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LAWRIE WILLIAMS: Gold and silver: Basel III price impact

Basel III is due to be implemented for EU and US banks on Monday and, according to some analysts and observers it could have a huge positive impact on gold and silver prices, although others disagree.   We prefer to remain neutral and undecided.  UK banks are expected to comply by January 2022 after a rearguard action by the London Bullion Market Association (LBMA) to delay it.  While Basel III directly affects gold, its knock-on effects for silver could also be significant.

So what is the Basel III accord?  It is an agreed-upon set of measures developed by the Basel Committee on Banking Supervision to try and prevent a similar global financial crisis to that which took place from 2007-2009 recurring.  Much of the protocol is aimed at improving major bank economics and accountability and make them less liable to potential collapse.  It involves stress testing, and controls on market liquidity and reliability.  It is technically a voluntary code of practice but it is expected that most, if not all, major banks which trade internationally will eventually comply.

What the impact is likely to be on gold and silver prices is a matter of some dissension among observers – most are either price bullish – some hugely so - on the potential outcome in this respect, or consider that things won’t change at all and the principal price driver will remain rising inflation and potential moves to control this trend, with silver taking its lead from gold for which there is a particular relevance from the Basel III proposals.

Basel III, and its implementation, remains somewhat contentious and moves to apply it in full have been fraught with delays and prevarications in many jurisdictions – not least in the UK where the LBMA continues to exert pressures for further delays in its coming into force.  It is technically a voluntary code but it is expected that most, if not all, major banks which trade internationally will eventually comply

The principal immediate change affecting gold in the strictures coming into force tomorrow is that allocated holdings of the yellow metal are to be reclassified from a Tier 3 banking asset to a Tier 1 asset, which is currently designated for cash and currencies and considered the safest level of bank assets.  By contrast Tier 3 – the old classification for all types of gold holdings – is considered to be the riskiest class for a bank’s assets, and applies also to equities, will still apply to holdings of unallocated gold.  Currently it is thought that the majority of bank gold holdings is deemed as unallocated, so there will be a consequent move to replace much of these with gold which meets the classified designation.

Some analysts and gold observers are of the opinion that the proposed changes could make it more expensive to buy and sell unallocated gold, and thus drive the spot price for gold up –some think dramatically so.  Others, as pointed out above, disagree, reckoning the changes will have little or no impact on spot gold or silver  prices.. 

There is an opinion that the implementation of Basel III will bring market manipulation of gold and silver (if this exists) in the major futures markets to an end too. and the metals will at long last be allowed to find their true price levels.  It certainly could put a major dent in the paper gold markets (hence the LBMA’s concerns) but whether that would in reality lead to massive gold and silver price changes remains uncertain.  Markets would probably adjust, but could be subjected to a degree of volatility until they do so. 

We, ourselves, are somewhat undecided on the likely price impact,on precious metals but recognise the assumed implementation on June 28th might well contribute to a degree of gold price volatility as the markets try and assess the likely fall-out.  This volatility will likely continue until markets settle down.  Less opinionated analysts do see a positive impact from the adjusted system, but perhaps only a gradual one.  A year end price likelihood for gold of perhaps $2,100 or above has been mentioned, which ties in with our  own forecast mad in December, immediately before Christmas.

Regarding the Basel III designations, it is important to understand the difference between allocated and unallocated gold.  Allocated gold is when a bank, or one of its customers, buys physical vaulted gold. with that gold treated as belonging directly to the bank or customer.  By contrast, unallocated – or paper – gold is more akin to a form of credit.  It doesn’t have to be physical gold, held in a vault. Unallocated gold can be sold over and over again to separate entities or individuals,  whereas allocated gold can only be sold the once..

The net result of the changes is that there will be pressure to make allocated gold the preferred option for banks and their customers.  That would, it is reckoned, put pressure on the supply of physical gold and potentially drive the price upwards. On the other hand it might well diminish the impact of trading in unallocated gold and thus also impact volumes traded on the futures markets.  The LBMA, for example, is reported to be extremely anxious about its effect.  The majority of LBMA trading is in unallocated gold with the amount of unallocated gold traded on a daily basis in London estimated at around $200 billion.

There is an opinion that the Basel III implementation will thus help bring possible market manipulation of gold and silver (if this exists) in the major futures markets to a timely end and the metals will at long last be allowed to find their true price levels.  It certainly could put a major dent in the paper gold markets (hence the LBMA’s concerns) but whether that would in reality lead to massive gold and silver price changes remains uncertain.  Markets would probably adjust, but could be subjected to a degree of volatility until they do do. 

However we do see even the partial implementation of the Basel III strictures as potentially positive for gold and silver, but whether this is sufficiently so to counteract – or complement – the effects of inflation expectations and their impacts on precious  metals prices, is rather less certain,  Consequently I remain on the fence with a strong interest in what the future holds for precious metals prices short term and long term..

27 Jun 2021 | Categories: Gold, Silver, UK

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