Commodities | Nov 18 2014
– SNB may be forced to hold 20% gold
– Would need to buy 1500 tonnes
– But there are means of circumvention
By Greg Peel
On November 30, the people of Switzerland will have to chance to vote in a referendum for which a “yes” result would require the country’s central bank, the Swiss National Bank, to hold a minimum of 20% of its official reserve assets as gold, to never sell gold once acquired, and to store all Swiss gold on Swiss territory. Currently the SNB holds only 8% of its reserves as gold.
A yes vote would thus require to SNB to purchase 1500 tonnes of gold at market prices, equivalent to more than half of annual global gold production. One can imagine just what impact this might have on the spot gold price. (See Switzerland And Significant Gold Price Upside; October 24)
The SNB has spent the years since the GFC selling a lot of gold. The main reason for the sales was the rapidly rising price of gold over the period, which blew out the percentage of gold the central bank did hold in its reserve portfolio. Profit from the sales could then be used to buy financial assets which pay a distribution. There is no distribution paid on gold.
The impetus behind the referendum, nonetheless, which has been instigated by concerned conservative observers, is a perception that SNB gold sales represent “a plundering of the nation’s intergenerational wealth and economic status”, as Deutsche Bank puts it. A requirement to hold 20% in gold would restrain the SNB from creating a risky level of “fiat” money (backed only by government guarantee). In the free-for-all money printing world of the post-GFC era, one might suggest those conservative observers have a point.
On the other hand, 20% of Switzerland’s “wealth” as defined by central bank reserves would not pay a return, and be subject to potentially violent price volatility. Immediately there is an issue that were the gold price to fall, the SNB would have to buy more gold to maintain the 20% level. Were the gold price to rise, the SNB could then sell excess percentage gold, except selling any gold is not allowable under the referendum’s prescribed rules.
Thus rather than the SNB have the opportunity to “trade” gold on what the market would call a “positive gamma” basis (always buying low and selling high), the rules would only ever result in buy-trades and a possible ever-growing reserve percentage. The SNB could, however, revert to marking its gold reserve value at purchase price rather than market price, Deutsche Bank suggests.
At this stage the polls show the yes vote ahead on a slim but distinct margin. A win requires both 50% of the population and 50% of provinces (cantons) to agree, although voting is not compulsory. Interestingly, the main Swiss political parties are recommending voters reject the proposal. The conservative SVP, to which the referendum sponsors are considered to be aligned, has not even endorsed the proposal, although the party is believed to be informally supportive at a local level.
Were the yes vote to get up, Deutsche Bank analysts concede there would likely be an impact on short-term gold price trends, but argue fears of an impact on longer term gold price trends are overblown. The SNB will have two years to repatriate its gold, held mostly in the US and Canada, and this should be easy enough. It will have five years to bring its gold level up to 20%.
Suggestions have been made the SNB could circumvent the impact of the requirement through the creation of a sovereign wealth fund alongside the central bank’s balance sheet. Deutsche does not believe this would be politically feasible. However, Deutsche does suggest the SNB could easily mitigate the impact through gold “swaps”.
In simple terms, each month when the SNB publishes its accounts it could borrow gold on the day to make up the 20% and then return it again the next.
Deutsche nevertheless does not agree with arguments from the “yes” camp there would be no inflationary impact from a 20% gold holding. The amendment would result in “a permanent constitutional expansion of the money supply,” Deutsche suggests, as the central bank would be unable to draw upon 20% of the excess liquidity it had created from the monetary system.
(When central banks move their cash rates up or down to fight inflation/disinflation, they affect this by withdrawing/injecting money out of/into the country’s monetary system.)
A “yes” vote would also bring into question the SNB’s commitment to maintaining a floor level for the euro-Swiss franc exchange rate. Neutral as always, Switzerland is neither a member of the eurozone nor the EU, yet is surrounded by the eurozone. But again there are monetary tricks the SNB could use, Deutsche suggests, which could “sterilise” gold-related liquidity creation.
The bottom line is that a “yes” vote on November 30 is likely to have an immediate upside impact on the gold price, if for no other reason the market will shift ahead of the SNB beginning its five-year purchase program. It is unlikely the SNB will place buy orders day one under such a scenario. In the longer term picture, however, there are various means by which the SNB could circumvent the impact of its gold restraints.
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