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  • Gold bid on banking woes

    16 March, 2023

    The failure of Silicon Valley Bank and Signature Bank this past weekend sparked concerns over banking stress contagion. The jury is still out on whether it’s a few bad apples or the whole cart but taking no risks, governments were quick to emerge with monetary disinfectant on Monday. An article in the FT summed up the probable outcomes of the bank failure and its subsequent policymaker remedies. 1 Here’s what they might lead to and what it might mean for gold.

    The SVB episode is likely to increase funding costs for banks, especially smaller regional banks. It highlighted the issue of Held-to-Maturity2  assets and in addition, the recent aggressive run up in interest rates has not been accompanied by a similar rise in deposit rates. The sensitivity of the latter to the former is known as the deposit beta. It has been low for a while. 3 A drive by banks to retain deposits could materially drive up the rates paid on them. With funding costs higher, and reports of deposits moving from smaller, regional bank to large too-big-to-fail institutions, banks are likely to curtail some lending too. This would lead to a further tightening of financial conditions. VC and tech companies and their founders and executives may find less understanding institutions than SVB reputedly was. 

    The second scenario could be a reticence by the Fed (and potentially other central banks) to continue on their aggressive policy path, particularly as impact of policy tends to arrive with a lag as we have seen. The sizeable collapse in the 2-year Treasury yield (-61bps, largest drop since Oct 1982) and the implied fed funds terminal rate (-80bps) suggests as much (Chart 1).

    Chart 1: The Fed funds rate is now expected to peak in May, 80bps lower and four months earlier than last week

    Third, digital currencies pegged to the US dollar are facing stronger regulatory scrutiny and cryptofirms may also struggle to access the US banking system as easily as in previous years following the failure of Signature over the weekend and Silvergate Bank a few days before.  4

    These three scenarios all look gold friendly. Tightening standards weakens the corporate and consumer sector and by extension the economy, inching the US closer to an official recession. Recessions have historically been good for gold. A lower ceiling for interest rates is gold friendly too, limiting the opportunity cost of holding gold. But a stalwart Fed possibly risks creating bigger problems down the line. Finally, concerns about systemic risks to bank deposits – whether warranted or not – may lead to investors moving some of their currency holdings into gold. A sign of this were the 16t (US$1bn) of inflows into global gold ETFs this week so far, reversing ten consecutive weeks of outflows.