Swiss gold referendum and SNB risk

It’s not too early to highlight the potential problems facing the Swiss National Bank, as we approach the November 30th Swiss gold referendum on whether the central bank should raise gold reserves to hold 20% of its total reserves from the current 7.8%. And given the risks to its policy-making, the SNB may have to act pre-emptively. The initiative, supported by the Swiss People’s Party, favours the inclusion of more gold at the bank, but Swiss parliament and the central bank counter that the yellow metal lacks effectiveness as a monetary policy tool. The SNB prefers to continue selling gold and holding liquid currencies to facilitate its FX interventions – a crucial instrument in staving off excessive franc strength and winning the fight against deflation. This includes the central bank’s commitment to support EUR/CHF above 1.2000, which it has been doing successfully since 2011. But this could change.

Beware of those polls

Although the SNB has won previous referenda in support of maintaining gold’s status quo, the latest polls indicate the SNB may have reason to be nervous this time. An online poll by 20 Minuten of 12,491 people on October 27th, showed 47% opposing the referendum, 38% in favour and 15% undecided. An October 24th poll by researcher gfs.bern of 1,206 people found 44% in favour, 39% against and 17% undecided. Will this prove to be another false warning as was the case in the Scottish indpendence referendum?

Disinflationary risk

A victory for the ‘Yes’ camp means the SNB will be forced to hold more gold, becoming constrained in limiting CHF appreciation. The immediate implication of a ‘Yes’ is a positive for CHF and gold bullion. Considering that total gold production stands at 2,982 tonnes, and the SNB’s gold holdings are just below 8.0% of its total reserves, the central bank will have to buy about 10% of annual production over the next five years. The inevitable resulting erosion to the SNB’s currency reserves would hamper its ability of managing policy and combatting disinflation. CPI remains at 0.0% y/y, and with the franc’s 5% appreciation against the euro, disinflation could come back and bite creditors.

The chart below shows that despite the sharp declines in gold and the Swiss franc against the US dollar recently, net speculative futures positioning remains well above its lowest point for both the metal and the Swiss currency. As gold hit fresh four-year lows, gold speculators remain bullish with net long positioning of 63,225 contracts, more than tripling the exposure of July 2013 when gold sustained its biggest decline in three decades. Similarly, Swiss franc speculators show more confidence than in 2012 when the Eurozone debt crisis was at its peak, but they do remain net-short of the currency. The fact that short positioning is a quarter of the peak seen in 2007 implies that there is more “comfortable upside” for speculators to target in the event of i) ; a ‘No’ vote and; ii) further selling of EUR/CHF near the 1.2000 support.

Pre-emptive SNB?

Drifting at 1.2020, EUR/CHF gives the SNB an early warning sign ahead of the November 30th referendum and the December 4th ECB decision (always a possible source for downside EUR/CHF risk). We expect the central bank to begin issuing precautionary statements later in the month in support of the 1.20 peg, such as hints at negative interest rates and reiterating the priority of restraining excessive franc strength. Another option is for the bank to allow a retest of the 1.20 peg and, possibly, a short-lived break of the figure before wrong-footing speculators with a fresh round of euro buying. Finally, there is the December 11th quarterly policy decision for the SNB to announce any new measures in its currency-based monetary policy, regardless of the outcome of the referendum. If you trust the SNB to continue saving the 1.2000 line, favouring USD/CHF remains viable. Having broken above its 2012 channel, USD/CHF’s 0.8200 appears intact.