Basel III Likely Price Impact on Gold and Silver


Basel III Likely Price Impact on Gold and Silver

July 1, 2021

It will not have gone unnoticed by those interested in the global gold market that the Basel III protocols are due to come into force for U.S. and European banks on Monday, June 28, 2021, and for U.K. banks on January 1, 2022.  What the impact is likely to be on the gold price is a matter of some dissension among observers – most are either bullish on the gold price (some hugely bullish) , or consider that things won’t change at all and the principal price driver will remain rising inflation and potential moves to control it.

Basel III, and its implementation, remain somewhat contentious, and moves to apply it in full have been fraught with delays and prevarications in many countries – not least, in the U.K., where the London Bullion Market Association (LBMA) continues to exert pressure for further delays in Basel III’s market regulations.   

The protocol is an agreed upon set of measures developed by the Basel Committee on Banking Supervision to try and prevent a similar global financial meltdown to that which took place from 2007 to 2009 from occurring.  Much of the protocol is aimed at improving major bank economics, like capital adequacy, and involves stress testing and controls on market liquidity.  It is technically a voluntary code, but it is expected that most, if not all, major banks that trade internationally will eventually comply.

As far as the direct impact on gold is concerned, the principal immediate change is for allocated holdings of the yellow metal to be reclassified from a Tier 3 banking asset to a Tier 1 asset, which is currently designated for cash and currencies and considered to be the safest level for all bank assets.  By contrast, Tier 3 – the old classification for all types of gold holdings that applies also to equities – which used to be seen as the riskiest class for a bank’s assets, will still apply to unallocated gold holdings, as far as this writer’s understanding is concerned.

Some analysts and gold observers believe that the implementation of the change could thus make it more expensive to buy and sell unallocated gold, and consequently, drive the spot price up.  Others, as pointed out above, disagree, reckoning the changes will have little or no impact on spot gold or silver prices.  To be honest, we are undecided on the likely price impact, but recognize the assumed implementation on June 28th might well contribute to a degree of gold price volatility, which will likely continue until markets settle down subsequent to the accord coming into force.  Some analysts are of the strong opinion that the gold price will rise as a result - possibly substantially – although cooler heads do still see a positive impact, but perhaps only a more gradual one.

It is important, therefore, for anyone considering the likely Basel III impact on precious metals 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.  Goldex CEO Sylvia Carrasco, for example, describes it thusly: "In this case, the bullion dealer does not have to have the gold. They are saying to the buyer — ‘I promise you that I owe you gold.[’] I refer to it as balance sheet gold…If anything happens to the bank, that gold doesn't belong to the buyer, and the buyer loses the position."  Also, unallocated gold can be sold many times to many different entities or people, whereas allocated gold can only be sold once. "This is the systemic risk that Basel III is alarmed about,” Carrasco noted in a recent article published on Viaqe.

What these changes mean for gold is that a resultant increased demand for the physical metal could well put a squeeze on liquidity, which, in response, is likely to trigger a rise in prices, Carrasco continued. "Basel III sees a systemic risk. If for whatever reason these banks go into financial trouble, all these clients [holding unallocated gold] will lose their money," she said.

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, in turn, put pressure on the supply of physical gold and potentially drive the price upwards – some suggest hugely!

Carrasco is thus bullish on the impact of Basel III on the gold price, although, there are plenty of others who are even more bullish, neutral, or even negative on the likely short-term effects of the Basel III implementation.  The LBMA, for example, is reported to be extremely anxious about its effects.  The majority of LBMA trading is in unallocated gold, with the amount of such gold traded on a daily basis in London estimated at around $200 billion.  A switch away from unallocated metal could have a severely negative impact on the association’s trading business.

"It is so enormous that an issue could create a massive systemic risk to the financial industry," Carrasco said. "LBMA is worried about this because the majority of trading that goes through LBMA is unallocated gold. They are asking their UK regulator to reconsider." Carrasco noted in a recent article published on Kitco. As a consequence, she expects to see the biggest impact from Basel III towards the end of the year — right before the U.K. banks are due to implement the Basel III changes.

Even so, unlike some of her peers, she is only conservatively bullish on gold, as exemplified by her predicting a $2,100 minimum year-end price.  While a number of U.K. banks are heavily involved in the global market, only a third of all European banks (those not based in the U.K.) will have to abide by the new rules set to begin June 28th. The rest will only be affected from January 1, 2022, assuming this goes through in the U.K. - which is still by no means a certainty.

There is an opinion that Basel III will also serve to bring possible market manipulation of gold and silver (if this exists) in the major futures markets to a timely end, and the metals, as a result, 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. 

However, I do see even the partial implementation of the Basel III strictures as potentially positive for gold and silver. But whether such a positive influence is sufficient 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 in the short term and the long term.

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