Gold is back in the spotlight as a hedge against uncertain times, with prices up by a fifth over the last six months. The price rally is being driven largely by central banks that are steadily adding to their gold reserves as insurance against geopolitical instability, high inflation and fluctuations in interest rates. Central banks’ purchases rose by 152%, to 1,136 tonnes, in 2022 and have continued this year as well, rising by 52 tonnes in February, the eleventh month of net purchases. The Reserve Bank of India, for its part, bought 3 tonnes in February, taking its reserves to 790.2 tonnes or 8% of the world’s gold reserves according to the World Gold Council.
Although gold no longer plays a direct role in the international monetary system, central banks are accumulating bullion due to the escalating risks due to the war in Ukraine and rising US-China trade tensions. Inclusive of the widening ambit of financial sanctions against Russia, more than 30% of all countries also face sanctions from the US, the EU, Japan and the UK, up from 10% in the early 1990s, according to a column in The Financial Times. In this milieu, it is but natural that central banks, especially of countries not aligned with the West, seek the safe haven of gold. The People’s Bank of China purchased 25 tonnes in February while the Central Bank of Turkiye added over 22 tonnes as a part of a buying spree over the last 15 months, according to the World Gold Council.
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India’s build-up of gold holdings, however, predates the geopolitical tensions due to the Ukraine war and is largely due to the heightened uncertainties in financial markets and compulsions of active reserve management. Around two-thirds of the RBI’s foreign currency assets are invested in securities, including US treasuries. So buying more gold—as it has been doing during the last three years, adding 137 tonnes from end-March 2020 to this February—helps diversify its portfolio of reserves, especially when yields on dollar-denominated securities are low. Interest rates in advanced countries have been on a declining trend over the last four decades and reached historic lows in many of them in 2020, as per RBI’s The Low Yield Environment and Forex Reserves Management report. Typically, gold has an inverse relationship with the US dollar: when the former rises, the latter dips in value, enabling central banks to shore up reserves. With the dollar weakening, thanks to the stimulus rolled out by the US Federal Reserve, RBI’s purchases reflect risk aversion in a low yield environment.
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Considering the adverse headwinds to global economic prospects, gold will remain central to the investment strategies of central banks, including the RBI’s. But there are limits to accumulating gold, especially if it begins to lose value. The big question is what will be the RBI’s stance when that happens? Will it then sell some of its gold? The problem is the emotions among most people of this country over gold sales. Look no further than the 1991 move to pledge gold that occasioned tremendous national angst. In sharp contrast, the move to buy 200 tonnes of gold from the IMF in 2009 was cheered. For now, however, the allure of this precious metal is in the ascendant because of heightened uncertainties.