With the specter of a “yes” outcome to the Swiss gold referendum finally being priced in by the market, and the frontrunning of the SNB’s potential 1,500 tons of gold purchases starting to move the price of gold higher, a question has emerged: is there enough physical gold to satisfy Swiss gold demand in case of a favorable outcome to the referendum. Well, as Deutsche Bank reports, that may not even be an issue. Because as the following step by step explanation demonstrates, the SNB may simply “window dress” its balance sheet with gold swaps.
So for anyone curious how banks “represent and warrant” that they have thousands of tons of physical gold when in reality they have far less if not zero physical in storage and all in “synthetic” form, here is the blow by blow.
From Robin Winkler of Deutsche Bank
An early suggestion of the ‘gold initiative’ was to transfer Swiss gold reserves to a sovereign wealth fund to protect them from perceived mismanagement by the SNB. This idea was soon dropped. The concern behind the referendum is not the SNB’s management competence but the perceived shortage of gold reserves. Transferring the SNB’s FX reserves to a fund to avoid gold purchases would therefore be a blatant disregard of the political will and probably involve another referendum.
Gold swaps a more realistic option
Another option for the SNB would be using gold swaps to ‘window dress’ its balance sheet rather than holding physical gold or futures contracts. The SNB could borrow gold from counterparties prior to monthly balance sheet reporting dates, re-exchanging it for currency the following day.
There would be two advantages to such an approach. First, by borrowing gold to meet reserve holdings disclosure requirements for one day of the month, the SNB would be free to invest in other, higher yielding assets during the rest of it. Second, if the SNB chose to meet its gold requirements through physical or paper gold, it could still use swaps to smooth out purchases beyond the initial 5 year implementation period thereby minimizing its market footprint.
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Second, using gold swaps to meet reserve ratio requirements would be consistent with international accounting standards. Gold swaps are recognized by the IMF as a legitimate means for managing central bank reserves.
Third, the amendment does not specify whether the gold has to be in physical or derivative form. The movement behind the gold initiative had initially demanded that all gold be held in bullion, rather than in financial derivatives such as swaps, but this is not an explicit demand of the constitutional amendment. The proposal does specify that SNB gold must be held in Switzerland. In theory, however, the SNB could meet this requirement by transacting swaps with counterparties whose gold is stored in Swiss vaults.
Is the gold swap market large enough to accommodate Swiss demand? It is unknown to what extent the major central banks engage in gold swap and repo transactions, since official statistics no longer disaggregate these. The BIS alone currently holds 236 tonnes of gold under swap agreements with banks. The IMF is prevented from entering gold swaps by its statutes. National central banks would need to step into the breach, as they did pre-Bretton Woods.
Full article: How Central Banks Use Gold Swaps To “Boost” Their Gold Holdings (Zero Hedge)
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