It is widely reported that the world’s central banks have purchased more gold in the month of October than they have in any month collectively, dating back to the sixties. This information was provided by the World Gold Council on the premise of research performed by Metals Focus, an independent metals research organization.
This comes amid relatively weak gold prices for 2022, where gold has fallen from a high of $2045 in March to the current price (as of the time of this writing) of $1750. What do the central banks know that we don’t?
Gold Demand is Strong
I have been telling people for a year now that the physical gold market is strong. Most precious metals enthusiasts have been focused on silver dating back to the SLV capitulation moment during the “Silversqueeze” in February 2021. Silversqueeze is a movement by silver stackers to accumulate metal in the effort to squeeze the short positions on the COMEX derivative market and thereby drive prices higher, towards what many investors believe is a fair price determined by physical supply and demand.
But while that movement has been taking the attention off gold, the central banks have been gobbling it up at a near-record pace since the last financial crisis. Since 2010, central banks have been big net buyers of gold as the WGC points out in this chart.
The central bankers have been quietly accumulating gold for over a decade in the knowledge that they need to improve their balance sheets. As I covered on our Youtube channel many times, the new Basel 3 standards formally define gold as a High-Quality Liquid Asset (HQLA) when hedged in the open markets. It basically puts gold on part with debt and cash as the highest quality assets the banking system can have. It is no wonder, then, that the central banks are accumulating it.
Gold Versus Paper
What else would the central banks be buying right now in order to solidify their balance sheets a decade after the Great Recession nearly wiped out the global mortgage market? Well, I can certainly see them being shy as to how much of other people’s debt they want to add to their balance sheet given the rise in interest rates.
As far back as 2020, central bankers were beginning to question the narrative on the debt and how an eventual rise in interest rates would change the risks substantially in holding it on the balance sheet. Honorary Governor, Banque de France Christian Noyer said back in September 2020.
“But Governments should clearly see the following: these extraordinary purchases by the central bank will have an end, maybe sooner than often thought; and interest rates will eventually increase, and with them the cost of newly issued debts that will have to be kept by the private sector. Therefore, ensuring sound public finance for the years to come is of the essence. “
A study by the BIS highlights the amount of central bank debt issuance exploding we have had in the past two decades.
What is interesting is seeing who holds that debt. Increasingly, non-financial institutions are buying more of the debt, with less attention paid to interest rate risk as one may think. In other words, the financial economy is taking on the burden of the central bank’s debt spree while the central banks quietly work on their reserve ratios to strengthen them.
What This Means
The banking system has been on a mission since 2009 to clean up its balance sheet and increase liquidity via the Basel 3 standards. While most of the framework of Basel 3 has been put into place, compliance with liquidity ratios has been a challenge for the international banking system. As such, the banks seem to be tightening their lending standards, as well as their risk strategies, to include higher quality assets on their books to offset the world of debt that is coming under pressure due to rising interest rates.
While the central banks and the rest of the commercial banks are exposed to massive amounts of interest rate risk, they are beginning to be a bit wiser in how they manage the risk of a liquidity event. And gold has become a big part of that strategy. The central banks recognize the importance of gold as a low-risk asset with strong long-term stability.
I expect the central banks to continue buying gold while they can afford to do it, simply because they now recognize what we all should. Gold is the ultimate asset with no counterparty risk and is a great way to offset risk in a balanced portfolio. The world’s central banks get it. We should too.