Good deeds and their unintended consequences​

Friday 11 June 2021

Shae Russell,
Group Communications Manager

Dear investor,

As the week draws to a close, we look back on the things we learned.

One of those, is that the Aussie stock market doesn’t care if Melbournians are trapped in their homes.

Another, could be coming from own our gold expert on whether cryptocurrencies can cut the mustard.

I personally learnt earlier in the week, that a magnet will ‘glide’ down a 1 kilo silver bar because of its slightly magnetic properties.

But the most important lesson for this week, is that changes to capital requirements for the banking system may impact the gold markets on the inside.

Aussies hunt for growth assets

Melbournians are allowed out to play once again – though we mustn’t stray more than 25 kilometres from our homes.

I’ll bet the rest of Australia likes that rule. Especially our Queensland friends. Word has it Victorians are a little on the nose in the Sunshine State after two of my brethren drove North with a case of COVID stowed in their luggage.

Nonetheless, the Aussie market doesn’t give two hoots about Melbourne’s 99th lockdown as it stormed to record highs this week:

S&P/ASX200 weekly chart (1998 – present)

Source: Trading View

As of this morning, the S&P/ASX200 [XJO] continued to march up, opening at 7,302. It appears there’s little to breaks the XJO’s stride.

What does this tell us about the Aussie market though?

Well, given XJO’s 32% weighting to the financial sector and 18% weighting to the material sector, Aussies remain bullish on both banks and mining stocks.

Once again Australian investors are keen to hold onto red rocks and bricks.

How long the XJO manages to stay at this all time high remains to be seen. For the moment, there is little to bring the index back down. Plus, it’s worth remembering, our own central bank says interest rates will remain very low until 2024.

The longer this next-nothing-cash-rate hangs around, the more investors will go hunting for any asset class offering a whiff of growth. Whew. Good thing gold thrives in low rate environments…

However, while the Reserve Bank of Australia (RBA) is telling the market very low rates are here to stay, a report from Australia and New Zealand Banking Group Ltd [ASX:ANZ] says different. Their analysis suggests the Aussie economy is about to boom and this will force the RBA to raise rates in the second half of 2023.

Who’s right?

Over the past couple of years, the RBA has had a woeful track record of calling the economy, and I’ve found most bank reports lean on the conservative side.

The short version is rates aren’t going up in the near term. So, we can revisit this topic when we’ve full financial year economic data to chew on.

The debate of the modern era: Gold vs Cryptocurrencies

Here’s a plot twist I’ll bet you didn’t see that coming.

Crypto talk…in a gold market newsletter! Sacré bleu!

It turns out, traders are curios people. They may be experts on precious metals, but a true trader will ply their trade on anything with a ticker and a candlestick.

Nick Frappell, our Global General Manager for ABC Bullion sent a chart around this morning on bitcoin (BTC)…of all things.

Bitcoin priced in US dollars Hourly price chart

Source: Bloomberg; ABC Bullion

Nick noticed that the bitcoin price had fallen back to the 2021 lows, and that the volatile ‘coin’ might find support around here.

Is this your cue to dabble into the crypto market? Well before you do, you might want to hear what Nick and some other people have to say on the matter.

The two day Virtual Asia Pacific Precious Metals Conference, starts next week on Wednesday 16th June. Nick is taking part in the Gold vs Cryptocurrencies debate. He’ll be flying the ‘gold’ flag, along with Adrian Ash from BullionVault.

Those two are teaming up against the ‘pro’ crypto side, Greg Gregersen founder of Silver Bullion and Charles Morris of Byte Tree Asset Management. Register for the conference here to hear the debate live.

Next week Nick and I will jump on camera to discuss the winner. Stay tuned for the outcome of that one!

Basel III and what it means for gold

Before our time together comes to an end, I wanted to expand a little more on the rules the big boss bank sets for the little banks around the world.

Though, these ‘rules’ aren’t legally enforceable. Rather the Bank for International Settlements (BIS) expects its ‘members’ commitments’ to follow the mandate.

As I wrote last week, changes introduced by The Basel Committee in 2017 – called Basel III - will be effective at the end June.

The crux of those changes mean that gold was ‘re-rated’ from a Tier 3 asset to a Tier 1.

Meaning the BIS now consider gold to be the least risky asset alongside cash.

Importantly there was a language change noted in the documents, where gold was referred to as a ‘currency’.

The reclassification as currency is a rabbit hole we’ll dive into another day.

Instead let’s look at the market implications of gold’s upgraded role.

Nick Frappell recently wrote an exclusive report on this matter, explaining to those in the industry that with banks now able to hold gold as a Tier 1 asset, it’ll likely increase the costs for those that operate in the across the entire gold precious metals chain globally.

Of the two provision changes Nick outlined, the one of interest today is what the Net Stable Funding Ratio (NSFR) will mean for the gold market.

As Nick put it, the new NSFR will alter the delicate balance between the creation of loans and how they are funded.

Under these new rules, the loans must now be longer. In addition, their ‘funding’ (where the cash comes from to back those loans) can no longer come from only very, very short term. Think loans that last from for one to seven days. Traditionally, these short-term loans are continuously rolling.

The problem isn’t so much the risk of short-term lending itself. Rather the risk to gold markets with the NSFR changes, is that it will remove ‘liquidity’ from the market. Liquidity dried up during the GFC, which is what caused us so many problems to begin with.

Or as Nick put it, ‘By compelling lenders to borrow for longer, the risk that a bank is compromised by a sudden decline in market liquidity, or even by a change in the bank’s own credit standing, is reduced.’

Furthermore, Nick says there are broad concerns that by lengthening loan periods, it will increase costs along the entire supply chain. With Nick writing:

‘By increasing costs and reducing the leeway for maturity transformation by banks, the lending market that is important for financing gold fabrication and refining is at risk of reduced margins for banks and higher costs for end-users.

‘The most likely outcome is the widening of spreads in general and an increase in borrowing costs, along with a tendency for lenders to incentivize longer term liabilities to mitigate the effect of the NSFR requirements.

‘The chance that fewer market participants are active in the market may also increase market volatility if market liquidity diminishes, as some observers believe it may.’

As well intended as these new policies might be, a reduction in in loan terms – and perhaps liquidity – is going to put pressure those who deal with gold. But these higher costs may not be reflected in the sport price just yet.

I’ll give the final word over to Nick, with him writing:

‘…may have unintended consequences, including reducing liquidity in a key investment asset, and raising costs for all precious metals end-users whose use-cases extend from investment, jewellery, electronics, cracking of key chemicals and pollution reduction in both the petrochemical and automobile industries.’

Until next time.

Shae Russell
Group Communications Manager, 
For ABC Bullion