Will the Swiss drive up gold prices?

Published in Business Spectator (Melbourne), 30 October 2014

If you are invested in gold, you should mark November 30 in your diary. That Sunday could have an impact on your portfolio as Switzerland votes in a referendum on a partial return to the gold standard.

The Swiss have a habit of voting for policies that mainstream political parties would never touch. If opinion polls on the ‘Save our Swiss Gold’ campaign are to be believed, they might be doing it again next month. This would not have only have implications for the Swiss National Bank (SNB) – it could also drive up the gold price.

Two current and a former member of the Swiss parliament initiated the campaign for a referendum on the Swiss central bank’s gold reserves. Having collected more than 100,000 signatures, their three proposals are now being put to a national vote:

– To stop the SNB from selling any more of its gold reserves.

– To return all Swiss gold reserves stored abroad to Switzerland.

– To mandate that the SNB will hold gold reserves equivalent to 20 per cent of its balance sheet.

The referendum is the culmination of a long discussion about Switzerland’s national gold reserves. Until the turn of the century, the SNB had reserves of 2,590 tons of gold – approximately 40 per cent of its total assets. But then the Bank declared its gold holdings to be unnecessary and started selling a large proportion of them. A total of 1,550 tons were sold, at relatively low prices, leaving only 1,040 tons as gold reserves (equivalent to 7 per cent of the SNB’s assets).

Critics of these gold sales complained that this would jeopardise the strength of the Swiss franc and diminish the ability of the central bank to intervene in the market if needed. However, they were unable to stop the bank from pursuing its policies through parliamentary means. Not even within their own parties could the campaign initiators find majorities for their motions. Their last hope now is that the Swiss people might share their concerns and impose new rules on Swiss central bankers.

An opinion poll released last week saw supporters in the lead, if only narrowly, with 44 per cent in favour of the motion, 39 per cent against, and 17 per cent still undecided. The way that opinion polls typically develop ahead of nation-wide referenda suggests a very close result on November 30.

Interestingly, the poll also revealed the support for a new Swiss gold standard is far from evenly spread across the spectrum. Right-wingers were more supportive than left-wingers; people with lower education attainment were more in favour than people with higher degrees; and less affluent people were more convinced by the referendum than people with high household incomes.

But it is not just poorer, less educated right-wingers who back the ‘Save our Swiss Gold’ campaign. Investment advisor, gold bug and serial doomsayer Marc Faber is also a supporter. He recently told an audience that he not only endorsed the initiative but he wished Switzerland would go for a 100 per cent gold standard.

On the other side of the argument are not only mainstream political parties, but also a large majority of Swiss companies and, unsurprisingly, the SNB itself. They all fear that a successful referendum would force the central bank into a fixed corset that would reduce the bank’s ability to effectively pursue its objectives.

The opponents of the referendum claim that the SNB needs flexibility to intervene in foreign exchange markets as it has done to fight an appreciation of the Swiss franc against the euro amidst the eurozone’s monetary crisis (Where Europe’s smart money hides, 3 June 2010).

Since September 2011, the lower floor of CHF 1.20 has been defended with large purchases of euros. However, it is not clear how this flexibility would be undermined by a requirement to hold 20 per cent of all assets in gold. Say the SNB purchased 100 billion euro in the markets, it could use 20 billion euro to purchase gold.

Opponents also claim that large gold holdings would reduce the profitability of the SNB which in turn would hurt Swiss cantons. It is cantons that receive a share of the SNB’s profit, so with reduced profits due to non-return yielding gold reserves, cantons would receive lower dividends. In addition, the opposition to the referendum also points out that gold is not the haven of stability that the ‘Yes’ camp makes it out to be. Gold, they say, is highly volatile and the SNB should not put all its eggs (or rather 20 per cent of them) in one basket.

Finally, the main opposition argument against the referendum is that it would be a very expensive exercise for the SNB and ultimately useless. If the referendum passes, the SNB would be forced to purchase gold worth more than CHF 60 billion (approximately $72 billion). However, since the referendum also aims to forbid the SNB from ever selling its gold reserves, it would never be able to use them in a crisis. Holding large gold reserves that cannot be accessed would be akin to having a fire extinguisher that one is not allowed to use in case of a fire, or so they say.

At least in one aspect, the SNB is already close to fulfilling the ‘Yes’ campaigns demands. It recently revealed where its current gold reserves are physically stored. According to Thomas Jordan, the Bank’s President, 70 per cent are in Switzerland, 20 per cent in the UK and 10 per cent in Canada. What it did not reveal was where it previously stored its much larger reserves and who they were sold to at low prices – a missing piece of information which nourishes conspiracy theories about Switzerland having been pressured into selling its reserves. As an aside, the Swiss are not the only nation wondering where their gold reserves are stored – and whether they actually still exist (Germany’s gold rush to the head, 1 November 2012).

It will be a tight race for the referendum but in case it ends up with a ‘Yes’ vote, one might well expect an effect on the gold price. Switzerland would need to purchase almost as much gold as it sold over the past 13 years – close to 1,500 tons. This is more than half the world’s annual gold production and about the same as the total gold reserves of the UK, Saudi Arabia, Venezuela and India combined.

So if you are a gold bug, and if you think the majority of the Swiss are too, you might want to consider adding some of the yellow stuff to your portfolio. But be careful – even in Switzerland, referenda can result in surprises, and not every opinion poll that glitters is gold.