THE CANARY IN THE GOLD MINE With the euro-area crisis and associated uncertainty escalating rapidly of late, safe-haven assets are outperforming, with the notable exception of gold. Why are high-quality government bonds rallying to new highs, while gold sinks to a six-month low? A key explanation is surprisingly simple if technical: Government bonds are Tier1 capital assets, gold is not (yet). With many banks already undercapitalised, as losses mount anew, so must banks acquire additional Tier1 assets to maintain their mandated capital ratios. As such, to the extent that banks or other financial institutions hold gold, but need to raise regulatory capital, they must sell the former for the latter. This process can continue until either banks raise sufficient capital or regulators relax capital requirements. In either case, once that happens, the gold selling pressure should abate immediately. The golden ‘canary’ is singing, warning of financial system distress yet also indicating an opportunity ahead....
