Ukraine changed everything
Gold is widely viewed as a safe haven asset that performs well in periods of war and geopolitical uncertainty. As risk perceptions go up, investors tend to flock to gold.
“Risk-off” conditions certainly applied in early 2022, when the Russian “special military operation” commenced in Ukraine. But the impact on gold markets went deeper than the market’s usual aversion to armed conflict.
The Biden administration decided to support Ukraine through financial sanctions, which included freezing Russian assets that were held in institutions over which the U.S. had legal and practical control.
The weaponization of the financial system sent shockwaves around the world.
Financial assets held by governments at various banks around the world were now at risk of confiscation based on the U.S. government’s position on that nation’s foreign policy.
Demand for gold began to build because it is an asset that is essentially exempt from sanctions risk.
Government bonds are effectively IOUs and therefore carry counterparty risk. The issuer of the bonds can refuse to make payments, or a third party intermediary can block those payments.
Gold, by contrast, is a bearer asset.
This means that whoever physically controls the asset owns the asset and generally has the ability to sell the asset. Gold can be shipped internationally and safely stored in bank vaults located within a country’s own borders.
The primary job of central bankers is to decide how to allocate foreign exchange reserves. These are financial assets denominated in currencies other than their own.
Foreign exchange reserves are used to settle international trade flows. In many cases, they are used to help central bankers exercise control over foreign exchange rates.
In crises, foreign exchange reserves can be used to prevent a currency from collapsing. The central bank in this scenario uses the reserves to purchase and prop up their own currency in international markets.
As a non-sovereign asset with zero counterparty risk, gold is unique among the options available to the world's central bankers. (A potential exception is Bitcoin, which we address below at the very end.)
Playing catch-up
Most of the nations of the world hold their foreign currency reserves in U.S. or Euro-area government bonds.
With some notable exceptions, gold at the nation-state level is owned in large proportions only by the U.S and a handful of European countries that were historically wealthy and had gold-backed currencies.
According to the World Gold Council, out of 36.2 million tons of gold currently owned by the world’s central banks, the U.S. (22%), Germany (9%), Italy (7%) and France (7%) collectively own some 45% of the total.
Relative to the size of their populations and economies, emerging market countries like China and India own comparatively little gold.
China has slightly less gold than France. India has less than 40% as much gold as China.
These emerging market countries are also precisely the ones who are most at risk when it comes to U.S. coercion within the global financial system.
China is viewed by the U.S. as an adversary. India is historically non-aligned and is highly dependent on Russian energy.
Central banks around the world have been net buyers of gold ever since the Global Financial Crisis in 2008, which introduced the world to quantitative easing and raised fundamental questions about fiat money.
Central bank gold purchases have only accelerated since 2022, when the Ukraine conflict began.
