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Gold’s Basel III Conundrum

by Chirag Sharma
Gold’s Basel III Conundrum

It is a historic moment when Basel III new regulations on gold became effective from June 28th for European banks this year and it will become effective for British banks on January 1st 2022.
 
This means that tangible hedged and allocated bullion has now become a ‘zero risk’ asset class, moving up from being classified as tier 3, to now tier 1, which is currently designated for cash and currencies. It retains its full market value without the need for any haircut to be applied. This is great news as many believe that gold is the equivalent of holding currency. It has unofficially been the only alternative reserve asset to fiat currencies.
 
On the other hand, and this is where the greatest impact lies, is that holders of unallocated gold i.e. gold derivatives, gold leases and other risky instruments without direct gold backing; are required to maintain an 85% reserve against the value of the holding. Reserves are to be maintained in cash.

What does this mean for bullion banks with unallocated gold on their balance sheet?

Clearing and Settlement banks would be driven to the point that some of them would be forced to exit this market as holding costs increase
Squeeze on physical liquidity as part of the market moves towards allocation
Increase in short term precious metals financing costs and assuming these get passed on through to non-bank market participants

That’s the technical explanation, but what does this mean in reality?

Such cost increases would impact miners, restrict refining, raise costs of inelastic supply to industrial and consumer goods i.e. medical equipment, technology, catalytic converters are some of them.

Does this mean the paper markets are completely disconnected from the fundamentals like physical supply and demand?

Whilst banks will be incentivized to move to allocated gold, it would be a step in the direction towards more transparent price discovery.
 
It is all to be seen in coming months with the biggest test at the start of next year when British banks will be subject to the new regulations implementation.
 
In all likelihood, it is positive for the gold price and we expect an upward trend as physical liquidity is drained.
 
Physical gold is a great portfolio diversifier and will only increase in relevance. Own some physical gold now!

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