Opinion Leader | Guan Tao
Since reaching the bottom of 1628.75/ounce on November 3, 2022, the international gold price has started a new round of rise. Since 2024, spot gold prices in London have hit new highs, rising to $2401.50/ounce on April 12, up 47.4% at most. Due to the market's revaluation of the Fed's tightening expectations, the US dollar index and the US bond real yield rose again. Recently, the gold price rose and fell, but it still fluctuated around 2300 US dollars/ounce, reflecting two special supporting forces behind it.
Gold plays the role of anti inflation asset again
In 2019, during the seminar in Singapore, the author was lucky to be with Paul Krugman, the winner of the 2008 Nobel Prize in Economics. He pointed out at the outset that all currencies should be devalued in the gold standard era. The implication is that since the outbreak of the international financial crisis in 2008, major central banks around the world have flooded. If the gold content of their own currencies shrinks in the gold standard era, the gold price measured in that currency should rise. In fact, the European and Japanese central banks have not yet withdrawn from the last round of quantitative easing (QE), just to deal with the epidemic in 2020 and then release water; Although the Federal Reserve has carried out the normalization of monetary policy, it gave up halfway in the second half of 2019. At the beginning of 2020, it offered "zero interest rate+unlimited QE".
After two rounds of water release, the world can be described as "monstrous flood". From 2009 to 2023, the broad money supply (M2) of the United States increased by 1.53 times, and the real gross domestic product (GDP) of the same period increased by 0.33 times; Japan's M2 increased by 0.67 times, and its real GDP increased by 0.07 times; M2 in the euro area increased by 0.88 times, and real GDP increased by 0.16 times; In the UK, M2 increased by 0.64 times and real GDP increased by 0.18 times; China's M2 increased by 5.15 times and its real GDP increased by 3.50 times. During this period, the ratio of China's real GDP change to M2 change was 68%, reflecting the relative restraint of China's monetary policy in response to the public health crisis; Britain, the United States, the euro area and Japan were 28%, 21.7%, 17.7% and 11% respectively.
According to the statistics of the International Monetary Fund (IMF), from 2009 to 2023, the world's real GDP grew 1.59 times and the annual average consumer price index (CPI) rose 1.82 times. In the same period, according to the statistics of the World Gold Council, the gold supply only increased by 0.40 times (see Figure 1). If the gold supply is less than the real GDP growth during the gold standard period, it will lead to deflation, but the actual situation is global inflation, which means that the gold content of global currencies has dropped significantly.
Figure 1: Global economic growth, inflation and gold supply (unit:%; ton)
Source: International Monetary Fund; World Gold Council; Wande; BOC Securities
In theory, the gold content of global currencies shrank from 2009 to 2023, corresponding to the 3.01 times (=1.82+1.59-0.40) appreciation of gold price, while the average annual gold price rose only 1.23 times in the same period. In particular, since the second round of water release in 2020, the gold price has surged in the short term. After breaking through 2000 dollars/ounce, it fluctuated between 1600 and 1800 dollars/ounce for a long time, and won't rebound until the end of 2022. In the same period, the price of Bitcoin rose from more than 7000 dollars to more than 60000 dollars, and further exceeded 70000 dollars at the beginning of 2024. Compared with that, gold is nothing.
This is not a short-term phenomenon, but a long-term development trend after the decoupling of the dollar from gold in the early 1970s and the non monetization of gold. For example, from 2004 to 2008, the world's real GDP increased by 1.26 times, the CPI increased by 1.25 times, but the gold supply decreased by 0.09 times. In theory, the gold price should rise 2.61 times (=1.26+1.25 - (- 0.09)), but the average annual gold price in the same period only rose 1.40 times (see Figure 1). However, the return of high inflation in the world once in 40 years has revived the market's memory of gold as a traditional anti inflation asset, which may be an important reason for the recent strong trend of international gold price, or it can be said that the price of gold has risen after years of deviation from the trend value (see Figure 2).
Figure 2: Monthly average international gold price and 10-year US bond real yield (unit: USD/oz;%)
Source: US Treasury Department; London Precious Metals Exchange (LME); Wande; BOC Securities
Speed up of diversified allocation of global reserve assets
The central bank has always been an important participant in the international gold market. When the central bank sells gold, it is the supplier of the gold market, and when it purchases gold, it becomes the demander of the gold market. According to the statistics of the World Gold Council, from 2003 to 2009, the central bank was an important supplier of gold in the gold market, and the ratio of central bank's gold sales to the global gold supply averaged 11.2%. Among them, in 2008 and 2009, although the central bank still sold gold net, the two-year average gold sales were 135 tons, far lower than the average of 522 tons from 2003 to 2007; The average ratio of central bank gold sales to global gold supply is 3.8%, which is also far below the average of 14.2% from 2003 to 2007 (see Figure 3). In 2008, the US subprime crisis gradually evolved into a global financial tsunami, which caused the international community to reflect on the current dollar based international monetary system. Accelerating the multipolar development of the international monetary system and reducing the excessive dependence on a single currency is an important way out. According to IMF statistics, by the end of 2023, the share of US dollars in foreign exchange reserves constituted by disclosed currencies in the world will be 58.4%, 5.5 percentage points lower than that at the end of 2007. Since the fourth quarter of 2020, except the third quarter of 2022, the share of dollar reserves in other quarters has been below 60%.
Figure 3: Global gold supply and net gold trading volume of central banks (unit: ton;%)
Source: World Gold Council; Wande; BOC Securities
Note: (1) The central bank's gold sales are positive, increasing the current global gold supply; The purchase price is negative, increasing the current global gold demand; (2) 2024 is the first quarter data.
Since 2010, the central bank has become an important demander from the supply side of the gold market. From 2010 to 2023, the ratio of central bank gold purchase to global gold supply averaged - 11.9%. Among them, from 2014 to 2019, the Russian Central Bank was the main force in purchasing gold. According to the data disclosed by the Central Bank of Russia, after using the London gold price at the end of the year, the Central Bank of Russia accumulatively increased its holdings of gold reserves by 1111 tons, which is equivalent to 34.5% of the total amount of gold purchased by global central banks in the same period. Over the same period, the ratio of global central bank purchases to global gold supply averaged 11.5%, higher than the average of 9.8% from 2010 to 2013 (see Figure 3 and Figure 4). It should be noted that, as a major gold producer in the world, the increase of gold reserves held by the Russian Central Bank does not necessarily require foreign exchange to purchase all of the gold reserves from the international market. However, since 2014, Russia has been repeatedly subjected to western economic and financial sanctions. Affected by this, from 2014 to 2019, Russian investors reduced their holdings of US bonds in the form of clearance, and the balance of holdings fell sharply from US $138.6 billion to US $10 billion. The market speculated that a considerable part of it was converted into gold reserves.
Figure 4: Gold reserves held by the Russian Central Bank (unit: 100 million US dollars; ton)
Source: Central Bank of Russia; Wande; BOC Securities
In 2020 and 2021, the enthusiasm of global central banks to purchase gold declined, with an average of 353 tons of gold purchased in two years, 29.1% less than the average amount of gold purchased by central banks in 2010-2019; The ratio of global gold supply is - 7.5% on average, and the negative value is 3.5 percentage points lower than the average value from 2010 to 2019. In 2022 and 2023, the central bank entered the market again to purchase gold on a large scale, with an average of 1060 tons in two years, 1.24 times more than the average value from 2010 to 2021; The ratio of global gold supply is - 21.9% on average, and the negative value is 11.6 percentage points higher than the average value from 2010 to 2019 (see Figure 3).
After the Russian Ukrainian conflict broke out at the end of February 2022, the western countries jointly imposed financial sanctions on Russia, freezing more than half of Russia's foreign exchange reserve assets, which further shook the credit foundation of the current international monetary system. More and more countries and regions have to reduce the demand for liquidity and security and accelerate the diversified allocation of international reserve assets. As the last means of international liquidity, gold is more sought after by the central bank. In 2022, the global central bank purchased 1082 tons of gold, a record high, including 459 tons of gold in the third quarter, an increase of 1.89 times month on month, which also set a new record. It is worth noting that from the first quarter of 2022 to the first quarter of 2024, the central bank's purchase of gold was negatively correlated with the international gold price (quarterly average) by 0.458, indicating that the central bank's purchase of gold generally avoided "chasing up and killing down". In turn, this also shows that the central bank's purchase of gold is expected to become the support for the downward trend of gold prices.
The changes in global gold reserve holdings disclosed by the IMF (excluding gold reserves held by the IMF and the Bank for International Settlements (BIS)) are generally consistent with the above changes: global gold reserves declined for four consecutive years from 2003 to 2007, and increased for 16 consecutive years from 2008 to 2023; Only in 2008 and 2009 did they go in the opposite direction. The World Gold Association standard is the central bank selling gold, and the IMF standard is the decline of global gold reserve holdings. During the period of central bank gold sales from 2003 to 2007, the amount of central bank gold sales counted by the World Gold Council was basically consistent with the change of central bank gold reserves disclosed by the IMF, during which the cumulative amount of central bank gold sales was 1.05 times the cumulative decrease of global gold reserves; During the period of foreign exchange purchase by the central bank from 2010 to 2023, the data trends of the two standards were consistent, but the deviation was increased. During this period, the cumulative amount of gold purchased by the central bank was 1.41 times the cumulative decrease of global gold reserves (see Figure 3 and Figure 5). This reflects the difference between the two statistical caliber, indicating that the relevant data should be used prudently to avoid being conspicuous.
Figure 5: Balance and change of global gold reserve holdings (unit: ton)
Source: IMF; Wande; BOC Securities
Note: The global gold reserves exclude the holdings of international financial institutions such as IMF and BIS.
China opens the fifth round of increasing gold reserves
At the beginning of reform and opening up, China's gold reserves have been stable at 12.8 million ounces. At the end of 1981, it dropped to 12.67 million ounces. At that time, it was mainly through selling gold to enrich the country's foreign exchange reserves and ease international payment difficulties. In 1980, after excluding the foreign exchange reserves of financial institutions in the central bank, the balance of China's foreign exchange reserves on an international comparable basis was US $1.3 billion, rising to US $2.7 billion at the end of 1981. Since then, China's gold reserves have been maintained at 12.67 million ounces for a long time.
Before the central bank began to continuously increase its holdings of gold reserves in November 2022, China had increased its holdings for four rounds. The first round was in December 2001 and December 2002. The gold reserves were increased by 3.41 million ounces and 3.21 million ounces respectively, reaching 6.62 million ounces to 19.29 million ounces in total. This round of increase in gold reserves does not correspond to the increase in monetary gold reserve assets caused by transactions in the current quarter in the balance of payments, which indicates that the two increases in gold reserves were purchased and purified at home rather than imported. The second round was in April 2009, when China once again increased its gold reserves by 14.6 million ounces to 33.89 million ounces. This corresponded to an increase of $4.9 billion in monetary gold reserve assets caused by the transaction, indicating that in addition to domestic procurement and purification, this round of increase in holdings was also partially imported (about 5.55 million ounces, accounting for 38%). The third round was from June 2015 to October 2016. Except for no increase in holdings in May 2016, China's accumulated gold reserves increased by 25.35 million ounces to 59.24 million ounces in 16 months. The fourth round is from December 2018 to September 2019. China has accumulated 3.4 million ounces of gold reserves to 62.64 million ounces for ten consecutive months. There was no increase in monetary gold reserve assets caused by corresponding transactions in the last two rounds, indicating that these two rounds of increase in holdings were still purchased and purified domestically (see Figure 6).
Figure 6: China Gold Changes in monetary gold reserve assets caused by reserve holdings and transactions (unit: ton; US $100 million)
Source: People's Bank of China; State Administration of Foreign Exchange; Wande; BOC Securities
Note: The negative change in monetary gold reserve assets caused by transactions indicates that the central bank purchases gold to increase gold reserves.
At present, China is carrying out the fifth round of increasing gold reserves. By the end of March 2024, it has been 17 consecutive months and the accumulated gold reserves increased by 10.1 million ounces to 72.74 million ounces, up 16.1% from the end of 2021. Except for the unused foreign exchange reserves in the third quarter of 2023 and the unpublished data in the first quarter of 2024, the other three quarters corresponded to the increase of monetary gold reserve assets caused by transactions, amounting to 14.7 billion US dollars, which roughly matched the increase of gold reserve holdings in the current quarter, indicating that the increase of gold reserves in the first three quarters was all imports, However, the fourth quarter of 2023 will be domestic acquisition and purification, and the first quarter of 2024 will be confirmed after the release of the preliminary data of the balance of payments of the current quarter (see Figure 6).
The five rounds of gold reserve increase in China all belong to the diversified allocation of reserve assets, but the background is different. The first two rounds were the diversified allocation of reserve assets triggered by the increase of foreign exchange reserves. The first round of increase in holdings was a sharp interest rate cut by the Federal Reserve, and the interest rate gap between China and the United States became positive again. China completely walked out of the shadow of the impact of the Asian financial crisis, and reappeared the pressure of capital return and exchange rate appreciation. After breaking through 200 billion US dollars at the end of 2001, China's foreign exchange reserve balance further increased to 286.4 billion US dollars at the end of 2002, an increase of 73% over the end of 2000. In the second round, after the global financial tsunami in 2008, China's economy realized a V-shaped rebound and renewed the pressure of capital inflows and exchange rate appreciation. By the end of 2009, the balance of foreign exchange reserves had reached 2399.2 billion US dollars, 1.25 times more than that at the end of 2006. At the end of 2006, the Central Economic Work Conference had already made it clear that the main contradiction of China's balance of payments had shifted from foreign exchange shortage to excessive trade surplus and rapid growth of foreign exchange reserves. During this period, foreign exchange was imported from the international market for the first time to increase gold reserves.
The third round of increase in holdings comes at the beginning of China's "8.11" foreign exchange reform, when China encountered a high intensity of capital flow shock of "capital outflow - reserve decline - exchange rate depreciation". At this time, gold reserves were increased by domestic procurement and purification, mainly to hedge against the reduction of foreign exchange reserves and enhance international liquidity. The fourth round of increase in holdings comes at a time when foreign trade frictions are escalating, and the increase in gold reserves may have geopolitical considerations. At that time, no foreign exchange was used to import gold, or it was related to the "7" of the RMB exchange rate. With the resumption of foreign economic and trade negotiations at the end of 2019, the shareholding increase stopped. The fifth round of increase in holdings is to import a large amount of gold from the international market in 2022 and 2023 under the background of the continuous pressure of the RMB exchange rate, and the consideration of avoiding international economic and geopolitical risks is more obvious.
By the end of 2023, the ratio of global gold reserves (excluding those held by international financial institutions) to foreign exchange reserves will be 19.4%, up 7.7 percentage points from the end of 2007. In the same period, the proportion in China was 4.6%, up 3.5 percentage points from the end of 2007, and further rose to 5.0% by the end of the first quarter of 2024 (see Figure 7). This reflects that there is still room for improvement in China's gold reserve holdings, although the goal may not be to reach the international average.
Figure 7: Ratio of gold reserves/foreign exchange reserves between China and the world (unit:%)
Source: IMF; LME； Wande; BOC Securities
Note: (1) For comparability, the global gold reserves exclude the holdings of international financial institutions such as IMF and BIS; (2) 2024 is the first quarter data of China.
In addition, from November 2022 to September 2023, there was a strong negative correlation of 0.751 between China's increase in gold reserves and the international gold price (monthly average), reflecting that China paid more attention to bargain hunting rather than chasing higher in the process of increasing its gold reserves. From the perspective of time, China began to purchase gold in November 2022. Although it was later than the peak of the global central bank's large-scale purchase of gold, it was just the beginning of this round of international gold price rise. The ability of the People's Bank of China to seize market opportunities can be seen from its years of experience in managing huge foreign exchange reserves.
In conclusion, this round of gold price rise or a liquidation of the current international monetary system will accelerate the reconstruction of the international monetary system. The rise in gold price is a signal of the resurgence of gold, a correction of the non monetization of gold in the 1970s, even if it is not to return to the gold standard.
(About the author of this article: Global Chief Economist of BOC Securities)
