Swiss Gold Update: What A “Yes” Vote On Nov. 30 Means For Gold Investors
Commodity Trade Mantra | Nov 26, 2014 11:48PM ET
A Swiss Gold Referendum will take place on Nov. 30, 2014 — just 5 days from now. Its terms prohibit the Swiss National Bank (the central bank) from selling any gold, require the bank to purchase gold up to the level of 20% of Swiss reserves and require that all Swiss gold held abroad be returned to Switzerland.
If it obtains a majority “yes” vote, it becomes law despite the objections of bankers and politicians. This would deliver both a demand shock and a supply shock. The gold market and central banks are whistling past this graveyard. They may be in for a shock when the votes are counted.
I have spoken to a number of economists, bankers, gold dealers and other people directly involved in the upcoming referendum. The one thing everyone says is that regardless of your view on the referendum vote, they will abide by the referendum results.
There is certainly a large group in Switzerland that is opposed to the gold referendum. But even the group that opposes the referendum says that if it passes, they will respect the democratic process and the will of the Swiss people. I think that’s important to bear in mind because unfortunately that respect doesn’t exist in every country.
So that brings us to what the referendum would actually do. The Swiss can vote “yes” or “no”. If they vote no, nothing changes. If they vote yes, it requires the Swiss National Bank to hold 20% of their assets in gold.
Any central bank has a leveraged balance sheet. They create money digitally and then use it to buy other assets. They can buy bonds, which the Federal Reserve does, or they can buy other currencies, or some central banks can buy anything. For example, the Japanese central bank has the capacity to buy equities.
In any case, central banks have balance sheets. They have a certain amount of liabilities, which is the money they create, and then their assets. What the referendum would do is force the Swiss National Bank to have 20% of its assets in gold. Right now they do not have that much.
They would have to go and buy a very substantial amount of gold on the market to meet that requirement.
Second, the referendum would require that all of the Swiss gold held abroad has to be brought back to Switzerland. A lot of people say that they have to get their gold out of the Federal Reserve Bank of New York, but that’s actually not correct. The Swiss gold is not held in New York.
10% of it is held in Canada in Toronto and then about 30% of it is held in the U.K. in London. Then the remainder is held in Switzerland. The other part — the part that’s held in the U.K. and Canada would have to be brought back.
A lot of people say, “Well, gee, you have gold in a vault in Canada and you pack it up put it on a plane and move it to a vault in Switzerland. What difference does it make? It goes from one vault to another vault. It’s still underground and it doesn’t change the supply of gold at all.”
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Well, it’s true that a move like that does not change the total supply of gold. But it does reduce the floating supply. The floating supply is the gold that’s available for pledging to support paper gold contracts.
What are paper gold contracts? A lot of customers say, “I want to own gold”. So they call up big banks, one of the London Bullion Market Association banks and say, “I’d like to buy some gold”. If you read the fine print of the gold contracts they sell you, however, it says that the gold is unallocated. What that means is that the banks have a certain amount of gold in their vaults and they can sell that gold more than once. So they can sell the same gold 10, 15 or 20 times.
So a bank may have ten tons of gold and use it to back 100 tons of unallocated gold contracts. The idea is that, just like any aspect of banking, all of the customers don’t come at the same time and ask for their gold back. If they do the banks have to go out and buy that much gold to satisfy the demands. The banks have suspected that will not happen however.
This is one of the ways — but not the only way — that banks, and central banks in particular, can use to manipulate the gold market and keep the price down. When you put a lot of selling pressure in the market that tends to reduce the price. If there’s demand and you’re able to meet the demand that tends to put a lid on the price.
As long as there is gold available and pledged — or, “rehypothecated” is the technical term — ten, twenty or even fifty times that puts a lot of gold on sale in the market that doesn’t actually exist. That keeps the price down.
To do that, the banks need some amount of gold to back up those unallocated sales. That gold is in London… New York… and, to a lesser extent, Canada. When gold is moved from a place like London or Canada to Switzerland the total supply isn’t changed, the floating supply is. In other words, the paper gold game banks play is made more dangerous. Think of it as an inverted pyramid.
As you keep making the amount of gold the pyramid rests on smaller, you either have to shrink the pyramid or the whole thing becomes unstable. You get closer and closer to a point where the price of gold could skyrocket because suddenly somebody can’t deliver the gold because there’s not enough gold to go around.
You can see a lot of gold from around the world being pulled out of banks and put into other kinds of storage where it’s not available to support the paper gold market. I saw this in a recent visit to Switzerland. I met with VIA-MAT — a private vault (i.e. a non-bank vault), which is one of the biggest private vaults in the world.
They said they’re getting a lot of gold inflows from just down the street — meaning in Switzerland. They were in Zurich where there is UBS and Credit Suisse (SIX:CSGN) and branches of Deutsche Bank (NYSE:DB) and others and here’s a vault just a couple miles outside of town in a place called Clauten and the gold was moving from UBS SIX:UBSN) to VIA-MAT. Again, no change in the total gold supply, but a change in the floating gold supply.
The third thing the Swiss gold referendum would require is that the Swiss National Bank would not be allowed to sell any of its gold. It’s kind of a Roach motel — a one-way street where, once Switzerland gets this gold and puts it in its vaults, it has to stay there. It can’t go back on the market.
Putting it all together… First, the Swiss National Bank would not be allowed to sell any gold… Second, they’d have to get all of their gold back… And third, they’d have to maintain 20% of their assets in gold. And since they don’t have the gold to meet that ratio, they’d have to buy — analysts estimate — 1,500 tons of gold, which is an enormous amount.
If you’re unfamiliar with the gold market… 1,500 tons is more than half of world production for a full year. The world produces about 2,500 tons, sometimes more, but even if we had a big year and it got up as high as, say, 3,000 tons, 1,500 tons would still be half of annual production.
I can tell you from my own meetings and conversations with gold dealers — people who actually handle the physical stuff — that the physical supplies are extremely tight. It would take the Swiss a very long time to buy 1,500 tons of gold. They’d probably have to do what the Chinese are doing which is buy the gold in chunks on an ongoing basis.
There’s something else going on, as well. The Swiss National Bank is trying to maintain a peg to the euro. They’re trying to keep their currency, the Swiss franc, from getting too strong. Left to its own devices, the Swiss franc would actually be much stronger than it is today. The way they keep a lid on it is by printing Swiss francs and buying euros to maintain the peg.
Well now, if the referendum passes and the Swiss National Bank has to have 20% of its assets in gold… but meanwhile, it’s printing more and more francs to buy euros (increasing its assets)… the SNB is going to have to buy even more gold.
And, of course, what would the 20% gold backing do to the franc? It would make it stronger against the euro… which would force the Swiss National Bank to print even more to maintain the peg… which would force it to buy even more gold and so on. They’d be in a feedback loop that they’d never get out of. The government would have to abandon the peg and let the Swiss franc move freely against the euro and the dollar.
Putting all of these things together, the Swiss gold referendum could have a massive impact on the gold market. It would be extremely bullish, not only putting a floor under gold but also sending the price of gold up significantly. The price would stay there too because the buying pressure would not go away — the Swiss would be in the market for years.
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