For several years the Federal Reserve has embarked upon an operation dubbed ‘Quantitative Easing.’ Essentially, quantitative easing is the purchasing of debt including U.S. treasury bonds and mortgage backed securities. U.S. treasury bonds and mortgage backed securities are important in financial markets because of there usage as collateral. Access to quality collateral is paramount in modern financial markets as access to quality collateral provides liquidity. Years of quantitative easing by the Federal Reserve has removed quality collateral from financial markets. The financial markets, in the event of lower access to quality collateral accentuated by the Federal Reserve have moved to gold to raise liquidity.

The slogan is, “When all else fails, repo gold.” Gold can be loaned out or leased to earn an income. Gold can effectively be used as collateral to obtain funding in global financial markets. This universal quality allows gold to mitigate extreme liquidity issues due to a lack of access to quality collateral.

Here is a chart of ‘Gold Repo.’ The ability to monitor gold repo is created from the buying and selling of gold futures contracts. Today was a very significant day in the gold repo market. A collapse today in the price of gold repo may signify the conclusion of gold being used extensively as a tool to stem liquidity risk.

gold repo plunge

The ending of the Federal Reserve’s quantitative easing program as well as the collapse in gold repo both display a financial market recovering from liquidity stress due to lack of access to quality collateral. This may bode well for the eventual recovery in financial markets to a sustainable path of growth. However, U.S. equity markets are not a good barometer of the health of financial markets. Equity markets may rise in times of extreme stress in financial markets due to lack of access to quality collateral. This is an inverted way to look at equity prices. A fall in equity prices may be a good sign that global financial markets are on the path to recovery.

 

Advertisements