Volatility has become the new normal for gold, as a $50 +/- range in a single trading day has become a frequent trend.
So, for this week’s article, I will not give an insight into the latest price movements. I would rather see how and why gold has become an investors favourite along with the Central Banks. We will see why the focus has been gradually shifting from USD to gold.
Over the past twenty-three years, the US dollar (USD) has declined gradually as a share of global foreign exchange reserves, according to the International Monetary Fund (IMF). The shift has not benefited any other major currency viewed as a potential competitor to the USD, like the Euro, the Great British pound (GBP), or the yen.
In fact, the prime beneficiary of de-dollarisation has been gold. Or rather we can say gold has been responsible for the decline in global dollar reserves.
If gold—which has recently experienced a surge in purchases by many central banks, as well as the general public—is included in reserve asset portfolios, the share of the USD is smaller than what the IMF has highlighted. As geopolitical confrontations deepen, the share of the USD in global reserves is likely to continue declining in the future, eventually diminishing the dominant role of the dollar and the US in the international financial system.
As per bullion king of India, Gold purchase by central banks is not a new thing. The difference is the scale at which it has been happening this year.
Since the global financial crisis in 2008, the world’s central banks have increased their gold purchases in an attempt to manage heightened financial system uncertainty. Doing so has pushed gold prices up over the past sixteen years to reach the current record highs of over $2,532 ounce. As per Gold Update by Prithviraj Kothari, Gold buying has accelerated further in recent years as part of a growing popular demand. In 2022 and 2023, central banks purchased more than one thousand tons of gold per year, more than doubling the annual volume of the previous ten years. Purchases have been spearheaded by the central banks of China and Russia, followed by several emerging market countries including Turkey, India, Kazakhstan, Uzbekistan, and Thailand. In particular, the People’s Bank of China has raised the share of gold in its reserves from 1.8 percent in 2015 to a record 4.9 percent at present. At the same time, it has cut its holding of US Treasuries from $1.3 trillion in the early 2010s to $780 billion in June 2024.
The yellow metal has forged meteoric gains this year, emerging as the world’s second-best-performing asset next to crypto.
Central banks — especially those of developing countries — have been buying the yellow metal at a record clip. According to the World Gold Council, central banks have purchased 290 tonnes in the first quarter alone, beating out the prior Q1 record from 2023 and setting CBs on a path to record gold purchases in 2024 that are estimated to easily eclipse 1,000 tonnes.
The central bank buying spree has solidified gold’s status as a reserve asset. According to recent study, gold has now surpassed the euro to become the world’s largest reserve asset second only to the US dollar.
The precious metal’s performance can be attributed to its unique position as a real asset with one of the lowest correlations to stocks across asset classes, making it a safe haven from market swings and inflation.
Apart from this, the rally in gold prices can be attributed to varus reasons-
- hedging against inflation and/or against political and geopolitical risks
- positioning for expected US Federal Reserve rates cuts
- diversifying reserves portfolios,
- de-risking from vulnerability to sanctions risk from the United States and Europe
- central banks have moved into gold in a way to diminish sanction risks
The recent war like situations have imposed sanctions on various countries. This sense of vulnerability has become acute for some countries in conflict or potential conflict with the US/Europe, after the West imposed substantial sanctions on Russia following its invasion of Ukraine. Decisions to immobilize overseas reserve assets of the Bank of Russia, subsequently appropriate the interest earnings of those assets, and threats to seize assets outright to help pay compensation to Ukraine proved especially unsettling.
In response, they can take physical possession of the gold they have bought and kept it in domestic vaults
Gold faced similar situation in 1979 and 2011 when it peaked globally.’
In 1979, there was a crisis world over. The USSR had invaded Afghanistan, Margaret Thatcher had been elected Prime Minister and the US was experiencing its first nuclear accident.
On the economic front, inflation was at an unprecedented 11% Y-o-Y and the unemployment rate was nearly 6%. Owing to all of this gold peaked at record highs, however, with Zyla as he acting chairman of the FED, things changed, under his leadership, federal funds peaked and gold plummeted from the top and never reached the same levels until 2011. It took 32 years to witness that.
The events surrounding the 2011 gold rally were different, but gold’s price rise was also driven by specific geopolitical and economic shocks.
While the 1979 inflation event was spurred by an energy crisis stemming from the Middle East, gold’s spike in 2011 was attributed to one major factor — the bad behaviour of global banks — and several minor contributors. Gold became the most sensible alternative after the U.S. government decided to save most banks from bankruptcy by using taxpayer money to offer bailouts. The situation the U.S. government was entering was unprecedented. Not many economists knew precisely what the effects would be, so naturally, investors turned to the safe-haven asset of gold.
By August of 2011, the yellow metal was trading above $1,900 per ounce in the spot market before it once again embarked on a downtrend that saw it lose over half of its value peak-to-trough.
But this spike was also short lived.
As per Prithiviraj Kothari, the U.S. government’s policy of bailing out the banks provided short-term worry that boosted gold, but as years went on and the practice proved to be successful, gold’s price began steadily dropping as the prospect of a global financial collapse subsided.
If we observe closely, both the above rallies were really quick and investors didn’t get much time to react and respond- in both the up and down trends. but because of the more laid-back nature of gold’s rise this time around, that’s unlikely to reoccur and we continue to see gold as one the best investment asset in its class.
