- A yes-vote on “Save our Swiss Gold” referendum could have implications for financial markets
- Gold and Swiss franc will likely receive support, with the cap on the Swiss franc being challenged
- … while net demand for eurozone government bonds will likely be lower…
“Save our Swiss Gold” referendum
On 30 November this year, the Swiss electorate will vote on the “Save our Swiss Gold” initiative. The referendum has been the result of the gathering of 100,000 signatures supporting it. In Switzerland, the Federal Constitution states that any 100,000 citizens may request a partial revision of the Federal Constitution. This gold initiative was launched by members of the Swiss People’s Party or SVP in 2011. The SVP is considered to be a conservative or right-wing nationalist populist party. There are various motivations for launching this initiative. For starters, proponents argue that holding a certain percentage of gold reserves would result the Swiss Franc to act as a strong, gold-backed currency allow to constrain devaluation. Moreover according to the SVP, Switzerland’s gold had always been considered to be “property of the Swiss people”. In addition, to increase transparency, the Swiss National Bank should be forced to reveal where the gold reserves are located and top repatriate any gold reserves abroad to Switzerland. So this initiative calls for three things.
1. The Swiss National Bank should hold at least 20% of its assets in gold. But is has 5 years to implement this (counting from 30 November).
2. It should no longer be allowed to sell any gold at any time
3. All of its gold reserves should be stored in Switzerland
SNB is opposing the initiative…
The Swiss National Bank (SNB) has reacted several times on this gold initiative, the latest one being on 9 October. In a speech Vice Chairman Jean-Pierre Danthine said that “a country’s gold reserves usually have the function of an asset to be used only in emergencies. For that reason it makes sense to diversify the storage locations. In addition, it makes sense to choose locations where gold is traded, so that it can be sold faster and at lower transaction costs. Therefore 70% of the Swiss National Bank’s gold reserves are stored in Switzerland, 20% held at the bank of England and 10% at the Bank of Canada. The initiative’s demand to hold at least 20% of the SNB’s assets in gold would severely restrict the conduct of monetary policy”.
…so are the center parties
Members of the Swiss parliament’s lower house voted 129 to 20 with 25 abstentions against the gold initiative. The government also recommended the initiative to be opposed. Parliament and the multi-party government issue recommendations on all national referendums as a matter of procedure. Center parties are strongly against this initiative because of the need for an independent SNB in conducting monetary policy.
…but the latest poll shows that it will be a close call
GFS Bern conducted a public poll in the period 13-18 October about the gold initiative. This poll showed that 44% of respondents are in favour of the gold initiative, while 39% are against and 17% are undecided. In the month before the referendum, the initiative will be widely debated, with the pros and cons likely to be widely discussed. So the momentum will build in the coming weeks. In the end, the Swiss people will decide and the decision will be respected.
If this referendum is passed, the Swiss National Bank needs to take the following actions. For starters, it needs to repatriate the gold that is held at other central banks abroad. It holds 70% of its gold in Switzerland, 20% of its gold with the Bank of England and 10% at the Bank of Canada. This would mean that it needs to repatriate 30% of its gold reserves. Moreover, it would be obliged to hold 20% of its total assets in gold. Currently it has 1,040 tonnes of gold (see graph above) or around 8% of its total assets. To meet this requirement it should increase its gold reserves to 2,784 tonnes over 5 years. As a result, it would need to buy around 1,744 tonnes over 5 years or around 350 tonnes per year.
A yes-vote should give support to gold prices,…
The Swiss National Bank would need to buy a total of 1,745 tonnes over 5 years or around 350 tonnes per year. For 2015 we expect annual supply to be around 4,000 tonnes of gold, while we expect total demand to come in at around 3,400 tonnes in 2015. This is mainly because we expect lower demand for bars and coins and investor position liquidation. We expect that investors will shy away from gold as an investment asset because of higher US dollar and higher US interest rates. As a result, supply will comfortably outpace demand in our view and this will cause a substantial drop in gold prices. If the SNB would need to buy gold, this would dampen the downside in gold prices. However, do not expect a turnaround in trend. So despite the SNB buying gold, it is unlikely that a new bull run will start in gold prices, in our view. However, if sentiment were to deteriorate sharply or if the Fed were to delay the tightening of monetary policy, sentiment in the gold could abruptly improve. It is likely that in this scenario, gold prices would rally towards USD 1,500 per ounce.
…send the Swiss franc higher in the near-term
As at 30 June 2014, the Swiss National Bank’s currency allocation was as follow: 27% in US dollars, 46% in euros, 7% in sterling, 9% in yen, 4% in Canadian dollars and 7% other currencies. These foreign currency reserves are mainly held as government bonds (73%). To increase the gold holdings, it is likely that the SNB will sell part of its foreign currency reserves to the equal percentage as the current composition. As a result, a large part will come out of the reserves denominated in euro. By selling euros it will directly impact defending the cap on the Swiss franc versus the euro. As a result, the risk will increase of a substantial move lower in EUR/CHF. This is because currency markets will seriously test the commitment of the SNB to defend the 1.20 level in EUR/CHF. If this level were to be broken, prices could decline sharply, because there appears to be substantial stop losses layered below 1.20. Investors have taken for granted that 1.20 in EUR/CHF will not be broken. Therefore, currency markets could freeze and become quite volatile if this level were to be taken out.
…and result in a reduction in net demand for eurozone government bonds
To finance the increase in gold reserves, the SNB would likely decrease its positions in government bonds, which are by far the largest asset class of the foreign currency reserves. If the SNB would decide to do this and if the central bank would want to keep its current currency and asset class portfolio exposure, we estimate that it could divest up to approximately EUR 25bn of euro denominated positions and USD 18bn of USD denominated positions over a 5 year horizon. Holdings of AAA and AA rated bonds would most probably be impacted, since both classes account for 92% of their investment portfolio. If the SNB also wants to stick to its current investment duration of 3.8 years, then it will need to rebalance its portfolio accordingly and more frequently. We expect the impact of these reserve adjustments on eurozone government bond markets to be relatively muted.
…but weakness of Swiss franc likely over the longer term
It is likely that gold prices and the Swiss franc will be supported following a yes-vote. However, over the longer term the sentiment towards Switzerland could seriously deteriorate. There is a risk that foreign investors and companies will worry that referenda could also start to hurt their business. As a result, they could reconsider their positions and/or being located in Switzerland. In addition, Switzerland has been proud of the independence of its central bank. In fact, after a yes-vote this independence is seriously being questioned. This could also result in an overall deterioration in sentiment towards Switzerland.