Gold reserves serve as a hedge against sanctions primarily due to their unique characteristics and global perception. Firstly, gold is considered a store of value and a safe haven asset, meaning it retains its worth even during times of economic turmoil or geopolitical instability.
When a country faces the threat of sanctions, which can disrupt its financial systems and access to traditional currency reserves, gold provides a stable alternative.
Central banks and governments can hold gold as a form of insurance against the potential freezing or seizure of other assets, as it is less vulnerable to the restrictions imposed by sanctions.
Secondly, gold offers diversification benefits to a country’s reserves. By holding gold reserves alongside traditional assets like foreign currency reserves and government bonds, central banks can reduce their exposure to the risks associated with those assets, particularly in times of heightened geopolitical tensions.
Gold’s lack of correlation with other assets means that its value often moves independently, providing a buffer against market fluctuations caused by sanctions or other geopolitical events. Therefore, by increasing their gold reserves, central banks can enhance the resilience of their reserves portfolios and better protect their economies from the adverse effects of sanctions.
Gold is a tangible asset that can be stored securely. Unlike digital currencies or financial assets that can be frozen or seized as part of sanctions, gold can be physically held and stored in various locations, including within a country’s borders. This makes it immune to the jurisdiction of other countries and less susceptible to the effects of sanctions.
Gold Procurement by Central Banks
In recent years, several central banks have been increasing their gold reserves in their forex portfolio. This trend has caught the attention of economists and financial analysts, leading to discussions about the reasons behind this shift in strategy.
According to Gita Gopinath, the First Deputy Managing Director of the International Monetary Fund (IMF), this increase in gold purchases by central banks is primarily aimed at hedging against economic uncertainty and sanctions risk.
In a speech addressing global economic trends, Gopinath highlighted the notable development of an increase in gold purchases by central banks during 2022-23. She emphasized that India is among the countries actively increasing its gold assets in forex reserves. India, for instance, added 19 tonnes to its forex reserves in the March quarter alone, bringing its total gold reserves to 822 tonnes.
Gold has long been considered a politically neutral safe asset. It is valued for its ability to be stored securely and insulated from sanctions or seizure. Additionally, it is often viewed as an inflation hedge, although it is not easily used in transactions, as Gopinath pointed out.
The trend of increasing gold holdings is not limited to one region. The share of gold in the forex reserves of the China bloc has been steadily rising since 2015. Notably, this trend is not exclusively driven by China and Russia. Conversely, during the same period, the share of gold in the forex reserves of countries in the US bloc has remained broadly stable.
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This suggests that concerns about sanctions risk may drive gold purchases by some central banks. This assertion is consistent with a recent study by the International Monetary Fund that confirms FX reserve managers tend to increase gold reserves to hedge against economic uncertainty and geopolitical issues, including sanctions risk.
China’s Increased Gold Reserves
Taking China as an example, the share of gold in its total forex reserves has increased from less than 2 per cent in 2015 to 4.3 percent in 2023. During this period, the value of China’s holdings of US Treasury and Agency bonds relative to forex reserves has declined from 44 percent to about 30 percent. This decline reflects both net purchases and valuation effects.
Even when accounting for the possibility that some of China’s holdings of US bonds may be held in Belgium by Euroclear, as suggested by some analysts, the downward trend persists, Gopinath added.
In conclusion, the increasing trend of central banks adding gold to their forex reserves is a strategic move aimed at mitigating economic uncertainty and geopolitical risks, including the risk of sanctions. Gold Reserves, with its historically stable value and status as a politically neutral asset, provides central banks with a reliable hedge against such risks in an increasingly uncertain global economic environment.
