A key change for global banks is looming – could it change the outlook for gold?
Link copied to
Gold watchers have observed a steady move higher in the precious metal over the past month.
The gains have coincided with a constructive macro backdrop as inflation expectations rise.
But there’s another event which has so far snuck under the radar of most analysts and investors – the pending changes to Basel III rules surrounding gold stockpiles held by global banks.
The rule change will stipulate that banks can only count physical gold when calculating their Tier One asset ratios to meet financial stability regulations.
Right now, banks can classify both physical gold and paper gold — derivatives such as gold stocks or gold ETFs – in their Tier One calculations.
The proposed changes to Basel III have been in the works for years, but all of a sudden, the June 28 deadline is looming.
In terms of the market response, the bullish case is centred around upward demand pressure.
Ostensibly, if banks want to maintain gold as part of their Tier One asset ratios, they may need to buy more physical bars. But there are a number of layers involved.
Could it be a market-moving event? We spoke to two professionals on the ground to find out.
The June 28 deadline hasn’t escaped the attention of Shaw and Partners metals & mining analyst Peter O’Connor, who sought feedback from his network earlier this month.
“I’ve canvassed all my gold companies firstly, and broadly speaking it’s not even really on the radar at this stage,” O’Connor said.
“That’s across large corporates, mid-size companies and smaller emerging exploration plays, so a whole range.”
“That’s interesting in a sense because I thought I would’ve got more intel from those companies. So what’s clear is how embryonic it still is, even at this stage.’
From there, O’Connor’s research trail has spanned wider — from discussions with a number of gold derivatives traders, to “down the rabbit hole with YouTube videos by gold bugs”.
Again, no real consensus has emerged. At this stage, his framework is one of awareness, rather than hard conclusions.
“It’s hard to say sure exactly how big a deal it is, but it’s something that I’m going to be watching over the next 4-6 weeks,” O’Connor said.
On that front, there are a few extra layers to discussion worth knowing about as June 28 approaches.
Firstly, the Basel III changes on gold aren’t exactly a new development. The proposal got deferred in 2019, then again last year because of the pandemic.
Given the closeness of the deadline, another postponement would be surprising, but O’Connor said it’s not something he’s ruled out.
One the “early conclusions” he’s drawn so far is that the Basel III changes have received some pushback from the London Bullion Market Association – an industry group with around 150 member companies that represent the global over the counter (OTC) market for bullion.
Earlier this month, the LBMA released a response paper which said the proposed changes will have a “damaging effect” on the precious metals clearing and settlement system.
It’s thus important the Bank of England’s prudential regulation authority “can resolve the unintended consequences” stemming from the changes, the LBMA said.
So it’s a situation where “investors and corporates aren’t really talking, you’ve got the gold bugs all over YouTube talking, the LBMA doesn’t really want it — so where does this play out?” O’Connor said.
“As a directive for where gold is going, it’s important that Basel III is going to happen. But it’s a situation where everyone’s still flying blind at the moment.”
While demand for physical gold is one thing, trading in derivatives based on the underlying asset is a much bigger market.
In that context, O’Connor has spoken with a number of gold derivatives traders, but they too don’t have a set view at this stage.
“If you look at the (proposed) rule changes it’s physical gold that goes into Tier One, but gold derivatives aren’t excluded entirely, they just form part of the Tier Three pool,” O’Connor explained.
“So I’ve tried to do a lot of work with derivatives experts here.”
Again, a lack of consensus is evident – partly because derivative and options traders construct multiple trades to account for a variety of different outcomes.
They also typically trade on a daily or weekly view, which means June 28 is still outside of their investment timeframe.
“Options guys could talk for hours about a particular trade without really knowing what the outcome will be,” O’Connor said.
“But I think the view in the (derivatives) market is that may produce a degree of volatility just because no one really knows what’s going to happen,” he said.
Adding it all up, the Basel III story is still one that O’Connor will be watching closely in coming weeks.
And so will John Terpu, executive chairman at ASX-listed Great Southern Mining (ASX:GSN).
While the June 28 date is yet to reverberate across corporate boardrooms in the Aussie gold sector, Terpu said it’s on the radar of broker and investor resources events and trade shows.
Among those in the bullish camp is Pierre Lassonde, a luminary of the gold industry and well-known mining investor from Canada.
“He’s a big believer these changes will push gold prices higher,” Terpu told Stockhead.
While noting that Lassonde is obviously a “gold bull”, Terpu said any material uplift in prices – towards, say, US$3,000/oz – will drastically change the unit economics for a lot of junior Australian gold plays.
He cited the example of GSN’s own project in WA’s Duketon province, where previous operators only drilled to shallow depth because gold prices at the time meant the numbers didn’t stack up.
“So we are watching for the impact of catalysts like this because if gold price did go to US$3,000/oz, that will have a huge impact on our sector,” Terpu said.
“Like we’ve seen with copper and lithium, it changes the economics and for a lot of Australia’s existing gold projects, the outlook would shift dramatically.”