Gold reserves at central banks increased by 97.6 metric tons during the July-September period, albeit at a slower pace compared with a record year-ago quarter. The official sector accounted for 9 percent of overall gold demand during the third quarter.
“I wouldn’t emphasize the fall of 31 percent [from a year ago],” said Marcus Grubb, managing director for investment at the WGC. “Anything close to 100 tons is very high by the last 15 years.”
The world’s central banks collectively bought 374 tons of gold in the first nine months of this year. That’s higher than last year’s 343 tons for the same period.
“We still think we might beat last year’s total for central banks of 456 tons, though it’s going to depend on Q4,” Grubb said. “[This year will likely come in at] somewhere between 455 tons and 500 tons, which will be another record since the early 1960s.”
Diversification of reserve assets remains the driving force behind gold demand by central banks and purchases of a similar order of magnitude are expected for the fourth quarter. Official sector demand is likely to act as a fairly solid pillar of demand going forward.
The Federal Reserve said on Oct. 24 it will buy $40 billion of mortgage debt a month and probably hold interest rates near zero until 2015 to boost economic growth and cut the jobless rate. Minutes of the Fed’s October policy meeting released Wednesday suggest that the U.S. central bank might unveil a new bond-buying program in December to replace an existing program, called “Operation Twist,” which expires at year’s end. The new program would come on top of QE3.
The Bank of Japan expanded an asset-purchase program on Oct. 30 for the second time in two months, and the European Central Bank has said it is ready to buy bonds of indebted nations.
The increase in money supply could be a potential catalyst for higher inflation in the future, which is positive for gold investment. Previous research by the World Gold Council shows that a 1 percent change in money supply, six months prior, in the U.S., Europe, India and Turkey tends to increase the price of gold by 0.9 percent, 0.5 percent, 0.7 percent and 0.05 percent, respectively.
Closely linked to the inflation effect is the impact that unconventional monetary policy has on currencies. Given that gold prices are typically denominated in U.S. dollars, the exposure gained from buying or selling gold is influenced by changes in the exchange rate for U.S. dollars. U.S. dollar-based investors typically see a negative correlation between the US dollar and gold.
Until about 2009, central banks as a group have been net sellers of gold of about 500 tons a year on average, according to Grubb. During that 15-year period going back to the 1990s, the sellers were almost always the Western central banks, while any buyers were almost always central banks from developing countries.
Grubb said two things happened around 2008-2009: Western central banks ceased to sell gold. And with the increasing foreign exchange reserves in surplus countries in Latin America, Asia and Far East, their central banks started buying gold because they had very low weightings in gold in their reserve portfolios.
Developing countries started to diversify their reserve portfolios as they continued to build up large currency reserves by exporting goods to Europe and North America. Then came the 2007-2008 credit crunch, the large-scale monetary easing actions and widespread economic issues.
As a result, central banks have continued diversifying away from the dollar, the euro and the sovereign debt because of the higher risks associated with those currencies and asset classes.
“Emerging country central banks are now buying gold like they never have done before to increase the weightings in gold in their reserve asset portfolios and to protect against the effects of unconventional monetary policy, which is now being implemented on an international scale like we’ve never seen before,” Grubb said.
The average weighting of the European and American central banks in gold is between 50 percent and 100 percent. But for a developing country’s central bank generally has less than 5 percent of its reserve portfolio allocated to gold.
“Because it is [central-bank buying] is driven by those factors that are longer term, we do think it is a trend that will continue,” Grubb said. “Even if the economy improved, I still think that you are going to see developing country central banks buying more gold, simply because they are very underweight.”
Developments during the third quarter included a reported purchase of 1.7 tons by the Brazilian central bank, taking its reserves to around 35.3 tons. The last time the bank reported an addition to its gold reserves was in June 2005.
Another notable purchase came from the Latin American region, with Paraguay reporting a rise of 7.5 tons in its gold holdings, representing a more than 10-fold increase from 0.7 tons prior to the purchase.
South Korea increased its holdings of gold by 29 percent in July, announcing that it had purchased 16 tons “having judged ...market conditions were good” to do so. The bank has clearly stated its intention to diversify its reserves, and its current 70.4 tons of gold accounts for around 1.3 percent of total reserves.
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