With five weeks’ to go until the Basel III regulations affect the way that gold is valued, we look at the likely scenarios and what it will mean short and long term for the world’s oldest monetary metal.
For a number of months now, the hysteria around Basel III has grown. The three key points to Basel iii we are interested are:
- The Net Stable Funding Ratio which is clarified as the amount of available stable funding relative to the amount of required stable funding.
- Gold being classified in the same Tier class as cash
- Unallocated Gold only valued at 85% given the haircut vs 100% allocated Gold.
Many countries have already claimed they are compliant ahead of the June 28 date. The COMEX is said to still hold massive unallocated short positions of which they cannot want to hold by the end of June as it will become very expensive. The LBMA has been granted an extension until Jan. 1 2022 due to the mess they are in, however it may well spell the end for gold trading this way, not just in London, but across the globe.
We saw signs of what can happen when the market goes into panic back in March 2020. We saw the contango when gold futures prices traded far above spot gold prices which is a sign of liquidity problems and a disconnect between New York and London – the world‘s two prominent precious metals trading landmarks. Enormous opportunities for futures traders to clean up, and they did.
To put in perspective just how big an event Basel III is, if we were to see unallocated gold disappear – and given the haircut it is highly possible if not considerably reduced – then we could see the supply of gold shrink by 100:1 going on the basis of the paper trade ratio. Reducing such supply, given the paper gold is effectively wiped out is only half the story. Since the bullion banks have been stacking physical gold for years they are not going to be trading it when it is far more valuable to them to sit allocated in their vaults to offset their debt as the price increases. China are well ahead of the game with the Shanghai exchange leading the way in physical trading. What is unclear is whether this will spell the end of derivatives trading. Given the circumstances when you could end up with nothing, who would you want to take the risk? No coincidence the ETF’s have seen huge outflows.
What we must also bear in mind, is the LBMA is almost 9 times the size of the COMEX, and deals almost exclusively in unallocated paper gold. No one knows for sure what the percentage is albeit it is rumoured that for gold the differential for paper vs physical sits at a staggering 100:1. This was testified in 2010 by Jeff Christian at a CFTC hearing. With the LBMA still pushing back against this regulation it is clear why as if all the “owners” contacted these banks and wanted delivery, it would be the end of the paper market. It is heading closer to this scenario.
I wrote an article of Basel III back in February 2021 and claimed that it wasn’t in windscreen view because people seemed to have forgotten about it with the banks likely behind that narrative. Well it is well and truly headline news now. Analysts from major websites are now starting to mention it and the likely outcomes. YouTube is now full of videos on the subject, and even news articles on Google (NASDAQ:GOOGL) are far higher populated than a month ago. The well kept secret is now out, and players are beginning to position themselves for the move.
We would expect the price of gold now to continue its stair step higher. I’m not expecting to wake up on June 28 and see a huge gap open, although what I am expecting is volatility towards the end of 2021 when we will see the fall out of the LBMA, and the dump of massive short positions. Given the fundamentals above and having that amount of paper supply removed from the market, I’m not sure how anyone can see this event for anything other than a potential riot in the gold price. A scenario where physical is extremely hard to get your hands on is highly likely, and when that happens the price is only going one way. It is also difficult to fathom any scenario where the LBMA continues to trade unless it is exclusively physical, and by that time, they would have taken such a hit it would be difficult to see any continuation. This will disrupt the games they have played for years and manipulated the price of the metal. I have no sympathy whatsoever for what has been essentially a criminally run organisation that has been allowed to operate with complete impunity. When they fall over we will see the true, fair and non supressed price of gold.
One more thing – don’t forget silver. Whilst that paper trail doesn’t fall under the same guidelines, its relationship to gold will follow the route higher and as we have always seen with silver, it far out accelerates gold in a bull run. If the LBMA collapses then I wouldn’t want to even guess how high gold and silver goes.