Business & Finance

Lear Capital Explains Why Banks Prize Precious Metals — and How It Can Affect Your Investments

Although U.S. currency hasn’t been backed by gold for decades, central banks continue to express a strong interest in the precious metal, which investors may want to consider factoring into their portfolio plans, according to Kevin DeMeritt, founder and chairman of Los Angeles-based precious metals firm Lear Capital.

While at one time, consumers could redeem paper bills for precious metals like gold and silver, following the collapse of the international fixed currency convertibility structure known as the Bretton Woods system in the early 1970s — and the demise of the subsequent Smithsonian Agreement exchange rate structure — many of the world’s currencies began operating on a monetary standard that’s based on paper redemption.

Today, the notes that Federal Reserve Banks hold are generally tied to collateral such as U.S. Treasury securities. (For a brief look at how Treasury securities differ from the U.S. dollar, view this breakdown from Lear Capital.)

A number of countries, though, that previously had focused on U.S. Treasury securities — which have traditionally been viewed as safe investments because the U.S. government will honor the associated terms — are increasingly opting to invest in gold. 

“Central banks entered the market in 2022,” Kevin DeMeritt says. “They purchased a quarter of all the mining supply, which is a huge jump from [their previous activity].”

A Big Year for Gold Buying

In 2022, the central bank-related demand for gold was higher than it had been since 1950, with banks buying 152% more of the precious metal than in 2021, according to the World Gold Council.

Central banks, according to Lear Capital, “know that throughout history, whoever holds the most gold has the most power.”

“We have not seen this kind of buying from central banks for 50 years,” Kevin DeMeritt states. “That trend is going to continue to get more intense.”

Take China, for example. Once one of the largest foreign holders of U.S. Treasury securities, in 2022, the country decreased its amount of its U.S. debt-based holdings to less than $1 trillion for the first time in more than a decade.

As of May 2023, China’s gold reserves had risen by 144 tons following seven consecutive months of increases.

Russia, too, has shed some of its securities-related investments; between March and April of last year, its holdings dropped by 84% — a more than $81 billion decrease. Russia’s gold holdings, though, appear to be on the upswing, and reportedly have risen from 1,112.5 metric tons in October 2014 to 2,298.5 metric tons in January 2022. 

“Russia has completely eliminated all of their reserves of U.S. Treasurys, and what did they replace it with? Gold,” Kevin DeMeritt says. “They’ve doubled the amount of gold they’ve held in reserve at their central bank.”

What Portfolio Holders Need To Know 

What does central banks’ fervor for gold mean for U.S. investors? With precious metals like gold only available in limited quantities — only so much is mined a year, and a finite amount exists on Earth — supply constraints are a constant possibility.

For gold — which had roughly the same value for approximately 200 years before 1914 and has generally risen since — an even more unbalanced supply-and-demand scenario could potentially equate to considerable price growth.

Banks’ recent gold-buying spree, Kevin DeMeritt says, may add more pressure to the gold supply because they tend to hold on to the assets for possibly a decade or more.

“That metal is gone [from the market] — and you’re not talking about small amounts,” the Lear Capital founder explains. 

With elevated interest rates due to the Fed’s ongoing efforts to lower inflation, coupled with fears a recession will occur, other entities’ interest in gold, too, may rise in the coming months, according to Kevin DeMeritt.

“When investors are worried about the economy, usually you get more people turning to gold, which can drive up its price,” he says. “We’re starting to see that more and more. If a recession takes hold [and] we start to see more financial instabilities happen around the country, and probably around the world, the demand from central banks could intensify, along with [the] demand from institutional and individual investors. You might just wake up to $3,500 or $3,700 gold [prices] in the next 24 to 36 months.”

Prices for 1 troy ounce of gold have already reached impressive levels this year, climbing to the second-highest point on record in April: $2,041.30.

Investors may want to consider taking a cue from central banks and investing in gold and other precious metals through a self-directed individual retirement account.

“The central banks have been stockpiling gold over the past four or five years because we’ve printed up so much money,” Kevin DeMeritt says. “There’s a distrust that we’ll be able to service the debt here in the United States. When you’ve printed $22 trillion since 2008, it’s a cause for concern. You need to look for an asset that’s going to give you stability and offset the volatility from some of the other investment areas.”

With an inverse relationship to stocks and other assets, precious metals like gold, which is often seen as a hedge against concerns like inflation, can potentially help safeguard investors’ portfolios against challenging economic and other events.

“Economic uncertainty right now is going to be a big factor,” Kevin DeMeritt says. “In times of war or economic uncertainty, usually you’re going to find the markets become extremely volatile. On a day-to-day basis, nobody knows what’s going on. Gold typically is going to give you more stability.”