Gold bugs are speculating about the impact of Basel III regulations set to take effect next month. European banks, minus those in the all-important London markets will soon be subject to Net Stable Funding requirements.
The effect may be to reduce bank activities in the paper metals markets.
Marketwatch actually put together a fair summary of the regulation and its potential impacts. The new rules seem to recognize the risk associated with holding derivatives versus holding the real thing. They will be required to hold extra reserves to offset any paper metal they have on the books.
Tangible bullion, however, is being classed as a “zero risk” asset, so long as it’s hedged and in an allocated form.
But unallocated gold holders –holders of gold derivatives, gold leases, and other more risky instruments without direct backing -- will be required to hold an 85% reserve as an offset.
Bullion investors are cautiously optimistic because it appears regulators are acknowledging the risks inherent in the leveraged paper metal markets. Rules which penalise participation in these derivatives markets and incentivize the banks to hold allocated physical metal would be a step toward more honest price discovery.
However, there are very few communities more skeptical of regulators than physical bullion investors. They have been continually let down by captured agencies such as the CFTC. Most will wait to see metals prices more properly reflecting the fundamentals before they credit the Bank of International Settlements with solving any problems.
That said, there is some reason to hope. It comes from another organization with few fans. The London Bullion Market Association -- LBMA -- has come out with dire warnings against the new rules. If that group of crooked bankers is opposed, it is a good sign.
The LBMA is complaining the updated Net Stable Funding Requirements will:
“Undermine Clearing and Settlement -- The required stable funding for short-term assets would significantly increase costs for LPMCL clearing banks to the point that some would be forced to exit the clearing and settlement system, which may even be at risk of collapsing completely.”
LBMA Most gold bugs will shout “Hallelujah!” if price-rigging banks are forced out of the paper markets.
“Drain liquidity -- The required stable funding would dramatically increase costs for remaining LPMCL members taking gold on deposit to be held as unallocated metal relative to the cost of providing custody of allocated metal.”
There will be few tears shed if liquidity in the derivatives market diminishes, and some migrates to the markets for physical, allocated metal. The paper markets are almost completely disconnected from fundamentals like physical supply and demand.
“Dramatically increase financing cost -- The required stable funding would penalise LBMA members who hold unallocated balances of precious metals. This would increase the cost of short-term precious metals financing transactions as stable funding costs are passed through to non-bank market participants.
“Such cost increases would impact miners, restrict refining, and raise the costs of an inelastic key input to industrial and consumer goods. This includes some essential medical equipment and technologies required to reduce pollutants (such as catalytic converters).”
The last sentence implies the LBMA member banks help medical equipment manufactures and the environment, but they won’t be able to do that without the unfettered ability to trade paper metal. That’s rich. Bullion investors have seen chat logs which demonstrate just how charitable and caring these bankers are!
“Curtail central bank operations -- Fewer LPMCL clearing banks may curtail central bank deposits, lending and swaps in precious metals. These operations are essential to offset costs of storing gold reserves and generating income. In addition, this provides important liquidity to the market.”
This criticism hints at what might be the best reason of all to support the new rules.
Anything which reduces the ability of Central banks to interfere in the metals markets would be a good thing. All of the lending and swapping has but one purpose; to artificially increase the supply of metal and cap prices.
It is important to note the new rules do not take effect in the London markets until the end of the year. There is still time for the LBMA and its member banks to seek further delay of the rules and to promote changes.
Gold bugs know better than to count on regulators doing the right thing, but fingers are crossed.
About the author
Clint Siegner is a Director at Money Metals Exchange, a precious metals dealer recently named "Best in the USA" by an independent global ratings group. A graduate of Linfield College in Oregon, Siegner puts his experience in business management along with his passion for personal liberty, limited government, and honest money into the development of Money Metals' brand and reach. This includes writing extensively on the bullion markets and their intersection with policy and world affairs.
