Will Basel III ignite gold prices?

Dubai - New rules would lead to liquidity squeeze in physical demand, leading to higher spot prices

Will the new set of international banking regulations — Basel III — coming into force on June 28 trigger a gold price rally? Bullish industry experts predict that since the new regime warrants a major shift towards allocated gold, it could lead to a liquidity squeeze in the physical gold, sending yellow metal to $2,100 by year-end.

Gold will become a zero-risk asset according to the Basel III framework that comes into force on Monday for European banks and on January 1, 2022, for British banks, which analysts believe would be a great game-changer for physical demand.

Commodity analysts at Bank of America, however, are not expecting the new regulations to increase gold demand. Instead, the bank sees costs in the gold market going up and liquidity falling.

Goldex CEO Sylvia Carrasco believes that Basel III would affect the gold price more than many people believe leading to a higher spot price. The rationale for higher prices is that Basel III includes the new Net Stable Funding Ratio requirement, which specifies that an 85 per cent Required Stable Funding needs to be held by banks against the financing and clearing of precious metals transactions.

“Basel III requires banks or dealers to collateralise 85 per cent of the value of their unallocated gold with a Tier 1 asset, which is cash,” Carrasco explained.

“If people turn to allocated gold, liquidity will be squeezed, and prices should go up,” she said.

Explaining further, Carrasco said if a bank has $1 billion in gold positions, with $300 million in allocated gold and the other $700 million in unallocated gold. “Before Basel III, the bank didn’t have to put any collaterals for those positions. But with Basel III, the $300 million positions in allocated gold are fine. But the $700 million positions in unallocated gold are now considered risky as equities.”

One of the biggest changes for gold is that the precious metal is being reclassified from a Tier 3 asset, which is the riskiest asset class, to a Tier 1 asset, which is currently designated for cash and currencies. The change could make it more expensive to buy and sell unallocated gold.

“The biggest impact might be visible at the end of the year before January 1, if Basel III kicks in the UK. In the last quarter of the year, we’ll see an impact. At the very minimum, I can see gold go over $2,100 by the end of the year,” she pointed out.

However, Bank of America’s commodity strategist Michael Widmer said that faced with the new funding requirements, bullion banks are more likely to either increase transaction costs or reduce their exposure in the precious metal sector. “In our view, rising funding requirements for unallocated gold means that financial institutions either reduce the bullion business or sustain activity and put more funding aside. “Either way, we don’t think that these dynamics are bullish for gold as such, also because it seems unlikely that banks would support their business by purchasing gold outright, rather than using unallocated gold,” Widmer said.

Bank of America has been neutral on gold prices since the start of the year. It currently expects gold prices to average this year around $1,845 an ounce.

Pictet Wealth Management analyst Alessandro Cortese said together with Fed hawkishness, dollar strength — a result of the rise in real rates and relatively strong US economic activity — has been putting downward pressure on gold.

“To sum up, we remain cautious on gold over the coming months, despite the sharp correction that we have been seeing. Having already declined to our three-month target of $1,780 per troy ounce, we expect the gold price to move further down towards our six-month target of $1,700,” said Cortese.

Metals Focus analysts see a more tempered outlook for the precious metal as uncertainty over the global Covid-19 pandemic continues to ease. They expect gold prices to average around $1,820 an ounce this year, up three per cent from last year’s average price. However, this year’s rally doesn’t compare to the 27 per cent jump seen in 2020.

— issacjohn@khaleejtimes.com