Why Central Banks Buy Gold

In the past two years, central banks around the world have been on a gold buying spree. By Q3 2023, global central banks bought around 800 tonnes of this precious metal and now hold roughly a fifth of all the gold ever mined. According to the World Gold Council, around a quarter of central banks intend on continuing to increase their reserves in the next year.

There was once a time when central banks were mostly net sellers of gold, but since the Global Financial Crisis (GFC) of 2008, central bank gold purchases have only been on the up. It’s no surprise: gold’s safety, liquidity, and unique characteristics make it a stable and attractive investment.

If you’d like to better understand why central banks buy gold, keep reading. In this article we explore the primary reasons why central banks buy gold, which central banks hold the most gold, and where central banks store their gold.

Why central banks buy gold

As part of the World Gold Council Central Bank Gold Reserves Survey in 2023, central banks all over the world were asked for the major factors at play in their decision to hold gold. The five most popular responses - and therefore the biggest reasons why central banks buy gold were:

• Historical position
• Performance during times of crisis
• Long-term store of value/inflation hedge
• Portfolio diversifier
• No default risk.

Let’s examine some of these factors in more detail.

Historical position

Gold is one of the oldest and most universally valued assets. People from all cultures, all across the world, have revered gold since ancient times. Royal treasuries, temples, and other important authorities hoarded gold as a way to assert their economic stability and power. There are many reasons for this:

• Scarcity: Gold is rarer than other metals, such as iron or copper, but not so rare that it’s unfeasible to use it.
• Durability: From a chemical perspective, gold is a solid metal that doesn’t rust or corrode when left exposed to the elements.
• Malleability: Gold is extremely soft and malleable, making it easy to mold to different shapes and stamp for gold coins.

Gold’s value today stems from its past use as a currency and object of value, giving it a strong historical position. Should the financial system as we know it crumble, it’s likely that the world will turn back to gold as an asset. If this were to happen, central banks with gold reserves can maintain their position as economic powerhouses.

Performance during crisis

Gold has proven itself to be a safe-haven asset that maintains its value - and even increases in value - during periods of instability and crisis. Whether its political turmoil, economic instability, or a global financial crisis, gold tends to hold its value regardless of what’s happening in the world. This is why it’s often called the ‘crisis commodity’.

These two examples highlight gold’s ability to skyrocket during periods of crisis:

• USA in the late 70s: At this time, interest rates were over 15%, inflation was at 14%, and the world was experiencing the Cold War, Soviet invasion of Afghanistan, and an oil embargo. During this time, gold’s price increased by 721% between 1976 and 1980.
• Early 2022: In the wake of the Russia-Ukraine conflict and the global uncertainty that followed, a similar situation occurred where gold prices increased by 6%.

Essentially, gold’s continuing performance during a crisis allows central banks to confidently navigate economic uncertainties and geopolitical tensions. The Dutch central bank, De Nederlandsche Bank (DNB), sums up its perspective on the matter succinctly:

“A bar of gold always keeps its value. Crisis or not. That gives a safe feeling”.

Long-term store of value/inflation edge

Besides its ability to perform well during a crisis, gold has shown itself to act as an effective inflation hedge and long-term store of value. While paper money is known to depreciate in value over time, gold is a limited-supply asset. This means it cannot be produced at will.

Its scarcity, combined with its intrinsic value, makes gold resilient to the effects of inflation and helps retain its purchasing power in the long-term.

Portfolio diversifier

Another reason why central banks buy gold is to diversify their reserves. The value of a country's currency is likely to fluctuate in value depending on the state of its economy. In dire situations, central banks might need to print off more money to prevent economic collapse. This results in currency devaluation.

Unlike fiat currencies, gold is a physical commodity that cannot be printed on demand. This helps add a layer of diversification to central banks, reducing overall risk, increasing resilience, and optimizing their potential for long-term returns. Having gold reserves allows central banks to weather economic storms and maintain a balanced portfolio that won't collapse in situations where paper money loses value.

On top of that, gold tends to move in opposition to conventional financial assets like stocks and bonds. When these assets depreciate, gold’s price tends to increase. This makes gold a reliable anchor and diversifier in central banks' portfolios.

No default risk

Another key reason why central banks hold gold is the absence of default risk. Unlike other financial assets, like bonds or loans, gold doesn’t rely on a third party to make good on contractual obligations or promises.

Once acquired, gold is a tangible, physical asset with intrinsic value that does not depend on a third party. This means that central banks holding gold can be confident that their investments will remain secure, stable, and reliable into the future.

Other reasons why central banks buy gold

While the factors outlined above play the biggest part in central bank gold buying, there are other reasons why they may choose to do so. These include:

• Anonymity: Amidst heightening geopolitical tensions, the Society for Worldwide Interbank Financial Telecommunications (SWIFT) payments system has imposed sanctions on countries like Iran and Russia. Countries weary of sanctions can trade their US dollar assets to the more anonymous gold.
• It makes them safer: In an uncertain world, gold purchases can help make central banks look (and feel) more stable and secure. Should there be any financial crisis or decline in a country’s currency, these countries can rely on their stores of gold to weather the storm.
• De-dollarization: Many countries buy gold to diversify their reserves from US dollar over-concentrations. For example, BRICS nations - Brazil, Russia, India, China, and South Africa - are in talks of developing a new currency as part of a de-dollarization strategy. They’ve hinted that new currency may be backed with gold and other metals with intrinsic value. Should this process develop further, it would be no surprise to see more central banks flocking towards gold.

Which central banks hold the most gold?

As of 2024, the top five countries with the largest gold central bank purchases are the United States, followed by Germany, Italy, France, and the Russian Federation.

• United States: The US Federal Reserve holds the most gold out of any other central bank with more than 8,100 metric tonnes. This equates to about 68% of their total foreign reserves.
• Germany: Deutsche Bundesbank manages Germany's gold holdings, which are around 3,352 MT. This is less than half of the US’s holdings and equates to about 67% of the country’s total reserves.
• Italy: The Banca d'Italia holds gold reserves in various locations, totalling around 2,451 metric tonnes or 64% of their total reserves.
• France: Following closely after Italy is the Banque de France, holding around 2,436 tonnes of gold reserves, equating to about 66% of their total foreign reserves.
• Russian Federation: Russia’s central bank only recently began buying gold reserves and it now lags behind France with 2,332 tonnes of the yellow metal. This is only 24.67% of their total reserves.

Emerging markets flock towards gold

More recently, we’ve been seeing more emerging economies flocking to the gold market. This includes China, Turkey, India, and Poland. While these markets still hold less reserves than their developed market peers, they’re purchasing gold at a higher rate and may soon hold more of this reserve asset.

In 2022, the largest increases in gold reserves came from Turkey, China, Egypt, Qatar, and Uzbekistan. While complete 2023 data is not out yet, it seems like Turkey and China continued to lead the pack, along with other emerging markets like Poland, Kyrgyzstan, and India.

Where do central banks store gold?

Central banks store their gold reserves in various locations both domestically and abroad. Where a country chooses to store its physical gold will depend on various factors, including security concerns, historical practices, and geopolitical considerations.

Most central banks will store their gold in either:

• Domestic storage: In most cases, countries will store a significant portion of their gold reserves within their own borders. These include secure facilities like government-owned vaults or facilities operated by the central banks themselves. For example, the US stores a large amount of its gold at the Fort Knox Bullion Depository.
• International storage: Some central banks store gold in vaults located in other countries. This is referred to as holding gold reserves in ‘foreign exchange reserves’. Keeping gold internationally is a way for central banks to diversify and add an extra layer of security to their reserves. For example, some European countries store their gold in the vaults of other European central banks.
• International financial centers: Certain central banks choose to store their gold in vaults located in international financial centers like London, New York, or Zurich. These cities are known for having well-established financial infrastructure and secure facilities that can protect gold reserves.
• International organizations: In some cases, central banks choose to store their gold with international organizations like the International Monetary Fund (IMF), which holds gold on behalf of its member countries in designated depositories.

Invest in your future with gold

For centuries, gold has played an important role in preserving the wealth of nations and it doesn’t seem that it will stop any time soon. Gold’s stability, liquidity, intrinsic value, and ability to act as a diversifier makes it a prime asset for any nation to hold. If you’d like to invest in your future, you can purchase your own gold holdings too.

StoneX Bullion sells pure, investment-grade gold bullion to help you start your wealth-preservation journey. Whether you choose to invest in your future with a hefty Argor-Heraeus 1 Kilo Gold Bar or crown your collection with a collectible 100 Corona Franz-Joseph Gold Coin, our range of gold coins and bars suits investors of all budgets and portfolios.