How Do Central Banks Impact Precious Metal Markets?

Key takeaways

• Central bank activity is an important driver for precious metals.
• Recent central bank buying has helped push gold prices to record highs.
• Investors track closely central bank decisions on interest rates.

Central bank buying has been an important factor behind the latest rally in gold which has taken prices to new record highs above $2,400/oz. Central bank activity focuses on maintaining the stability of financial systems through the raising or lowering of interest rates and changes in money supply, with their reserves of precious metals, as a store of value acting as an important support mechanism in difficult times. 

These reserves impart confidence in a central bank’s strength and ability to maintain financial security for a country or group of countries. Given that central banks hold substantial reserves of precious metals, changes in holdings are a key metric for investors, influencing market sentiment and prices.

What are the Central Banks?

Central banks are financial institutions that are tasked with managing the monetary system of a country, or country grouping (as with the European Union), and with maintaining its financial stability. As part of their remit to manage inflation, employment and economic growth, the central banks make decisions on monetary policy, with a particular emphasis on money supply and interest rates. 

With interest rates a key tool in a central bank’s armoury, and the often-cited inverse relationship between gold and US interest rates, investors in the yellow metal constantly seek hints on the next rate decision by US central bank, the Federal Reserve. Though it may often constitute an initial response, the gold price usually increases when interest rates fall as other assets become less attractive.

Who Owns Central Banks?

Central banks usually are owned and run by a country’s government and hence not influenced by private parties that might have commercial interests and seek to push their own financial agenda. In the case of the European Central Bank (ECB) each EU country member is a so-called shareholder and pays for its share as determined by the size both of its population and economy when compared with the EU in its entirety. The US Federal Reserve meanwhile is an independent body in the federal government and has some degree of private ownership with its regional banks owned by member banks. Nevertheless, profits of the Federal Reserve are destined for the US Treasury, once these member banks have received dividends.

Do Banks Have Precious Metals In Capital and Reserves?

Central banks hold precious metals such as gold as part of their capital and reserves. According to the World Gold Council, gold “is an important component of central bank reserves because of its safety, liquidity and return characteristics.” Gold, more so than silver, acts as a store of value and holding the metal diversifies a central bank’s reserves, instils confidence in a country’s economy, while also acting as a natural inflation hedge. The amounts of gold held can vary substantially from one country to another, depending on factors such as economic health and monetary policy. It is interesting to note that gold does constitute a growing proportion of central bank reserves, particularly in the case of emerging markets.

How Much Gold Do Central Banks Hold?

Central banks held a total of just below 36,000 tonnes of gold, according to the latest table available on the World Gold Council’s website, that was published in April 2024 and cites data from the International Monetary Fund’s International Financial Statistics (IFS). The United States topped the table at 8,133.5 tonnes of gold, equating to 69.7% of reserves as of February, with Germany a distant second place at 3,352.3 tonnes (68.7% of reserves).

Central banks can also choose to sell gold at times, but in its survey, published last May, the World Gold Council reported that almost one-quarter of central banks planned to boost their gold reserves in the following 12 months. The main reasons provided were “increased buying of domestic gold production, rebalancing to a more preferred strategic level of gold holdings, and financial market concerns including higher crisis risks and rising inflation.” The trend in buying activity has continued into early 2024 as geopolitical concerns persist.

What is the Effect of Central Banks Buying Gold?

Central bank gold buying can have a significant impact on sentiment in the market, particularly if it represents a trend rather than one bank buying for reasons specific to that nation. Wide-scale central bank purchasing enhances gold’s haven status. This has been evidenced in recent weeks with geopolitical tensions in the Middle East sparking a rally in gold prices to fresh record highs above $2,400/oz that was attributed in large part to central bank buying.

How Does This Impact on Investors?

A period of strong central bank buying tends to encourage most investors to do the same, with the effect of driving prices higher still. Often the banks’ buying will have been triggered by periods of geopolitical instability as is the case at present with ongoing and escalating tensions in the Middle East a key influence.  

Citations

https://www.ecb.europa.eu/ecb-and-you/explainers/tell-me/html/what-is-a-central-bank.en.html

https://www.ecb.europa.eu/ecb-and-you/explainers/tell-me/html/who-owns-the-ecb.en.html

https://www.reuters.com/plus/why-central-banks-buy-gold

https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q3-2023

https://www.gold.org/goldhub/data/gold-reserves-by-country