It seems the fate of gold is depended on central banks across the world. Till now, economic crisis looming over the global economy has been the biggest boost for gold prices as more and more people rushed to buy gold as a safe haven option.
However, in the recent past central banks have started playing a crucial role in gold prices. It all began when India's Reserve Bank bought 200 tonnes of the yellow metal from the International Monetary Fund (IMF). After the RBI's purchase, gold prices zoomed to new levels setting a record of sorts. The RBI move was taken by the market as a hint that more central banks are shifting to gold as their main foreign reserve.
After this other central banks of various countries like Sri Lanka bought gold from IMF. This also added to the price rise of the yellow metal.
In the recent past after the Greek tragedy lifted gold prices, another move by central banks brought gold prices down.
This happened when some central banks in Europe pawned their gold with Bank of International Settlements (BIS) to raise cash. This news caused panic among buyers and the bullion market was hit by the news that the BIS may release the gold in the market. However, another move by China's central bank helped the global gold market.
A note by China's foreign exchange regulator stated that gold will not be a key investment in the superpower's foreign exchange reserves. The announcement had more to do with assuring investors that they wouldn't suddenly be divesting treasuries, than about the gold market itself.
A Chinese sale of even part of its significant stock of US Treasuries would have a pretty profound impact on the US Dollar.
China has actually been gradually accumulating gold for several years now as have a number of central banks. China announced in April 2009 that its gold reserves had risen from 600 tonnes in 2003 to just over 1,000 tonnes. Although as a percentage of its reserves, it remains quite small at 1.6%.
The structural shift by central banks from being net sellers of the metal (as was the case for the previous two decades) to net buyers is one of the key reasons behind the continued good performance of the metal.
When one looks at central banks one needs to make a distinction between the developed economy banks who have large stocks of gold in their reserves as a legacy of the Gold Standard days and, the developing economy banks who have no, or very low allocations to gold.
The first group has been selling its gold holdings over a period of years to rebalance their respective portfolios while the second group has been adding to their reserves for much the same reason.
European central banks in particular had large stocks of gold as a legacy of the Gold Standard days, and have been selling those through Central Bank Gold Agreement Programmes since 1998. Their sales have now slowed to negligible levels and new buyers in emerging market countries came up.