Cautious central banks push on gold, pushing up prices

Gold prices rarely rise when monetary policy is tightening, interest rates are rising and the dollar is strong, as higher interest rates on other investment options make the precious metal less attractive. This is because unlike bonds, gold does not offer any regular returns.

But there is an additional factor in the ongoing phase of monetary tightening. As Russia’s endless war of words throws geopolitics into turmoil, the US dollar has replaced gold as the preferred safe haven for central banks. Their frenzied buying is a result of fears triggered by Western sanctions on Russia shortly after it invaded Ukraine nearly a year ago. These sanctions effectively froze large parts of Russia’s foreign exchange reserves.

Not surprisingly, among the biggest buyers are the central banks of Turkey, China, Qatar, Egypt, Iraq and the United Arab Emirates. The Reserve Bank of India (RBI) also increased its gold reserves, but at a slower rate. It also plans to buy 33 tonnes in 2022, down 57% from the previous year. The only advanced market economy central bank to buy gold in 2022 was Ireland.

The People’s Bank of China is also reportedly buying gold for the first time since 2019 to hedge the risk of its foreign exchange reserves freezing over its close ties with Russia.

New data from trade body World Gold Council shows 4,741 tonnes of gold will be bought in 2022, up 18% from the previous year, the largest volume since 2011, and the second most in history since 1950 Most when the dollar was still pegged to gold.

Originally, the rupee, like many other currencies, was backed by gold holdings of the RBI. The original Reserve Bank Act prescribed a proportional reserve system under which at least 40% of total note issuance had to be backed by gold bullion and sterling. But after the breakdown of the gold standard, central banks, including the Reserve Bank of India, began to look into the issue of mixing domestic and foreign securities and gold.

Since then, the outlook of central banks regarding gold as an asset has been changing and gold purchases are being made from a long-term perspective. These banks have been net buyers of gold every year since 2010, after being net sellers in the two decades before the 2008 global financial crisis. Central banks collectively bought more gold than they had bought in the previous 55 years, receiving 1,136 tonnes. Or more than double to 450 tonnes in 2021 and proved to be the main reason for the increase in demand.

In November 2009, nearly a year after the global financial crisis, when gold reserves stood at about 3.5% of the RBI’s foreign exchange reserves, the then Governor D Subbarao decided to buy 200 tonnes of the precious metal from the International Monetary Fund for $6.7 billion. The idea was to diversify the exposure to India’s reserves, as gold prices and the dollar’s value generally move in opposite directions. The IMF had announced that it plans to sell some gold to help pay off its loans to low-income countries reeling from the effects of the global financial crisis. It was offered on first come first serve basis in the open market.

In 1991, when Subbarao was joint secretary in the finance ministry, he signed an agreement on behalf of the government authorizing the RBI to pledge India’s gold reserves to cover defaults in the balance of payments. The foreign exchange required to be avoided can be secured. crisis.

He decided to take 200 tonnes of gold from the IMF for the RBI’s reserves, despite logistical challenges, given the need for high secrecy. Any leak could inflate the market price of gold, increasing transaction costs, so no one outside the RBI team working on the purchase was told about it. Subbarao informed Prime Minister Manmohan Singh and Finance Minister Pranab Mukherjee about it a few days after its completion (on 3 November 2009), when he met them in another context.