Why are troubled EM nations hoarding gold?
“The instruction manual for surviving a zombie apocalypse is pretty straightforward. Once you’ve kitted out your bunker with canned goods and firearms, get a supply of bullion. You’ll need it to buy bullets and bribe your way out of a death fight in Thunderdome.
That’s a line of thinking you might associate with cranky gold bugs, but it’s not a million miles away from the rationale behind fund flows in the precious metals market right now — and
nations are in the driving seat. Central banks bought 400 metric tons of gold in the September quarter, the World Gold Council reported this week. That’s a record inflow on a par with what
they’d purchase over a whole year in normal times. In the notoriously opaque world of government gold trading,
it’s not always immediately clear who the biggest buyers are. Monetary authorities are such big players that they can distort the entire market by showing their hands, one reason that prices
plummeted in the 1990s and 2000s when some of the European central banks sold in unison.
There is one obvious factor in common between the declared buyers, however: All are from nations facing serious problems.
Turkey, whose lira slumped 52% over the year through September, added 95.5 tons to its gold holdings in the same period. Egypt bought 44.8 tons while its pound fell by 20%. India’s 40.5-ton
purchase was matched by an 8.7% weakening of the rupee. Iraq’s dinar is fixed against the dollar, but credit-default swaps protecting against non-payment of its debts surged to nearly 9%
in September, even after it bought 33.9 tons of the metal.
That’s a curious situation. Stacking up bullion in the central bank’s vault has long been a powerful signal to investors that a government is going to be a prudent and reliable borrower. No amount of gold buying, though, is going to convince anyone that the fiscally incontinent Egyptian government is a good credit. US 10-year Treasuries, currently yielding 4.2%, also look a much better proposition than a metal that pays no interest, especially now that gold is no longer outperforming the total returns on government debt.
Bullion does have one crucial advantage: unlike bonds, it doesn’t bind you into a relationship with an unreliable counterparty. US government debt was at one time the hardest form of currency, a true risk-free investment. Then, in February, coordinated sanctions on Russia’s central bank vaporized most of the $498 billion in reserves sitting on its balance sheet. The European Union is now looking at using those funds to pay for the rebuilding of Ukraine, Bloomberg News reported last week. In a world where you can trust no one, it makes sense to bulletproof yourself with metal. Looked at through that lens, the purchases by Turkey and Egypt come into focus. Though both nations are key US allies, they’ve seen relations deteriorate substantially over the past decade as their governments have found themselves more simpatico with rising authoritarian powers. The path ahead for international relations is more uncertain now than it has been in decades. It makes sense in that world for central bank reserves not to be too heavily committed to ties with any one country.
The behavior of those smaller nations is a clue to the identity of the biggest buyers in the market, too. Declared purchasers only account for about 120 tons of the 400 tons that central banks bought in the September quarter, but you can get a good idea of the other candidates by looking at which countries have been racking up the largest current account surpluses. (Such surpluses, after all, are the balances which governments use to buy theirforeign exchange reserves.)
Outside of Europe, which stopped large-scale bullion purchases decades ago, the biggest players are all nations whose ties with the US are fraying by the day: China, Russia, and Saudi Arabia.
The dollar’s role as the world’s preeminent medium of exchange remains unassailable. Some 88% of currency transactions involved the greenback this year, according to the Bank for International Settlements.Still, its share in central bank reserves has been falling rapidly, from 65% at the end of 2016 to 59% earlier this year.
That’s almost certainly a result of Washington’s increasingly muscular view of its currency dominance in recent years, whether it means coercing French banks to obey US sanctions, forcing Hong Kong politicians to be paid with stacks of banknotes, or blockading Russia’s reserves from the global economy.
Such a situation makes gold look like an appealing alternative. Even then, though, there are risks. Venezuela is currently three years into a series of legal cases in London about whether its de facto president or his political rival should control its bullion reserves in the city’s bank vaults. So far, opposition leader Juan Guaido, who’s recognized by the UK government, seems to be winning. When the zombie apocalypse comes, even gold might not be enough to save you.”