During the summer months, most investors take a break. Volatility goes down, and market trends contract. As fall arrives, activity levels start to grow, and gold becomes more volatile. However, there is a new risk factor that could affect the market this year: Basel 3.
Basel 3 is a set of recommendations aimed at making the financial world more stable. According to the demands of the Federal Ministry of Finance, banks will need to increase their capital and provide additional capital reserves.
The new rules also state that paper gold (such as gold futures, forward contracts, and options) will be classified as riskier than physical gold in the form of coins and bars. This means that banks will have to allocate more liquidity to back these paper assets (up to 80% of the asset’s value), same as for loans, for example. This will make holding paper gold less profitable for banks and cause some institutions to close such positions.
This, in turn, will reduce the liquidity of paper gold in the interbank market and can cause increased volatility. Considering that London banks hold vast amounts of gold delivery obligations (10,000 tons, according to some estimates), and that each gold bar in the dealers’ vaults has been sold and re-sold dozens of times, mass liquidations of such positions can cause a rapid spike of demand for physical gold – and, consequently, of its price.
One can expect banks to close their paper gold positions gradually to avoid a price pump. This strategy will lead to a long-term rise in physical gold prices.
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