Solution to Basel III Disruption of Gold Markets?

Last week our blog focused on understanding the implications of Basel III regulations for the European and UK precious metals markets. It highlighted the technical interpretation and on the ground realities of its imperative implementation. Whilst we touched upon the main aspects, its potential winners and losers, it was more on a high level notion that the views were compiled.

We have recently been in deliberation with influential experts across the global supply chain and here are some snippets of what we learned first hand.

1. Banks

  • Our business and profitability is governed by our ability to provide loans to our customers. Unallocated accounts forms the basis of our lending pool. Allocated accounts means we cannot use these assets for lending so we will lose a revenue line when our customers choose to convert their unallocated gold accounts to physically allocated options. We are likely to face a physical liquidity squeeze to meet our clients requirements, in which case we would have to consider if this business is profitable for us. Adding that precious metals, and specifically, gold faces compliance scrutiny with many international due diligence obligations. So will the cost of compliance overwhelm us to the net profits of this business? Is the writing on the wall that bullion banks will cease to operate and be replaced as it was earlier by frontier trading houses outside of the regulated financial system?

2. Central Banks

  • It is great that physical gold is valued at 100% and when we use this as form of collateral for funding our borrowings i.e. be it in the form of FX reserves, closing national debt or using funding for emergencies, it gives us more value of funding obtained. We know that physical gold has no credit risk. We also keep unallocated balances with financial institutions as it is more cost effective and provides us a residual revenue when loaned out. But we are not totally experienced to manage our gold reserves, therefore we outsource operations to experts. Going forward if we have allocate the gold, then we need assistance on the operational management i.e. analysis on when to sell/buy? Access to international markets for trades?

3. Physical Gold Traders

  • We have unallocated metal accounts with prominent Clearing & Settlement financial institutions and banks. We fear that we will be passed on the costs of banks for us to maintain a metal account with them as they seek to recoup loses increasing costs. It does not make sense for us to keep positions in gold i.e. loans, derivatives, non-direct physically backed and then asked to fund part or full amount of the 85% reserve balances. We may as well keep our physical gold under our pillow, but that is complicated and not efficient.

4. Miners

  • ASM: We are neutral. We need just in time capital to fund our extraction of the next gold ore batch. As long as we are paid on time as per our contractual agreements, we can function as is. Our financiers are not banks but private entities that have a stake in our infrastructure and offtake commitment on our production volumes.
  • MSM/LSM: Funding is a key element of our operations and long term sustainability. Our strategic partners are banks and refineries. We are subject to producer hedging and de-hedging as it forms a critical component to effectively manage our exposure to the gold price vis-à-vis our cost of production per ounce. We would have to move towards seeking funding from private investors. This is not easy and in the short term will cause major disruption. Our business model does not permit us the luxury of keeping our production in allocated accounts and conversion to liquidity is of paramount importance. Our pool of investors mostly are in form of equity holders in mining stocks. If the value of stocks are subject to perception of declining, how do we secure investment? How do we maintain our current investors?

5. Speculators, Day Traders, Algorithmic Traders

We think the best option for us to close our accounts with entities that are subject to Basel III regulation. We have other options, to open accounts with Derivative Exchanges as a Trading and/or Broker Member. Do we really need to use gold as asset class? Ultimately we don’t care for the physical, so we just need a mechanism that mirrors the gold price? Then why gold, why not cryptocurrencies?

If you notice, there is a common theme that is emerging and its becoming so apparent as we think through the markets comments.

The solution is keeping physical gold in a decentralized non regulated platform that enables storage, trading at efficient market prices and with no leverage like margin trading. Combined with the simplicity of secure logistics and access to credible counter-parties would be perfect.

Sounds like a good idea for a crypto to be physically backed by gold? Not ETFs. Could this be the solution to the disruption in global markets? If it is, does it satisfy the requirements of the depth of market participants? It does prompt a healthy and constructive discussion. We encourage you to engage with us and provide your opinions.

A solution is best found collectively!