To a man with a hammer, everything looks like a nail, said Mark Twain. So it is that pundits have interpreted forthcoming Basel III rules as simply an opportunity to bash bullion banks and to assert that gold prices are going to the moon. Again … yawn.
Imagine for a moment that your cash at bank became “allocated” … that is to say your bank holds it in physical form and it moves from account to account to reflect every single transaction you make, instead of the current book entry system that allows debits and credits to be offset, cleared and settled overnight through a central agency that used to be called BACS. Yes, chaos would ensue … but assuming banks could manage, costs would rise dramatically, and that would be passed on to you. Madness you might think … why would regulators introduce something so retrograde and inefficient … herein lies the story behind the proposed Basel III changes and gold ...
The Basel III rules on unallocated gold will require bullion banks to hold more High Quality Liquid Assets (HQLA) for longer periods of time to offset loans to their clients. It follows that for example gold miners who finance themselves with a gold loan (most do) will find it more difficult to secure funding and it will be more expensive to finance rendering many projects uneconomic or simply difficult to fund. Industrials such as jewellery fabricators, physical gold stockists and precious metals refineries who also lease metal will find those markets thinner and far, far more expensive. Shortages of physical will become a frequent occurrence, especially when you most want it as pipelines shrink. We don’t yet know for sure, but borrowing costs could likely double or treble. These sectors are very low margin, high cost businesses who are highly sensitive to cost increases and they will respond by keeping physical stocks of borrowed metal to an absolute minimum. Some will simply shut up shop. The outcome of the proposed rules is less about the existential issues around the professional market and actually about the broader sector becoming far smaller, less efficient and by extension far more expensive… and that’s what I believe the BIS wants to achieve. It is my belief the regulators are deliberately locking the fire exits in the theatre and simply looking to make gold less relevant. What next … reverse the decision of Jan 1 2000 and reintroduce VAT at 20% on investment gold across UK and continental Europe ?
We are in a time where significant fiat currency debasement looks to be upon us, and further financial repression a given … how else to relieve the massive debt burden crushing the economy ? … and to be effective the BIS needs to render alternatives less appealing. Financial innovation has given us a large number of alternative safe haven assets and it follows that as inflation takes grip, many savers could and would slip out from under the net. Gold is one of those go-to's. Perhaps in that light, the war-on-cash and the rising rhetoric by central banks against alternative digital currencies makes sense.
Bullion banks under Basel III will in future have to set aside more HQLA in order provide unallocated metal, to oil the wheels of trade, especially around trade settlements. Bullion desks will approach their treasury colleagues for say US treasuries with a 13 month tenure (a HQLA needs to be over a year in tenure) to offset say a rolling 3 month gold lease to a jewellery fabricator and now be expected to pay handsomely for that funding … as costs rise ... and this is the important bit ... they will be passed onto clients. Without this consignment facility whatsoever the jewellery fabricator could find it difficult to hedge his risk or indeed the price swings in underlying metal prices could render him insolvent - on thin margins they might simply elect just shut up shop. Compromising the services that bullion banks provide will make being in gold less attractive right through the value chain ... it would be reducing the lubricant from the machine. Unallocated gold has been necessary because, without it, physical bars will need to move between vaults and across borders to settle trades each day. The BIS seemingly wants to hamstring the bullion markets and we shall all pay the price for these new inefficiencies.
Likely this is price neutral, but renders the gold market less relevant as an alternative asset as pipelines shrink. Yes, perhaps a small number of unallocated positions will become allocated (forcing some buying) but this is small in size and there are many offsetting scenarios. More importantly a significant number of would-be institutional investors will be dissuaded from buying gold simply becomes the market is too small, spreads are too wide and the market shrinking … a lobster pot … easy in, but difficult out.
Yes, there is some irony that Central Bankers are themselves the largest single holders of physical gold at about 90,000 tonnes collectively and they will be rendering their own reserves much less liquid … and they do seem determined to shoot themselves in the foot … but, needs must … and such is the scale of the macro-problem.
In the 1970's gold represented about 6% of total assets under management. Today it is about 0.5%. Expect that figure to fall further as gold becomes increasingly niche and less relevant.
Tragically too much attention has focused upon the narrow desire to bash bullion banks, which has served as an un-necessary distraction in that it is masking the real story being played out here…
In short, it my view that the contingent problems are not being fully evaluated ... for want of a nail the shoe was lost; for want of a shoe the horse was lost; and for want of a horse the man was lost.
Metals Daily Ltd