Since the beginning of the year, the National Bank of Poland's (NBP) gold reserves have increased by almost half, making Poland the second largest buyer of bullion in the world as of April this year. Despite the drop in gold prices from US$2050 to US$1850 per ounce, the NBP continues its buying programme, currently ranking 18th in the world in terms of gold reserves. Why do central banks invest in gold and is such a decision justified?
Gold reserves at the National Bank of Poland
Poland's history with gold dates back to the very beginnings of the state. However, it is worth noting the inter-war period, when, in flight from the Second World War, the central bank's resources travelled successively: Romania, Turkey, Syria, France, the north and west of Africa, eventually ending up in New York, London and Ottawa. Nearly 80 tonnes of gold in various forms after the war were used by the communists as pledges for loans. When the loans were not repaid, the pledge was lost.
Source: https://nbp.pl/wp-content/uploads/2022/09/zloto-jako-skladnik-rezerw.pdf
Currently, gold reserve holdings have risen to 314.4 tonnes and the pace of purchases of the bullion, held mainly in London at the Bank of England, has since April this year surpassed even the world's largest economies, including the central bank of Singapore, which is renowned for its continued investment in large amounts of foreign reserves. According to the World Gold Council (WGC), Poland led the world in the second quarter of this year alone, purchasing 48.41 tonnes of gold (compared to China's 45.1 tonnes). The latest information from September shows that since April this year. Poland has increased its holdings by 85.7t of bullion.
Source: https://www.gold.org/goldhub/data/gold-reserves-by-country
As the President of the National Bank of Poland Adam Glapinski stated, "We are a very serious partner and we will continue to buy this gold. The dream is to reach 20%." This announcement indicates that Poland intends to continue buying to increase the share of gold in its reserves from the current 11.2%.
Source: Dane NBP
But why are central banks buying up gold?
There are several reasons why central banks invest in gold. After the so-called 'Nixon shock' in 1971, when we left the gold parity system in favour of a free exchange rate, a new model of central bank intervention emerged. Currencies are now judged, among other things, by the competitiveness of economies against each other. Developing countries could expect their currencies to strengthen. Of course, such a scenario is only the case when the central bank acts independently (which is not the case, for example, in euro area countries) and there is free movement of capital. Hence, increasing the share as a component of reserves can serve to:
- increase the credibility of the state in the eyes of investors, since gold, unlike printed currency, cannot be counterfeited;
- increase the security of the financial system, as gold can always be sold regardless of the situation;
- diversifying the sources of reserves and becoming less dependent on, for example, the US dollar, which is the largest reserve currency.
In the case of China, which imposes strict restrictions on investment, the central bank buys gold primarily because of the threat of recession, currently marked by, among other things, an 8.8% year-on-year decline in exports in August. It is worth noting that China has only 4% of its total reserves in gold, which places it seventh in this hierarchy. This also appears to be an attempt to diversify the sources of reserves to become independent of the situation in Western countries. Until now, the main asset purchased by the Central Bank of China has been US bonds, i.e. US debt.
The main motivation for the National Bank of Poland to buy gold, on the other hand, seems to be to increase the stability of the Polish financial system and to strengthen the confidence of foreign investors. This confidence has been clearly damaged by high inflation (18.4% at its peak) and the rapid weakening of the Polish currency. Another argument could be the increase in national security. Poland is one of the largest suppliers of arms to Ukraine, which is reflected in increased tensions in relations with Russia and Belarus. As President Glapinski put it: 'Contrary to what some people said during the war, it turned out that the rating agencies and the world take gold reserves very much into account because they are so safe, flexible, easy to use. There is a respect for us and our position, a confidence that comes with it'. This could be confirmed by the form in which the central bank acquires in the form of deposits with the Bank of England. This allows such reserves to be quickly liquidated when needed without the risk and cost of holding bullion.
What determines the price of gold at present?
Gold is considered a so-called safe haven in investments, which means increased demand during periods of economic and geopolitical uncertainty. Currently, after a prolonged decline, we may see a temporary rise in bullion prices as a reaction to the Hamas attack on Israel. This situation is of particular geopolitical significance due to Israel's close relationship with the United States, which has its military bases in the region. As the price of gold is influenced by demand and supply is limited, it seems that we could now expect a change in trend and price rises.
Source: Conotoxia MT5, XAUUSD, Daily
Grzegorz Dróżdż, CAI MPW, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
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