Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Hans F. Olsen,Global Head of Investment Strategy at Barclays Wealth discusses the fate of the gold price.
Referendums are a way for democracies to put an issue directly to the electorate to decide. The issue might be a constitutional amendment; a vote on independence; the legalisation of marijuana; or the legality of bear baiting. In the rarified world of central banking, a Swiss referendum on November 30 mandating the country’s central bank to hold a large portion of its assets in gold captured my attention. In the post-Great Crisis age, central banks are the apex player in economic and financial matters. Consequently, an effort to materially limit a central bank’s degree of freedom is a noteworthy event.
The initiative, called Save our Swiss Gold, is the product of the Swiss People’s Party, a centre-right political party that seeks to create a stable currency for the country by requiring the central bank to repatriate the gold it holds outside Switzerland, prohibiting it from selling any of its gold, and finally, mandating it to hold at least 20% of its assets in the precious metal.
According to reports, a recent poll by a Bern public opinion firm showed support for the plan has fallen to 38%, while those opposing it stands at 47%. Undecided voters will be the swing factor, as they represent 15% of those surveyed. This represents a reversal of fortune for initiative supporters, as a poll conducted last month revealed supporters held the advantage to those opposed to the plan by 44% to 39%.
Giving the Central Bank Room to Manoeuvre
This change in mood represents a reassuring turn of events for the Swiss National Bank (SNB) and central banking at large. Were the initiative to pass, it would undoubtedly inspire similar initiatives in other countries. Moreover, it would fundamentally change the efficacy of a central bank’s role in the markets and the economies in which they operate. In times of extremis, the considerable flexibility of central banks to provide liquidity to markets is a critical element in arresting episodes of panic and crisis.
These exertions buy markets time to find a footing and provide time for the formation of public/private responses to the offending event. In the case of the Save Our Swiss Gold initiative, the central bank’s balance sheet would be ossified, since any expansion to its balance sheet could never be fully contracted; at least 20% of the expansion would be mandated to be held in gold, which could never be sold.
Over time, through normal central bank operation, gold would eventually consume the bank’s balance sheet, rendering the institution impotent to respond as needed to economic and market conditions.
To wit, the SNB is currently engaged in the herculean effort of maintaining a Swiss Franc-Euro peg target of 1.20 to prevent a rising franc from hurting the Swiss economy. In its successful campaign to prevent a rise in the franc, the central bank has had to expand its balance sheet considerably. Passage of the initiative would be a monumental, if not fatal, impediment to the central bank maintaining this program.
In an odd twist of fate, passage of the initiative would require the bank to repurchase gold it sold years ago at prices that are approximately four times higher, forcing the country into the unenviable position of selling low and buying high, which strikes me as a very un-Swiss thing to do.
Recently I spent a week in Switzerland meeting clients in Zurich and Geneva. The consensus of investors I spoke with is that the initiative, as recent polling suggests, will not pass. Gold bugs seeking a catalyst to support higher prices will have to look elsewhere such as falling mine production for a change in trend.
Disclaimer
The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring your content on our website, please email submissions to UKEditorial@morningstar.com.
