Basel III Update on Gold and Silver

Not a lot has changed since we last updated you on the international banking regulations known as Basel III, except for what is arguably the most important aspect of the new rules.  

When we wrote our second article about this topic at the beginning of March 2021, gold had increased by 36% since writing the first article in April 2019.  Today, it is up 45% since that first publication.  Instead of 1.35% per month, the pace has quickened to average 1.8% per month for the last 25 months.  That level of increase is equivalent to receiving two years’ worth of bank interest every month.  As the end of June approaches, we may see the pace increase even more. The effects on silver are even more phenomenal, as our charts today highlight.  Unlike with previous deadlines, there does not appear to be any willingness thus far to delay the implementation of the rules again.  

Some might be wondering what Basel III is all about and why it is impacting both gold and silver prices.  As a brief review, Basel III refers to the third generation set of rules being implemented by the international banking community.  The Bank of International Settlements (BIS), which is based in Basel, Switzerland, is responsible for creating these rules.  As Americans, we often think of the financial center of the universe as being in New York City.  While this might be true in some regards, there is a rich and deep history of world finance that has been centered in Switzerland for hundreds of years.  Switzerland is sometimes referred to as the “Banker to the World,” a nickname derived, in part, from the country’s history of remaining neutral during periods of international conflict.  

Switzerland has long been entrusted with managing assets from both sides of a conflict, often times, in accordance with strict secrecy standards.  In 1713, the Grand Council of Geneva made it against the law in Switzerland to reveal private information about someone’s holdings in a Swiss bank.  Switzerland has also been a proponent of sound money, and many gold refining and vaulting operations exist in and around the Swiss Alps.  For these and other reasons, it was acceptable to world financial authorities to look to Switzerland to be the home for the governing body of international banking agreements.  Basel III is the response to the Lehman Brothers bankruptcy during the Great Recession of the late 2000s.  The BIS wanted to reduce the counter party risks associated with large banks trading with one another.  Removing unallocated, paper gold positions from bank balance sheets is a large part of Basel III.

So, what are these new rules everyone is talking about, when do they go into effect, and what will be the likely result?  For many years, banks have been allowed to have an unallocated gold position on their books and to use a portion of it as collateral to help meet reserve requirements.  Beginning on June 28, 2021, the European Banking Authority plans to implement the reserve requirements of Basel III.  According to British economist and precious metals enthusiast Alasdair Macleod, this will remove 10 banks, including Swiss banks, from the LBMA system.  These banks represent 25% of the institutions using the LBMA with unallocated contracts or positions.  For these banks, unallocated gold will no longer be an allowable asset to keep on their books.  Those desiring exposure to gold will have to purchase the physical metal.

By the end of December 2021, the Prudential Regulatory Authority, which is part of the Bank of England, will implement Basel III across all of England (they oversee 1,500 financial institutions of various types).  At that point, all LBMA member banks must comply with Basel III.  Since the primary activity of the LBMA is related to unallocated gold, this will essentially mean the end of the LBMA and unallocated gold positions trading hands in London.  There will be a winding down of trading desks related to unallocated gold between now and June 28 in Europe, and between now and December 31 in the UK.  As paper unallocated gold must be removed from bank balance sheets, other assets will need to be added to take its place.  Physical gold is one of those options, and it will be considered a Tier-1 asset, weighted at full value for reserve requirement purposes.

Keep in mind that it has often been the trading of unallocated gold contracts that have been used to manipulate the spot price of gold.  Without this ability to manipulate the metal, gold will be more free to find a true market price.  And the motivation of banks will no longer be to manipulate the price to make trading profits.  They will be more content to see the price rise, because it makes their reserve positions stronger if they hold physical gold.

What about the gold contracts traded on the COMEX?  Liquidity will largely dry up from the COMEX, as firms will no longer have the arbitrage and trading business from the LBMA.  There will still be some hedging business for miners and bullion banks, but when the LBMA leaves, COMEX trading volumes will become much smaller.  

According to famed metals trading specialist Andrew Maguire, the LBMA has sent a 50-page letter requesting another delay in (or removal of) the implementation of Basel III, because of the devastating impact it will have on its existence.  Thus far, neither the regulators of the BIS, the European Banking Authority, nor the Prudential Regulatory Authority have expressed any interest in honoring the LBMA’s request.  What sway might the operators of COMEX have to slow this process?  Time will tell, but so far, not very much.  We have talked a great deal about the impacts on gold, which we’ve seen begin to manifest over the last two years as the deadlines have gotten closer.  But what impacts, if any, is there for silver?  As it turns out, lots.

Gold and silver often travel together, in a loosely coordinated dance. While there are many things that can affect price, there are no long-term trends that affect only one of the metals and not the other. Silver often moves more violently than gold, in both directions. While gold is up 45% since we started talking about Basel III (25 months ago), silver is up 89%. That is an average of 3.56% per month, for 25 months. Great time to be a silver-stacker - and the party is just getting started. As we have mentioned in previous articles, “spot price” is becoming more irrelevant as time goes on. It remains to be seen what will happen to the concept after the LBMA is moved offline.

If we look at the current price for physical metal, then the rate of return for both gold and silver is markedly higher than the spot price indicates. Especially for silver. Try 164% for 1 oz Silver Eagles from April 2019 to today. Thanks to efforts made in the recent #SilverSqueeze movement and the incessant currency creation worldwide, the implementation of Basel III could not have come at a more opportune time for the owners of gold and silver.