Central Bank Buying Gold, How Much Do You Know?

Caitong Securities released a report on Wednesday stating that the central bank's gold purchase demand has become the main factor driving gold price changes in recent years. With the increasing trend of de-dollarization, most central banks have begun to implement the strategy of "buying gold, selling US dollar assets", with developing country central banks showing a more significant increase in gold holdings compared to developed countries.

The report predicts that China is likely to continue buying gold and gradually reach the global average level, with still a growth space of 10 percentage points. The future global central bank gold reserve ratio is expected to increase by nearly 1 percentage point annually, corresponding to an annual gold purchase volume of over 350 tons.

The Relationship between Central Bank Gold Purchases and the International Monetary System

The report indicates that after World War II, central bank gold purchases can be divided into four stages. Firstly, in the early stage of the Bretton Woods system, the United States continued to buy gold to stabilize the "gold - US dollar - other currencies" dual peg mechanism. Secondly, before and after the dissolution of the Bretton Woods system, global gold reserves fluctuated significantly. Thirdly, after the establishment of the Jamaica system, global trade flourished, and central banks actively sold gold and increased US dollar assets. Finally, after the subprime mortgage crisis, global de-dollarization continued, and central banks actively bought gold. In these four stages, global central bank gold reserves showed a trend of rising, fluctuating, declining, and rebounding.

In recent years, the escalation of geopolitical conflicts, combined with the United States repeatedly "weaponizing" the use of the US dollar system, has further highlighted the safe-haven properties of gold, making gold a primary asset for incremental reserves of central banks worldwide. In the past two years, the scale of global central bank gold purchases has significantly increased, with demand reaching new highs in 2022 and 2023, exceeding 1081 tons and 1037 tons respectively.

Among them, developing economies represented by China and Russia are the main forces behind gold purchases, while the proportion of gold reserves in developed economies is declining globally, with only two developed countries among the top ten economies in terms of gold reserve increments.

According to the report, central bank gold purchases mainly include five methods, with purchasing from gold producers and open market operations being the most common, followed by purchases through international gold exchanges, and less commonly through international institutions and bilateral agreements. The price of gold purchases depends on the specific method, with pricing benchmarks mainly determined by the London gold price and COMEX futures price. Generally, direct purchases and open market operations are slightly below the price benchmark, purchases through international gold exchanges have a slight premium, and other methods are more difficult to predict The primary reason for central banks to purchase gold is the unique historical status of gold, which is the consistent recognition of the value, function, and characteristics of gold that has been formed over thousands of years of human history. Research reports categorize the motives for central bank gold purchases into five main factors, namely maintaining the stability of sovereign currency values, guarding against related risks of global financial and geopolitical conflicts, optimizing the existing foreign exchange reserve asset portfolio and scale, and adapting to the transformation of the global monetary and trade system.

The trend of central bank gold purchases is likely to continue

The research report believes that as the international monetary system is still in a prolonged transitional period, gold may still be the optimal choice for central banks to increase reserves.

The research report points out that the fundamental reason for central bank gold purchases is the transformation of the international order. In recent years, the transformation of the international monetary system has begun to show signs, with the weakening of the US dollar's position as the global dominant currency and the increasing trend of de-dollarization becoming more apparent. On one hand, developed countries led by the United States are promoting trade against globalization and geopolitical alignment, leading to a continuous decline in demand for US dollar reserves, settlements, and payments in traditional trade and investment fields. On the other hand, the skyrocketing US government debt has not seen an end, and the weaponization of the US dollar system is further eroding the patience of the remaining economies in development. Since 2022, the impact of these factors has been significantly strengthened, leading to a noticeable acceleration in central bank gold purchases thereafter.

During the transitional period of the international monetary system, gold may be a preferable choice. From an international perspective, the current situation is in a state of transition from the disintegration of the old monetary system to the formation of a new monetary system, roughly similar to the period before and after the collapse of the Bretton Woods system in 1971.

However, unlike history, there was the US dollar that could eventually take on the major role, but currently, there are no signs of a new international dominant currency. In this situation, central banks of various countries may only be able to follow the old path of increasing gold reserves to adapt to changing circumstances and await the formation of a new monetary system. It is worth noting that based on historical experience, the formation of a new monetary system is not immediate. The process of the US dollar replacing the British pound as the dominant international currency in the previous round lasted for more than half a century. Therefore, from a medium to long-term perspective, central bank gold purchases are expected to continue.

Emerging economies will accelerate gold purchases

Since the outbreak of the Russia-Ukraine conflict, a new wave of de-dollarization has emerged globally, and gold, as a reserve asset alternative to the US dollar, is favored by many central banks. The research report believes that under the wave of de-dollarization, most central banks will implement a strategy of "buying gold, selling US dollar assets."

A central bank survey released by the World Gold Council shows that more than half of central banks believe that the proportion of US dollar assets will decrease in the next five years, an increase of 13% from the previous year. At the same time, nearly 70% of central banks expect to increase gold reserves in the next 12 months. In addition, over 60% of central banks believe that gold reserves will increase in the next five years, a 16% increase from the previous year. Given the changing international political and economic landscape, the research report predicts that the trend of central banks purchasing gold will continue in the future, especially for central banks of emerging economies. According to the research report, the proportion of gold reserves in developed economies is close to sixty percent, while the proportion in developing economies is rapidly increasing. In terms of the development level of economies, the proportion of gold reserves in most developed economies remains stable, accounting for nearly sixty percent. The proportion of gold reserves in developing economies has increased significantly on a global scale, almost doubling to nearly thirty percent from 2008 to the end of 2023.

Looking at specific economies, the United States has the largest gold reserves globally, exceeding 8000 tons, with little change since 1980. Germany, Italy, and France, as the top three countries in Europe in terms of gold reserves, have seen their gold reserves remain relatively unchanged in the past decade. For developing economies such as China, Russia, and major economies in the Middle East, the increment of gold reserves is on the rise, and these economies have been the main force behind central bank gold purchases in recent years.

Central Bank Gold Reserve Proportion Expected to Increase by 1% Annually

The research report suggests that China may continue to purchase gold to optimize its international reserve structure.

Looking at the specific reasons for gold purchases by individual countries, for China, on one hand, the proportion of US dollar settlements in our foreign trade has been continuously decreasing, while the proportion of settlements in RMB has been rapidly increasing. In economic exchanges with friendly countries participating in initiatives like the Belt and Road, the demand for US dollar settlements and payments has also decreased, leading to a reduced actual need for holding US dollar foreign exchange reserves.

On the other hand, in recent years, the international environment has been unpredictable. Currently, China's gold reserve proportion is less than 5%, significantly lower than the over 50% proportion of major Western economies and the global level of nearly 15%. Increasing gold reserves appropriately is of great significance for stabilizing the value of the RMB and even promoting the internationalization of the RMB. From this perspective, we anticipate that the central bank will continue to increase its gold reserves in the next five to ten years or even longer, gradually reaching or exceeding the global average level, which implies a potential 10% increase. Additionally, in response to sanctions and turbulent situations, Russia and economies in the Middle East may also increase their gold holdings.

The research report indicates that on a global scale, the current proportion of gold reserves held by all central banks is about 15% of total reserves, which still has significant potential upside compared to the over 40% level after the collapse of the Bretton Woods system. Based on current trends, the annual average increase in the proportion of global central bank gold reserves may be close to 1%, corresponding to an annual gold purchase volume of over 350 tons.