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Gold is often criticized by Wall Street as being kind of a useless
investment.
Institutional investors tend to prefer investments that are thought to
contain the potential for growth, growth = sprouts. An investment has
to produce a growing revenue stream - if it doesn’t grow it doesn’t
compound. Gold is rejected as an investment because it doesn’t produce
sprouts, meaning the steady income and systematic growth so sought after by
institutional investors just isn’t there.
But gold performs two jobs that fiat currencies, or any other financial
innovation, cannot do; gold acts as a safe haven in times of
turmoil. Indeed, gold’s status as store of value, as money, the only
currency available when yours is worthless, has come into play with respect
to the drama that has been unfolding in Venezuela over the last couple of
years. Hyperinflation and shortages of basic foods and medicine have led to a
political crisis.
What do you do when your country is falling apart? Well, if you’re
Venezuelan President Maduro, you find bullion to sell, or use as a bargaining
chip. This is a sad state of affairs especially for the people who
must be enduring a monetary hardship the equal of Weimar Germany. But on the
other hand, it’s a solid vindication of gold. You don’t see Maduro trying to
sell bitcoin to pay the bills.
Gold, for the last couple of thousand years has acted to preserve your
purchasing power. In 1913 (the year the US Federal Reserve was born) when the
US dollar was a dollar, gold was US$20 an ounce. Today, 116 years later, the
dollar has lost 95 percent of its purchasing power and gold is bouncing
around $1,300 an ounce.
Gold gives all of us something that fiat (paper
money), or any other financial innovation, cannot deliver.
Gold is insurance. That’s what gold is, it’s insurance,
sprout-less yes, but irreplaceable in its functions.
Basel III
Basel I, II and III are a response to the 2008 financial crisis. The
regulations require banks to maintain proper leverage ratios and to meet
certain minimal capital requirements.
Under the old Basel I and II rules, gold was rated a Tier 3 asset. Under
Basel III Tier 3 has been abolished. As of March 29th 2019, gold
bullion is a Tier 1 asset. Also, and this is important, under Basel III a
bank’s Tier 1 assets have to rise from the current 4% of total
assets to 6%.
“Tier 1 capital is the core measure of a bank's financial strength
from a regulator's point of view. It is composed of core capital which
consists primarily of common stock and disclosed reserves (or retained
earnings) but may also include non-redeemable non-cumulative preferred stock.
Banks have also used innovative instruments over the years to generate Tier 1
capital; these are subject to stringent conditions and are limited to a
maximum of 15% of total Tier 1 capital." Wikipedia
The Basel Committee for Bank Supervision (BCBS), the maker of global
capital requirements and whose Basel III rules form the basis for global bank
regulation, just made gold a bank capital Tier 1 asset.
“Gold has historically been classified as a Tier 3 asset. When
determining how much money a bank can loan, the bank's gold holdings have
traditionally been discounted 50 percent of the current market value. With value
cut in half, banks have little incentive to hold gold as an asset.” Frank
Holmes, usfunds.com
The BCBS is a committee of banking supervisory authorities established by
the central bank governors of the Group of Ten countries in 1974. The
Committee's members currently come from Argentina, Australia, Belgium,
Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia,
Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi
Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the
United Kingdom and the United States.
Because gold is a Tier 1 Capital asset banks can operate with far less
equity capital than is normally required. Gold is the new backstop for debt,
currencies and bank equity capital.
"Anyone who understands gold’s historic role will grasp the
importance of the argument behind extra bank leverage. Direct ownership of
bullion by a bank is superior to holding the fiat money issued by a central
bank. It should increase confidence in any bank and the system as a
whole. Given relative values, bank purchases of bullion will drive the value
of gold as Tier 1 capital up relative to other qualifying assets, increasing
its desirability for regulatory purposes further without a gold-owning bank
doing anything." Alasdair Macleod, resourceinvestor.com
Because of the upcoming massive debt rollover, and a collapse of faith in
traditional collateral values, gold just become a core banking asset.
Debt
Lenders loan money based on the criteria of:
- The borrower’s ability to service the debt - cash flow
- The borrower’s collateral
- A combination of both cash flow and collateral
Debt has a maturity, and when maturity is reached borrowers look to roll
it over. Unfortunately for borrowers the value, and high levels of esteem, of
what has traditionally been thought of as good collateral (sovereign
obligations – currencies) has collapsed.
“Given the regulatory pressure to collateralize exposures, regardless
of transaction type, there is a greater need for collateral. But going
forward, there may be a risk of a shortage of good-quality collateral.” Olivier
de Schaetzen, director, Euroclear
The latest debt figures come from a report by the Institute of
International Finance (IIF). In September 2019 worldwide debt - all
government, household and nonfinancial business borrowing - totaled a whopping
US$244 trillion, or almost a record 318 percent of world gross
domestic product (GDP).
Government debt tripled from US$20 trillion in 2000 to
US$65 trillion in 2018, rising as a share of GDP from 55 percent to
87 percent. During the same time period household debt increased from
$17 trillion to $46 trillion (from 44 percent to
60 percent of GDP) and nonfinancial corporate debt rose from
$24 trillion to $73 trillion (71 percent of GDP to
92 percent).
Rollover risk is high, according IIF data emerging-market borrowers face
US$2 trillion of debt maturing in 2019.
“The great corollary of over indebtedness is the relative scarcity of
good collateral to support the debt load outstanding. This imbalance of debt
to collateral is impacting the ability of banks to make loans to their
customers, for central banks to make loans to commercial banks, and for
shadow banks to be funded by the overnight Repo market. Hence the growth of
gold as a collateral asset to debt heavy markets is inevitably in the cards
and is de facto occurring. Gold is stepping up to the plate as “good”
collateral in a world of bad collateral.” Professor Lew Spellman,
former economist at the Federal Reserve and former assistant to the chairman
of the President’s Council of Advisors
Exter's Pyramid
John Exter is known for
creating Exter's Pyramid - useful for visualizing the
organization of asset classes in terms of risk and size.
John Exter’s Inverted
Pyramid
When the credit system is expanding most money flows to the top of the
pyramid - the increasingly speculative and illiquid investments. When the
credit system comes under pressure and debt cannot be repaid, the items at
the top of the pyramid get sold and money flows to the bottom items.
Collapsed asset value
After the 2008 financial crisis government bonds – Greece and Italy come
to mind – lost nearly all their value. Mortgage backed securities, innovative
instruments, are near worthless.
A quick scan of recent news reveals bonds
are tiring, stocks are struggling, real
estate is collapsing and small business is still being decimated
by online sales. As already discussed the US$ - paper money,
the world’s reserve currency - has lost 95% of its value.
Gold buying binge
According to the World Gold Council, central banks backed up the truck for
gold in 2018, buying 651.5 tonnes versus 375 tonnes in 2017. That’s the
largest net purchase of gold since 1967.
Among the top gold buyers was Russia, which all but liquidated its US
Treasury holdings, to try and diversify away from the US dollar. (more on
that below)
Bloomberg
reportsthat within a decade, the Russian central bank has quadrupled its
bullion reserves, an effort that continues. In February the Central Bank of
Russia added a million ounces, the most since November 2018.
Central banks clearly see the value in increasing their gold
reserves. After the massive value destruction suffered holding paper assets
(After 2008 MBS lost most of their value and many sovereign securities are
today, also near worthless), perhaps almost a doubling of gold bullion
purchases in 2018 over 2017 totals is indicative they believe gold is a
better Tier I asset then government debt and mortgage backed securities?
There is also that 2% increase in total assets to 6% that now needs to be
filled, likely by gold.
For me, and you, gold is insurance. For the banks who hold the world’s
debt, gold is the new backstop. It will be an interesting exercise to
watch future Central Bank gold bullion purchases.
Legal Notice / Disclaimer
This document is not and should not be construed as an offer to sell or
the solicitation of an offer to purchase or subscribe for any investment.
Richard Mills has based this document on information obtained from sources he
believes to be reliable but which has not been independently
verified. Richard Mills makes no guarantee, representation or warranty and
accepts no responsibility or liability as
to its accuracy or completeness. Expressions of opinion are those of
Richard Mills only and are subject to change without notice. Richard Mills
assumes no warranty, liability or guarantee for the current relevance,
correctness or completeness of any information provided within this Report
and will not be held liable for the consequence of reliance upon any opinion
or statement contained herein or any omission. Furthermore, I, Richard Mills,
assume no liability for any direct or indirect loss or damage or, in
particular, for lost profit, which you may incur as a result of the use
and existence of the information provided within this Report.
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