The Phaserl


The Basel III Gamechanger for Gold and Faux AAA Sovereign Debt

by Russ Winter, Financial Sense:

Do a Google search for Basel III, gold and tier 1 and you will see a lot of bullish chatter about banking regulations and moving gold from tier 3 to tier 1 or quasi tier 1 status. Gold is being brought back, at least in part, into the global financial system as money, ending the argument that it has no utility.

Basel III (and Basel II) divides bank assets into three risk categories (credit, market and liquidity risk) and weights its risk depending on its attributes. Gold is “zero percent risk-weighted” in terms of credit risk. This is a huge upgrade for the metal. Delving into the nuances, gold still has “market risk” stemming from its price fluctuations. This means capital must be marked to market. Physical gold is not treated the same as cash or AAA to AA- sovereign bonds when it comes to calculating its Tier 1 ratio. The market risk will only be negative if the value of the price of gold (POG) drops.

But what happens if POG takes off? Then well-positioned banks would see a boost in capital. The chance of getting a capital boost holding the assortment of faux, central-bank-inflated, “higher-rated,” no-return sovereign bonds is nearly zero. How much upside is there in a two-year U.S. Treasury yielding 25 basis points? The fact is that in a steep sell off, liquidity would erode fast. Some may argue that banks won’t make a directional gold bet using their equity as the buffer. I would argue that they make directional bets with currencies and bonds every day.

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