Goldspread

Tuesday’s unanimous agreement by the European Parliament’s Committee on Economic and Monetary Affairs (ECON) to allow central counterparties to accept gold as collateral, under the European Market Infrastructure Regulation (EMIR), is further recognition of gold’s growing relevance as a high quality liquid asset.

World Gold Council provides four reasons that make gold the perfect collateral:

1. Nil credit risk

Gold is having no credit risk especially as government bonds are losing their sheen in the wake of financial crises and facing downgrade possibilities. Real estate, currency, notes, bonds or bills; every collateral faces one or the other kind of value erosion. Gold is immune to such value fluctuations that damage growth and investments.

2. Transparency in pricing

Gold is arguably best in maintaining a transparent pricing system even as a majority of trading happens in the OTC market. Even there, the market makers are obliged to quote a two-way price in gold continuously throughout the day.

Further, the price of gold is fixed twice daily in London (the AM and PM fix) which forms the international benchmark.

3. Deep, liquid market

Gold market is having a deep pocket. At the end of 2010, above-the-ground gold stocks were estimated by GFMS at 166,600 tons. This figure, in 2010 value terms means a whopping $6.5 trillion. With this money half the debt of US could be paid off!

Of the $6.5 trillion worth of gold, about $2.5 trillion worth are carried by the private individuals, and official institutions in the form of coins and bars.

Between December 2010 and February 2010, IMF had sold 181 tons of gold in the OTC market creating nil ripples which is a testimony to the market’s appetite for the yellow metal.

4. Diverse holding pattern viability

Gold forms a class in itself as it is different from bonds and other financial assets in its diversity of holding. Investment is not the only option by which value accumulates in gold. “Over the past 5 years, 58% of gold demand came from jewellery sector, 30% from investment and 12% from technology…”, says World Gold Council.

Background

Market demand for gold to be used as a high quality liquid asset and as collateral has been building for some time. In late 2010, ICE Clear Europe, a leading European derivatives clearing house, became the first clearing house in Europe to accept gold as collateral.

In February 2011, JP Morgan became the first bank to accept gold bullion as collateral via its tri-party collateral management arm. Exchanges across the world, such as Chicago Mercantile Exchange, are now accepting gold as collateral for certain trades and London-based clearing house LCH Clearnet has said that it also plans to start accepting gold as collateral later this year, subject to regulatory approval.

As regulators, from G20 countries, demand that more OTC trading is cleared on exchanges and with the ongoing world economic difficulties further eroding the credit worthiness of other forms of collateral, World Gold Council expects to see increasing demand by clearing houses, exchanges and investment banks to use gold as collateral.