The volatility and fragility of exchange rates means that something small can have a large impact on currencies like the Euro (EUR), US Dollar (USD) and Swiss Franc (CHF). Imagine, if you will, dropping a tiny pebble in a large pond. The initial impact is negligible, but the ripples eventually spread across the surface of the water and reach the edges.
To that end, the Swiss National Bank having to buy 20% of their reserves in gold may seem inconsequential to some. However, the ripples in this case could spread far beyond the edges and disturb a few big fish on their course.
What is the Gold Referendum? Swiss Franc (CHF) Trends Lower
The right-wing Swiss People’s Party has campaigned for the Swiss National Bank to stop offloading its gold holdings. The referendum on the issue, due to conclude on November 30th, is aimed at not only preventing the SNB selling its gold reserves, but ensuring that the central bank would also have to hold at least 20% of its assets in gold.
With only around 8% of its reserves in gold at the moment, the Swiss National Bank firmly opposes the initiative. To meet the criteria outlined in the referendum they would have to purchase around 1,500 tonnes of the precious metal in the next five years. This would devalue the Swiss Franc simply because the cost of such a purchase would mean selling a lot of its currency. Having to hold the commodity rather than selling it on will only compound the CHF depreciation.
What do Traders Think? CHF Down, Euro (EUR) Also Declines
Reuters states; ‘The bank now invests the bulk of its currency reserves of around 500 billion Francs in Euros and about a quarter in Dollars. The share of gold holdings has been coming down over the past few years as it stepped up its intervention in the currency market. A ‘Yes’ vote would see it more than double the quantity of gold holdings. Given the preponderance of Euros in its FX reserves, that would most likely entail selling Euros. The single European currency would probably drop, threatening the SNB’s 1.20 Francs per Euro floor.’
‘Even if considered a remote tail risk, some investors might want to take out insurance, particularly if the polls […] were to suggest more support than is currently expected,’ said Beat Siegenthaler, currency strategist at UBS, Zurich. ‘If it (the initiative) came through, the market would immediately conclude that the (Euro/Swiss Franc) floor is less viable, less sustainable.’
Swiss Franc to Lose its Safe-Haven Status, CHF, EUR Exchange Rates Depreciate
Investopedia defines a safe-haven asset as; ‘An investment that is expected to retain its value or even increase its value in times of market turbulence. Safe havens are sought after by investors to limit their exposure to losses in the event of market downturns. However, what are considered safe havens alter over time as market conditions change, and what appears to be a safe investment in one down market could be a disastrous investment in another down market.’
So how did the Swiss Franc gain its safe-haven status? For the past three years the Swiss National Bank has imposed a cap on the value of the Euro to Franc exchange rate to prevent Franc appreciation and to boost growth while warding off deflation. By having a healthy store of Euros as part of the reserve, the SNB has sacrificed the potential high value of the Swiss Franc for safe-haven status.
As expressed above, in order to buy the gold demanded in the terms of the referendum the SNB would have to sell a large stock of their Euros, which would essentially destroy the Swiss Franc’s safe-haven credentials. By selling those Euros, not only would the Swiss Franc depreciate from the purchase of so much gold, but the Euro would also depreciate from huge sales. When a central bank wants to lower the value of a currency’s exchange rate, they sell large portions of their reserves in that currency. Recent activity from the Reserve Bank of Australia is a good example of this.
Gold Prices Up; CNY, AUD, USD Exchange Rates Advance
A ‘yes’ vote to the Swiss National Bank gold referendum would see the institution have to more than double the amount of gold in its reserves. This equates to about 1,500 tonnes of gold over the next five years. Such a huge amount of gold locked away as reserves will see the global supply fall, and therefore the price of bullion would rise substantially. To put it in perspective, the whole world produced 2,770 metric tons of gold in 2013. That would mean the SNB is required to purchase nearly 55% of the total global gold production.
At present, the three countries responsible for producing the most gold are China, Australia and the United States. Such a dramatic shortage of gold would trigger a sharp increase the price of bullion and the Chinese Yuan, Australian Dollar and US Dollar would benefit.
On the flip side of the coin, those countries who import gold will see their currency devalued. Currently the European Union imports the most bullion. That would mean the Euro (EUR) exchange rate would decline because the price of importing the precious metal would increase dramatically.
Those countries which import and don’t export gold will suffer the most from a ‘yes’ vote. The United Kingdom, for example, is fourth in the world rankings for gold imports but doesn’t export any of the commodity itself.
Expensive Electricals to Push KRW and USD Exchange Rates Up?
While we’re on the subject of gold, you might find it interesting that the largest quantities of lost gold every year is due to consumers throwing away their electrical goods. In a scenario where the SNB are forced to purchase huge quantities of gold, electrical goods will be more expensive to make, and therefore more expensive to purchase.
One of the largest electronics companies in the world is Samsung Electronics, a South Korean company. Samsung products would have to be sold at a higher price in order to cover the cost of the more expensive gold needed to produce them. Therefore, the South Korean Won (KRW) would appreciate from higher global import prices.
Perhaps the most successful country in the world, in terms of the manufacture of electrical goods, is the United States. The US Dollar would appreciate from the sale of higher priced products.
However, it is also possible that consumers will be unwilling or unable to purchase more expensive goods. In that scenario, electronics companies would have to spend more to manufacture. They would make much less profit and the currencies of the companies’ origin would also depreciate.
To conclude, I think a quote from Plato is apt; ‘All the gold which is under or upon the earth is not enough to give in exchange for virtue.’
