On May 25, the European Parliament’s Committee on Economic and Monetary Affairs (ECON) unanimously approved the acceptance of gold as collateral by central counter parties, that is, financial institutions that operate as intermediaries between securities and market participants.
“It is very significant that the European Parliament is putting its weight behind the argument that the unique characteristics of gold make it an ideal form of high quality liquid collateral,” said Natalie Dempster, director of government affairs at the World Gold Council (WGC), in a recent press release.
At this time, the vote by ECON is not binding, as the European Parliament and Council of the European Union must ratify it and vote for or against its inclusion into the European Market Infrastructure Regulation (EMIR) after the July plenary vote. The plenary vote requires all assembly or meeting participants to be present during the vote.
“The ratification would mark a significant step forward in redefining what constitutes a highly liquid asset under the Capital Requirements IV Directive, due in the coming month, from the European Commission,” Dempster said.
Gold Accepted as Collateral
The Europeans are a little late in jumping on the bandwagon. The Chicago Mercantile Exchange Inc. (CME) announced on Oct. 16, 2009, that beginning on Oct. 19, it would accept gold as collateral. J.P. Morgan Chase Bank in London, England, was assigned as depository.
“CME Clearing is introducing an enhancement to the existing Performance Bond Collateral schedule. Effective October 19, 2009, firms will be able to post physical gold to CME Clearing to cover non-segregated (NSEG) Performance Bond requirements,” announced CME in its 2009 press release.
Since March 17 of this year, the New York J.P. Morgan Chase Bank NA became an additional depositary for gold. Other depositories include: Brink’s Inc., HSBC Bank USA, Bank of Nova Scotia, and Ledoux & Company Weighmasters.
IntercontinentalExchange Inc. (ICE), a leading regulated European exchange, trading platform, and clearing house, announced in November 2010 that it would accept gold bullion as collateral for energy and credit default swaps (under such an arrangement, the buyer has credit protection and the seller guarantees that the product is creditworthy), in addition to cash and government securities, which are already accepted as collateral.
“We are pleased to offer these enhancements as the first clearing house in Europe to permit gold bullion as collateral,” said Paul Swann, president of ICE Clear Europe, in a press release.
JPMorgan Chase & Co. made the move toward accepting gold as collateral in February of this year and relegated J.P. Morgan’s Worldwide Securities Services as the division with responsibility for the gold. The firm also let it be known that other precious metals may join the collateral list this year.
“J.P. Morgan today announced it is the only tri-party collateral manager to accept physical gold as collateral to satisfy securities lending and repo obligations with counterparties. This comes as more clients look to use gold as a hedge against inflation and to post as collateral,” according to J.P. Morgan’s February press release.
In early December 2010, LCH.Clearnet, another independent clearing house group that serves the major international exchanges and platforms, included gold as a price risk management tool, as well as aluminum, copper, tin, nickel, zinc, lead, and other precious metals.
“We wanted to bring all the benefits of clearing to the bullion market, whilst enabling them to preserve the OTC [over-the-counter] nature of the business which makes it such a success. Together with the LME [London Metal Exchange], we look forward to supporting the future growth of the bullion market,” said Roger Liddell, chief executive of LCH.Clearnet.
However, LCH.Clearnet has not accepted gold as collateral yet, but has begun the process and will most likely accept it by the end of this year, according to the WGC.
Next...Gold Lessens Credit Risk
Gold Lessens Credit Risk
“Gold’s strong price gains in recent years have seen its appeal as collateral increase. ... The G20 said it wanted to try to reduce financial market risks by putting more products into clearing houses, increasing the demand for collateral as security against risks,” according to a May 25 NASDAQ press release.
Gold has become, in the minds of financial experts, the perfect collateral asset, as European government bonds and other traditional collateral have become more and more risky for the lending community.
“Gold is emerging as a solution. Its lack of credit risk and countercyclical behaviour make it an ideal source of collateral,” said the WGC in its recently published report “Gold as a Source of Collateral.”
Anyone who holds gold is exposed to very little credit and market risk. Gold may be valued much more easily than any other recognized collateral and is seen as a valued trading vehicle.
“There is no credit risk associated with gold after it has been settled. By contrast, credit risks on other collateral assets have grown discernibly recently,” according to the WGC’s report.
Gold pricing is very transparent and easily available. With the price set twice daily in London, the London gold price is commonly used as a benchmark for pricing gold worldwide.
ICE and LCH.Clearnet are in complete agreement with the WGC position and have told the world that gold is much more useful than any other presently recognized collateral.
Additionally, the value of gold has increased significantly since 2000. According to Kitco, an online precious metals store, in 2000 gold averaged around $279 per ounce and continued to move up slowly from year to year. By 2005, it had reached $445 per ounce. In 2006, it averaged $604 and by 2010, it reached an average of $972 per ounce.
In 2011, the gold price has fluctuated between a low of $1319 and a high of $1535 per ounce. On May 28, the gold price per ounce stood at $1,535,95, according to the Gold Price website.
Investors have been clamoring for gold and demand has risen by more than 1,000 tons over the past five years.
“The demand and supply dynamics of the gold market underpins the precious metal’s extensive appeal and functionality, including its characteristics as an investment vehicle,” according to the WGC’s website.
The supply of gold generally flows toward jewelry production (57 percent), investments (31 percent), and industrial use (11 percent).
A little less than 60 percent of the five-year average of gold supply comes from mining, 35 percent comes from recycled gold, and 6 percent from official gold sales.
East Asia, the Indian subcontinent, and the Middle East combined consume 70 percent of the world’s gold supply, with China, Hong Kong, the United States, Turkey, and Saudi Arabia swallowing half of it.
Gold Confiscation Materializing
“The European Gold Confiscation Scheme Unfolds” states the headline of a May article on the Zero Hedge website. “Wonder why Europe is pressing so hard for Greece (and soon the other PIIGS [Portugal, Italy, Ireland, Greece, Spain]) to collaterize its pre-petition loans on a Debtor in Possession basis?” asks the article.
Debt-ridden countries, such as Italy, which owns 2,451.8 tons of gold; Portugal, which owns 382.5 tons of gold; the United Kingdom, which holds 310.3 tons of gold; and Spain, which holds 281.6 tons of gold, still have some value, as the gold can be used as collateral, making the European Parliament’s acceptance of gold as collateral a very smart move.
Greece, one of Europe’s debt-laden countries, owns 111.5 tons of gold. The storage location is not known, but it is assumed to be at the Federal Reserve Bank of New York, according to Zero Hedge.
“Greek reserves have already been ple[d]ged as collateral with the first loan treaty and greek gold is held at UBS Switzerland and the Bank of England,” chastised a respondent to the Zero Hedge article.
