Central banks losing taste for gold as buying power falls

Alessia Pierdomenico | Bloomberg | Getty Images

Central banks, key players in gold's meteoric 12-year rise, are losing enthusiasm for the metal as official-sector purchases show signs of decline, with the buying power of emerging markets fading and lower prices expected to slow the pace further.

Official buying has been a major pillar for gold even when markets have been at their most volatile, with emerging market institutions adding metal to balance portfolios.

Central banks globally became net buyers of gold in 2010 to the tune of 77 tons, compared with net sales of 34 tons and 235 tons in 2009 and 2008, respectively. That came after a 20 years of significant sales, characterized famously by Britain's 395-ton disposal between 1999 and 2002, when prices stood around their lowest level for 20 years.

Purchases rose to a 48-year high of 534.6 tons last year, but buying should decline to 400 tons this year, according to the World Gold Council.

"Further softening [seen] in second-quarter demand is likely to be driven by the weakness in emerging market currencies and increased currency intervention in foreign exchange markets," said Natalie Dempster, WGC director of government affairs.

French bank Societe Generale forecast the pace of demand will fall further next year, to about 300 tons, with subdued gold prices after this April's spectacular crash as well as fading reasons for dollar diversification.

(Read more: The end of gold's speculative trade)

"Everybody seems to accept that the dollar is going to strengthen. ... So you probably don't want to diversify anymore if you have already have diversified out of the dollar," SocGen analyst Robin Bhar said.

Forex effect

The pace of forex accumulation by emerging countries, mopping up inflows to keep domestic currencies competitive against trillions of cheap dollars printed by the Federal Reserve, slowed after the Fed signaled its readiness to reduce monthly $85 billion bond purchases as early as September.

"Countries such as Turkey and Brazil have been selling dollars in markets to defend their currencies, but now that the dollar is strengthening there is both less to spend on gold and less desire to do so given gold is not an effective means of intervening in FX markets," Macquarie analyst Matthew Turner said.

Emerging market economies started warming to the metal during the 2008 financial crisis, when the Fed began its first round of money-printing to boost economic activity.

But anticipated change in the Fed's policy has started eroding the case for holding gold. The market is now in bear territory, down 33 percent from an all-time high above $1,920 in September 2011.

"Ten or 12 years of steady price increases gave central banks a lot more confidence that they could step up their purchases," said George Milling-Stanley owner of GMS on Gold.

"This year we have seen a couple of speculative attacks on the price, and some of the central banks may have decided to slow down a little bit," he added.

(Read more: Here's what gold bulls need to see)

Europe's official sector divestments have been limited by successive Central Bank Gold Sales Agreements since 1999.

But one of the events that shook the gold market earlier this year was the perception that heavily indebted euro zone nations could put their bullion reserves to work after the European Commission assessed that Cyprus, in need of a bailout last April, could sell its excess gold reserves to raise around 400 million euros ($534.4 million).

"When the EC said that Cyprus could use its gold reserves to fund its bailout, there is no question it had an impact on sentiment," Milling-Stanley said.

"It is not realistically on the cards that countries like Italy, Spain or Portugal are suddenly going to start selling their gold reserves, unless we see the price going back below $1,000 an ounce."

Between them, Portugal, Ireland, Italy, Greece and Spain hold more than 3,230 tons of gold worth 100.5 billion euros at today's prices.