Gold’s Identity Crisis

A very significant development took place in the US early last month which could perhaps turn out to be very bullish for gold. The OCC (Office of the Comptroller of Currency) and the FDIC (Federal Deposit Insurance Corporation) circulated a public note asking for comment on their proposal to change the risk weightage of gold from the current 50% to 100%! It’s even more pervasive – the BIS’ Basel Committee for Bank Supervision are not only contemplating  increasing the amount of regulatory capital that banks must set aside through the forthcoming Basel III rules but they are indeed contemplating giving gold a Tier I asset status (i.e. a 100% risk weight). In other words, they propose to make gold a zero risk asset. Banks have to risk weight their assets and have to set aside regulatory capital for the more riskier assets that they hold. If gold becomes zero risk weighted then this will release a lot of steam from the banks’ balance sheets. This move (as also the proposal to ask banks to put aside more regulatory capital going forward) if implemented from 1Jan’13 onwards, will effectively put gold on the same pedestal as US treasuries and it logically seems that the yellow metal will see a run to catch up with the handsome gains that US treasuries have witnessed in recent times.

To investigate myself, I studied the correlation between the gold and equity prices (Gold in $ terms vs. the DJIA). The result (blue line) is shown below. The red line shows whats happening in India by comparision – the difference, of course is due to exchange rate fluctuation. It’s clear from the charts that both gold and US equities have been moving in step since July 2011 and going by the oscillatory nature of the plot, it looks likely that this positive correlation will continue for some more months to come.

The neat divergence between the gold/equity correlations between US and India is interesting. The charts below try to show the relationship between these two sets of correlations. The picture on the left below shows all correlation pairs over the past 10 years – it’s truly inconclusive. Perhaps an indicator of India’s closed economy status and the lack of full free float in the INR? On this messy chart, I have indicated where we are today – that position is clearly on the boundary of the plot. If the law of averages holds here, then there are three possibilities for this boundary position to go away: A) the correlation between US equities and gold starts to get positive; B) gold starts behaving like a risk asset in India as well and C) both A & B happen in tandem. The chart on the right covers a much recent period (since start of CY’12). This chart zooms in to the data points pertaining to the most recent 6 months and presents another look at the hypothesis that while gold is behaving like a risky asset in the US, it is very much a safe haven in India!

I think what is happening today is that everything is moving in tandem based on “news”: Fed/ECB announce more printing of their respective curriences – everything rallies; jobs report comes out in the US – everything falls, etc etc. Is it that the markets believe that no further QEs will get done? I guess gold better decide what it really wants to be and my hunch is that the day gold’s identity crisis will be resolved will be the day that’ll mark a clear trend for the markets. On the flip side though, I guess the weirdest story would be in the eventuality that gold does get classified as a tier 1 asset, rises in price and somehow equities rise further up as well – in which case would you still dub it riskless?