HomeAnalysisIs all that glitters gold?

Is all that glitters gold?

By Gilbert Muponda
THE gold coins are finally with us. According to the Reserve Bank of Zimbabwe (RBZ) a total of 2000 gold coins have been released to the market.

This translates to about US$3,6 million worth of gold coins at the going price of about US$1 800 per coin.

Approximately 75% of the coins were sold within the first week, and 85% were sold in United States dollars (USD) and about 15% in local Zimbabwean dollars (ZWL).

This amount is on the low side to be able to shift or control the market. So small that the market can be cornered and manipulated, which explain why the RBZ indicated that another batch of the coins was due for release.

When a market is thin and shallow, it becomes a heaven for financial gymnastics and mecca for speculating. The market has to be widened and deepened by introducing more coins of smaller denominations to attract more participants as currently a majority of working Zimbabweans are excluded from directly participating in the gold coin market. This partly defeats the purpose of the gold coins.

As can be expected, unfortunately, there are a few misconceptions about the coins. A few “experts” are claiming that the gold coin represents a get-rich-quick scheme and an arbitrage opportunity for those with connections and deep pockets.

This is not the case as the buying and selling system, mechanics, terms and conditions make arbitrage virtually impossible. The gold coin is an investment opportunity to hedge against inflation, store value and diversify risk for medium- to long-term investors, not speculation free for all.

For starters we need to define arbitrage opportunity/activities. In financial markets, arbitrage happens when a market participant makes profits without being exposed to risk. Profit is normally a result of one taking some risk and reward of being a risk taker.

So for arbitrage to happen you need to simultaneously buy and sell the gold coins, resulting in locking entry price and exit price ensuring that the price cannot shift whilst the transaction is being executed.

This is not practical with the gold coins given their trading terms and conditions.

Simultaneously buying and selling an asset ensures there is no risk in price movements, assuming the buyer and seller both honour their obligations.

Now coming to gold coins, such arbitrage opportunity does not exist as there is a mandatory holding period of 180 days, in which, you have to hold on to the gold coins once you buy them. So you cannot buy the gold coins today and sell them next week even if there was a ready buyer. In addition, there are transaction costs of at least 5 % before security and insurance.

The additional requirements, such as know your customer (KYC) make speculating and financial gymnastics less likely as the issuing authority can easily trace, who is holding the coins.

In this regard, the RBZ needs to promote and improve on transparency in terms of the market participants’ trade volumes and indications on anticipated volumes.

This is critical in generating market confidence and market goodwill, which is required to enhance the attractiveness of gold coins as high quality asset desirable for any serious portfolio manager, in addition to the general public, who may have excess liquidity to invest.

The gold coins are ideal for medium to long-term investors, who are seeking to diversify their portfolios and hedge against inflation. The denominations need to be increased to allow retail investors’ participation.

Considering that the RBZ would like the gold coins to be an alternative investment asset for Zimbabweans, more coins need to be released and the amount needs to approach at least the US$1 billion market for the coins to have the desired impact.

This is based on the country’s financial sector size and expected savings that would reflect a savings culture needed to broaden and deepen the local financial markets.

The gold coins have prescribed asset status, which means they will be highly sought after by pension funds, insurance and assurance companies.

Pension Funds and Life Insurance firms should hold 20% of their portfolios in prescribed assets. Assurance and short term insurance have to hold 15% and 10%, respectively in prescribed assets.

This means these financial market players now have a wider choice to reach their compliance levels by investing in gold coins.

Whilst the amount released is relatively small, what is more important is the idea and concept being introduced by the RBZ. The linking of gold to currency pushes the country towards the Gold Standard.

The Gold Standard implies that a currency can be readily exchanged for gold worth the amount of currency involved. This is exactly what the RBZ has introduced albeit at a very limited scale and without directly announcing it.

It goes without saying that the RBZ, ministries of Finance and Economic Development and Mines and Mining Development need to come up with proper sustainable structure to mine and build significant gold reserves as previously most gold was being exported.

A currency that is linked to a highly valuable commodity is stable and is expected to outperform just paper money, which is not directly backed by a valuable commodity.

The Russian rouble is a ready example of what happens when a currency is directly linked to a valuable commodity. Despite record sanctions, as soon as, Russia demanded that certain players buy Russian oil/gas using only roubles, the Russian currency began to strengthen as there was a direct link between the currency and the oil/gas.

If the gold coins are released in sufficient quantities on a sustainable basis, then the local currency should stabilise. It should be noted the rouble benefited from the demand that oil/gas buyers are forced to look for roubles for them to buy the commodities.

In the Zimbabwean scenario, it therefore means gold coins should be sold only in RTGS$ (ZWL) and not in any other currency including the USD.

This will boost demand for the ZWL (RTGS) as participants are forced to liquidate their USD to buy gold coins. This will reverse the trend, whereby holders of ZWL flee to the USD safety as there are no other ready acceptable alternatives.

If done sustainably and at the correct scale, this effectively means Zimbabwe will be running a Gold Standard currency as opposed to Fiat money, which is effectively paper money backed by nothing much except a promise to pay by the Central Bank. Zimbabwe’s gold coins become a gold standard as they are available in local currency.

The RBZ needs to fine tune the mechanics around it such that the market is wide and deep enough to stabilise the local currency. A long road ahead with the usual humps and bumps!

The idea behind the Gold Standard is that all the currency issued is backed by actual and real gold stored owned and controlled by the issuing Authority  where.

The central bank would therefore be limited from printing excess money as it is limited by the amount of gold in its reserves. This helps to limit and avoid inflation and hyperinflation, which are phenomena driven by excessive money printing beyond the production capacity available.

As a result that currency exchange is closely related to gold as such its value and worth is stable and predictable. This is what the RBZ is pushing towards. It remains to be seen how determined the authorities are to see this vision through.

  • Muponda is an investment banker, economist and entrepreneur. He holds a B.Comm (Finance) and an MBA. He is a PhD Candidate. — gilbertmuponda@gmail.com

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