Capital Classifications Will Give Gold A Boost

City AM

Craig Drake

US BANKS are staging an eleventh hour appeal to have the implementation of Basel III delayed from its 1 January 2013 deadline, arguing that they would need to bolster their balance sheets with an additional $800bn (£493bn) in core capital assets under the new framework.

But while there may be some protests, and the date may be pushed back, the changes contained within Basel III will eventually go through and shift the way that banks are capitalised. And although it may give banks a headaches, it could be good news for gold bugs.

Changed attitudes

What the Basel Committee on Banking Supervision (BCBS) says isn’t binding, but as a supranational committee of the central banks of the group of ten, when it tells the banks to jump, they ask “how high?” In the first two Basel accords, gold could be treated as capital, but as only a tier three asset, meaning that just 50 per cent of its market value could be treated as bank capitalisation.

This classed gold not as an alternative currency but, in terms of capital, instead put it just above a pile of old computer monitors that could fetch some cash on eBay if push came to shove. At the top of the pile, and treated as core capital and 100 per cent convertible, were government treasuries, mortgage-backed securities and cash.

Clearly, the events of the last half a decade have demonstrated that, when the markets slide into a crisis, mortgage-backed securities cannot be considered freely convertible to cash at face value.

But with the coming of Basel III, gold is now considered as tier one capital and a 100 per cent loan-backing reserve. The new regulatory framework will consider gold as equivalent to cash or bonds and a de facto currency.

Prophets and profits

Warren Buffet has long been dismissive of gold and other precious metals as an investment asset. Famous for his dividend focused investment strategies, Buffet has quipped: “you can’t eat gold.” But on the other side of the fence, a higher authority than even the Oracle of Omaha, in Isaiah 1:22 the prophet admonishes: “Thy silver is become dross, thy wine mixed with water.”

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Bank holdings

Clearly the debate will rage on and on. But the Basel Committee on Banking Supervision has implicitly sided with gold as a currency in Basel III. But just how much of a difference will it make to gold prices?

You could argue that banks will have little incentive to go to the gold markets, and will instead use the changes to use existing gold to meet the higher liquidity requirements, but at the full 100 per cent of the market face value rather than the 50 per cent at its old tier three status.

But this is to neglect the draw of gold – it is the ultimate liquid, portable and divisible store of value. If the Mayan calendar is almost correct, and the world is destroyed on Friday save for a few dozen people, it is likely that you would be able to use your gold holdings as a proxy to barter for food and water. But while governments and individual investors are quick to buy gold in times of financial instability, the regulations reducing gold to tier three capital and assuming 50 per cent of its face value may have suppressed institutional demand.

Daniel Fisher, chief executive of Physical Gold, is understandably bullish about the effects of Basel III. “Banks realise that a fast depreciating dollar does nothing for their reserve levels and only gold can provide a reliable store of wealth,” says Fisher. “I’m sure banks have also been tempted to shift their reliance on holding paper currency as capital but the traditional tiering ratio has prevented this. Now they have a compelling reason to re-address this balance and we don’t believe the delays to implementing the bank capital rules will change this.”

Even if the shifting focus does not lead to a net increase in institutional gold purchases, it will at least stop banks from liquidating gold holding to buy up government bonds or hold cash. And if that happens, gold will hold firm in 2013.