Banks Crumble While Next Leg Up For Gold Prices Draws Near

July 22nd, 2012
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Money Morning Article of the Week

by Peter Krauth, Global Resources Specialist, Money Morning

Something's afoot in the world of high stakes finance.

The Basel Committee for Bank Supervision (BCBS) is about to decide something crucial to bankers, sovereign nations, and gold investors alike.

As part of the Bank of International Settlements (BIS), the BCBS is reviewing the upcoming new Basel III rules. That may sound arcane to you but I promise it's not.

Though rarely discussed in the mainstream press, the all-important Bank of International Settlements is essentially a global central bank to the world's central banks.

Follow up:

Its goal is ostensibly to provide global stability to the monetary and financial systems.

And in a surprise twist that only a few years ago would have been considered preposterous, the BCBS is entertaining whether gold should qualify as a full-fledged Tier 1 capital asset.

Currently, the precious metal is relinquished to a Tier 3 status, deserving no more than a 50% weighting at that.

Here's why that distinction is important and potentially astonishing.

Achieving Tier 1 status would credit gold with the recognition it's been denied ever since Nixon closed the gold window on August 15, 1971.

In essence, it would mark the official recognition that gold is real money.

But that's not the only reason gold is gaining respect. Other factors are brewing that will set the stage for the next leg up in gold prices.

As Banks Teeter, Gold Gains Respect

One of them is the crumbling state of world's banks. Once unwavering, the trust in these financial ivory towers is precarious at best.

In the last couple of months alone, Greek depositors have withdrawn billions of euros in deposits, as the fear of a "Grexit" looms large.

Not to be outdone, Spain banks have been emasculated by the Iberian nation's own bursting real estate bubble. After denying for weeks that a bailout would be required, officials finally caved to a "Spailout", giving Spain's banking system a 100 billion euro rescue package.

This phenomenon is not exclusive to the Eurozone either.

Around the world, banks are under intense pressure from depositors, regulators, and even tardy ratings agencies.

In fact, Moody's recently downgraded 15 of the world's largest global financial institutions including those "too big to fail" behemoths.

We're talking about Goldman Sachs, Citigroup, Morgan Stanley, Bank of America, Credit Suisse, and a host of other European and foreign banks. Some of them fell as far as three ratings notches.

While the shares of many of those same banks rallied briefly on the news, the longer-term impacts are likely to be ignored by a majority of investors, at their own peril.

These recent downgrades mean many affected banks will have to post higher collateral to their partners when trading derivatives.

Bob Young, managing director of North American banking for Moody's, said every one of the concerned U.S. banks was placed on negative watch, signifying they could be subject to further downgrades.

To stem the risk of future meltdowns, regulators are now requiring banks to keep no less than 4% of their capital in Tier 1 assets, which are exclusively AAA-rated holdings, according to ratings agencies and regulators alike.

There's that phrase again---Tier 1 assets. In the future that may mean more gold, depending on how the BSBC rules.

But there's a third part to this story. Increasingly, the ownership of physical gold remains "sticky".

The Ongoing Accumulation of Gold

Even when the price of gold endures a prolonged selloff as it has for several months, gold ETFs rarely see much of a decline in their total holdings.
In the past year or so, central banks across the globe have become net buyers of gold bullion, reversing a multi-decade trend.

Gold is also readily finding its way into a growing number of investment accounts as well.

According to Scott Powers, President and CEO of State Street Global Advisors (SSGA), the #2 money manager in the world with $ 2.3 trillion in assets under management, gold and "real assets" are an important component of client portfolios.

For discretionary accounts, SSGA recommends a 5% -15% weighting in hard assets, with gold representing a significant portion.

Surely, it doesn't hurt that SSGA are the sponsors of the SPDR Gold Shares (NYSE:
GLD), the second-largest exchange-traded fund in the world.

When such a large money manager considers gold not only legitimate but essential and recommends significant exposure to its clients, that speaks volumes about the level of recognition gold has achieved.

Clearly gold has gained favour not only with the world's largest money managers, but even with central banks which are now accumulating the metal at a growing pace.

Right now it's the perfect storm of ongoing aftershocks of the 2008 financial meltdown and the unrelenting rise and strength in the
price of gold that may help it regain the financial respect it deserves.

Today, it seems even the BIS and commercial banks, those relentless proponents of fiat money, could well be forced to admit what's becoming increasingly clear: gold is real money, free of both counterparty
and credit risk.

An increase from 4% to 6% Tier 1 capital requirements, together with a favorable revision as a full-fledged Tier 1 asset, could combine to trigger the next massive upleg in the gold secular bull market.

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About the Author

Peter Krauth is a former portfolio adviser and a 20-year veteran of the resource market - with special expertise in energy, metals, and mining stocks. Peter uses the connections he amassed over the years to exploit the moneymaking potential of every kind of commodity. As editor of Real Asset Returns, he travels around the world to dig up the latest and greatest profit opportunity. Peter has also contributed some of the most widely read and highly regarded investing articles on Money Morning. Learn more about Peter on Money Morning contributors page.


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