Last year central banks bought the most gold since 1964 - just before the collapse in prices into a bear market underscored investors' weakening faith in a globally traditional store of value.
Nations from Colombia to Greece to South Africa bought gold as prices rose for an 11th year, highlighting the reversal of a three-decade-long bout of selling that diminished the world's biggest bullion hoard by 19 per cent. The London-based World Gold Council says they added 534.6 tonnes to reserves in 2012, the most in almost a half century, and it expects purchases of 450 to 550 tonnes this year.
Central banks are the biggest losers, with about US$560 billion of value erased since gold reached a record US$1,921.15 an ounce in September 2011. Gold was already in the eighth year of its longest bull market since the end of the first world war when reserves started expanding again in 2008. Central banks were also buying in 1980 when bullion peaked at the equivalent of US$2,400 in today's money, and selling in 1999 as prices slumped to a 20-year low.
"They sell at the wrong time and buy at the wrong time," said Walter Hellwig of BB&T Wealth Management in Alabama. "They are looking at it as a long-term holding, as an ultimate reserve currency. With the benefit of hindsight, they tend to get it wrong more often than not."
Gold tumbled 15 per cent to US$1,431.95 this year and entered a bear market on April 12. By the end of the next trading day, prices had slumped 14 per cent, the biggest two-day rout in three decades. Should the price of gold fail to rally by the end of the year, it would mark the first annual decline since 2000. Goldman Sachs is forecasting a price of US$1,390 in 12 months.
The timing of the rout is surprising, because the events that sustained the bull market over the past few years are still unresolved. Central banks are printing money on an unprecedented scale as they seek to boost growth, Europe's debt crisis is spreading and the International Monetary Fund is among those getting more pessimistic on the global economic outlook. Yet investors are now shunning an asset traditionally seen as a hedge against currency devaluation and financial turmoil.
Central banks owned 31,671 tonnes of gold at the end of 2012, one fifth of all the gold ever mined, the World Gold Council estimates.
Gold holdings peaked at 38,347 tonnes in 1965 and began their most recent contraction about a decade later. Nations from Canada to the US to Belgium sold more than 2,000 tonnes in the 1990s, contributing to the 28 per cent slump in prices and spurring an agreement between 15 central banks in 1999 to set annual sales limits.
Disposals under the accord dwindled to less than 6 tonnes last year, against 400 tonnes when it started, and were eclipsed by the purchases of other central banks.
Britain had the world's second-biggest reserves in 1958 and now ranks 18th. Gordon Brown, the finance minister at the time, sold 400 tonnes in auctions from 1999 to 2002, getting no more than US$296.50 an ounce, and sometimes as little as US$255.75.
Britain's Treasury raised almost US$3.5 billion through the sale of gold, which was invested in dollars, euros and yen. The gold it sold is now valued at about US$18.4 billion.
Morgan Stanley expects central banks to buy another 655 tonnes up to 2018, while the gold council predicts purchases valued at as much as US$25.3 billion this year alone. The price slump may not deter central banks, because of how much longer they typically hold assets relative to most investors.
Rachel Benepe, of the First Eagle Gold Fund in New York, said: "Central banks are strategic investors, and look at it as the currency of the last resort that lenders will gladly take. When there are any big moves, investors get panicked. Nothing has changed from our viewpoint. Gold is a hedge against policy actions, and governments globally are announcing policies that are unproven."
The bear market is a blow to investors who anticipated that stimulus by central banks and the almost doubling of sovereign debt to US$22.9 trillion since 2008 would debase financial assets and boost demand for gold, the traditional store of value.
The Bank of Japan and the US Federal Reserve have said they need to keep buying bonds and the International Monetary Fund has cut its estimate for world growth in 2013 four times since July last year.