Banking capital adequacy ratios, once the domain of banking specialists
are set to become centre stage for the gold market as well as the wider
economy. In response to the global banking crisis the rules are to be
tightened in terms of the assets that banks must hold and this is
potentially going to very much favour gold. The Basel Committee for Bank
Supervision (or BCBS) as part of the BIS are arguably the highest
authority in banking supervision and it is their role to define capital
requirements through the forthcoming Basel III rules.

In short, they are meeting to consider making gold a Tier 1 asset for
commercial banks with 100% weighting rather than a Tier 3 asset with just
a 50% risk weighting as it does today. At the same time they are set to
increase the amount of capital banks must set aside as well. A double win
potentially.

Hitherto banks have been much dis-incentivised to hold gold while being
encouraged to hold arguably riskier assets such as equity capital,
currencies and debt instruments, none of which have fared too well in the
crisis. With this potential change in capital adequacy requirements. bank
purchases of gold would drive up its value relative to other high quality
qualifying assets, increasing its desirability for regulatory purposes
further. This should result in gold being re-priced to bring it on a par
with all other high quality assets.

Currently banks have to have core Tier 1 capital ratio of 4% of which will
rise to 6% from the beginning of next year. In addition to its store of
value merits, central to the argument in favour of gold as a bank reserve
is its countercyclical nature to most other assets in that it tends to be
inversely correlated. Gold is ideal as it bears no credit risk. it
involves no other counterparty and it is no one’s liability. It is a
reserve asset diversifier if you like.

This is a treble win for gold – it would be a major endorsement of its
role in preserving wealth and as a store of value from the highest
financial authority, it would lead to significant purchases of gold by
major financial institutions and it would lead to a reappraisal of its
value with respect to other Tier 1 capital such as quality sovereign debt.
Under the new rules gold could become a very significantly larger
proportion of a reserve pool which is about to grow very much larger.

The 2 questions that come to my mind are when and how much metal – on
timing Basel III kicks in from January 2013 with a further tightening in
capital adequacy ratios in 2018. That said, it is not yet clear when
gold’s re-rating to Tier 1 might take place.

With the inevitable talk of further easing from the ECB and the ‘Fed must act soon surely’, this chart via UBS shows the longer-term support channel suggesting, at least for those who follow technical analysis, that gold’s dip may be over…

John Embry, Chief Investment Strategist of Sprott Asset Management. John discusses gold and other major markets, but first, here is what Embry had to say regarding recent derivatives turmoil: 

“This makes me very uncomfortable because I’ve always been very wary of the whole derivative situation. I believe the notional value of the outstanding derivatives is comfortably north of one quadrillion dollars. The Bank of International Settlements changed the definition, so they said there is only $700 trillion worth of them, rather than one quadrillion.”

But it doesn’t make any difference, these (derivatives) are many, many multiples of the world GDP. If these things get in any trouble, and I think the JP Morgan thing may be the first sign of significant trouble again, it’s fantastically important to the whole financial situation. In a rational market the gold price should have been up $100, not down $40 in the wake of this.

I would defer to Jim Sinclair, who I have the utmost respect for on this one. He has said for a long time that the derivative situation ‘guarantees quantitative easing to infinity,’ which is one of the great statements of all-time….

“I think this JP Morgan revelation just confirms that everything Jim’s been saying for a long time on this subject is dead right. The fact that we will have QE to infinity would suggest that an intelligent person would be buying every single ounce of gold and silver he can get his hands on at these prices.

They are trying to sell this idea that gold goes down on the ‘risk off’ trades that we are experiencing now. And that the ‘risk off’ buyers all go running into the US dollar and the US bond market. I think those are two of the riskiest things on the planet. But somehow they are still getting this ‘Pavlovian response’ that when things are bad out there, you should sell your gold and buy US bonds. It’s ridiculous.

It’s important, at this time, that people who have been around, and have a pretty good grasp of what’s unfolding, should express their views to the public just to counteract the propaganda they are receiving from mainstream media. It’s tough enough out there without being lied to all of the time.”

Embry had this to say regarding gold: “What they want to do is keep it (gold) in a range. Right now that range is $1,550 to $1,900. Can it go below $1,550? Sure, in the short-run it could. But the fact is the big move coming from these levels is going to be to the upside.

Trying to pick a bottom is always a difficult thing to do. Put it this way, you’re a lot closer to a significant bottom than you are to a top.”

Sell first and ask questions later. That seems to be the global investment strategy this week. Whether it was JP Morgan’s $2 billion loss, Greece’s possible exit from the euro, or ‘Greece of America’ California’s $16 billion budget deficit, investors found plenty of reasons to sell everything. US dollar cash and US Treasuries rallied, go figure.

I see no reason for gold /silver to be getting hammered this badly, as fundamentally the debt keeps rising by about 100 billion a month in the USA alone. However due to operation Twist this is not showing up now on the Feds balance sheet. Op Twist is where the Fed buys long term bonds and keeps rates at zero for the banks to artificially create a no lose carry trade for themselves.  Banks can buy Short dated bonds and are guaranteed to make 20-30 Basis points with no risk as the Fed has told them rates will stay at zero till 2014  . . .

The only reason for gold to fall is the slight strength in the US$ index.  But the move does not / should not mean gold and silver should be getting this badly whacked! Especially given the multiple issues in Europe and Japan Debt load.

U.S. Dollar Index Daily Chart  

Gold

  The recent price action in gold has been quite ugly and price is resting at key support stemming from an intermediate-term descending channel shown above. Should the lower bound break to the downside a sharp move lower could play out.

It is important to remember that gold is coming off a monster multi-year bull run and it only serves to make sense that a nasty pullback that shakes out the bulls would be forthcoming.

Gold and silver both are starting to become oversold on the daily time frame. While the gold bugs have been feeling pain the past few weeks, the gold miners have been taken out back to the woodshed for a good whipping. The miners have been absolutely crushed in 2012 .

Gold Bugs Index Weekly Chart 

 As can be seen above, the Gold Bugs Index (HUI) has been under considerable selling pressure since early September of 2011. However, note how low the True Strength Index is based on 5 years of price data. We are nearing the same level that we saw back in 2008 which marked a major bottom that ultimately resulted in a monster move to the upside for the gold miners.

I am of the opinion that this chart demonstrates quite clearly that a great buying opportunity for gold, silver, and the miners is likely going to present itself in the near future. I will be watching this price relationship over the next while waiting for a strong entry point for a longer-term purchase. After this pullback concludes, the potential returns that could occur in gold, silver, and the miners could be breathtaking. 

The start of this week has been ugly so we may very well be there this week and with the bottom in place !