interest rates make fixed-interest investments such as bonds more attractive than gold, which does not pay interest. Nevertheless, the price of gold has risen significantly in recent months – despite the high interest rate environment.
Since the beginning of January, the yellow precious metal has risen by 13.48 percent at a current price of $2,076.70 (as of December 28, 2023). In the last three months alone, gold investors were able to enjoy profits of 10.37 percent. In addition to its attractiveness as a hedge against inflation and the prospect of the first interest rate cuts in 2024, Asian central banks were probably primarily responsible for the price increases.
Asian central banks are increasing their gold holdings
Many Asian central banks were among the largest gold buyers in 2023. From July to September, central banks made the third-largest gold purchases ever, according to the World Gold Council. By the end of October, purchases had increased by 14 percent compared to the previous year. The People’s Bank of China was the main buyer among central banks in the third quarter. The Chinese central bank’s gold reserves have increased by approximately 200 tons of gold in the past twelve months. According to Bloomberg, China bought 23 tons of gold in October alone. The total gold inventory is now 2,215 tons, which is higher than that of the countries in Africa and Latin America as well as India combined.
But the People’s Bank of China was by no means the only gold buyer in Asia in 2023: the central banks of Singapore, India and the Philippines also massively increased their gold reserves. The group of buyers also included banks from Russia, Qatar and Kyrgyzstan. Since the outbreak of the Ukraine war in February 2022, central banks have purchased more than two and a half times the average amount of gold per quarter over the past decade, according to the World Gold Council report.
US sanctions against Russia revealed geopolitical risks to US dollar reserves
According to a report by Sprott Asset Management, the US decision to confiscate Russia’s $650 billion in 2022 US dollar reserves made it clear to Asian central banks that their US dollar reserves were not sacrosanct. That’s why more and more central banks – especially the People’s Bank of China – are relying on gold to reduce their US dollar exposure. According to the Sprott report cited by the South China Morning Post, this signals a “strong desire to diversify away from the US dollar and US dollar assets.”
The head of the central banking department at the World Gold Council, Shaokai Fan, sees similar reasons. “Increasing geopolitical uncertainty coupled with concerns about sanctions on foreign reserves are undoubtedly important factors,” he said. Banks either have low gold reserves or “have large US dollar holdings, which could lead to a greater desire for diversification,” Fan added to the South China Morning Post.
Debate about “dedollarization”
The discussion about “de-dollarization,” i.e. reducing the dominance of the US dollar, has gained in importance since the US sanctions against Russia imposed in 2022. Alternative currency models have been proposed. In April this year, for example, Malaysian Prime Minister Anwar Ibrahim spoke out in favor of a new currency that the BRICS countries – Brazil, Russia, India, China and South Africa – could use to conduct global trade.
“The U.S. government’s sanctions against several nations – which some have described as weaponizing the U.S. dollar – have prompted vulnerable governments to seek reserve assets that are not at immediate risk of exclusions,” said Ross Norman, CEO of the U.S. government London-based precious metals website Metals Daily, the readers of the “South China Morning Post” the situation on the international foreign exchange market.
However, there is no real alternative to the US dollar when it comes to foreign exchange reserves – the euro, the Japanese yen, the British pound and the Chinese yuan are also key currencies and part of the currency basket of the International Monetary Fund (IMF). However, these currencies are of regional rather than global importance and do not come close to the importance of the US dollar. Central banks therefore see gold as the best alternative to the US dollar when it comes to their reserve assets, especially since it is considered to be particularly stable in value and independent of geopolitical upheavals. Additionally, it can be purchased globally.
What could happen next in 2024
The question arises as to how the Asian central banks’ gold purchases will develop in 2024. Fan expects a slower continuation of de-dollarization in terms of central bank reserve assets. “On the whole, we expect that central banks will continue to buy gold in 2024, although purchases will not be as high as in recent years,” said Fan. A slowing factor could be the already significant rise in gold prices.
On the other hand, a further falling US dollar could boost the price of gold, as the precious metal quoted in US dollars will then become cheaper for buyers from non-US dollar currency areas – such as the Asian central banks. In the past, central banks’ purchasing programs were “fairly independent” of price, but “nowadays they are more nuanced and tend to accelerate purchases when prices are perceived to be cheap,” Norman said.
However, the diversification into gold should not be overestimated, says Gnanasekhar Thiagarajan, head of the Indian financial analysis company Commtrendz Risk Management. Although the central banks’ intention to diversify their asset reserves by purchasing gold could continue in the new year, it is absurd to sing the swansong for the US dollar. “The US dollar can be parked in interest-bearing assets, while gold does not yield any return until it is sold,” Thiagarajan points out. “That’s why gold will only make up a smaller share. The majority of the currency reserves will remain in the US dollar,” summarizes Thiagarajan.
However, since the current weighting of gold at many central banks is less than the usually targeted 10 and 20 percent, a further increase in central banks’ gold reserves – and the associated pressure on demand for gold – could also be within the realm of possibility in 2024.
Editorial team finanzen.net