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Central Banks Buying Most Gold Since 1971?

Over the last several years, big institutions have been acquiring gold at a feverish pace. Countries such as Russia and China accumulate massive amounts of the yellow metal each month. According to the World Gold Council, central banks added 651.5 tons of gold in 2018, an increase of 75% year-over-year while countries such as Hungary, Kazakhstan, and India increased their holdings as well. Global gold demand rose 4% year-over-year to 4,345 tons, according to the World Gold Council. Additionally, jewelry demand for gold remained level year-over-year at 2,200 tons. Demand for gold bars and coins expanded 4% to 1,090 tons last year.

Any Standard?

One must wonder why central bank net purchases of gold are at the highest level since 1971. Nixon ended the gold standard in 1971 as the U.S. went to the petrodollar and anyone who pays any attention to the graph of debt knows that it has gone up exponentially since 1971. We know that gold is the best hedge for counter-party risk. Geopolitical tensions around the world make owning gold a prudent play, as you don’t have to rely on fiat currency controlled by other countries. Everyone knows this fiat regime is not sustainable and Earth is dying around us due to over-consumption. Humans are greedy and always wanting more, needing to be held accountable and having some sort of standard. A form of gold standard would help re-engineer the imbalances all over the globe. Politically, a gold standard is extremely unlikely, but why are central banks still buying gold?

Basel Accords

   What does Basel, Switzerland have to do with gold? Well, it has everything to do with gold and global finance. The Germans used to hide their gold in the Swiss Alps. The Swiss franc is considered to be one the most-sound fiat currencies in the world.  Basel is the home of the Bank of International Settlements, the bank of all banks. There is a little rule switch happening at the corner of the financial system in 2019. It is not something that I have heard mentioned often. Many in the financial world have heard of the Basel Accords, which are rules put in place for capital requirements on banks.

The Basel committee on banking supervision was formed in 1974 as a committee where members could coordinate issues relating to banking supervision matters. The committee issued Basel I in 1988, which classified risk assessment for different assets in 5 different categories ranging from 0 to 100%. The 50% category was made up of residential mortgages and the 100% category is made up of private sector, non-OECD bank, real estate, plant, and equipment debt. According to the rules, the banks must contain at least 8% of their risk-weighted assets in these categories.

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  Basel II is based on three tiers, including minimum capital requirements, regulatory supervision, and market discipline. Basel II laid the groundwork for defining regulatory capital for risk-weighted assets. Under Basel II, gold was considered a tier-3 asset and had a 50% risk-weighted assessment. This meant that banks could only assign 50% of gold market value toward its total reserves. Under Basel III, there are now only two tiers, and gold is moving to a tier-1 asset. All systemically important financial institutions must comply with new Basel III capital requirements. Under Basel III, banks can now use 100% of gold market value towards reserves.

Gold held in vaults is essentially cash and can make a bank’s reserves look much better. With negative interest rates being charged around the world, it makes sense for a smart banker to hold gold as a hedge against fiat. A risk-free 0% versus risk of bank defaults and a negative-percent return makes no sense. With all the gold accumulation happening by central banks, this new Basel III rule that takes effect in 2019 may be the reason for such big accumulation. If central banks are buying it and hedging their risk, the average person on the street should as well.

Cheers,

Colin

 

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