Federal Reserve Mulling New Gold Regulation; ‘May be biggest event in gold market since US dropped gold standard’

US authorities have recently called for comment on a rule change that may impact the gold market.

The US Treasury, Federal Reserve and the FDIC have jointly sought comment on changing some capital adequacy rules for when an institution holds gold in its own vaults or in another’s vaults.

According to the draft documents released, when gold is currently held as an asset, it is risk weighted at 15% – that is, a 15% haircut is taken on its current value for capital adequacy calculations. (See page 86 of the attached Federal Reserve document.)

However, in this same document, they are proposing that there be no (zero) discount.

That would then put gold on the same basis as cash.

217.131 Mechanics for Calculating Total Wholesale and Retail Risk-Weighted Assets.

(i) A bank holding company or savings and loan holding company may assign a riskweighted asset amount of zero to cash owned and held in all offices of subsidiary depository institutions or in transit; and for gold bullion held in a subsidiary depository institution’s own vaults, or held in another depository institution’s vaults on an allocated basis, to the extent the gold bullion assets are offset by gold bullion liabilities.

This seems an adventurous move. Over the past five years, the US$ value of gold has moved more than +/-50% from its average over that time, and is currently sitting -20% below its high in that same period. In cash terms, there certainly has been market price risk.

However, as Skyler Greene at Seeking Alpha points out, the break from the current risk weighting of gold could impact the market.

He points out that retail investors have more long positions in gold futures than short ones, while “commercial investors” have far more short positions than long. If the rule change is approved, perhaps US banks will start accumulating more gold as an efficient way to bolster their capital.

It’s important to note two things. First, the rule change is only proposed. Second, gold isn’t going to go sky-high on the news, because banks are unlikely to buy market-distorting amounts of the shiny metal. However, a steady buyer of gold can’t hurt the market, and if the rule change goes through, “it may well set the stage for a long-term gold rally”.

Fans of gold are taking an interest in this potential development. As Greene notes: “It may be one of the most important events in the gold market since the US abandoned the gold standard.”