IN 2024, all that glitters is gold indeed. Central banks, who take refuge in the security and resilience of the yellow metal in turbulent times, have been hyperactively adding it to their reserves. The result: the yellow metal hit 15 all-time highs this year till mid-April on London Bullion Metal Exchange. Central banks, in fact, bought nearly one-third the total gold mined in 2023. As per World Gold Council (WGC), annual mine production last calendar year was 3,644 tonnes; of that, central banks bought 1,037 tonnes. “Most central banks are buying based on gold’s performance during crises and its role as a long-term store of value,” Juan Carlos Artigas, Head of Research, World Gold Council, tells Fortune India. In 2023, top buyers included China (224.88 tonnes), followed by Poland at 130 tonnes. India was at the sixth spot with 16.22 tonnes.

Mike McGlone, Bloomberg Senior Commodity Strategist, says the rally started with the “unlimited friendship” between Chinese President Xi Jinping and Russian President Vladmir Putin. “Led by China, the deepest pockets on the planet, central banks, are colossal buyers of gold,” he says. In 2023, they cumulatively bought 1,037 tonnes, only 45 tonnes less than 1,082 tonnes in 2022, which was the highest since the abolition of the Bretton Woods agreement in 1971. In 2020 and 2021, global central banks’ net purchases were 255 tonnes and 450 tonnes, respectively. Central banks bought 65 tonnes on a net basis in January and February 2024, according to data from International Monetary Fund (IMF) and publicly available sources.

Plugging Trust Deficit

It is not a coincidence that 2022, when Russia-Ukraine war started, was also the point of origin of the current gold rally. In 2022, demand for gold was the strongest (1,081.8 tonnes) in 11 years, as per WGC. By the end of February 2022, Russian central bank confirmed that about half its assets, worth $300 billion, have been frozen as part of an economic war initiated by U.S. and its European allies. This was not only a blow to Russia but also to the international financial and monetary system that is based on trust. In his book, The Economic Weapon: The Rise of Sanctions as a Tool of Modern War, historian Nicholas Mulder mentions that even when Britain and Russia were fighting the Crimean War in 1853-56, they continued to service their debts to each other. The ‘freeze’ of Russian forex funds sent a stark signal to the world that U.S. will no longer play by rules and any country crossing it may find itself in Russia’s shoes. Thus, 2022 marked a paradigm shift for international finance, with central banks starting diversifying assets to build immunity from any financial onslaught by U.S. A major part of their strategy involves shifting to gold rather than building forex, especially U.S. dollar, reserves. As per IMF data, in 2021, there was an addition of 5.08% in forex reserves and 2.28% in forex accumulation in U.S. dollars. In 2022, there was a net reduction in both forex (-6.23%) and dollar reserves (-6.44%). In 2023, there was a marginal addition in both forex (0.64%) and dollar reserves (0.19%).

WGC’s 2023 survey revealed that central banks’ views on future role of U.S. dollar were more pessimistic than in previous surveys. In contrast, their views on gold grew more optimistic, with 62% saying gold will have a greater share of reserves compared with 46% last year.

WGC research suggests central banks have been net buyers of gold for 14 years, including periods when prices increased significantly. It expects another year of robust buying.

The China Factor

In November 2022, People’s Bank of China reported the first increase in gold reserves since September 2019. Its gold reserves rose to over 2,000 tonnes for the first time in 2022, as per a WGC report.

Between 2002 and 2019, China had accumulated 1,448 tonnes gold. It has continued buying since November 2022. In 2023, the Chinese central bank became the largest buyer by purchasing 224.88 tonnes and boosting holdings to 2,235 tonnes. In an article published in 2022, Yu Yongding, one of the most influential economists of China, wrote: “Whatever the causes, there is no denying that China has accumulated an excessive volume of foreign exchange reserves. With more than $2 trillion of net international assets, China’s net investment income has been negative for almost 20 years, because its holdings are disproportionately in low-yield U.S. treasuries. This is a grotesque misallocation of resources.”

China’s foreign exchange reserves peaked at $3.8 trillion in 2014. Since 2016, they have fluctuated around $3 trillion. In 2022, when Russian forex reserves were frozen, China had $3.2 trillion worth of forex reserves. It seems Beijing was already cautious about the fate of its huge forex reserves when U.S. reneged on the moral code of international finance. This perhaps strengthened its resolve to create alternatives to U.S.-based monetary systems. Not only has China started expanding its gold reserves, it has also initiated CIPS, Cross-border Interbank Payment System, to move away from dollar-dominated SWIFT (Society for Worldwide Interbank Financial Telecommunications).

Furthermore, there is a concerted effort by BRICS nations and Shanghai Cooperation Organization, bolstered by China, to introduce an alternative international trade currency to challenge the dominance of the U.S. dollar. In response to this evolving landscape, central banks have started divesting dollar-denominated assets such as U.S. treasuries and allocating a portion of their reserves to the yellow metal.

Gold Outshines Gold ETFs

Even when central banks are on a gold shopping spree, there is a dichotomy between performance of physical gold and gold ETFs. While more and more physical gold is making its way to vaults of central banks, gold ETFs are getting trimmed from portfolios. As per Bloomberg data, total holdings of gold ETFs are about 82 million ounces, down from the peak of 111 million ounces on October 15, 2020. Total decline is 29 million ounces or about 26%. “About $8 billion gold ETF outflows in current year show investors shunning a top performer, for now,” says Mike McGlone of Bloomberg. One ounce is 28.349 grams.

As per WGC, global gold ETFs saw third consecutive annual outflow in 2023. Despite heavy selling by gold ETF funds, the yellow metal is up about 25% in dollar terms.

Central banks’ purchasing patterns are predominantly influenced by their reserve portfolio composition and geopolitical uncertainties. The divergent performance of physical gold and gold ETF may be attributed to different motivations. Whereas central banks are primarily motivated by factors related to strategic reserve management, a fund manager buys ETFs for earning profits.

RBI’s Measured Moves

India’s love for gold earned it the epithet of ‘The Golden Sparrow’ in ancient times. This continues to be relevant even now as Reserve Bank of India (RBI) is among top 10 gold buyers among all central banks.

It bought 41.68 tonnes, 77 tonnes and 33 tonnes gold in 2020, 2021 and 2022, respectively. This is 15.26%, 16.63% and 2.9% of total gold purchased by central banks in those years. In 2023, RBI reduced its pace and bought just 16.22 tonnes, or 1.54% of total gold purchased by central banks.

RBI gold buying matched the rise in India’s forex reserves. As per RBI data, India’s forex reserves rose from $580 billion in December 2020 to $633 billion in December 2021. During the period, India bought 77 tonnes gold, its second-highest purchase since 2009. The aim was to diversify forex reserves, 60% of which were in U.S. dollar. However, the situation reversed in 2022, when India’s forex reserves declined from $633 billion to $563 billion. WGC’s Gold Demand Trend Report 2022 says RBI’s intervention in forex market to support the rupee caused a $70 billion decline in India’s forex reserves. This may have impacted its gold buying, it says.

Thus, RBI’s modest buying can be attributed to erosion of forex reserves on account of weakening rupee and appreciation of U.S. dollar. In 2022, rupee lost 10.68% value against greenback, while India’s forex reserves declined 11.7%. India’s mammoth gold buying occurred in 2021 when rupee gained 2.4% against U.S. dollar and forex reserves rose 9.1%.

Although India’s forex reserves swelled to $623 billion by 2023-end, they were still $10 billion shy of the 2021 number. Thus, RBI reduced its buying pace and bought just 16 tonnes in 2023. As per RBI, India’s total forex reserves stood at $648.56 billion while gold reserves were $54.56 billion on April 5, 2024, accounting for 8.4% of India’s forex reserves.

Be it gold or crude, the vital commodities which India imports, the mode of payment is U.S. dollar and it seems RBI’s current focus is on earning dollars rather than paying for gold in U.S. dollars.

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