Gold is emerging as a solution. Its lack of credit risk and countercyclical behavior make it an ideal source of collateral for CCPs, while their members benefit from being able to use their gold holdings more efficiently.
Here are some the advantages of GOLD that can’t be found to such extent in other asset classes:
*No credit risk
There is no credit risk associated with gold after it has been settled. By contrast, credit risks on other collateral assets have grown discernibly recently. The last several years have proved that no assets can be considered “risk free.” The European sovereign debt crisis showed that even the credit quality of government bond markets can deteriorate rapidly as rating agencies continue to downgrade many European bonds. Western government bonds have become much riskier in recent years, as public finances have deteriorated sharply. Declining credit ratings mean some government bonds are no longer acceptable forms of collateral and/or have much higher haircuts than in the past. Even cash cannot be considered to be truly “risk free”, against a backdrop of such aggressive quantitative easing, which could see a steep rise in future inflation.
The daily price of gold is arguably one of the most widely-known prices in the world. It is dif?cult to think of any other asset whose price is just as readily known by low-income households in rural emerging market economies, as in the global technology, public and financial sectors. The gold market trades on a continuous 24 hours a day basis around the world. The price of gold is “fixed” twice daily in London (the AM and PM fix), ensuring that there is an international benchmark, published price. The London PM fix is widely used as a pricing medium by producers, consumers, investors and central banks.
*Deep and liquid market
The gold market is deep and liquid. GFMS precious metals consultancy estimates that, at the end of 2010, total above ground stocks of gold were 166,600 tonnes. Converting at the average 2010 gold price of $1,225.42 gives an estimated value of above ground gold stocks of US$6.5 trillion. Around US$2.4 trillion is thought to be held by private individuals, in the form of coins and bars, and by official institutions. By way of comparison, this would make the gold market larger than each of the Eurobond markets.
*Greater diversity than pure financial assets
Where the gold market differs substantially from bond markets and other financial instruments is in its diversity. Unlike financial assets, the gold market is not solely dependent on investment as a source of demand. Over the past ?ve years, 58% of demand came from the jewellery sector, 30% from investment and 12% from technology. Gold has a diverse range of buyers, ranging from Indian jewellery manufacturers, to electronics producers in Asia, to worldwide dentistry and medicine, to pension and endowment funds and central banks.
*Gold can bring additional bene?ts to CCPs
Having a proportion of collateral in gold can bring additional benefits to CCPs in times of acute financial market strains. The 2007-2009 financial crisis demonstrated that even the liquidity of assets thought to be supremely liquid, such as Western government agency bonds and money market funds, can dry up. Gold, on the other hand, is a counter cyclical asset often enjoying ?ight-to-quality in?ows during times of market duress.
Between the beginning of the financial crisis in the summer of 2007 and May 2011, the gold price has rallied from US$650/oz to US$1450/oz. Inter alia, this re?ects gold’s lack of credit risk, diverse consumer base and store of value tendencies. Gold often bene?ts from the policies put in place to remedy financial crisis, such as expansionary fiscal policies or quantitative easing, both of which can be in?ationary hence undermining fiat currencies. Thus, in the event of a financial crisis, when CCPs face the highest credit and market risks, there is a good chance that gold will be performing at its best.