Investing.com — This year’s rise has outpaced other commodities such as and, setting it apart in global markets.
The rise in gold prices has been driven in part by central bank purchases, which have become a major factor in recent years.
According to analysts at BCA Research in a note on Friday, central banks, especially those in emerging markets, have been adding to their gold reserves, and this trend is expected to continue.
These purchases have contributed to continued demand for gold, supporting the potential for further price increases in the near future.
In recent years, central banks have become one of the main drivers of gold demand. “Central bank purchases in the first half of this year reached their highest first-half mark on records dating back to 2000,” the analysts said.
Over the past two years, central banks have been responsible for about a quarter of global gold demand – more than double the 11% average of the previous five years. Emerging market central banks have led this charge, increasing their precious metal reserves for a variety of strategic reasons.
The reasons behind central banks’ gold purchases are related to several key factors. The value of gold is supported by its limited supply, which differs from fiat currencies which can be subject to inflation or devaluation due to the increase in money supply.
As a result, gold serves as a hedge against inflation and currency devaluation, which are important considerations for central banks.
Furthermore, gold carries no credit or counterparty risk, providing central banks with protection against economic instability or financial disruptions.
In addition, gold’s tendency to move inversely to the U.S. dollar provides a means to diversify reserve portfolios, protecting reserves during periods of dollar weakness.
Geopolitical considerations have further fueled the drive for gold.
“The West’s response to Russia’s invasion of Ukraine ultimately underlines the vulnerability of holding reserves in traditional currencies,” the analysts said.
Sanctions against Russia resulted in the freeze of its foreign reserves, prompting other countries to consider the security of their own reserves.
Gold, a tangible asset over which central banks have full control, offers protection against such risks.
According to the World Gold Council’s latest Central Bank Gold Reserves Survey, the outlook for continued central bank demand is robust.
The survey shows that 81% of central banks expect global gold reserves to increase in the coming year, the highest percentage in the survey’s six-year history.
This sentiment is not just global; 29% of central banks specifically expect their own gold reserves to rise, indicating a strong commitment to further accumulation.
One of the central players in this wave of gold buying is the People’s Bank of China (PBoC). Since 2022, the PBoC has increased its gold reserves by as much as 316 tons, an average of 11 tons per month.
However, in recent months (May to July 2023), the PBoC has reported no new purchases, raising questions about whether rising gold prices have caused a temporary pause in their purchases.
Analysts at BCA Research believe that while the PBoC may be sensitive to short-term price movements, its long-term strategy to diversify away from US dollar-denominated assets will remain the dominant factor.
Gold plays a crucial role in China’s efforts to reduce its dependence on the dollar, and this strategic imperative is likely to support future purchases regardless of short-term price developments.
Historically, the PBoC has been known for its opacity regarding gold purchases, with large increases often only made public after years of accumulation. For example, in 2015, China revealed that it had increased its gold reserves by 60% over the past six years, during which no purchases were reported.
Despite recent gold purchases, gold still makes up only 4.9% of China’s total reserves, compared to an average of 15% for other upper-middle-income economies. This leaves significant room for further accumulation.
If the PBoC were to increase the share of gold in its reserves to 15% over the next ten years, it would have to buy roughly 120 tonnes of gold per quarter, which at current levels would represent 11% of global annual gold demand. Such a rise would impact the gold market, causing prices to rise further.
China is not alone in its enthusiasm for gold. Other emerging market central banks have also significantly increased their gold reserves in recent years. Poland, for example, has explicitly set itself the goal of increasing the gold share in its reserves from 13.5% to 20% in the coming years.
The Polish central bank has already purchased 149 tons of gold since the second quarter of 2023 and more purchases are expected. This is part of a broader trend among emerging market central banks to diversify their reserves and reduce their exposure to the US dollar.
Similarly, the Reserve Bank of India has been steadily increasing its gold reserves as part of a strategy to diversify its assets. The RBI has also repatriated a significant portion of its gold reserves from foreign vaults, transferring 100 tonnes from Britain to India earlier this year.
Nigeria has taken similar steps by repatriating its gold from the US to domestic storage. These moves reflect a growing desire among emerging market central banks to safeguard their gold reserves and protect them from potential geopolitical risks.
The broader strategic trend of emerging market central banks increasing their gold holdings is clear. Gold provides these countries with a safe store of value, free from the potential risks associated with holding reserves of foreign currencies, especially the US dollar.
The geopolitical climate and recent global events have reinforced the importance of this diversification strategy.
In addition, the current economic outlook also supports gold. According to BCA Research, a global economic downturn is forecast by late 2024 or early 2025, a period when gold has generally performed well.
In times of substandard economic activity, central banks often increase their gold purchases as a precaution. As a result, the likelihood of an economic slowdown in the coming year is likely to maintain strong central bank demand.
In addition to central bank demand, real interest rates are a key factor influencing gold prices. As real interest rates in the US fall, the opportunity cost of holding gold decreases, making it a more attractive investment.
“Real rates are likely to move lower as the Fed is likely to initiate the easing cycle at the September 17-18 FOMC meeting,” the analysts said, which would further boost gold buying from both institutional and central banks.
Global gold ETFs have seen inflows for four straight months, reversing nearly a year of outflows in a sign of renewed investor interest.
