Russia Can’t Help Being a Gold Bug

The reason for this strange behavior lies in the dependency of Russia's gold industry on central bank purchases. Last year, according to the Moscow-based Gold Mining Union, Russia became the world's second-biggest producer of the precious metal, extracting 288 tons. Producers are not allowed to export their output directly. Instead, they have to sell it to banks, which are authorized to deal with foreign buyers and the Russian central bank. Last year, European banks bought 76 tons — they have long-standing trading arrangements with state-owned Russian banks, the biggest buyers on the domestic market — but the central bank dwarfed that, snapping up 59 percent of all output.

At the end of February, the Gold Mining Union, worried that its members' biggest customer was showing no interest, wrote a letter to the central bank, asking it to expand purchases by 30 percent this year compared with 2014 as compensation for sharply increased interest rates (the key rate had gone up to 17 percent in December to prop up the free-falling ruble) and to balance the domestic market. In response, deputy governor Dmitri Tulin promised to keep buying but said the central bank "considers it impossible to replace all domestic market buyers including domestic industries."

Now that the oil price, which Russia depends on to fill its coffers with export revenues, is weakening again, the central bank needs to be mindful of the size of its international reserves, which stood at $358.2 billion last week. In recent months, the central bank has been buying foreign currency to keep the ruble relatively weak and stimulate consumption of home-produced goods, but on July 28, it announced that it would suspend the purchases because of increased volatility.

It wouldn't do to have the ruble plunge too much.

Buying gold, however, is a safer bet than intervening in the market, as it doesn't affect exchange rates. The central bank can print as many rubles as the gold producers need without causing a market panic or even boosting inflation all that much. It makes sense to play gold bug despite the falling global price, because that way the top-line number for Russian international reserves (which includes gold, foreign currency assets and IMF Special Drawing Rights) can be kept from slipping too much and sending distress signals to speculators. 

Of course, with the current panic, the gold stockpile is having an adverse effect on the reserves data — it loses value faster than the central bank can print more rubles and buy more gold. There's nothing to be done about that, however; now would be a bad time to sell off the gold reserves. That in itself is a worry for Russia. If the oil price tanks again and the gold market doesn't recover, 13 percent of its reserves will be illiquid.

Other countries, however, are bigger gold bugs: Apart from the U.S. and the euro-zone countries, which print major reserve currencies and so are not particularly concerned about the size of their international reserves, countries like Lebanon, Egypt, Laos, Pakistan, Kazakhstan and Turkey all have a bigger share of gold in their reserves than Russia does, and so face bigger problems from the price collapse.