For centuries, nations and central banks have accumulated reserves of gold to conduct trade, pay for military campaigns, and fund exploration and settlement. Before the advent of fiat — paper — currencies, gold was the primary medium of exchange.
Although today’s consumers are more likely to pay for goods and services with dollars rather than gold bars, countries around the globe continue to build up their stores of precious metals.
This trend has been reflected in recent headlines, with central banks worldwide adding to their gold reserves in recent years.
So, why are central banks buying gold, and what is the impact of this trend on gold prices?
Why Are Central Banks Buying Gold?
Central banks purchase gold to diversify financial reserves and protect against value declines in reserve currencies such as the U.S. dollar. Here’s a brief rundown of the main reasons why countries buy gold.
To Diversify Their Financial Reserves
The primary job of a country’s central bank is to oversee the national monetary system. However, the values of currencies can fluctuate depending on a variety of factors, including economic considerations such as inflation and interest rates, geopolitical tensions, and even extreme weather.
Many countries hold reserves of foreign currencies — particularly the U.S. dollar. The devaluation of the dollar or other fiat currencies can lead to the devaluation of a country’s reserves.
On the other hand, the gold market has historically remained relatively stable. By holding reserves of gold, central banks can protect the government from significant currency risks. In the event of a currency collapse, the country would have a means to financially recover thanks to its gold reserves.
To Hedge Against Inflation
Inflation — the increase in prices for goods and services — can dramatically affect a country’s economic health. After all, inflation leads to the depreciation of a currency as it loses its purchasing power.
For years, gold has been used as a hedge against inflation. This is thanks to its finite supply — unlike U.S. dollars, you can’t just “print” any more gold.
By increasing its gold market investment, the country can still have a reliable way to fund its budget even if the value of its own currency drops.
To Foster Growth
The case for gold as a source of financial stability has been proven. By investing in gold, nations can help ensure their own stability against economic crises.
In turn, the economic stability that comes from gold reserves can help countries around the world grow. This is especially important for developing countries, which tend to have highly volatile fiat currencies.
Which Central Banks Are Buying Gold?
According to the World Gold Council, China was the biggest purchaser of gold in 2023, with its central bank adding nearly 225 metric tons of the precious metal. That was followed by Poland, which purchased 130 tons, and Singapore, which added around 76 tons of the precious metal to its financial reserves.
However, the largest holder of gold is still the U.S., with reserves of more than 8,133 tons in 2023. Germany is second, with just over 3,352 tons.
Why China Wants To Buy as Much Gold as Possible
By the end of 2023, China’s central bank, the People’s Bank of China (PBC), had gold reserves of more than 2,235 tons. So far into 2024, the PBC has continued to add to its holdings.
The main reasons for this gold-buying spree include:
- Diversification against the dollar: Over the decades, China has amassed a huge reserve of foreign currencies, especially the U.S. dollar. By purchasing more gold, the Chinese government can diversify against the devaluation of the dollar.
- Protect against sanctions: Potential sanctions by other countries could prevent China from easily completing international money transfers. China could theoretically avoid these financial headwinds by using gold for international trade.
- Hedge against economic and geopolitical risks: Like all gold investors, China is likely drawn to the precious metal thanks to its history as a safe haven from economic and geopolitical crises.
How Do Central Banks Affect the Global Gold Market?
There are several ways in which central bank activity can affect the market for gold:
- They create demand for gold: Central banks’ large purchases of gold can have a big impact on the global demand for the precious metal. The forces of supply and demand are among the main factors behind the values of gold futures contracts, which are bets on the future value of the metal, and the gold spot market price, which is the current value of an ounce of gold.
- They boost market sentiment: When a central bank adds to its gold reserves, it signals to investors that there is good reason to be confident in the precious metal. That tends to create more buying activity, which drives up demand, which in turn causes the value of gold to rise.
- They can trigger volatility: Particularly large gold purchases — and sell-offs — by central banks tend to cause gyrations in the value of the precious metals as investors react to the news. Purchases can trigger spikes in the gold spot rate, while sales often have the opposite effect.
How Are You Affected?
History and experience have taught central banks that gold investments are critical for wealth protection. The same applies to individual investors, too.
All of the reasons for central banks to add to their gold reserves — from its use as an inflation hedge to diversification to a safe haven in times of crisis — should be reasons for anyone to add gold to their portfolio.
