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Central Bank Gold Demand Is Simple Diversification, Not De-Dollarization - Former Central Banker

Kitco News

graphic courtesy of the World Gold Council

(Kitco News) - Some commodity analysts have speculated that growing central bank appetite for gold is part of a global initiative to weaken the U.S. dollar role as the world’s reserve currency. However, one former central bank executive sees the move as a natural diversification amid global economic uncertainty.

Timothy Fogarty, an international banking expert and former senior vice president at the New York Fed

Timothy Fogarty, an international banking expert and former senior vice president at the New York Fed, said in a telephone interview with Kitco News that this world-wide diversification initiative will continue to drive central bank gold demand through the rest of the year.

Forgarty’s comments come a week after data from the People’s Bank of China revealed the central bank bought gold for the fifth consecutive month this year, adding 480,000 ounces of the yellow metal to its reserves in April, which now total 61.1 million ounces.

The first quarter was extremely busy for central bank gold purchases. In its first quarter demand trends report the World Gold Council said that central banks bought 145.5 tonnes of gold in the first three months of the year.

Looking at China, Fogarty said that the nation holds about $3 trillion in U.S. government debt. Its gold reserves are now hovering around 1,900 tonnes but represent less than 3% of China’s total reserves.

“I think China has a legitimate problem with a foreign reserve and they are heavy into U.S. dollar,” he said. “I think their gold buying is reasonable. I don’t see it as de-dollarization, but more of an effort to bring their portfolio to a more normal diversified level.”

However, Fogarty said that Russia’s motivations behind its gold reserves are a little more political. He added that it’s clear that Russia is trying to move away from the U.S. dollar. The country’s central bank has sold a significant portion of its U.S. dollar and U.S. Treasuries holdings. At the same time, Russia has been the biggest gold buyer in the last decade.

“Their decision to de-dollarize and buy more gold is a lot more politically related,” he said.

Fogarty added that Russia’s political statement won’t be enough to dethrone the U.S. dollar as a reserve currency. Fogarty explained that a significant problem with de-dollarization is what replaces the U.S. dollar. He added that no other market is as big or as liquid as the U.S. currency and bond markets.

Looking at other central bank’s growing gold reserves, Fogarty again dismissed the de-dollarization theme. He noted that many central bank gold holdings are well below traditional portfolio standards.

“There are good economic reasons for countries to hold a portion of their reserves in gold,” he said. “Central banks around the world need to have a balanced portfolio that includes gold. Ultimately though, to settle international trade, you are still going to use U.S. dollar.”

Although central bank buying will continue to support gold prices, Fogarty warned investors not to expect that market demand to drive prices significantly higher.

The gold market still faces stiff headwinds with the fact that the Federal Reserve is probably not done raising interest rates.

Although markets are pricing in a 70% chance of a rate cut by the end of the year, Fogarty said that expectations might be a little too high. With interest rates currently trading in a range between 2.25% and 2.50%, Fogarty noted that the central bank doesn’t have much room to cut if the U.S. economy starts to deteriorate.

“I think the Federal Reserve is going to be very reluctant to cut rates unless there is something very serious happens,” he said. “The Fed is going to hold fire as long as possible.”

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