Why central bank buying moves gold by more than you think

Investing.com -- Gold’s price dynamics are shaped less by mine supply and more by who is buying, with central bank purchases having an outsized effect, according to Goldman Sachs.

Unlike oil or natural gas, gold is not consumed but stored, meaning traditional supply-demand models are inadequate. Instead, the market clears through changes in ownership.

“Conviction flows – the directional force – explain 70% of monthly gold price moves,” Goldman Sachs strategist Lina Thomas said in a note.

These conviction buyers include exchange-traded funds (ETFs), speculators, and, most importantly, central banks. Goldman groups them together because their flows have a similar price impact, even if the underlying motives differ.

ETFs, for instance, are highly rate-sensitive and respond gradually to Fed policy shifts, while central banks buy for financial or geopolitical reasons.

Goldman’s strategists estimate that “100 tonnes of net purchases by conviction holders – central banks, speculators, and ETFs – corresponds to a 1.7% rise in the gold price.” Opportunistic buyers, such as households in emerging markets, play a supporting role by cushioning moves, but they do not drive the trend.

This helps explain why central bank buying often moves gold by more than investors might expect. Unlike other commodities, higher prices do not automatically trigger more supply or curb demand.

Mine output is stable and price inelastic, while emerging-market households rarely sell, keeping most of their gold locked away.

That means when conviction buyers step in, prices can run far. Thomas emphasizes that “price moves are driven by one ratio: net conviction purchases/mining supply.” With mine production steady, even modest swings in conviction flows account for nearly all month-to-month variation in gold prices.

Recent history underlines the point. Central banks shifted from being net sellers to net buyers after the global financial crisis, and purchases accelerated sharply following the 2022 freezing of Russia’s reserves.

“Emerging market (EM) central banks responded by buying gold as the one reserve asset that cannot be frozen if held domestically,” Thomas notes.

This fivefold surge in official demand reset the relationship between interest rates and gold prices, as ETF outflows were more than offset by sovereign accumulation.

The report also highlights that central bank demand moves in long cycles, driven by financial or geopolitical concerns.

Net buying tends to rise when confidence in the reserve system wanes, such as during sanctions or fiscal sustainability worries. When trust is restored, the urgency fades and flows slow.

In practical terms, price direction in gold is set by conviction flows relative to limited new mine supply. That is why even modest shifts in central bank buying can have disproportionately large effects on gold.