The gold-based money system is long gone, and any attempts to restore the concept are currently unlikely to be implemented. Regardless of these experiences, gold is still very popular among both theorists, who are considering the possibility of returning to some form of money fixed in gold, andinvestors, who treat gold as the surest alternative for securing assets. In recent months, we have been observing increased interest in the precious metal. In August, its price expressed in US dollars, exceeded USD 1,500 per ounce, reaching a level not recorded over the last six years. In turn, the price on the Polish market in early August 2019 (over PLN 5800 per ounce) was the highest since the beginning of our economy’s transformation.
The growing gold prices are accompanied not only by an increase in demand from institutional and individual investors, but also by purchases made by some central banks. These also include the National Bank of Poland, which has joined other central banks from developing countries in recent years. In 2018, the NBP bought 25.7 tones of gold, and in 2019 as much as 100. These are the first such large transactions over the last 20 years, and they have doubled Polish gold reserves and moved our country to the 22nd position among central banks with the largest gold reserves. The above actions also have a significant impact on the structure of official reserve assets held by Poland. Until then, gold accounted for 5% of these assets, and now it is 9%. Interestingly, in parallel with purchasing gold, the NBP took actions to bring to Poland half of its reserves with the intention of storing them in the central bank’s treasury.
Central banks have gone hunting
The attractiveness of gold is determined by two of its features. First of all, it has high resistance to price increases, which guarantees very good protection against inflation. It is also an excellent means for storing value (thesaurization). Gold is important for central banks responsible for monetary and payment systems in individual countries. Large gold reserves may reinforce the countries’ credibility on the international stage and provide protection in the event of a financial deadlock.
Treating gold as a safe haven during times of crisis means that many central banks (particularly in developing countries) are increasing the share of this precious metal in their reserve assets.
Since the beginning of 2019, Russia and China have made record gold purchases, thus maintaining the trend of recent years. In 2008-2018, the share of gold in total Russian reserve assets increased from 3% to 19%, in China from 1% to 2.25%, and in India from 4% to 6%. These countries joined the club of regular gold buyers, which includes e.g. Kazakhstan and Turkey. Not only developing countries are purchasing gold but also highly developed ones. The Netherlands can serve as an example. The share of gold in its total reserve assets increased over the analyzed period from 60% to 66%. Such transactions mean that states strive to diversify their reserves, which until now have mainly been denominated in US dollars; they also indicate the desire to hold liquid reserve assets.
Gold purchases by central banks over the past six years are the largest since suspending the convertibility of US dollars to gold in 1971. One can assume that the central banks in these countries are not only concerned about the economic conditions in the United States, but also about the global economy and political situation.
Although gold purchases are a dominant trend, not all central banks are following the crowd. The largest decrease in gold held over the past decade has occurred in Switzerland. The share of gold in this country’s total currency reserves in the period 2008-2018 decreased from 39% to just 6.6%. A similar situation is also observed e.g. in the United States (down from 77% to 74%) and France (down from 67% to 60%). The characteristics of the current situation of central banks with the largest gold reserves are shown in the table below:
|Stocks of gold (in tones)||Share of gold in the value of reserves (countries with the largest share)||Share of gold in the value of reserves (countries with the smallest share)|
|1.||United States||8,133||United States||74%||China||2.25%|
Table 1. Volume of gold stocks in countries with the largest assets; countries with the largest and smallest share.
Source: Author’s own work based on World Gold Council data and media information.
Why is gold becoming more expensive?
Theoretically speaking, four key groups of factors influencing gold prices on global markets can be distinguished. These include: monetary policy pursued by central banks, the behavior of investors and their attitude to investment forms alternative to gold (e.g. shares, foreign currencies, derivatives, etc.), the economic situation and moments of its slowdown (financial crises), as well as the international political situation.
Currently, one of the primary factors affecting the price of gold is the behavior of the most important central banks, particularly the United States Central Bank.
This is indicated by the correlation between decisions made by the Federal Reserve System (FED) and the evolution of the price of gold on the global market. The reduction of interest rates by the Americans (the first one in many years) has confirmed the investors’ expectations and translated into further price strengthening. The situation is also reinforced by the quantitative easing policy, which has been pursued in the United States since the last financial crisis in 2008. The Federal Reserve System has a huge problem with ending the unconventional approach in its monetary policy. Markets are observing the FED’s struggle, exerting additional pressure to strengthen the price of this precious metal.
Apart from monetary policy, the behavior of investors, particularly institutional investors, also has a significant impact on gold prices. The prices of shares listed on the US capital market are at their historical highs. Due to their dynamic growth in the last few years, investors are expecting a correction and strive to diversify their risk by purchasing gold. It should be emphasized that gold first of all provides security in a situation where paper money or any financial innovation (e.g. securities, derivatives, cryptocurrencies) cannot guarantee this.
Gold is also finding more and more supporters among individual investors. At present, it is difficult to indicate an alternative that can be offered to conservative investors, who want to maintain high liquidity of their capital involvement while also maintaining an appropriate level of security. Investments in all types of securities seem too risky in a situation where capital markets are booming, additionally based on assets pumped into economies in the form of quantitative easing.
Gold is also a much better investment than foreign currencies. The latter have disadvantages that cannot be ignored: the US dollar exchange rate points to the deterioration of some economic data and the abovementioned quantitative easing policy; the euro involves numerous imbalances in the Member States’ balance of payments and excessive public debt; the yen and the Swiss franc – too small economies, vulnerability to international flows and pressure for excessive appreciation; yuan (renminbi) – limited convertibility on international markets. More and more possibilities of investing in gold are being offered. These are not just securities any more, but also gold bars and investment coins. The forms mentioned above are becoming more and more popular.
The third key determinant of gold price developments is the economic situation. There are currently many threats, even for the economies in highly developed countries. One can identify the following issues here: a relatively long bull market period, after which one should expect an economic downturn; widespread trouble with excessive debt. The increase in the US debt is of particular relevance. Currently, over 60% of all foreign currency reserves held by other central banks are kept in this country’s currency (for comparison, reserves held in EUR are only 20%).
The increase in the US debt poses a threat to future inflation growth. Gold, in turn, is a reserve asset resistant to degression. Hence, interest in gold is growing in the face of the impending financial crisis or other turmoil in the economies.
Not only the United States, but also many other countries have very high public debts. Combined with recurring budget deficits and questionable crisis recovery programs, there is an increasing threat to economic stability. In this situation, central banks resort to the most secure assets, which include gold.
Finally, the fourth of these factors is the political situation. There are currently many tensions, the most important of which include: the trade wars announced by President Trump (particularly in relations between the United States and China), the uncertain situation associated with Brexit, as well as the increased tension in the Middle East. If one adds to this the various other events affecting the international political and economic situation, one can create a long list of factors that significantly contribute to higher gold prices.
Prospect of further increases
It is extremely difficult to tell whether the value of gold would continue to rise in the coming weeks and months. As with currency prices – this is influenced by various factors. On the one hand, over USD 1,500 per ounce seems to be a very high price. However, there are analyzes indicating that further increases are possible.
Certainly, the behavior of central banks, which have the potential for further purchases, will have a great impact on the price of gold. It is worth highlighting that gold currently accounts for only 10 percent of all reserve assets held by central banks in individual countries. This means that in the case where they would like to diversify their reserves, buying gold is a very likely scenario. Its exchange rate is inversely correlated with currency exchange rate, which is also very important. If, for any reason, there is a decrease in confidence in the world reserve currencies (dollar, euro, yen, etc.), it will certainly translate into a further increase in the gold exchange rate.
It is worth remembering, however, that the gold price chart is a linear one. Prices are strongly influenced by various investor behaviors, particularly the sentiment to finance this type of assets. Historical data shows that the price of this precious metal stays at a low level, sometimes for an unusually long period of time, and then suddenly increases very sharply. The current increases in gold prices cannot therefore be closely associated with current events, but rather with the long-term situation in the international economy and financial markets, as well as with investors’ interpretations.
A calm reflection taking into account current macroeconomic data from major economies, a fairly stable economic situation (particularly in the United States), prevailing despite many rhetorical tensions, and balanced behavior of decision-makers and financial institutions allow concluding that gold prices should not significantly break from the current trend over the next six months. By the end of 2019, gold should not significantly exceed the barrier of USD 1,500 per ounce and will certainly remain a safe form of investing in relation to other alternatives. This fact, in turn, will translate into the metal’s attractiveness.
Polish version is available here.
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The publication co-financed by the Ministry of Foreign Affairs of the Republic of Poland as part of the public project "Public Diplomacy 2019" („Dyplomacja Publiczna 2019”). This publication reflects the views of the author and is not an official stance of the Ministry of Foreign Affairs of the Republic of Poland.
dr Piotr Łasak