What's Bugging the Gold Bugs: Busch
Last week, I mentioned rumors of Cyprus being forced to sell gold. I apologize for the inaccuracy of that rumor. The markets were focusing on comments made by European Central Bank's Mario Draghi regarding gold sales by the Cypriot central bank to cover any losses on the ECB's ELA lending facility.
"The decision (to sell gold holdings) is going to be taken by the central bank…What's important, however, is that what is being transferred to the government budget out of the profits made out of the sales of gold should cover first and foremost any potential loss that the central bank might have from its ELA." - Draghi
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The ELA is the ECB's Emergency Liquidity Assistance lending facility. Here's how the Wall Street Journal explains it:
"To understand, it helps to review how the ECB provides funds to banks under normal circumstances. The ECB, or really the national central banks of the countries that use the euro, provides weekly loans to banks at the main refinancing rate, currently 0.75%.
This all works well and good when banks are healthy, but when they're not and lack adequate collateral, the ECB passes on responsibility and the risks this entails for liquidity provision to national central banks.
This means that the national central bank must provide the troubled commercial bank with needed liquidity, set the collateral rules and ultimately take on the risk if something fails. This is different than regular Eurosystem operations where counterparty risk is distributed across the central banks in accordance with the capital subscription, where Germany is the largest shareholder.
Interest rates on ELA are higher than those offered at the ECB's main refinancing facility, thus incentivizing banks not to use it. The facility is, however, not entirely at the discretion of the national central bank in question. The Governing Council has to approve its use and a two-thirds majority of the 23-man Governing Council can reject its continuation."
Ok, why is this important?
Simply, the ECB said it was willing to cut off Cyprus from the ELA unless certain conditions were met. This is the ultimate death threat by a central bank to get a country's attention and to get them to shape up.
(Read More: Here's Why Gold Is Getting Crushed)
Getting back to gold, you can see now how this plays out.
If the ECB says sell, Cypress should say how much. The World Gold Council states that Cyrus has 13.9 metric tons of gold valued at $622 million. According to the European Commission, Cyprus had committed to sell about 400 million euros ($525 million) of excess gold reserves as of an April 9th debt assessment.
This development has clearly spooked the gold bugs.
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Would this have mattered a year ago? Probably not. To me, the reason this is hitting home now is because of the massive rallies in global equities, the improvement in the U.S. economy, and the likelihood that the Federal Reserve Open Market Operations is closer to pulling back on their massive Quantitative Easing program. This has called into question whether gold should be held versus other assets that either are appreciating in price or hold the promise of appreciating in price during a recovery.
From here, the markets will ponder what hedge funds are still long and wrong on gold. They will also ponder the timing of Goldman Sachs' recommendation last week to sell gold. Lastly, they will try to decide if they want to buy gold at a time when the Bank of Japan is now engaged in a massive quantitative easing program. Gold holdings in the world's largest gold fund have fallen their lowest level since April of 2010 and indicate that speculation in the yellow metal is falling with investors (like George Soros and others) are dumping.
Given this, I think we can expect a $1,250 print in the future before stabilizing.
(Read More: The Scary Number for Gold Investors: $1,200 )