LONDON (Reuters) - A small footnote in the Bank of International Settlements’ latest annual statement has flagged up a potentially major development in the way the metal can be used as an active financial instrument.
But its ultimate impact on the bullion market is dependent on the identity of the counterparty in the swap — a topic still being hotly debated in the gold community in Europe.
The BIS noted in page 163 of its annual report, released in June, that its gold holdings included 346 tonnes of gold “which the bank held in connection with gold swap operations, under which the bank exchanges currencies for physical gold”.
When analysts picked up on the move, it sparked a flurry of speculation over who the counterparty was, the origin of the gold, the impact on the market and what it said about the extent of bank stress at the height of Europe’s sovereign debt crisis.
The BIS said the gold in question was used for “pure swap operations with commercial banks”, but declined to respond to further questions from Reuters on the transaction.
The largest question mark hangs over where commercial banks would have found 346 tonnes of gold — worth around $13.5 billion (8.8 billion pounds) at today’s prices — for such an operation.
In an interview with Reuters Television this week, GFMS Chairman Philip Klapwijk said commercial banks may have had enough unallocated gold on deposit to make up such a tonnage.
But even the largest commercial banks would struggle to trade that amount on an annual basis, and as this would be on behalf of clients, it would be unavailable for swaps.
“No commercial bank has ever had 350 tonnes of gold to swap,” said Commerzbank analyst Eugen Weinberg. “Even 10 tonnes seems out of range.”
If the gold were sourced from unallocated gold accounts, that would also raise questions over the viability of the bank effectively pawning its clients’ gold to support itself.
More likely, analysts say, is that the gold was sourced from the official sector, with a central bank loaning gold to a commercial bank or banks that used it to raise currency.
“Just as the bullion banks were the go-betweens between the producer and the bullion market in the days when there was gold hedging being done, in the same way, the producer may have now been replaced by the central bank, and the investment bank may be the conduit,” said Credit Agricole analyst Robin Bhar.
The timing of the swap, which is likely to have taken place in December or January, suggests it may have been done by European commercial banks needing to source liquidity during the sovereign debt crisis of early 2010.
Of those countries on the front line of the crisis — Portugal, Greece and Spain — only Portugal has enough gold to have covered the swap, with 382.5 tonnes in its reserves. Portugal’s central bank declined to comment on the deal.
But analysts point out that banks in the nations closest to the euro zone sovereign debt crisis are not the only ones exposed to it. Commercial banks elsewhere also have exposure to problems in southern Europe.
Until recently, the amount of gold that could be used in swap operations by European central banks was limited by the Central Bank Gold Agreement, which was designed to prevent disruption of the gold market by official sector activity.
In the first two CBGAs of 1999 and 2004, signatories agreed not to increase their activities in the derivatives and lending markets above the levels of Sept 1999. But the third pact, which came into force in September 2009, included no such commitment.
So what does this mean for the gold market? The swap was first seized on as bearish, as some claimed it could lead to the BIS selling the metal on the market in the case of a default.
But the fact that the gold was mobilised for temporary financing without being sold was ultimately identified by analysts as positive.
“In conversations with clients we are consistently asked why central banks do not sell some or all of their gold to reduce their debt burden,” UBS analyst Edel Tully said.
“The latest CBGA figures, in addition to wider sovereign activity, indicate that central banks do not want to sell their gold in 2010. The BIS swap operation highlights that central banks can mobilise their gold without selling it.”
A lot will depend on the risk of default. If the counterparty in the transaction fails to redeem the gold, it could hit the market, with heavy consequences for prices.
The thesis that the swaps are connected to the financial crisis is one that can be tested. Analysts will be closely watching the next BIS statement in early August for signs that the swaps are rising, or being closed out.
“We can monitor its progress relative to the funding crisis, so if the euro crisis quietens down after the stress tests, it will go away,” said Andy Smith, senior metals analyst at Bache Commodities. “If it blows up again, it should expand.”
Editing by Sue Thomas