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>>> IS THE REMONETIZATION OF GOLD IMMINENT?

Dave Allen, of Discount Gold and Silver


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Basel III Rules Are Pointing in That Direction - By Dave Allen for Discount Gold & Silver

Is gold's re-monetization just around the corner? Some precious metals analysts think so. Others believe it's already in place.

Last week ushered in the advent of spring - an-already magical and uplifting time of year...and my favorite. And next week - Sunday, March 31st, to be precise - kicks up that magic a couple more notches with the implementation of the so-called Basel III rules and what some observers believe will result in the start of a new boom for the price of gold. WHAT IS BASEL?

In a nutshell, the Basel Standards comprise a voluntary, global regulatory framework on bank capital adequacy, stress testing, and market liquidity risk. They were developed initially - as Basel I - in 1988 and revised in 2004 - as Basel II -by the Basel Committee on Banking Supervision.

The BCBS is an independent body formed in 1974 by the Group of Ten countries to develop "prudential" standards for international banking regulation. Today, it is made up of 45 central bankers from 28 countries and entities, including the U.S. and the European Union. The BCBS provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide.

The BCBS is housed in the headquarters of the Bank for International Settlements (also known as "the central bank for central banks") in Basel, Switzerland - thus, its name. THE BIS IN BRIEF A quick aside: The BIS - a distinct and separate entity from the BCBS - was founded in 1930 as a clearinghouse for German war reparations imposed by the Treaty of Versailles.

The original members were Germany, Belgium, France, Britain, Italy, Japan, the U.S. and Switzerland. Reparations were discontinued shortly after the bank's founding, and the BIS became a forum for cooperation and a counterparty for transactions among central banks. The bank was officially neutral during World War II, but it was widely seen as abetting the Nazi war effort, beginning with its transfer of Czechoslovakian national bank gold to Germany's Reichsbank in early 1939.

At the end of the war, the Allies agreed to shut the BIS down, but the decision was not implemented - partly at the urging of the provocative economist John Maynard Keynes. While the 1944 Bretton Woods agreement remained in effect, the BIS quickly evolved to play a crucial role in maintaining international currency convertibility.

It also acted as the agent for the 18-country European Payments Union, a settlement system that helped restore convertibility among European currencies from 1950 to 1958. When the world transitioned to floating exchange rates in the 1970s, the BIS and BCBS focused on financial stability, developing capital requirements for banks based on the riskiness of their financial positions.

The resulting Basel Accords have been adopted widely by national governments to regulate - or is it simply to protect? - their banking systems. But I digress..... III Basel III is the third phase of the Basel Accords. This latest iteration was developed in 2010 in response to the shortcomings of financial regulation made abundantly clear by the 2008 global financial crisis.

Basel III is intended to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage. Its capital standards and additional capital buffers require banks to hold more and higher quality capital than under the earlier Basel II and I rules. A new leverage ratio introduces a non-risk based measure to supplement the risk-based minimum capital requirements. Liquidity ratios are meant to ensure that adequate funding is available during periods of stress. Basel III will affect all banks; however, the intensity of its impact will differ according the type, scale and location of banks.

Most banks will be impacted by the increase in quantity and quality of capital, liquidity and leverage ratios, as well as enhanced requirements for pillar 2 and capital preservation. Most sophisticated investment banks will be affected by the amended treatment of counterparty credit risk, a more robust market-risk framework and, to some extent, the amended treatment of securitizations. Global Systemically Important Banks (aka Too Big to Fail Banks) are subject to higher core tier 1 capital requirements.

The U.S. has been implementing Basel III under the auspices of the Dodd-Frank Act since 2015 for banks using what's called the "standard" approach. Larger institutions - typically banks with over $250 billion of assets - which are covered by the "advanced" approach, were required to comply by January 1, 2014. It covers almost all banking institutions and closely mirrors the BIS framework, with modifications that meet the requirements of the U.S. regulators.

A complexity for U.S. banks is that banks must also manage their stress testing alongside their Basel III compliance, under the Comprehensive Capital Analysis and Review and the Dodd-Frank Act stress test frameworks. This presents a challenge, because a bank's Basel III results need to be consistent with the stress testing results.

Moody's Analytics has an excellent Q&A guide to Basel III's capital and liquidity standards. HOW IS GOLD AFFECTED? - Nick Barisheff of the BMG Group reminds us that during the Great Recession, gold was used in international settlements as a zero-risk asset "after many decades of being sidelined in the monetary system." Since then, the world's central banks have been substantially increasing their official gold reserves. Barisheff observes, "Gold's old emergency usefulness resurfaced, albeit behind closed doors, at the BIS in Basel."

Indeed, official world gold reserves, as of May 2017, reversed 41% of the 1967-2008 gold sales. Further, as we reported on these pages early last month, the World Gold Council showed that gold demand in 2018 exceeded 4,345 tons - up from 4,158 tons in 2017 and comparable to the five-year average of 4,348 tons. If that number sounds large, it's because it is. The rise reflects the highest central bank gold-buying in almost five decades - all the way back to 1971 when Bretton Woods was dissolved.

The big question is who owns the world's gold. Turns out, the same central banks and ministries that control BCBS and the Basel Accords do - they now hold roughly 34,000 tons of gold - worth about $1.4 trillion. But almost 28,000 tons, or more than 80%, of that is owned by just the 15 largest international holders of gold. Among them, the U.S. has remains the world's largest. The WGC study also showed that 76% of central banks view gold as a "highly relevant safe-haven asset," and 59% of central banks see gold as an "effective portfolio diversification tool." And, most notably, almost one-fifth of the central banks also have indicated that they intend to increase their gold purchases over the next 12 months. That factor alone would put upward pressure on the price of gold. But with Basel III kicking at the end of the month, the upward pressure on gold could ignite, causing prices to skyrocket.

To cut to the chase, the need for liquidity was a key change in the creation of Basel, and it spotlighted an asset that had largely been ignored for this purpose - physical gold. The gold market is bigger than all financial markets - exceeded only by bond and money markets. A point to consider here is that gold is not traded at the commodity desks of large banks. It is traded at the currency desks. And a staggering $250 billion worth of gold changes hands on a daily basis via the London Metals Exchange. Under the previous rules, gold was rated as a Tier 3 asset (there are now only two Tiers)- and had a 50% Risk Weighting Assessment.

That meant an institution that held gold reserves on its balance sheet could only apply half of its market value towards its solvency (capital) requirements. But under Basel III, monetary gold now qualifies as a Tier 1 asset, and is 100% valued for the purposes of banking viability.

Another point to consider is that the Too Big to Fail Banks are now required to quadruple their reserves (to 8%) compared to the previous minimum requirements before the banking crisis (2%). In short, monetary gold is now considered risk-free.

This significant development, however, remains relatively unknown - for now. But as gold's status under Basel III becomes an open secret, increasing demand will have a positive effect on its price. Barisheff says that the world banking sector may take some time to shed its "false anti-gold indoctrination, but it will." He adds, "Gold is already a de facto zero-risk asset and has been for thousands of years." The LBMA cautions that, under Basel III, funding gold transactions for commercial banks will be difficult and will increase the cost of doing business. Nevertheless, as the reset of the international monetary system approaches, gold will be adopted, even by the banking establishment, as the only riskless asset - just as the Chinese and Indians are already doing.

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