Gold Soon to Be the Only Safe Reserve?

In recent months, many investors have watched the rising gold price with disbelief. Most had not anticipated such a massive rally in gold and were therefore not invested. Meanwhile, the $3,000 per troy ounce mark has been significantly surpassed, but signs of slowing the rise or even initiating a correction can, if at all, only be recognized after President Trump’s ‘tariff hammer’.

In the last twelve months alone, the gold price has formed 50 new all-time highs. To see a similarly rapid development, one must go back to the late 1970s. They too were characterized by high inflation, economic weakness, and geopolitical uncertainty. Some of these factors are also partly responsible for today’s rise in the gold price.

Although inflation is no longer as high as in the months immediately following the end of the Corona period, core inflation still persists at levels significantly above the Western central banks’ target of two percent. A rapid end to inflationary development is not in sight, as every new euro or US dollar created by commercial banks still increases the money supply. If it rises faster than the amount of goods and services produced, prices inevitably rise.

No End to Global Debt Orgy and Political Uncertainty

The fact that the already over-indebted Western states are taking on even more loans and generously spending money they don’t have on highly dubious projects with both hands increases the pressure on the gold price additionally. Moreover, the biggest gold buyers are the central banks. The fact that the guardians of fiat money are massively investing in the oldest and most reliable money in the world speaks volumes.

So far, many investors have ignored the ongoing gold purchases by central banks. The question is how long they will continue to do so, because more than the gold purchases themselves, investors should be puzzled by the strikingly low price sensitivity that central banks display in their purchases. The message being given to the market is that owning gold is more important than the question of at what price the gold was acquired.

Gold is an investment free from counterparty risks. Even the fiercest enemies accept it as compensation for claims when a settlement is sought after a long and relentless war. Since gold cannot default, the risk associated with its purchase is comparatively low. The knowledge that one can’t go far wrong with buying a gold coin or a gold bar gains importance especially in times of heightened uncertainty, because in these times uncertainty is high and good advice is expensive.

Many participants in the financial markets are likely to feel that geopolitical risks have once again risen massively since Donald Trump took over the office of US President for the second time on January 20. In the short term, the US President will not change his way of making policy. This too will support the gold price and in case of doubt, many will prefer to choose reliable gold over unpredictable US government bonds.

Massive Gold Purchases by Central Banks Have Their Justified Reason

Looking at the central banks, one could argue that with gold purchases of over 1,200 tons, 2023 was the record year so far and this level has not been reached since. However, such an argument overlooks two important aspects. The first concerns the year 2024. In it, central banks bought less gold than in the previous year, but the difference between the two years was not significant.

So it remains to be noted that although 2024 did not bring a new record in gold purchases by central banks, purchases remained at a very high level in the long-term comparison. This does not yet look like a real trend weakening. Rather, the 2024 figures show that central banks’ willingness to increase their gold holdings continues to exist and remains determinative for their behavior in the gold market.

The second aspect to consider is the long-term trend. The increased gold purchases by central banks began when the financial crisis in 2007 and 2008 massively shook general confidence in the stability of our financial system. At that time, a process of rethinking began, which initially led to cautious and then to increasingly determined gold purchases.

The Motive of Central Banks to Buy Gold is Different

While gold offers reliable protection against both inflation and geopolitical tensions, this does not mean that all buyers have the same motives when purchasing gold. For most private investors, the aspect of inflation protection is likely to be in the foreground. The fact that gold also offers protection in times of heightened international crises is an additional strength that one gladly takes along when buying. However, for most small investors, this is probably not the primary motive for purchasing.

For large, internationally investing investors, the geopolitical protective function is likely to have a much greater significance compared to private investors. This protective function is even more prominent when central banks act, as they manage the assets and reserves of the respective states that support them.

How vulnerable these reserves can be under certain circumstances has been repeatedly shown by numerous international crises. In the conflict with the US, the Venezuelan government was prohibited years ago from disposing of its gold stored in London. This made it clear that assets stored abroad are not worth much in case of doubt if one does not have access to them.

The War in Ukraine Has Initiated a Rethinking

The war in Ukraine and the sanctions subsequently imposed by Western states have not only brought gold stored abroad into focus, but also government bonds held by foreign creditors, showing how vulnerable these can be under certain circumstances.

Since foreign exchange reserves are mostly held in the form of government bonds, after February 24, 2022, it became immediately clear not only to Russia but to every other country that these reserves could be lost in case of doubt if one no longer has access to them. At this point, many central bankers likely woke up highly disturbed from their perceived security, because foreign exchange reserves constitute by far the largest item in central bank balance sheets.

That immediate remedial action was and still is necessary is obvious. Even if our world were to become completely peaceful again from tomorrow and all countries got along perfectly, it should have become clear to everyone that there is an open flank here that no state in the world can afford in the long term.

Will Gold, Stored in One’s Own Possession, Soon Become the Only Secure Reserve?

The haste with which central banks have been acting since February 2022 therefore has its reasons: It is not only about quickly closing the open flank, but also about being quick in view of the limited nature of gold. Because gold that others have acquired can no longer be bought by oneself.

Therefore, it can be assumed that the trend observable since the financial crisis, which has gained massive momentum in the last two years, will not end abruptly. It only comes to its ‘natural’ end when the reserves of most central banks consist predominantly of gold stored in their own country, rather than foreign currencies. However, until this point is reached, central banks still need to acquire a lot of gold.