Taking sense amid gold frenzy

07:25 | 29/08/2011
Ho Quoc Tuan, a doctoral candidate at the United Kingdom’s Manchester University, examines the best way to restore order to the local bullion market and create a balance between domestic and world market gold prices.


Huge amounts of local speculative money is racing into gold
as other investment channels come up short

Mobilising gold from the community, how to do and why?

These are two basic questions that arise when it comes to the State Bank of Vietnam’s (SBV) plan to raise idle gold from people. According to SBV governor Nguyen Van Binh, commercial banks would act as middlemen in the raising of this idle gold from the community and this gold stock would be used as foreign currency reserve. Binh estimated the amount of gold held by people in Vietnam at around $10 billion, a huge number in light of Vietnam’s current foreign currency reserve of around $12-13 billion as estimated by the Asian Development Bank (ADB). It would be a huge bonus if the country could mobilise such a huge gold stock and treat it as foreign currency reserve.

However, turning that ‘if’ into a reality represents a great challenge. Firstly, how can we raise that idle gold from people? If the central bank issues bonds to lure idle gold or opens bank accounts to keep gold and pay gold depositors interest, what interest rate should be set? And is that similar to the gold mobilising practices local commercial banks previously applied? If so, why doesn’t SBV ‘undo’ current regulations applied to commercial banks on gold deposits and lending?

SBV chief was correct to comment that rigid regulations on gold management has caused the gold stock held by people to remain idle - banks are illegible to receive gold deposits or lend gold and cannot convert gold deposits into money to use for production and trading activities. Why doesn’t the central bank roll back these regulations giving more rights to commercial banks instead of mulling over the plan to act as gold keeper for the people?

The questions of how to mobilise idle gold, what instruments to use and what interest rate most suitable are market issues which must be addressed by the market and the answers depend on the context at any particular point in time. SBV’s roles should include creating the policy framework, macro management and system security supervision. Its role shouldn’t be holding gold for the people or thinking of ways to mobilise gold or what interest rates should be set. Besides, the mechanism whereby the central bank holds gold and commercial banks act as agents is vague and can mislead people as to who is responsible for gold deposits and where depositors  should go, to SBV or commercial banks, when they want to take back gold?

The second question is what to do with this gold stock? It would be excellent if the gold stock could be used as foreign currency reserve. However, if SBV ‘holds’ gold for people when people want to take back gold, the central bank must return it. Therefore, that gold stock would be shaky. Besides, if mobilised gold is kept in SBV stock or deposited in accounts abroad it would be a remarkably wasteful in economic terms. It makes no difference if gold is kept by SBV or stored by local people in their safes.

The difference is that the State Bank would use that gold stock to intervene in the market when necessary. Central banks would be better off allowing commercial banks to raise gold and force them to put an appropriate obligatory gold reserve ratio in their coffers. By doing so, the central bank would have gold to intervene in the market when necessary and gold mobilising would become the task of commercial banks which have a better grasp of the market situation.
 

Addressing the bottleneck in gold market management

Another question of interest is whether raising idle gold from the community would help restore order in the local bullion market. No one can say for sure this solution would help achieve that goal since Vietnam’s current gold price volatility stemmed from fluctuating world gold prices, speculative world gold fund transactions, an impasse in settling the Eurozone debt issue and a gloomy perspective for global economic growth as well as the impacts of developed nations’ loosening monetary policies. These are all factors beyond the control of SBV.

Besides, if people agree to deposit their gold at SBV but then they jostle to buy gold on the back of world market price uptrend could SBV’s selling out gold help restore order in local bullion market?

For bullion market stability, SBV could impact on local price manipulators or create the mechanism to help achieve balance in domestic and world gold market prices. To bring the local gold price closer to world gold prices industry experts suggest loosening current regulations on gold import-export or SBV directly involving in physical gold trading while allowing reciprocal account-based gold transactions. Flexible gold import-export or interactive physical and account-based gold trading would narrow the divide between domestic and world gold prices. By doing that it would not be easy for price manipulators to trigger artificial gold scarcity or redundancy to push up or pull down prices.

Also, founding a central gold exchange would bring the local gold price closer to the world price. The exchange should have the right to engage in flexible gold import-export and not be restricted by the quota regime as currently. The exchange should also be given more tax incentives and have the right to perform account-based gold transactions parallel to physical gold trading to create balance in domestic and world market gold prices.

If so, the exchange would help limit illegal gold import-export and artificial gold scarcity or redundancy occurrences infused by speculators. Besides, it would help state management organisations more effectively control speculators.

Gold investors may conveniently deposit gold at the exchange and conduct gold trading via agents as is the case with commercial banks or gold trading centres. Then the target of maintaining gold stock for intervention when necessary could be achievable.

There are concerns caused by the fact that a lot of people previously incurred losses in transactions at gold trading centres. Would it happen again if a new gold exchange was opened? It depends on required deposit or financial leverage levels of investors in gold transactions, and also on price setting in the gold market. Investors taking money to buy gold or borrowing gold to sell must present a big deposit ratio of 80-100 per cent for instance. Such minimal financial leverage means the chance of magnifying profits is small but loss-making risk is abated.

Vietnam’s gold exchange should play a ‘gold price moderator’ role to ensure the gold price in the domestic market is close to the world’s gold price. By doing that, gold traders would not feel as if they are being cheated in the event that local gold prices are far divergent to those on the world market. This could be achievable through allowing the gold exchange to perform account-based gold transactions internationally and flexibly handle gold import-export. When people know they can always buy in gold at prices similar to world gold prices and the gold stock is ample, gold prices won’t be pushed up in a frenzied manner.

The gold exchange can be structured as a joint stock firm with gold trading firms and commercial banks having the right to buy shares and become the gold exchange stakeholders. The gold exchange can operate with consultation from professional gold exchange organisers and resort to assistance from international management and consulting firms to protect stakeholder legitimate rights. This is also the initial step towards futures gold transactions in later period to insure against price-related risks in gold transactions. The gold exchange should assist SBV with mobilising gold as well as stabilising the gold price for SBV to focus on policy enforcement and supervision.

The gold exchange will create a level playing field for market players to engage in marked-based solution executions to balance gold supply and demand and concentrate physical gold in a single-window through a gold depository, as is the case with the securities depository.

The big questions are whether gold import-export would threaten the dong-dollar exchange rate and whether the gold channel would compete with the stock market in wooing long-term investment capital.  The stock market’s lack of long-term investment capital is due to a number of factors other than the existence of a gold exchange. When locals wish to get their hands on ‘quick bucks’ but cannot pour money into gold speculation they will pump this cash into other speculative items, making it harder for the state to govern.

The gold exchange is not a channel vying with the stock market when it comes to luring long-term investment. Instead, it might only compete with local bourses in luring short-term and speculative capital.

The dong-dollar exchange rate is a pressing issue. Recent shaky exchange rates caused by gold import-export were just momentary. However, it often occurred at times when people ignored dong-denominated assets to rush into buying gold and dollars. This then exaggerated dong depreciation pressures. That fact of life needs to be realised. If SBV wants the local gold price to be close to the world gold price it should accept a flexible gold import-export regime. And if the central bank wants a stable VND/USD exchange rate, it should limit gold import-export for particular periods of time.

However, with restricted gold import-export when the exchange rate faces tension, illegal import-export activities might fuel exchange rate tensions. After all, gold import-export is not the key factor leading to exchange rate unrest but only its after-effect.

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