Will Saving Switzerland’s Gold Save The Day?

 | Oct 23, 2014 07:07AM ET

h2 Forex News and Events

On November 30th, Swiss people will vote to decide whether

- The SNB should hold 20% of its reserves in gold,

- The gold reserves should be stored in Switzerland,

- The SNB should be allowed to sell its gold reserves.

The recent polls revealed 45% support for the campaign, while we believe that the likelihood of a “yes” vote is limited. Both chambers of Swiss parliament are heavily opposed to the “golden cage”. One thing is sure: polls tend to be unstable and therefore should inject some volatility to relatively quiet Swiss markets in month ahead.

In a recent interview, Swiss Finance Minister Eveline Widmer-Schlumph said the current 1,040 tons of gold reserve is more than sufficient to taper risk-off periods. To which we add that the negative correlation breakdowns since 2007 crisis has proven that the gold is not a perfect hedge nowadays. Nor a source of stability. As the VIX index surged 80% in October 2008, the 1-month realized volatility in XAU/USD spiked to 56%, the 1-month implied vol neared 58%. This is certainly not a track record one seeks in a safe-haven investment.

In this respect, to condemn one fifth of SNB’s balance sheet to a risk asset is not efficient from a portfolio point of view. Even if this was the case, there is no restriction preventing SNB from allocating 20% of its assets into gold.

The SNB currently holds about 8% of its reserves in gold (USD 43bn of gold holdings versus CHF 522bn balance sheet). Introducing the potential 20% bottom will therefore require a sizeable market operation, the necessity is somewhat uncertain. Especially regarding the quantities on table, a 1500-ton XAU-long operation (in five year period) can hardly be profitable for the SNB. Given that the annual mine production nears 3000 tons, this would mean that the SNB would buy 10% of world’s mine production per year during the five next years. This additional gold demand can only push the gold prices higher and increase the cost of the operation. In addition, a “yes” vote will certainly boost speculative demand and provide an additional leveraged lift to the market, pushing the gold prices disproportionally higher! At the end of the game, the SNB would only constitute an expensive reserve in a quiet risky asset.

The gold initiative is therefore a heavy constraint on SNB strategy and would only limit the independence and efficiency of SNB’s investment activities. In fact, the SNB, unlike its worldwide peers, has a meaningful maneuver margin on its activities. While the majority of its counterparts invest mostly in sovereign bonds, the SNB has the flexibility to hold 30% of its balance sheet in foreign assets, corporate or sovereign, which provides interesting geographical diversification and undisputable time advantage. In 2008, the SNB opened a branch in Singapore “to extend its coverage of markets in Asia”, “to ensure a more efficient management of its assets in the Asia-Pacific region” and more importantly to “facilitate round-the-clock operations on the FX market”.

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It would only be dangerous and expensive to narrow SNB’s maneuver margin. The SNB has already an important constraint: it should defend its 1.20 floor versus the euro. The situation in the Euro-zone remains alarming with the possibility of QE introduction in the close future. Although we do not see an immediate impact on the franc, the SNB clearly needs to keep the entire control at hand, and that rules out the sizeable 20% gold constraint that a “yes” vote would require.

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