Why central banks buy gold
Gold price traded higher on Friday, in the $2,400s, helped by positive data from China that brightened the prospects for the country with the world’s largest market for Gold.
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The Bank of Ghana (BoG) had acquired a total 432,358 ounces (oz) of gold from the Ghana Chamber of Mines (GCM) members as of mid-December 2023 under the Domestic Gold Purchase Programme (DGPP) and voluntary forex sales initiative.
This is equivalent to about 84 per cent of the bank’s planned purchases in 2023 and nearly 15 per cent of members’ planned output in 2023, according to the GCM. The BoG’s gold purchases are primarily aimed at alleviating the depreciation of the local currency and its knock-on effect on inflation.
The DGPP was announced in 2021 by the government to enable the BoG to have the first right of refusal for all gold mined in the country. It is part of the central bank’s plan to build gold reserves to stabilise the cedi.
The decision was also against a background that the central bank had only 8.7 tonnes of gold reserves at the end-2021, despite the country being one of the world’s leading gold producers.
Central banks are the biggest gold holders. In their aim to support their currencies in turbulent times, central banks tend to diversify their reserves and buy gold to improve the perceived strength of the economy and the currency.
Gold has an inverse correlation with the US dollar and US treasuries, which are both major reserve and safe-haven assets.
Dollar depreciates
When the dollar depreciates, gold tends to rise, enabling investors and central banks to diversify their assets in turbulent times. Gold is also inversely correlated with risk assets. The price of gold has long had a close relationship with real interest rates of the US dollar: higher real interest rates in the United States – which usually mean a stronger greenback – lead to lower gold prices and vice versa.
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The war in Ukraine has fuelled buying, with US sanctions against Russia, including the freezing of its dollar assets, prompting more countries to reduce their dollar reserves and increase their gold holdings, resulting in a gradual global trend of de-dollarisation.
Gold has played a key role in human history as it has been widely used as a store of value and medium of exchange.
Safe haven
Currently, apart from its shine and usage for jewellery, the precious metal is widely seen as a safe-haven asset, meaning that it is considered a good investment during turbulent times.
The yellow metal is also widely seen as a hedge against inflation and depreciating currencies as it doesn’t rely on any specific issuer or government. High gold reserves can be a source of trust for a country’s solvency. Central banks added 1,136 tonnes of gold worth around $70 billion to their reserves in 2022, according to data from the World Gold Council.
This is the highest yearly purchase since records began. Central banks from emerging economies such as China, India and Turkey are quickly increasing their gold reserves. A rally in the stock market tends to weaken gold prices, while sell-offs in riskier markets tend to favour the precious metal.
The price can move due to a wide range of factors. Geopolitical instability or fears of a deep recession can quickly make gold prices escalate due to its safe-haven status. As a yield-less asset, gold tends to rise with lower interest rates, while the higher cost of money usually weighs down on the yellow metal.
Still, most moves depend on how the US dollar behaves as the asset is priced in dollars. A strong dollar tends to keep the price of gold controlled, whereas a weaker dollar is likely to push gold prices up.
Chinese production
Gold got a shot in the arm on Friday after Chinese Industrial Production showed an expectation-beating 6.7 per cent rise year-over-year in April, according to data from the National Bureau of Statistics of China.
Economists had forecast a more modest 5.5 per cent. The figure was substantially higher than the 4.5 per cent reading registered in March. Despite the positive data, some economists remain sceptical about Chinese growth, describing it as “uneven”.
“Activity data for April suggested growth remained uneven. Growth was supported by investment growth and exports, while consumption slowed,” said Tommy Wu, the Senior Economist at Commerzbank.
Wu says greater fiscal spending is required to keep growth momentum steady and points out that the Chinese government is starting to sell sovereign bonds to boost spending.
Growth expectations
Much of the country’s growth expectations depend on whether the government sticks to its spending plans, he adds. The government is also working on comprehensive solutions to the housing crisis.
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A plan for local governments and State-Owned Enterprises (SOEs) to buy unsold homes should help absorb inventory and prop up the ailing sector.