Zero-Risk Gold

by: Skyler Greene

SeekingAlpha member goldmember steve recently brought an interesting development in the gold market to my attention.

[O]n 4th June the Federal Reserve, OCC (Office of the Comptroller of the Currency) and FDIC (Federal Deposit Insurance Corporation) collectively circulated a memo asking for comment on their proposed changes to the regulatory capital risk-weighting framework. Section 11, 'Other Assets', specifies that a "zero risk weight" is to be applied to "gold bullion held in the banking organization's own vaults, or held in another depository institution's vaults on an allocated basis.

The exact text can be found here (page 57) straight from

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 (such as equities, fixed income, spot foreign exchange and spot commodities) 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.

Basically, gold will have a risk-weighting of 0%, just like cash. The break from the classic 50% risk weighting of gold could dramatically impact the market. Why?

Well, a look at the CFTC charts of gold futures shows that the commercial positions in gold and noncommercial positions in gold are somewhat of an inverse: retail investors have far more long positions than short, and commercial investors have far more short positions than long.

. Source: CFTC)

Yet central banks have shown an interest in buying gold recently. You have to wonder if commercial banks will follow suit and reverse the disparity I discussed earlier.

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.

Investors following the SPDR Trust (NYSEARCA:GLD), the Sprott Trust (NYSEARCA:PHYS), or even other precious metals like silver (NYSEARCA:SLV), palladium (NYSEARCA:PALL), and platinum (NYSEARCA:PPLT) should take note and follow the development and implementation of this rule. It may be one of the most important events in the gold market since the US abandoned the gold standard.

Disclosure: I am long SLV.