Silicon Valley Bank rattles the markets; throws up gold’s role as a risk-hedge

This week’s Coininvest is taken very largely from a piece that we have written for the StoneX clientele which is equally relevant for CoinInvest clients, taking a look at the collapse of Silicon Valley Bank.?This is a bank that has concentrated on start-up companies in the technology sector and went into receiver ship last Friday following the failure to sell a portfolio, and prompting at least one fund manager to recommend that people reduce their exposure to the bank.?It is doubtful that this will permeate through the banking systems a whole, but it is clear that government leaders have been very swift to act over the weekend to try and contain any contagion.?There was a run on the smaller banks last Friday, while gold benefited from a surge in buying.?After many months with interest rates taking the headlines where gold is concerned, with geopolitics as a supportive factor, gold’s long-term role as?a hedge against risk has again been brought to the fore. ?

• Gold has benefited in the short term from the SVB receivership; its perceived market role likely now to revert to risk-hedging as the headline element
• Any escalating financial sector distress would almost certainly see an initial gold sell-off to raise liquidity, followed by fresh safe haven buying -?this is the usual pattern.?See the 2020 COVID meltdown as a case in point (chart is below)
• Meanwhile Treasury?yields tumble, partly from risk-hedging and partly discounting Fed caution next week
• CPI this week; FOMC meeting on 21-22nd.
• Markets therefore likely to be very cautious

Key points:

• Friday’s market reaction saw a surge of gold buying as the bank stocks came under pressure and risk-aversion came to the fore, with SVB pushing the NonFarm Payroll numbers to the side-lines
• The Silicon Valley issues do not equate to Lehman Brothers
• But smaller banks may suffer as depositors move to larger entities
• There are checks and balances in place that underpin the banking sector overall, but some smaller banks are struggling in the face of the sharp rate rises of 2022 and concerns about the outlook
• Friday’s events point up the risks inherent in over-concentrating on one sector – the problems with the oil sector in the 1980s were similar
• Will this tip the FOMC to 25 points next week rather than 50? ?

Background

Silicon Valley Bank went into receivership with the Federal Deposit Insurance Corporation (FDIC)?on Friday 10th March following a run on deposits as a number of tech start-ups, which were the primary focus of SVB’s operations, removed deposits after the bank had failed to sell a portfolio and needed to plug the ensuing hole in its balance sheet.?Assets had been approximately $209Bn and this is being reported as the largest failure of an international bank since 2008.

SVB’s position shines a spotlight on potential systemic risks for parts of the banking system as cheap money disappears – that said, though, SVB is reported to have over-concentrated on one sector, and potentially over-lent likewise.

SVB had earlier in the week tried to sell a portfolio that partly comprised Treasuries, and which was offering a yield of less than 2%, against prevailing rates above 4%; this triggered a run on deposits and arguably the subsequent bank failure. ?

The FDIC has said that insured depositors (up to $250,000) should have access to their funds by Monday morning, while uninsured depositors will have a receivership certificate although the amount that will be available is still uncertain.?Government leaders, not just in the United States, have been moving fast to constrain any contagion.?The Bank of England, for example, put the UK SVB arm into insolvency on Friday.

Further fall-out is likely to be constrained

The speed with which Regulators in the United States and beyond suggest that the fall-out from the SVB problems should be relatively limited.?Anyway, the larger banks are well-capitalised and maintain prudent balance sheet management policies.?U.S. Treasury Secretary Janet Yellen has said that she has “full confidence in banking regulators to take appropriate actions in response”.?The lessons of 2018 were harsh, but have been learnt and led, inter alia, to the Dodd-Frank Act of 2010 that is fundamental in bolstering banks’ risk-resilience, notably with respect to capital adequacy and liquidity levels.

Market outlook fuzzy; key relationships

• Gold’s perceived market role likely now to shift to risk-hedging in the spotlight
• any escalating distress would almost certainly see an initial sell-off to raise liquidity, followed by fresh safe haven buying -?this is the usual pattern.?See the 2020 COVID meltdown as a case in point
• Treasury?yields tumble, partly from risk-hedging and partly discounting Fed caution next week

The markets’ reaction on Friday, however, threw gold’s role as a risk-hedge into the spotlight.?So here are a few charts to show key relationships.

COVID meltdown saw gold drop 12% from its early-March peak and had recouped its losses in less than five weeks. The S&P lost 33% from its late-February peak and only recouped its losses 5-1/2 months later. Brent collapsed by 67% from late-February and took just under a year to break even.