Gold: Debunking the Myth of Central Bank Reserve Holdings
Introduction:
Gold has been one of the best-performing markets this year, fueling speculation about the role of central bank reserve holdings in driving up its price. However, data suggests that this may not be the case. In this article, we will explore the relationship between central bank reserve holdings and the gold price, debunking misconceptions and shedding light on the true factors at play.
The Gold Price and Central Bank Reserve Holdings:
Contrary to popular belief, the increase in central bank reserve holdings does not seem to be directly correlated with the rise in gold prices. Looking at the accompanying chart, which depicts the gold price alongside the change in central bank reserve holdings month-over-month (MoM), it becomes evident that the claim lacks substantial evidence. While central bank reserve holdings have been steadily increasing since the early 2010s, the gold price experienced significant surges in 2019/2020 and 2023/2024.
In fact, an inverse relationship can be observed. As gold prices trended upwards from the mid-2000s, central bank holdings shifted from being underweight to overweight. This raises the question: if the increase in central bank holdings is supposed to drive up the gold price, why didn’t central banks further increase their holdings during the recent surge? One plausible explanation could be the constraints of actual available gold mined.
The Scarcity of Gold:
When considering the availability of gold in the market, it becomes clear that there is a limited supply for central banks to purchase. Nearly half of all mined gold is already in the form of jewelry, leaving a smaller portion for bars, coins, ETFs, and other private and central bank reserve holdings. Moreover, while sellers in the market are scattered, central banks as buyers are concentrated. This makes it challenging for central banks to acquire significant amounts of gold.
China’s Role:
Some conjecture that China’s increase in holdings has played a significant role in pushing up the gold price. Historical statistics indicate that China tends to do so when the gold price is near a low point. However, recent reports suggest that China is now selling instead of buying. It is reasonable to assume that China is acting as a speculator, capitalizing on buying low and selling high, rather than betting on the collapse of the U.S. Dollar or bolstering its own Renminbi.
The Limited Impact of Central Bank Holdings:
It is important to note that central bank holdings only account for 17 percent of total gold demand, indicating that they are not a key driver of the gold price. In today’s financial landscape, where none of the fiat currencies are backed by gold, U.S. dollar holdings, particularly in Treasury bonds, play a more significant role in maintaining exchange rates. The sheer volume of gold makes it impractical to be readily liquidated at a reasonable price within a short period.
The Downsides of Gold Holdings:
Apart from offering no yield and carrying storage costs, gold holdings are also subject to price volatility. Despite being labeled as a “safe haven,” gold can experience sharp losses within hours. Decades of experience have shown that the bull period for gold is approximately half as long as its bear period. In other words, long-term gold holdings tend to result in longer periods of unhappiness compared to happiness, with a ratio of around 2:1. This is because gold lacks productivity like stocks do, where underlying companies generate profits. Gold merely rides on its scarcity.
The Nature of Gold Prices:
Gold prices are inherently prone to demand shocks and volatility due to their inelastic supply. The scarcity of gold leads to constructional volatility. Central bank reserve holdings still follow human nature, with fund managers trading for central banks speculating on gold just like other speculators in the market. Given that the amount needed to defend a currency’s value is not substantial, gold becomes a speculative asset for central bank fund managers.
Conclusion:
The belief that central bank reserve holdings are the primary driver of gold prices is unfounded. While there may be some correlation, it is not a direct causation. The limited availability of gold, coupled with its price volatility and the dominance of U.S. dollar holdings in maintaining exchange rates, diminish the impact of central bank holdings on the gold market. Understanding these nuances is crucial for investors looking to navigate the complex world of gold investments.
