Why the Central Bank Bought 'Geum' [Seungseop Song's Financial Light]

'Gold' and 'Dollar' Moving in Opposite Directions
Gold Prices Struggle Against King Dollar
Price Rises on Expectations of 'All Interest Rates Up'
Emerging Market Central Banks Also Buying Gold

Editor's NoteFinance is difficult. Confusing terms and complex backstories are all tangled together. Sometimes, you need to learn dozens of concepts just to understand a single word. Yet, finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Therefore, Asia Economy selects one financial issue each week and explains it in very simple terms. Even if you know nothing about finance, you can immediately understand these 'light' stories that will light up your understanding of finance.

[Asia Economy Sejong=Reporter Song Seungseop] Since the second half of last year, there have been observations that central banks have been increasing their gold reserves. In particular, gold buying has continued mainly among central banks of emerging countries. Why have central banks decided to buy gold?

Humanity's Safe Assets 'Gold' and 'Dollar'... Their Values Move in Opposite Directions

First, we need to understand what kind of value and treatment gold receives in the market. Gold, along with the dollar, is considered a representative safe asset. A safe asset means an asset that you won't lose money by holding, right? Think about the dollar. It is the currency issued by the superpower called the United States, and the possibility of the U.S. collapsing is practically zero. Moreover, since it is the medium of exchange used by people worldwide, the probability of the dollar's value plummeting overnight is very low. That means it is very safe.

Gold is the same. Humanity has regarded gold as a 'valuable asset' for a very long time. There are records of gold being used as a means of currency since before the Common Era. In the 19th century, several countries, mainly in Europe, implemented the 'gold standard,' linking their currency values to gold. Although the gold standard no longer exists, many people still perceive gold as an investment asset. There is absolutely no chance that suddenly everyone in the world would think gold is just a useless mineral, so it is truly a safe asset.

Therefore, investors tend to hold dollars or buy gold when uncertainty increases, such as during economic crises or wars. So, do the prices of dollars and gold soar every time there is a crisis? At first glance, it might seem that the values of the dollar and gold rise and fall simultaneously since they are both safe assets. However, gold and the dollar, while both safe assets, often move in opposite directions. When the dollar's value rises, gold's value falls, and when the dollar's value falls, gold's value rises.

Graph showing the inverse movement of gold and dollar values. Source: International Financial Center

The reason is simple. Gold is priced and traded internationally in dollars. You might think, "But at the local gold shop, you can buy gold with Korean won?" However, the dollar price is just displayed in Korean won. Imagine 1 dollar equals the value of one lump of gold. One day, the dollar's value rises sharply. Now, 1 dollar can buy two lumps of gold, meaning the dollar's value has increased significantly. This means the value of one lump of gold has dropped to 0.5 dollars.

There is also a correlation with interest rates. Usually, when interest rates are high, gold prices fall. Interest rates mainly refer to those set by the U.S. central bank, the Federal Reserve (Fed). When interest rates rise, the value of currency rises. Simply put, gold is a product with 0% interest even if you hold it. On the other hand, if you put dollars in a deposit, you earn interest. The higher the interest rate, the more advantageous it is to sell gold and hold dollars.

However, gold shines during inflationary periods. Although it has no interest, it has the advantage of not losing value easily. Therefore, it is commonly believed that you should buy gold when inflation is high. Inflation usually occurs when a lot of money is printed, causing prices to rise. As the amount of money increases, the value of currency gradually falls, so holding dollars results in losses over time. But since gold generally maintains its value, more people seek gold during inflationary periods.

Gold Struggled Against the King Dollar... Rises on Expectations of Interest Rate Cuts

Then, how was the gold price last year? The economy was tough, and Russia and Ukraine even went to war, so it seemed like a crisis, but did everyone buy gold? In conclusion, gold did not receive much attention. Instead, gold prices continuously fell, disappointing investors. Inflation rates were high, and uncertainties like COVID-19, U.S.-China conflicts, and war were enormous.

One reason lies in interest rates and the dollar. To suppress high prices, the Fed rapidly raised the benchmark interest rate. The rate hikes that started in March last year continued for nine months, rising by 4.25 percentage points. The dollar also showed a sharp strength accordingly. In Korea, the term 'King Dollar' was even used to describe the increased value of the dollar. Gold was suppressed by the King Dollar and could not assert its position as a safe asset.

What about now? Gold prices are stirring and attracting market attention. According to the Wall Street Journal (WSJ), gold prices have risen for six consecutive weeks recently. They have risen to $1,930 per ounce. The reason is again the dollar and interest rates. Among investors, there is a view that the U.S. interest rate hike policy is nearing its end. Since rate hikes are expected to stop around the first half of next year and only maintenance or cuts remain, more buyers are purchasing gold, anticipating a rise in gold prices.

People's Bank of China

There is also analysis that the large-scale gold purchases by emerging market central banks since the end of last year have influenced the rise in gold prices. It is speculated that countries like T?rkiye, Uzbekistan, India, and Qatar have actually bought or are buying a lot of gold. With so many people seeking gold, prices inevitably rise. Especially, news that the People's Bank of China, China's central bank, has purchased large amounts of gold has sparked talk of it being the right timing to buy gold.

Various interpretations exist as to why central banks of emerging countries are particularly active in buying gold. Some experts speculate it is a learning effect from the Russia-Ukraine war. Russia, which invaded Ukraine, faced strong sanctions from the international community, including the U.S., such as freezing financial assets. They could not dispose of assets denominated in dollars. However, gold was an exception. Thanks to being the fifth-largest holder of gold globally, Russia was able to somewhat mitigate the shock.

Of course, you should not blindly buy gold thinking it will definitely rise. Even if the U.S. slows the pace of interest rate hikes, if it does not actually cut rates, gold prices may not rise as much as expected. If disappointed investors sell gold, prices may adjust in the short term. If inflation is not controlled as expected and rates are raised a bit more, gold prices will find it harder to rise. The World Bank also predicted in October last year that "with central banks continuing their rate hike stance into next year, gold prices could fall by about 4% more in 2023."