Central banks to keep buying gold, drive the price

The world’s central banks have been buying gold for years, and that trend could drive the price up over $2,000 next year, according to some experts. The problem is the ever-growing pile of public debt, which could be exacerbated by inflation next year.

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Central banks deal with stimulus using gold

Noble Gold founder and CEO Collin Plume told ValueWalk in an email that central banks will have to bear to brunt of "government generosity" by covering the costs of the many stimulus packages that have subsidized workers and businesses that couldn't function during the lockdowns. However, that money will still need to be paid back, which causes three major challenges for central banks.

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"They are all struggling with these issues simultaneously, and so borrowing amongst each other is not an option" Plume said. "Unemployment and bankruptcies will mean less tax revenue coming in to balance the books, and inflationary pressures are almost inevitable given the colossal figures involved. All of these realities will likely push prices for everyday household items higher (along with interest rates as well) at a time when people can least afford them – leading to recessionary fears down the line."

According to Plume, this is the second-highest year on record for gold buying by central banks. He said the trend started to pick up momentum in 2018. This year central banks have already bought 651 tons of gold, and a larger pool of central banks have been buying gold for its diversification benefits. This pushed annual demand from them to its highest level since 1971.

"The most obvious countries adding gold to their reserves included Russia, China, Poland, Turkey, and Kazakhstan, while other countries, such as Poland and Germany, have begun to ‘repatriate’ their gold from other countries where it has been kept for safekeeping," Plume explained.

Why central banks are buying gold

Plume explained that the main reason central banks want to hold gold is because of the stock-to-flow ratio, which compares the newly mined gold supply, or the flow, with above-ground stockpiles, or stock. He said new gold keeps getting added to the stockpile, amounting to about 1.5% per year. According to Plume, gold has a natural inflation rate of about 1.5%.

"If gold were money, it would be physically impossible to duplicate the rate at which the printing of fiat currency takes place," he said. "Gold is finite, and as more ‘currency’ is printed, it becomes more valuable. Central banks of course know this, so in anticipation of them stepping up their printing of money, they buy gold to offset this. It comes down to simple supply and demand."

For this reason, Plume expects the gold price to climb above $2,000 and stay there starting next year. He pointed out that U.S. national debt hit a new high of $27 trillion, which is an increase of almost 36% in less than four years. Plume added that it's simply unsustainable to keep printing more money.

A year of uncertainty

RBC analyst Christopher Louney also thinks the gold story isn't over yet. He noted that the gold price tumbled the most in months due to the news about the COVID-19 vaccine, but current price levels still leave plenty of unanswered questions. Louney pointed out that this has been a year of uncertainty which included a pandemic, economic crisis, heightened political tensions and plenty of drivers that have been positive for gold.

Even though the markets have appeared to be buoyant, he doesn't believe investors have forgotten their fear. Louney added that the dollar has strengthened alongside real and nominal rates, which is bad for gold. However, he doesn't believe those factors were enough to explain the steep drop in the gold price on their own.

He saw the decline as "a reset of gold-related pandemic expectations, a repricing of stimulus expectations by gold investors, a realignment of inflation fears and a shift in mindset around post-election political uncertainty." Louney said the reset could have helped gold find a new equilibrium and noted that even after the first shipments of the vaccine, there will still be challenges in distribution and uptake, which means the health crisis won't end immediately.

He is less positive on the gold price than Plume as he sees a price of $1,893 for next year with a low price of $1,628 and a potential high price of $2,608.