Is Gold a Zero Risk Financial Asset?

Gold has been called many things over the past several years. The shiny yellow metal is seen as a safe-haven to some, but a barbaric lifeless asset by others. In short, gold has trouble receiving a wide range of support as a key player in the global financial system. However, new developments may slowly change how investors and institutions view the precious metal.

Earlier this month, U.S. federal bank regulators issued a proposed rule-making note regarding capital risk-weightings for various assets. The Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency and the Federal Reserve asked for comments on a move that would place a “zero-risk-weight” rating on gold bullion held in banking organization’s own vaults, or held in another depository institution’s vaults on an allocated basis.

The full note can be found at FDIC.gov and Section 11 on page 57 states, “A zero percent risk weight to cash owned and held in all of a banking organization’s offices or in transit; gold bullion held in the banking organization’s own vaults, or held in another depository institution’s vaults on an allocated basis to the extent gold bullion assets are offset by gold bullion liabilities; and to exposures that arise from the settlement of cash transactions with a central counterparty where there is no assumption of ongoing counterparty credit risk by the central counterparty after settlement of the trade and associated default fund contributions.”

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The move will essentially place gold on the same risk level as cold hard cash, zero percent. Historically, gold has received a risk weighting of 50 percent. If the proposal stands, it appears that banks will have more flexibility and will not have their regulatory capital ratios punished for holding gold as a safe-haven, instead of government bonds or fiat currency. This will likely help gold be seen more as a true safe-haven in financial markets and further drive gold bullion demand, which is already at historic highs among central banks.

John Butler, chief investment officer at Amphora, explains, “A key reason why gold has not been acting like a safe-haven asset in recent months is because banks are so capital impaired that they are scrambling to reduce their holdings of risky assets in favour of so-called ‘zero-risk-weighted’ assets, against which they needn’t set aside any regulatory capital. As it stands, gold has a 50 percent risk-weighting. But some government bonds, including US Treasuries, German Bunds and British gilts, are zero-risk-weighted.” Interestingly, Standard and Poor’s downgraded the United States’ credit rating for the first time ever last year. Yesterday, Egan-Jones credit ratings agency downgraded Germany by one notch from AA- to A+ with a negative watch. The effort to reevaluate the meaning of “zero risk” appears to be long overdue.

While we do not expect the proposal to make gold prices skyrocket overnight if approved, as gold bullion positions will be hedged, it does aid the recognition that gold is an important financial asset that lacks counterparty and downgrade risk, making it the ideal safe-haven. Some of the world’s largest and most powerful organizations have already realized this. The Bank for International Settlements, which is basically an international central bank looking over other central banks, recently released its latest annual report. It showed that the BIS reported a profit of Special Drawing Rights 758.9 million. However, about 15 percent of that profit came from the sale of physical gold and the repayment of gold loans. Apparently, gold is not as lifeless as some may think.

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Disclosure: Long EXK, AG, HL, PHYS