Gold's Time is Coming
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Since the peak last September when Federal Reserve monetary policy turned on a dime and the wind was taken out of its sales, gold has been in a difficult position in relation to the U.S. Dollar. The drama in the E.U. coupled with whipsawing Fed policy has caused violent shifts in the gold price but with a bearish bent. Rallies have been sold with extreme prejudice at every technically important level to create the most fear in the futures market and keep longs from establishing positions that they feel comfortable holding onto.
Moreover, they cannot or will not take delivery as cash and U.S. and Japanese treasury instruments can be used with settled profits to provide collateral in the case of a problem in some other portion of a player’s portfolio. When the player in this game is an individual or small fund not buying on margin but rather buying with the intention of taking delivery, this analysis is invalid. But, when the player in the market is a bank, and these days there’s no difference between a commercial and investment bank, the selling of commodity contracts in the face of capital adequacy ratios is a reality.
Selling gold futures to raise cash and/or buy treasuries to stay solvent in volatile times is a marginal driver of price. For this reason I believe that the proposed FDIC changes raising gold to a 0% discount reserve asset, Tier I in Basel III parlance, is one of the most bullish signs for the paper price of gold that I’ve encountered in my years of participating in markets.
The net effect is that now longs standing for delivery can stand for delivery and not be immediately hit with a 50% haircut in the value of the asset on their books. In my mind gold is the only true Tier I asset class there is because even though its price is not stable, it carries with it no counterparty risk. Even a U.S. Treasury note carries some default risk premium, not much by European periphery standards, but non-zero nonetheless.
I am skeptical about the proposed rule change, however. Adding gold to the Tier I capital assets list runs counter to everything that the modern banking system is built on. And yet we know that central banks are buying gold in quantities that have not been seen in decades. So, while I am skeptical that this proposed rule change will make it through to implementation, if it does happen, expect the firm bid underneath the price of gold to be even firmer.
Since the beginning of March, the SPDR Gold Trust (NYSEMKT:GLD) has seen almost no change in AUM, a $30.3 million drop, or 0.04%, while the gold price has dropped $230 or 13%. On balance central banks, officially, have bought 135.1 tons of gold through the end of April. Turkey alone took in 32.5% of that for themselves and the majority of that, 40.2 tons, in just the months of March and April alone when the price began to drop and the Turkish Lira began to slide.
Gold’s problem is almost strictly in terms of the Dollar and the Japanese Yen. GLD has fallen versus the CurrencyShares Japanese Yen ETF (NYSEMKT:FXY) by nearly 15% since September but only 8% versus the Euro (NYSEMKT:FXE). Again, this speaks to the need to raise Tier I capital that is rising in value. This bull market in both U.S. and Japanese treasuries has become a run-away bubble, reinforcing itself as capital is spooked out of Europe. Some of it is moving into other currencies as well, like the Singapore Dollar but the flows there are minimal, big for Singapore, but not big relative to the U.S. Dollar or the Yen. If the FDIC does this and allows gold to be held at a 0% discount, then with bond prices at record highs, one would have to assume that this would be the catalyst for Gold to finally assault the $1650 line and hold it this time.
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