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It may surprise you to hear that there’s a strong relationship between central banks and gold prices since central bank monetary policy and macroeconomics affect the price of gold almost as much as the physical supply / demand balance and market psychology.
Gold has always held a special position in global finance. It’s not just a commodity – it is also considered as a store of value, as a hedge against inflation, and as a monetary reserve asset. Every country has a central bank whose function is to manage their monetary policy and currency stability. Gold plays a vital role in this process, and for that reason many central banks hold massive gold reserves as part of their foreign exchange assets.
As of 2024, global central banks collectively held over 35,000 metric tonnes of gold… that’s more than 1,200,000,000 ounces, and nearly 20% of all the gold ever mined! At a price of $3,000 per ounce, these reserves have a value of $3.6 trillion.
There are three main reasons that central banks hold such massive gold reserves:
In a word… Yes!
In recent years there has been some very significant central bank buying, led by countries like China and India. This huge demand applies upward pressure on the gold price, which has soared to repeated all-time highs.
One of the most direct ways central banks can affect the gold price is through direct buying and selling. When central banks buy gold, this maybe because they’re concerned about their currency stability, geopolitical risk or inflation. News of this buying often drives market speculators to follow suit, further boosting demand and pushing the price higher.
Occasionally (as seen in the 1999–2002 Central Bank Gold Agreement period) central banks become net sellers of gold. Of course, this large-scale selling will push the gold price lower.
Holding positions in gold does not generate any interest or dividends, so it is known as a non-yielding asset. This makes its opportunity cost directly linked to prevailing interest rates.
When interest rates are lower, the opportunity cost of holding gold is reduced, making it a more attractive investment relative to bonds or savings accounts (which will be paying out low interest). Conversely, higher interest rates increase the cost of holding gold, generally leading to gold price declines.
Central banks, particularly the US Federal Reserve (the Fed), exert enormous influence here since, when the Fed signals for lower rates (dovish policy), for example to calm high inflation, the gold price will often spike higher. Conversely, a hawkish Fed (looking to hike/raise interest rates) can push the gold price down as investors shift to yield-bearing assets.
Each country’s central bank manages their monetary policy by adjusting interest rates and money supply as required. Since gold is used as an inflation hedge, central bank actions that affect inflation can have a significant impact on the price of gold.
A tightening of monetary policy (usually carried out to curb high inflation or cool an overheated economy) typically weakens demand for gold, while aggressive quantitative easing (QE) or US currency devaluation will tend to trigger gold price rallies. For example, from 2008–2011 and again from 2020–2022 expansive central bank monetary policy coincided with substantial gold price increases.
Since gold is predominantly priced in US dollars, central bank (Fed) policies that affect the dollar will directly affect the price of gold. A weaker dollar (often driven by dovish US monetary policy) makes gold cheaper for other currency holders, boosting global demand, while a stronger dollar typically pushes the gold price lower.
Central banks that actively manage their currency valuations, like the People’s Bank of China or the Reserve Bank of India, also adjust their gold reserves to offset currency risks.
Central banks are pivotal players in the global gold market. Through direct buying and selling of gold, monetary policy decisions (money supply and interest rate changes), and interventions in currency markets, they shape the physical demand for gold and hence its price.
For investors, understanding central bank behaviour is essential to help anticipate moves in the gold market. You need to understand the macroeconomic calendar, including central bank monetary policy statements and inflation trends. You also need to be aware of central bank gold reserve reports since many major central banks are massive players in the gold market.
