Must-know: Why central bank policies impact gold price

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Nov. 20 2020, Updated 5:28 p.m. ET

Central banks and gold price

Central bank policies can have a significant impact on gold price. Central banks are a large gold holder. They own ~30,500 tons of gold. This is close to 20% of the gold ever mined. As a result, their policies on gold sales, gold purchases, and other monetary policies can have a significant impact on gold price.

Central banks net buying and selling

When gold was used to back currency—prior to 1971—central bankers used to buy gold. This formed a significant part of their reserves. After this system broke off, a flat trend was seen in central bank net purchases in the 1970s and 1980s. However, this was followed by central banks’ net sales in the 1990s. Superior returns on other assets and generally good economic growth were the major reasons for central banks’ selling spree. This changed with the first Central Bank Gold Agreement in 1999. It limited future gold sales. This helped improve investor sentiment. It also increased gold demand.

Central banks’ balance sheet and gold price

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Direct buying and selling has an impact on gold prices. However, other central bank activities have an even bigger impact. Since 2009, the U.S. Fed, the Bank of England, and the European Central Bank (or ECB) have expended their balance sheets significantly by lending to the banking sector and quantitative easing (or QE). With loose monetary policy, inflation’s future expectation increases. Investors’ demand for gold also increases. The Fed started to expand its balance sheet in 2009. Bullion increased 70% from December 2008 to June 2011.

Central banks buying or selling government bonds

Central banks maintain money supply in the market by buying and selling government bonds. Buying bonds puts money into the public’s hands. Selling bonds sucks up excess liquidity. Excess money supply is usually favorable for gold prices.

So, it’s important for investors to keep an eye on central banks’ actions. This allows investors to anticipate gold price changes. Price changes impact stocks like Goldcorp Inc. (GG), Barrick Gold (ABX), Newmont Mining (NEM), and exchange-traded funds (or ETFs) like the SPDR Gold Shares (GLD) and the Gold Miners Index (GDX).

Visit the Market Realist Gold ETFs page to learn more about investing in gold.

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