News that JPMorgan Chase (NYSE: JPM ) will accept gold as collateral on certain trades has created a bit of buzz in the gold market this week, which was amplified when a leading London clearinghouse, LCH.Clearnet, said it was considering doing the same. Is gold now the "It" currency? To some degree, but investors shouldn't misunderstand this news.
The good news
Being able to collateralize gold increases its attractiveness for institutional investors and hedge funds (for four more gold stock catalysts, see here). There wasn't much you could do with it previously, beyond going to visit the vault where it is stored to marvel at it. Investor and intermediaries are starting to treat gold as simply another financial asset rather than a financial totem. JPMorgan is responding to the demands of its customers, and it felt comfortable doing so because of the increased liquidity of the gold market.
But beyond that, does it imply that the market now recognizes gold as a store of immutable value -- equal or better than any other? Certainly not! We don't know the details of the collateralization program and, in particular, the "haircut" that JPMorgan is applying to gold.
Going in for a haircut
What is a haircut? It's the discount a lender applies to the market value of your collateral to determine the amount it is willing to advance you. Prudence dictates that the riskier or more volatile your collateral, the higher the haircut. The following table includes a comparison of haircuts at two clearinghouses that already accept bullion as collateral:
|Gold||U.S. Treasury Bills||U.S. Treasury Bonds, Highest Duration|
|CME Clearing||15%||No haircut||5% (10-30 years)|
|ICE Clear Europe||12%||3%||Could not confirm at time of publication.|
|LCH.Clearnet||Not acceptable as collateral -- under consideration.||0.5%-0.75%||9.75% (15-30 years)|
Source: Clearinghouse documents.
Individual investors: Don't misinterpret this
Individual investors who own gold exchange-traded funds or gold funds such as SPDR Gold Shares (NYSE: GLD ) , the iShares Gold Trust (NYSE: IAU ) , or the Sprott Physical Gold Trust (NYSE: PHYS ) can be pleased to see gold becoming a "normal" financial asset, but they shouldn't interpret JPMorgan's decision as confirming evidence that it is an ultrasafe asset equal or superior to any other -- after all, stocks are also used as collateral.
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