10 December 2010

Sprott says SLV has physical?

I found it interesting in this Sprott piece The Silver Lining that Sprott includes SLV in his table of "real investment demand for silver".

In the context of his point that GFMS and The Silver Institute neglect investment demand, I assume by the use of the word "real" Sprott must mean physical. In which case by including SLV's 305,205,951oz he is therefore saying it does have the physical.

If SLV doesn't, then he shouldn't include it in the table as their holdings would represent fake paper silver. However if he doesn't include SLV then he has no point about GFMS/Silver Institute missing investment demand of 225,783,924oz because without SLV the "aggregate implied investment demand" figure from GFMS/Silver Institute covers the other funds' inflows.

10 October 2010

Gold Bubbles

UK financial writer Dominic Frisby argues “that both metals [gold and silver] are still in a bull-market phase. Any mania is yet to come.” In support, he notes that in 1980 gold bullion went from $400 to $873 an ounce in only 36 trading days, with silver trading from $16 to $50 in 37 days. The current market is not exhibiting those sort of price moves.

He also proposes looking at the value of the US gold reserves compared to money on issue as an indicator of a bubble - “in 1980 … the market value of the 260 million ounces of gold held by the USA in Fort Knox came in at $221bn, yet only some $160bn of paper money was in issue” so if “the market value of the gold held in Fort Knox once again exceeds the number of US dollars the US authorities have issued, then gold will be in bubble territory once again, in that it will be trading at levels above its intrinsic value”.

Dominic closes his article with his definition of a bubble that I think may explain why a lot of financial commentators are consistently negative on gold: “A bubble is a bull market in which you don't have a position”. However, I doubt we will see many of them change their view and buy gold, because these days the internet means all their previous statements are recorded and easily searchable and I can’t see them admitting they were wrong.

09 October 2010

Perth Mint Blog

Perth Mint has launched an online bullion selling website and to go with it a corporate blog. After 2.5 years of blogging privately I'm finally going to be able to go legit!

The change in role means I will have more time to put into posts and be able to formally draw on our internal data. I'll keep this blog up for posts that aren't suitable for a corporate blog. For the moment I'll be dual posting as it is a soft launch before they go for a proper launch and marketing campaign. What I'm aiming to cover with the corporate blog can be found here and is pretty much the same as what I've tried to do with this blog.

08 October 2010

Prof Keen Compares Bankers To Drug Pushers

Professor Keen presents a dramatic analogy in his recent article on his speech at the American Monetary Institute’s 2010 conference: “banks are effectively debt pushers, and trying to control bank lending at the source is like trying to control the spread of illegal drugs by directly controlling the drug pushers. While ever there are drug users who want the drugs, then there’ll be a profit to be made by selling drugs, and drug pushers will always find ways around direct controls.”

The comments were a response to the American Monetary Institute’s campaign to establish a 100% reserve banking system. While Professor Keen is ambivalent about the proposal, he feels that the issue “is not how money is created, but how it is used. If it’s used to finance productive investment, then generally speaking all will be well; but if it’s used to finance speculation on asset prices, then it will lead to financial crises”.

He therefore feels reforms need to be focused on modifying borrower behaviour rather than trying to regulate lenders. His article is worth a read for his proposed reforms and the civil and mostly intelligent debate of them that follows in the comments section.

07 October 2010

High Court Judge Rules Paper Money “Almost Worthless”

In a recent High Court of Australia judgement on the Goods and Services Tax treatment of foreign currency transactions, I note with amusement Justice Dyson Heydon’s statement that:

“Apart from those rights [as legal tender], the pieces of paper had little value. They might have been used to stop an uneven table wobbling, or to jam shut a loose door, or to amuse small children, or to light a cigar. If the currency included coins, the coins might have been used to turn stiff screws or to lay on railway lines for the purpose of being flattened. But uses of that kind, which are very remote from their real purpose, would not prevent both the pieces of paper and the coins from being almost worthless.”

Before you rush to burn your money or flatten your coins, the judgement notes that “because the tokens are currency, the holder of the tokens can use them as a medium of exchange and as a store of economic value. Currency has value only because of the rights that attach to it.”

So relax, your paper money does have value. However, if you are concerned about what high inflation may do to the value of cash, you may wish to consider storing your surplus “economic value” in the form of legal tender bullion coins - sorry, tokens.

Of course, I can’t guarantee that precious metal prices will not fall, but at least you will always be able to use the coins to turn a stiff screw or two!

02 October 2010

Gold Symposium Bail Out

I've had to pull out of The Gold Symposium as the Mint's Board meeting (which I have to attend) has been moved to a day of the event. Was looking forward to meeting the speakers and attendees so not too happy. In that case the Board better approve my business case for redeveloping our exhibition area :) or I will have missed the event for no good reason.

05 September 2010

China desperate for gold & The Mind Conspirators

1) Reported by imarketnews.com:

Sales by overseas central banks could see a sharp fall in gold prices, the Financial News reported Wednesday, citing Zou Pingzuo, a central bank researcher.

"Investors should be careful about investing in gold. Gold prices could fall sharply because of intensive gold sales by the U.S. and other overseas central banks," Zou said.

To me this a sign of desperation by the Chinese. There has been no indication by the US to sell and all recent talk is about central banks buying. They are trying the old scare tactic of central bank selling to try and push the gold price down. They want to buy as much gold as they can but don’t like the current high price.

I think they are hoping this "bubble" will deflate and they can continue with their sneaky "get out of dollars and buy gold". What happens when the Chinese realise the price isn't going to drop? Will they be forced to go all out and start buying whatever physical they can?

2) Worthwhile read for libertarians - The Mind Conspirators by Nelson Hultberg. A quote:

Philosophical fallacies and socialist falsifications of economics and history have gained sway in the school system to poison our citizens' minds against the American concept of freedom. Such fallacies have created a grossly distorted image for the man in the street about the way the world works. Freedom is now seen as inimical to human dignity. Creative entrepreneurship is portrayed as exploitation of the poor instead of their only hope. Gold is termed a "barbarous relic" instead of history's proven store of value. ...

We are being conditioned to accept sloth as normalcy, servility as dignity, weakness of will as compassion, and government conveyed privilege as justice. The world of sanity and rationality gives way to regimental nightmares of Orwellian "newspeak" and "political correctness" in order for legions of middle-class sluggards to feel good about themselves while they live out their spiritually squalid lives queuing up to the entitlement troughs of the mega-state.

My response to the article agrees very much with the comments of MetaCynic:

Accepting Hultberg's argument that ideas are the engine of not only entire civilizations but of every individual, begs the question why do some ideas gain traction and not others. Why did the ultimately unworkable collectivist ideologies of the big picture intellectuals, Rousseau, Hegel, Comte and Marx, find acceptance in the midst of the wondrous prosperity produced by the Enlightenment's Industrial Revolution? Why does the siren call of unaccountable collectivism to this day continue to outsell individual liberty with all its attendant responsibilities?

Despite its clashes with reality, do collectivist intellectuals really have to work very hard to find widespread acceptance for their ideas? Maybe there has always been a ready market for their disabling poison. In politicians and bureaucrats they have, of course, an enthusiastic audience eager to legitimize their own drive for wealth and power. In the envious masses they have deluded voters proudly participating in the process to redistribute the wealth of others into their own pockets. And in the captains of industry they have "capitalists" in need of protected markets and guaranteed profits. The great majority of humans are conformists and clock watchers interested only in comfort and entertainment.

03 September 2010

Australia’s only hard money conference

From http://www.symposium.net.au/the-gold-symposium.htm

The Gold Symposium, Tuesday 9th and Wednesday 10th November 2010

Symposium announces the launch of The Gold Symposium being hosted at the Amora Jamison Hotel in Sydney, Australia on Tuesday 9th and Wednesday 10th November 2010.

Featuring highly respected speakers from Canada, Australia and the USA, this event will approach topics such as the current state of the global markets; why gold is important as an investment; and, gold versus paper as currency.

Amongst many renowned speakers, hear from the internationally respected gold analyst and author, Mr James Dines. Even now many do not believe Mr. Dines’ longstanding prediction of “The Coming Great Deflation” internationally, but what’s next? Boom or Bust, inflation or deflation, or even a hyperinflation?


Other speakers are:
Mr Dan Denning, Editor, The Daily Reckoning
Mr Louis Boulanger, CFA, Founder and Director, LB Now Ltd
Dr David Evans, mathematician and founder of GoldNerds
Mr Robert Lambourne, Chairman, Penox SA
Mr Rudy Fritsch, President, Allsteel
Mr Richard Karn, Managing Editor, The Emerging Trends Report
Mr Gavin Thomas, Managing Director and CEO, Kingsgate Consolidated
Mr Barry Dawes, Managing Director, Martin Place Securities
Prof Steve Keen, Associate Professor of Economics and Finance at the Uni of Western Sydney
And ME!

My presentation is: Paper gold – will it “crack-up”?
• You only protect your wealth by knowing when (or when not) to sell your gold
• To do this you need a real understanding of the risks inherent in the operation and interaction of the physical and paper gold markets, not the hyped-up commentary designed to increase the commentator’s Google ranking rather than your wealth
• Otherwise you may find yourself holding worthless cash after what you thought was a bubble in gold was really a collapse of paper assets

27 August 2010

Gold and silver versus market index bubbles

Below is a chart Nick of Sharelynx has been working on to show how much of a bubble gold and silver are in (or not).

Note that the x-axis does not have time on it because each bubble had a different timelength (some of the bubbles are 20 years, others 5 years). This does skew/stretch the time, but Nick's emphasis with this chart is more on the percentage growth factor rather than how long it took to get to those bubbles.

24 August 2010

GLD, leasing and encumbrances

In an otherwise good analysis of GLD (Precious Metals ETF Alchemy
GLD – the new CDO in disguise?
) and building on Catherine Fitts’ Precious Metals Puzzle Palace Hinde Capital (as does Ms Fitts) gets it wrong on leasing (see slide 18). A bit of a problem considering that "GLD has encumbered gold in it" is one of his key points.

In my experience most lease transactions are done in terms of unallocated account credits. In this case the lender has lent unallocated and if the Authorized Participant subsequently allocates this unallocated metal there is no direct link between the loan and the physical. The lender has an unsecured exposure to the Authorized Participant under the terms of the original lease. There is simply no legal link to what the Authorized Participant did with that leased unallocated gold.

In the case of lenders supplying actual physical bars (usually only be Central Banks) because it is understood that leased metal will be "used" (be that in a physical operation like a jeweller or mint, or for sale to create a short position), the contract cannot practically require the return of the same physical bars that were lent (ie the same bar numbers). If the lease contract was worded on a secured basis (most likely where the borrower is a jeweller or mint) the security would have to be against the general gold stocks of the borrower rather than the bars originally supplied as it is understood that the original bars are melted or sold.

Where lease contracts specify the return of physical at the end of the lease, it is acceptable to settle with any LBMA bar at maturity, with any ounce difference (due to the variability of 400oz bars) settled via cash.

As a result, there is no legal claim by the lender on the original physical bars supplied to the borrower. Therefore if an Authorised Participant borrowed physical and delivered that to GLD, there would be no claim or encumbrance by the lender to the Authorised Participant on those bars held by GLD.

I note that Hinde Capital avoids the “they don’t have the gold” claim. That is an issue I will post on another time.

03 August 2010

SMSF coin ban update

Further to my blog on the Cooper Review into Super and the recommendations on Self Managed Super Funds, see the 4 August 2010 press release below from ANDA:

Announcement of Government guidelines for SMSF numismatic investments ‘a relief’ says ANDA

The Australasian Numismatic Dealer’s Association (ANDA) says the announcement by the Federal Government that Self Managed Super Funds can continue investing in numismatics, as long as certain guidelines are followed, comes as a relief to many thousands of SMSF Trustees nationwide.

Mr Robert Jackman, Vice President of ANDA says: ‘I’ve been inundated with phone calls since the announcement was made last Friday. The reality is that many thousands of people would have been adversely affected if the Cooper recommendations on numismatics had been implemented. The vast majority of SMSF Trustees only invest in numismatics because they deliver reliable and attractive investment returns.

‘What’s more, the majority of investors already abide by most of the guidelines which ANDA has formally developed with the assistance of the Self-Managed Super Fund Professionals’ Assocation (SPAA). Those who don’t will be forced to adopt better prudential practices, which can only be to the benefit of the industry as a whole.’

ANDA has worked closely with SPAA during recent months, and expects to continue a consultation process on SMSF guidelines which ever party is elected to Federal Government. All three main parties have rejected the Cooper Review recommendations on collectibles for SMSFs.

01 August 2010

The Social Construction of (Gold) Reality

I have a book in my library called The Social Construction of Reality. Its basic thesis is that reality is socially constructed, or to put it another way, reality is what people believe it is. For example, if you moved to a new town and a rumor was circulated that you were an axe murderer, then you can imagine that people would avoid you, police would monitor you and if there was a murder, you would be an immediate suspect. Even though it was not true, you would in effect be experiencing the life of an axe murderer, at least in how people related to you. For you it would become reality because the social group believed it to be true.

You said “But if "smart" dollars of size (or let's just say all dollars of size) are not getting a bid from real physical gold of size... and only "idiot" dollars are getting a bid from "paper gold"... can we really say the gold basis is reflecting reality?”

My contention is that if the social belief is that paper gold is as good as physical gold then for all intents and purposes it is. As a result the basis reflects that and does not go into backwardation because people are accepting paper gold bids for their dollars. Saying this does not mean I condone it, but while the social belief continues, what the real “level of physical gold's bid for dollars” is does not matter regarding price.

There is little proof I have for my claim that we are still in phase two of the Degrees of Distrust as the gold market is opaque by nature. One fact I do have is the recent revelation by the Financial Times that the 346t of gold for the BIS swap “came mainly from investors' deposit accounts at the European commercial banks”. That is 346t of trust by those investors and indicates there are a lot of people who still believe in the system.

I can't 100% sure where we are at, but would caution against too much optimism. If we are still in phase two then a lot of education is still called for. I think the mass market is still not into gold in any major way and when it does it needs to be directed into products that take real physical off the market. We have to ensure investors are properly informed, that they understand the true "gold reality". That the Chimps turn into Champs, not Chumps.

31 July 2010

Speaking at Sydney ANDA coin show

I will be doing a how to invest in gold presentation at the Sydney ANDA coin show on 14 & 15 August, details can be found here.

I would recommend Mark van der Sluys' ‘Gold as Money’ and ‘The role of Gold in an Investment Portfolio’ presentation at 2pm and then I follow at 3:30pm. We will speaking on both Saturday and Sunday. Both our presentations will be filmed and put up on Perth Mint's YouTube channel if you can't make it.

30 July 2010

Understanding negative lease rates

The reporting by LBMA of negative lease rates is often misunderstood, resulting in some commentators coming to incorrect conclusions. Given my recent discussions with FOFOA on backwardation, some explanation of negative lease rates would probably be useful.

In the real world the cost of borrowing gold outright is never negative – no bullion bank will pay you to take gold. In fact, I am aware that some lenders have a minimum rate below which they will not lease. Makes sense, would you risk lending 1 tonne of gold worth $37 million on an unsecured basis at 0.1% for 3 months just to earn $9,400?

So why does the LBMA report negative lease rates? Our starting point is how the lease rate is calculated:

Lease Rate = LIBOR – GOFO (see the LBMA’s Guide for why this is so)

First point to note is that the lease rate is calculated from LIBOR and GOFO; the LBMA does not question its market making members for their actual lease rates. It is therefore based on the accuracy of LIBOR and GOFO. If we look at how these two rates are determined (see here and here) then we see a number of differences:

1. Set at different times – GOFO rate submitted at 10:30am and fixed at 11am, but LIBOR rates are requested between 11.00am and 11.20am and fixed shortly thereafter.

2. Set on different sides – LBMA’s website GOFO is the rate “at which the Market Making Members will LEND gold on swap against US dollars”, which involves using the USD interest bid rate. For LIBOR banks are asked “At what rate could you BORROW funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size”, that is the USD interest offer rate.

3. Set by different banks – LIBOR is set by 16 banks, GOFO by 8, with 6 common to both. LIBOR drops the top and bottom quartiles before averaging, GOFO drops the highest and lowest before averaging. It could therefore be possible that the 4 banks use to set LBMA’s GOFO (which they would calculate/relate to their estimate of LIBOR) don’t have their LIBOR rates included in BBA’s LIBOR. Probably worth noting that within a bank LIBOR and GOFO would be set by different desks.

Now these are minor differences as we would not expect rates to move too much between 10:30am and 11:00am, or much difference in the bid/offer spread, or too much divergence between banks on their rate so the dropping of high and low rates should not affect the average too much.

However, I think when rates get close to zero, these differences could have a material impact. Consider also that questions have been raised about LIBOR’s usefulness at these low rates, see here and here.

The fact is that GOFO and LIBOR are not “in alignment”. The resulting calculated lease rate is therefore just an approximation based on two averages. Caution should thus be exercised when trying to draw conclusions from it.

GOFO, however, should be able to be relied on. It should relate to the basis, although not equate to the basis as the basis is calculated from futures prices whereas GOFO is a forward rate - the economics of those two are slightly different.

29 July 2010

Degrees of distrust

My last blog was ultimately about trust and that maybe the basis is telling us that there is still trust in the system. After writing it I remembered the presentation I made to the 2009 Gold Standard Institute seminar in Canberra. Below is the conclusion from that presentation, where I proposed four phases, or degrees of distrust:

1st Phase

We start to see increasing investment in gold reflected by increasing balances in COMEX or ETFs or GoldMoney etc, but the majority of people still hold fiat and stocks/shares. In respect of gold, people have no problem with storing their metal in "the system".

2nd Phase

We start to see occassional backwardation which comes and goes and it usually only between cash and shorter futures/maturities - 1 to 2 months. This backwardation is arbitraged away by longs who still have belief in the system(s) so are willing to take the risk to make a profit. Gold is still held in the system but growth in reported balances is slowing.

3rd Phase

We see more backwardation periods, prolonged and now not just shorter maturities but maybe 3 month going to small backwardation. It demonstrates less interest by longs to take the risk. Possibly start to see reported balances of ETFs and less reputable custodians starting to stablise even though gold price still rising, which would puzzle ignorant commentators. A physical squeeze is developing.

4th Phase

Now backwardation persists, it is a permanent state in shorter maturities, increasing to longer maturities. Reported ETF balances are declining. A clear signal not all is well. Gold is being pulled and stored outside the system. The strong hands are in the majority, the squeeze is really on.

I'd say we are just starting in the 2nd Phase.

The basis does not lie!

My answers to FOFOA’s response.

I think an accurate definition of "paper" and "physical" is important to the accuracy of your statement: "I am reasonably confident that paper and physical are bound together."

“Physical” to me means real physical gold that has been delivered in settlement. Anything else I deem “paper”. Note that my definition of physical includes Allocated or GoldMoney for example, as they purchase real physical gold and store it, ie it comes off the market and is unable to be lent/fractionalised.

“Physical” does not include the near month futures contract. There is a place for buying 3 month and selling 6 month in which case you are arbitraging paper “gaps”, but what we are interested in is the effect on the real physical cash price.

But what if you could play the arbitrage (closing the gap) game without actually putting any physical at risk of delivery? Would this change the accuracy and credibility of the basis signal?

I assume you are talking here about using unallocated. OK so lets scenario it. Assume a stable supply/demand for both cash and futures so without the actions of an arbitrageur the cash price would remain at $1200 and Dec futures at $1195 for a period of 6 months. Hedge fund notices this and wishes to profit from it but it does not want to (or have) physical gold it wants to risk.

Hedge fund contacts their friendly bullion banker and asks to lend gold. Bullion bank conjures out of thin air some fake unallocated gold, merely recording an asset in its books (loan to hedge fund) and a liability (unallocated owed to hedge fund). Let us assume the amount of ounces is enough to move the price in our otherwise stable market by $3.

Hedge fund’s first step is to buy the Dec futures at $1195 but in doing so its price increases to $1198 (lets say that is the next offer price). Secondly they have to sell spot. Say they find a trusting investor who is willing to accept a transfer of the fake unallocated gold for $1200. Again, this action decreases the spot price to $1997 (next marginal bid price) and the market is now in contango. So far so good.

But what happens in six months? The hedge fund only has two choices – cash settle or physical settle.

If they cash settle then they have to sell back their Dec futures contract, but doing so will cause the price to decrease from its new equilibrium price of $1198 to $1195. Likewise, they have to buy unallocated to repay the loan to the bullion banker, but that will increase the spot price from $1997 to $1200. All that cash settling has done is delay the appearance of backwardation but not eliminated it.

If they physical settle then they get their gold from COMEX and deliver it to the bullion bank to repay their loan. Now this would have no effect on prices. However, the bullion bank now has physical 1:1 backing its unallocated liability to the trusting investor. If that investor asks for delivery, it will have no effect on price because the bullion bank has the physical. In a roundabout way the hedge fund eventually did sell real physical gold to the trusting investor.

Now your retort may be that the fact that the trusting investor was willing to accept fake unallocated allowed the manipulation of the basis to turn backwardation into contango. You would be correct, and that is the point of my scenario. The basis is therefore reflecting reality, the reality that there are idiots prepared to accept paper gold.

The basis IS telling the truth. It is not the hedge fund or the bullion bank who have “manipulated” the basis, it is the trusting investor. But in a sense the basis has not be manipulated, arbitrage is ensuring it reflects reality, that there are idiots who are prepared to bid dollars for paper gold.

If that trusting investor was not so trusting, then the hedge fund would not have been able to execute their arbitrage because there would be no one willing to accept their paper gold. The cash price would have remained at $1200 and the market in backwardation, and the basis would reflect reality, the reality that people were only willing to bid dollars for real gold.

You said “If gold stops bidding for dollars (low gold velocity), the price (in gold) of a dollar falls to zero. This is backwardation!” My reply would be that even if all (real) gold stops bidding for dollars, but there is plenty of paper gold bidding for dollars which are being accepted, then there is no backwardation.

My logic therefore leads me to the conclusion that the basis does not lie, that it cannot be manipulated. Professor Fekete was right all along, long live the basis. However, I don’t feel totally confident in this statement, as I said I’m not an expert in futures so there is probably a flaw in my scenario and logic. If so what is it?

Over time, group 1 will swell and end up holding most of the above-ground physical gold in the world. Group 2 will shrink and end up holding mostly paper gold. Group 3 will be financially sucked dry by the vampires in group 4. And group 4 will ultimately find it has no more markets to churn.

This is the theoretical process that gold backwardation should represent. A healthy and REAL gold contango SHOULD send this process into reverse, perhaps slowly at first, but reverse nonetheless.

So the question I am asking is which direction are we heading right now in this process? How close are we to the end of this process? And why aren't the market signals matching the rest of the picture?

If group 1 already has most of the physical gold and is now a one-way flow, is that not the state-of-the-market that backwardation should signal? And if the state is present but not the signal, what does that say about the signal?


Following from my conclusion that the basis does not lie, then the “signal” must be correct, which means “the state” of group 1 strong hands having most of the physical gold is not correct and we not close to the end of the process you describe. This is consistent with the defence by goldbugs to claims we are in a gold bubble that investment in gold is still a fraction of portfolio allocations and the mass market is not buying gold. Dollars are not being bid for gold, real or paper.

If you don’t like the conclusion, then you must find a flaw in my logic about the basis. I am more than happy to be proven wrong. Well, maybe not just yet, I'd like to pick up some more cheap gold :)

28 July 2010

Follow up to FOFOA

FOFOA has hit me with a lot of questions in this comment. It is 11pm in Perth, so this will be brief, but they are interesting questions and I will cover off on them over the next few days.

When it comes to COMEX FOFOA, I also am a "conceptual thinker and a fundamental analyst-blogger". This is because my gold market experience has only been with the Perth Mint and the Perth Mint has never traded on COMEX, and nor can I see any reason why we would in the future. It is a position you can take I suppose when you refine 300 tonnes of physical per year. I mention it so it is clear where my expertise lies and where it does not. This won't stop me from theorising however, because that wouldn't be any fun.

You question the reality of COMEX. Certainly the fact that one does not have to put down full cash and only margin means that there may well be many technical traders playing with computer digits, and they may be in the majority. However there are also real physical players like miners and manufacturers.

However, I am reasonably confident that paper and physical are bound together. To make that statement I rely on one thing - arbitrage, or greed. Greed as a motivator is something I feel pretty confident relying on. I just don't consider it believable that a bullion bank or hedge fund or other big trader would leave profit on the table.

We cannot discount manipulations or games being played with cash or future prices. But to manipulate one of those means that the gap (ie the basis) between the market you are manipulating and the one you aren't widens or shrinks. If the manipulation goes too far then that will present an arbitrage opportunity to other players, which if we rely on greed as a motivator, they will take. That action closes the gap.

Now as one can "trade" the basis (for another day) as distinct from the price, it must therefore be possible that the basis itself can be manipulated. However trading the basis involves two "legs" - eg buy spot, sell futures or sell spot, buy futures - which again widens or shrinks the gap/basis, presenting arbitrage opportunities to others.

The game of trading to my mind is a "base" of real price setting physical deals with that price pushed and pulled by competing manipulators, speculators and arbitragers, of both paper and physical price. Price may go up, it may go down. Both cash and futures prices may go up, but the gap widen. Or both prices go up and the gap shrinks.

I see it like an elastic/rubber band being stretched and then bouncing back. That stretching is the "noise" I mentioned in my last post. It is fun to watch and I'm sure such watching can give you an insight into the games being played, but what matters is when it is stretched to far, and breaks.

When does backwardation matter?

FOFOA started a little excitement with his post on backwardation. Professor Fekete responded and Zero Hedge weighed in as well.

I would not be surprised that for many this backwardation thing makes their head hurt and perceive it as all very theoretical and of no practical use. But this is not true and backwardation is a potential profit opportunity for those holding gold. However, it is also being overplayed.

Backwardation is when the future price is less than the cash (spot) price. Consider you are a long term holder of gold expecting to sell it in a couple of years when the price peaks. One day you wake up and note that the price of gold six months into the future is being quoted on COMEX at $1150. You check with your local coin dealer and he is quoting to buy your gold at $1200. What does this “backwardation” mean to you? See below (numbers for purposes of calculation simplicity, not real costs).

You work out that it will cost you $100 to ship your 100oz to the dealer. He will pay you $120,000. You deposit $20,000 of that with your broker as margin (plus extra to cover fluctuations) and buy the $1150 futures contract, plus brokerage fee of $50. You deposit the remaining $100,000 cash in the bank for 6 months at 0.5%. On maturity of the futures contract you stand for delivery and incur $50 brokerage and $100 shipment cost. Your profit on this is $4950, composed of

* Sale of gold: +$120,000
* Purchase of gold: -$115,000
* Interest on cash: +$250
* Brokerage and shipment costs: -$300

Now this is a great deal. At the end of the 6 months you still have physical gold but you have earned additional money while you wait for your eventual sale in a couple of years. Why would you not take up this opportunity?

Well, the deal is saying “Sell us your gold now and (trust us) ... we will have it to sell back to you in the future for less!” You are exchanging your current physical gold for a future claim to gold. You have “counterparty risk”, to COMEX, to the short on the other end of your 6 month futures contract.

Of course, such a wide difference between cash and futures prices does not normally occur, because faster and bigger players see the profit opportunity and get in first. Their action of selling lowers the $1200 cash price and their buying of the 6 month futures increases the $1150 price and thus eventually the gap (and profit) disappears. That is arbitrage.

But if you did see such a big difference in prices, it means the big players aren’t taking up the deal. The cash-futures gap is telling you that people don’t trust COMEX, they don’t think they’ll get their gold back in the future. What backwardation is telling you is that people don’t want to give up their gold, even for a little while. As FOFOA says: “gold stops bidding for dollars”.

This leads to my closing point, which is best summed up by Tom Szabo’s December 2008 comment: “Let’s talk if and when the backwardation is large enough that the arbitrage was there and yet still nobody chose to go after it. That would be truly something!”

For example, if the cash price was $1200 and 6 months futures $1199.25, in my simplistic (and unrealistic from a cost point of view) example, that would mean a profit of $25. That is technically backwardation and technically a profitable one. But could you (or the big players) be bothered with all the work involved in selling gold, buying futures and then taking delivery, all for $0.25 per ounce profit?

Therefore, the only backwardation that matters to me is backwardation that:

a) means reasonable profit and
b) no one is willing to take that profit (that is, it is persistent).

Any other backwardation is just noise and has no “information value” by itself.

If this topic interests you, the following two services specialise in tracking the gap between cash and futures (known as the “basis”):

The Metal Augmentor (Tom Szabo)
Gold Basis Service London (Sandeep Jaitly)

These services look at the bigger picture and don't get distracted by instances of technical backwardation. They look at the trend in the basis, trying to identify in advance when significant and persistent backwardation will occur.

24 July 2010

Why Investing In Gold Is An Illuminati Trap

There are a lot of "why you should buy silver instead of gold" advocates out there, but this blog Why Investing In Gold Is An Illuminati Trap is, well, in a league of its own:

Welcome to The Patriots Cave, I am Joel the K. And yes, that is correct, the Illuminati wants you to waste your money on gold. Gold coins, gold bullion, gold stamps and gold of every sort. ...

This is what I believe the NWO is planning to do with gold. They will scare the middle and upper class into sinking their money in gold, and then they will pull the rug out from under it all. Gold will plummet as panic selling ensues. Gold will fall to under $300/ounce. And then people will realize, that like diamonds, gold too, is just something pretty to look at, and that it has very little inherant value.

So say I am correct in my speculation. What then would be the smart move? Oh that is easy when you think with your instinct and intuition. SILVER. Silver will become worth MORE than gold. Mark my words. Brethren and sistren, for over 6,000 years silver was like gold, a pretty metal to make jewelry and spoons out of, and coins and bullion bars. However, in the last few decades, silver has been found to posess qualities unlike any other metal. Silver is now being used to make computers, electrical appliances, medicine, cars, planes, boats, machines, and millions of other things.

23 July 2010

Upcoming cardinal climax good for gold

I bookmarked this Seeking Alpha article from March this year Rare “Cardinal Climax” Planetary Alignment This Summer Puts Stocks at Risk, says Veteran Sky Watcher. To quote:

On August 1, give or take a week, we’ll have the most five-planet alignments in perhaps thousands of years. Known as the “Cardinal Climax,” this is the meanest, nastiest, most challenging and most transformational of any planetary phenomena in all of written history!

I looked at records going back to the 1800’s, and this is the most difficult alignment I found. When I was at a conference in Boston last month, someone said this was the most difficult alignment they have seen in the last "1,000 years." Another person told me this is the worst alignment in "10,000 years."

Worst cases include a nuclear accident. Nuclear war. Massive societal collapse. Maybe a pole flip, which can wipe out nearly everything.


One week "minus" 1st August is next week, so you have been warned :) Of course if this does eventuate I'm going to have to eat humble pie.

19 July 2010

Chart Mysticism

It is always good to get different perspectives on the markets. Bruce Edwards has worked in the refining game for many years, currently with Sabin Metal Corp. As a way of keeping in touch with his former and current clients he has a web site where he posts his Chart Mysticism on the markets.

He has a chart at the bottom of the page called Gold Shares and Industry Ranking. Bruce explains it thus: "The chart is an index of Gold Mining Company Shares (upper line) and a 10 week moving average of their relative performance when compared with 98 other Dow Jones Industry Groups. I have been keeping this chart since 1993 and it has been excellent predictor of the future relative performance of gold and gold mining company shares. When the lower line is at the high end of its range everyone loves mining company shares and gold. When it is at the lower end of its range everyone hates the group. A long term investor should sell when the lower line is high and buy when it is low."

18 July 2010

Coin & bar sizes

Below is a doc with actual (approximate) sizes of the Perth Mint's coins and bars. Consider that these coins and bars, which fit on an A3 page, are worth over $200,000. A great example of the "value density" of gold.

Perth Mint coin/bar sizes

16 July 2010

Opening up gold's distribution channels

Nick from Sharelynx forwarded two announcements to me today, one on Sprott's new Silver fund and Japan’s first precious metal ETF (actually four of them) where the metal is stored in Japan. The Mitsubishi series name is "Fruit of Gold", gotta love that.

I have been tracking all of these ETFs as well as other publicly reported storage facilities (eg GoldMoney) since 1999. I gave this proprietary data to Nick to combine with his extensive data sources to create a unique time series of these products, which you can find here if you are a subscriber (and if you're not you should be otherwise you are operating in the dark re data on the precious metals markets).

I'm sure we will shortly have some article by the gold haters that the growth of these ETFs are another bubble top indicator. I disagree, and would answer by quoting from a strategic paper I wrote for the Mint's Board in 2001, which probably sounds a bit old hat now:

The demonetisation of gold led to an emphasis on gold as an investment and this was reinforced further with the development of the Krugerrand and subsequent coin programs. However, from this promising start, gold has failed to move with its financial competitors and has thus lost its "market share" of the average consumer’s investment dollar.

What occurred with other investments was a shift from physical to virtual. For example, consumers moved from cash to credit cards, from bank passbooks to account statements, from physical share certificates to electronic registration of holdings. Consumers clearly became comfortable with the virtual form of investments and the convenience they offered. In contrast, however, gold remained physical and therefore became relatively more difficult to purchase and hold.

The result of gold remaining physical was that fewer and fewer intermediaries were willing to offer it to their customers. The two key intermediaries – banks and brokers – stopped offering direct investment in gold because other investment classes, such as shares and mutual funds, were easier to sell. This shrinking of gold’s distribution channels (in some countries it is only available from coin dealers) is it considered to be a contributing factor in the marginalisation of gold as an investment class. Hence, it is not surprising that gold is no longer considered part of a consumer’s investment portfolio.

The arrival of the Internet is accelerating the move to virtual investment categories. Customers will expect to interact through the Internet, especially for "low touch" products such as shares, insurance, and gold bullion. Customers will also increasingly move their banking and investment management online. However, this move will still involve intermediaries, it is just that the intermediaries themselves will become virtual, mirroring the change that has occurred in the financial products they sell. For example, instead of telephoning their broker, investors will trade shares directly with ComSec or Charles Schwab.

If gold is to regain a position on the average investor’s portfolio it must be on the intermediary’s "product list". The response of the gold industry to the move to virtual forms of investment does not address this issue. Virtual gold is only available via direct-to-consumer models, such as Perth Mint Depository Services or online from businesses such as Kitco. However, this approach requires consumers to find and set-up an account directly with the business concerned. These services are also not suitable for use by key intermediaries such as banks and brokers. As a result, gold is not truly "online" as far as average investors are concerned – it needs to be one of a number of investment options available when consumers ring or log on to their broker.

To do this gold needs to be virtual, as shares are. The difficultly is that, unlike shares or mutual funds, gold is inherently physical – failure to insist on physical backing against customers’ holdings leads to the temptation to issue more "paper gold" and with infinite supply, the price and value of gold becomes meaningless. Physical backing is the key to marketing gold as safer than mere paper assets, as something with intrinsic value.


The listing of ETFs on stock exchanges in my view begins the process of legitimising gold as an investment class in the minds of the average investor. However it is a necessary but not sufficient step - a case still has to be made for gold, it still has to be promoted. But at least it is "on the shelf".

The other advantage of ETFs is that they bring transparency to what is an otherwise very opaque market. While ETFs only account for 6-7% of estimated privately held gold, this percentage will increase over time, giving greater insight into the mood of gold investors. Well possibly greater insight, depending on how well analysts read the entrails of changes in ETF holdings.

15 July 2010

GLD contango strategy, or not?

A reader asked me to comment on A GLD contango strategy by Izabella Kaminska. It talks about Paulson & Co earning a return on its $3.4bn woth of GLD shares.

Holding GLD, meanwhile, is cheaper and more cost efficient than buying bullion outright.

I would note that most gold ETFs have management fees around 0.4%. Considering that Bullion Vault's storage fee is 0.12% and that Paulson would likely be able to get better rates than that from a bullion bank on $3.4bn worth of gold, it would be clear that GLD is not cheaper.

is it actually beginning to vacuum the world’s known gold supply float? Gold supplies, which previously, we might add, would have been put to work by central banks and bullion banks that owned them.

If you look at all ETFs and other storage services for which we have public numbers, together they only total 6.5% of all privately held gold. On top of that you can add the 30,000 or so tonnes of central bank gold. GLD is hardly vacuuming "known gold supply float".

Given the low costs associated with holding GLD versus pure bullion, as well as the permanent contango in the market — it is quite clear the asset lends itself favourably to the ever popular contango storage strategy

Because GLD is at least 4 times more expensive to hold than an allocated account for someone of Paulson's size, I'm not sure he could out arbitrage other players.

you buy GLD (perfect proxy for gold, but with no storage costs) you create a hedge by selling front month gold futures. You then lock in the spread further down the curve, and sit and collect the contango premium.

Firstly, GLD does have "storage costs", that is the 0.4% management fee. The problem with the strategy she proposes is that by selling a futures contract she has hedged the GLD long position. So while you may earn the contango, you won't make any money on the increase in the gold price because if the gold price increases, then you are losing on your short futures contract.

She has confused trading the basis (gap between spot and futures) with trading the price. You are either doing one or the other, but can't do both at the same time with the same capital.

13 July 2010

My fustration with GATA

Regular readers of my blog know my main objective is to educate. Unfortunately, this often finds me having to take objection to something GATA has written.

In Adrian Douglas’ latest dispatch he says that "the process by which only a portion of an investment is used to purchase bullion -- what is politely called "fractional reserve bullion banking" -- is fraudulent because it acts against the investor's interests. ... because the consequence of fractional-reserve bullion banking is undeniably price suppression."

This is a dramatic, but exaggerated and somewhat misleading statement typical of GATA. I understand their motivation to generate passion in their readers, but I don't think it excuses imprecision with the truth.

Fractional reserve bullion banking is not necessarily or inherently against an investor's interest and means price suppression. For example, an investor buys 100oz from a bullion bank, who then buys 100oz of physical. If the bullion bank then lends 50oz of that physical to jeweller, it has engaged in fractional banking as there is now only 50% of the investor's claim on the bank backed by physical. However, the other 50% of physical is with the jeweller and, most importantly, it has not been sold.

Yes, the investor is exposed in that the bank's lending has "locked out" 50oz of physical to the jeweller for the term of the loan as well as the possibility that the jeweller may go bankrupt (assuming the bank has no form of security). However, this sort of fractional banking does not result in a sale and therefore there is no price suppression.

My point is that it is the use (or to whom) the bank puts the metal backing its unallocated liabilities to that determines whether fractional banking = price suppression. Of itself, fractional banking does not necessarily mean price suppression as Adrian would have you believe.

Having said that, I should note that the majority of lending of metal (and I do not know the exact percentage) ultimately involves the sale of that physical to back some sort of short instrument (eg a miner selling forward). On this basis Adrian probably feels his black and white statement that fractional = price suppression is justified. I don't think it is. You may consider I'm being picky but I have a problem with this sort of rhetoric for two reasons:

1. GATA is a “tax-exempt educational and civil rights organization”. It is supposed to be about educating people. I think this is important, because a lack of understanding about how the market operates can lead people to exposing themselves to risks they may not be aware of. However by making these types of black and white statements, GATA is furthering misunderstanding. How difficult would it have been to say “because the majority of fractional lending is for short selling, it is a form of price suppression that acts against the interests of the (long) investor”? These sorts of qualifiers do not detract from the point being made, but give notice that the issues are more complex.

2. Adrian laments that “attempting to convince industry insiders … meets a lot of resistance”. Have GATA considered that simplistic statements and conclusions are interpreted by industry insiders not as rhetorical devices but read as ignorance of how the market really works. GATA therefore appears to insiders as lacking credibility, making it easy for them to ignore GATA and label what they say as “rants”.

This is the crux of my frustration with GATA and I don’t think it does them, or investors, any good.

As an aside, I note the dispatch refers to an earlier dispatch where Adrian Douglas says "a document published by the CPM Group in the year 2000 came to my attention recently". The document is "Bullion Banking Explained" and I made reference to this document in my London unallocated: Fractional Fubar or Benevolent Banking? post of 11 April. I considered it an obscure document, buried in CPM Group's website and had not seen it referenced to before. If you search google for "Bullion Banking Explained" with a date prior to 11 April there are only two other references to it in 2001 and 2004.

Coincidence that it comes to Adrian Douglas' attention in his 10 May dispatch one month after I reference it? By the way, this FOFOA blog attributes my post in a discussion of fractional gold banking in a discussion about whether the backing of fractional unallocated is actually physical or just further paper.

Another claim I was particularly intrigued by was when Adrian Douglas says that "as a consequence of my article it appears that Christian has realized how damning his paper was, and while it was posted at the CPM Group Internet site for 10 years, it recently was removed mysteriously." I was disappointed to find that it was just a website reorganisation. The document still exists at this link.

It would have been most amusing if CPM Group had been prompted to remove the paper as a result of GATA. Possibly Mr Christian no longer reads GATA – he did vow recently to never engage with them again after the debate on Financial Sense. Personally I think the paper CPM Group should remove is the two I reference at the end of my post on fractional banking where they say that bullion banks "take the opposite side of the hedge transactions, have inherent conflicts of interest, and always keep their own best interests in mind, even if these are the short-term best interests and arguably not in the banks’ own long term best interests." Mr Christian is the expert on the gold market, who are we to argue?

09 July 2010

Gold holds its value

On a recent trip to Sydney I visited the Reserve Bank of Australia's Museum of Australian Currency Notes. From the displays comes the following interesting information about prices in "the 1900's":

6 shillings a week for meat
16 shillings a week for groceries
25 shillings a week for rent
£250 for a Model T Ford
House equal to 10 times annual earnings
During war years average weekly earnings were £3

Given that there are 20 shillings in a pound and a pound is equal to a sovereign, which is equal to 0.2354 ounces, we can convert those prices at say AUD 1400 ounce into today's money:

$99 a week for meat
$264 a week for groceries
$412 a week for rent
$82,500 for a Model T Ford
$514,800 for a house

Of course this is a bit imprecise given the prices are as at "1900's" and wages are as at "war years", but it is a reasonable holding of value and certainly more than if one had just held on to paper money for a hundred years. See also this post on the same theme regarding the 1966 50c coin.

08 July 2010

Debtors vs Creditors

Those interested in this issue, which I have covered in this and this post, will find FOFOA's latest post useful.

FOFOA agrees with Marx that "the history of all hitherto existing society is the history of class struggle" but says that he got the classes wrong:

The two classes are not the Labour and the Capital, the rich and the poor, the proletariat and the bourgeoisie, or the workers and the elite. The two classes are the Debtors and the Savers. "The soft money camp" and "the hard money camp". History reveals the story of these two groups, over and over and over again. Always one is in power, and always the other one desires the power.

What is the relevance of this to gold? FOFOA argues that:

... when the soft money guys are in power the transfer of wealth happens slowly and gradually, and wealth flows from the Savers to the Debtors. But when "soft money" collapses - and it ALWAYS collapses - there is a very RAPID transfer of wealth in the other direction, from the Debtors back to the Savers.

... By selling your debt-financed paper savings and buying physical gold today you are making the conscious CHOICE to join the camp of the true Savers.

05 July 2010

Unfair coin ban for SMSFs

The Cooper Super System Review has been looking at the issue of collectables held in SMSFs and has a preliminary recommendation that:

a) the acquisition of collectables and personal use assets by SMSF trustees be prohibited;
b) SMSFs that own collectables or personal use assets be provided a transitional period,
up to 30 June 2020, in which to dispose of those assets; and
c) APRA‐regulated funds be exempted from these changes.

Their examples include paintings, jewellery, antiques, stamp collections, wine, exotic cars, golf club memberships, race horses and boats. The list is based on and makes reference to the ATO's definition of ‘collectables’ and ‘personal use assets’ and this definition includes “coins or medallions”.

The inclusion of coins, stamps and medallions and the requirement they be sold within 10 years has caused great concern within the numismatic community. It is the view of coin dealers that the market cannot absorb disposal of the volume of numismatic product held in SMSF over 10 years, resulting in a negative impact on market prices.

Now it is possible for a SMSF to “sell” their collection to the individual(s) who benefit from the SMSF, thereby avoiding any impact in the market. However this assumes that such individuals have the cash to pay their SMSF. In addition, the book sale would result in tax consequences for the SMSF.

I would note at this point that those who hold bullion coins through their SMSF should not have anything to worry about. The super review's reliance on the ATO's definitions for tax purposes means that bullion should be excluded due to the very clear difference the ATO makes between bullion and collectables for GST purposes in this ruling. I cannot see the super review going against this because it would result in the super treatment conflicting and disagreeing with the ATO's arguments around bullion/collectables, opening up all sorts of issues for the ATO. The primary problem would be that individual bullion items under $500 would not attract capital gains tax! I can't see the ATO letting that happen.

So on what basis has the super review determined that collectables are not a suitable investment? Initially they say that they believe “that there are certain types of assets that should not be regarded as investments that build retirement savings”.

Now this is contradicted by the fact that their recommendation excludes APRA regulated funds. If collectables were not good enough for SMSF to “build retirement savings” then logically they should also not be good enough for APRA regulated funds. The fact that they make this illogical statement indicates to me they are clutching at justifications for their position.

Later in their document they give the real reason: “The principal concern is that the cumulative regulatory and compliance complexities outweigh the potential benefits of allowing such a liberal investment menu to a sector that is not directly prudentially regulated.”

Now what this is really saying is that they suspect people are abusing the system but it is too much trouble to enforce compliance with the rules so lets just punish everyone and ban it all outright. But what really gets to me is that they are making this ban retrospective. They could have recommended disallowing further investment in collectables rather than forcing the liquidation of existing collections. There is no justice in retrospective law.

The fact is that it is bureaucrats who drafted the detailed legislation that allowed the loophole but instead of admitting their mistake and living with it, they want to perform a 1984 Orwellian expunging of collectable from SMSFs so they can pretend the whole thing never happened.

And the result? Forced sales that will depress prices and thus the value of those SMSFs. So much for helping people “build retirement savings”, Mr Cooper.

02 July 2010

AIG Precious Metal Manipulator?

Further to this Zero Hedge post note the following from CPM Group's Mr Christian:

Bullion Banking Explained (dated Feb 2000):

Many banks use factor loadings of 5 to 10 for their gold and silver, meaning that they will loan or sell 5 to 10 times as much metal as they have either purchased or committed to buy. One dealer we know uses a leverage factor of 40. (Long Term Capital Management had a leverage factor of 100 when it nearly collapsed in 1998.)

So CPM Group knew of a 40:1 precious metals leveraged firm in 2000, who were they? Mr Christian tells us in his April 10 2010 interview with Jim Puplava of Financial Sense at the 44 minute mark:

AIG was not a bank, was not a commercial bank, and under the US laws non-commercial banks don't come under the law, the guidance of the office of the controller of the currency. AIG used a leverage factor of 40, so if people gave them a million ounces of gold to hold for them, they could lend out 40. I mean, I have friends who are metals traders who were looking for job years ago and, you know, they went to AIG and AIG said “we use a leverage factor of 40” and the trader is a seasoned guy and he's worked at major banks and investment banks, he said “I can't operate at that level of leverage its just too risky more me” and AIG trading said “well this is what we do”, right, so there is a loophole in our regulatory system, its doesn't really have anything to do with gold and silver per se but it allows non-banks to participate in banking activities in a way that skirts banking regulations that are designed to promote stability in the banking system.

Interesting that in 2000 CPM Group could publicly talk about “one dealer we know” having 40:1 leverage and it was not considered an issue (although he didn’t publicly mention is was via a "loophole") – sign of those times I suppose. Question is, has anything changed?

29 June 2010

In gold we trust

In gold we trust is a special report by Ronald-Peter Stöferle of Erste Group Bank. It is very comprehensive and well worth a read because it covers across its 65 pages all key factors influencing gold prices, leading to their conclusion that:

"The risk/return profile of gold investments remains excellent. ... Our next 12-month target is USD 1,600. We expect the parabolic trend phase to still be ahead of us. At the end of this cycle the price should reach our target of USD 2,300."

In the section "Paper gold vs. physical gold" (pages 36-37) however I would debate the following statements:

"At the moment physical gold commands a premium of up to 20%."

In the wholesale physical market the Perth Mint is not seeing anything abnormal. Even in the retail market premiums are back to normal (subscribers to Sharelynx can see this for themselves at the CoinPremiums page). I have asked Ronald-Peter where he is getting this number from but no response as yet.

"According to Paul Mylchreest the London OTC market trades 2,134 tonnes of gold every day. This is 346 times the daily production and close to the global annual production."

This point is presented as proof of a discrepancy between the physical market and paper gold market. As discussed in this blog post, I don't see any problem with this rate of turnover. In his report Mylchreest concluded that gold's 12.7% turnover "is excessive and doesn’t pass the smell test." My alternatively conclusion is that "the very fact that gold is no one’s liability and cannot be printed means it attracts a disproportionate amount of trading and speculation. ... Could not the 12.7% figure be proof of the special monetary nature of gold, proof that it is the King of Currencies?"

"According to Jeff Christian, founder of CPM Group, the trade on the LBMA is based on a leverage factor of 100:1"

Mr Christian has stated that he was talking about COMEX paper trading versus physical COMEX deliveries. There are some who think he is trying to retrospectively cover up his admission. My view is that a 100:1 fractional is ridiculous considering the crucial role London plays in the physical market. London unallocated simply could not function on a 100:1 ratio in my view. Those who accept this number do not appreciate to amount of physical delivery made ex-unallocated accounts by the trade. In any case, Mr Christian actually confirmed the fractional/leverage ratio of bullion banks at around 10:1. See this blog post.

"The volume of gold derivatives is worrisome as well. According to the Bank for International Settlements, the nominal value of all gold derivatives at the end of 2009 amounted to USD 423bn."

I have often seen the nominal value referred to and while it produces an impressive number the way it is presented is often misleading on two fronts:

1. Common interpretation of these numbers is that the market is short $432bn worth of gold. In fact the nominal value is the summation of both long and short positions, it is not a net figure. If one looks at the BIS figures it can be seen that bought and sold options somewhat net out (although it is not that simple because of differences in dates and strikes).

2. Nominal does not equate to actual value at risk. As per the BIS report: "Nominal or notional amounts outstanding provide a measure of market size and a reference from which contractual payments are determined in derivatives markets. However, such amounts are generally not those truly at risk. The amounts at risk in derivatives contracts are a function of the price level and/or volatility of the financial reference index used in the determination of contract payments, the duration and liquidity of contracts, and the creditworthiness of counterparties."

They note that "Gross market values provide a more accurate measure of the scale of financial risk transfer taking place in derivatives markets" and if one looks to page six of the report it states that the gross market value of the $432bn nominal figure is actually $48bn.

There is also the issue of what is the actual delta-adjusted position (see page 10 of GMFS Hedge Book for an explanation) of the $432bn nominal gold derivatives and its real (past) impact on the spot market, but that is getting a bit technical. The point is don't get over excited by the $423bn figure and assume it means the market is short 10,000 tonnes of gold.

28 June 2010

Rory Robertson - Gold Hater

Michael Pascoe is at it again in this story reporting on Rory Robertson's (Macquarie Bank interest rate strategist) most recent article:

"Rather than worrying about US Treasuries or Australian house prices (he doesn't see a bubble in either of those assets for fundamental reasons), punters should be sceptical of gold around US$1,250 per ounce"

"Robertson admits one has to be careful about bagging gold bugs because for a decade they have been right - gold has been a standout performer"

26 June 2010

$4 billion of "fear" cash still out there

In late 2008 Australia nearly had a full blown bank run. The Australian newspaper's edited extract from the book "Shitstorm" details the run and is well worth a read:

"It was a silent run, unnoticed by the media. Across the country, at least tens and possibly hundreds of thousands of depositors were withdrawing their funds. Left unchecked, there would soon be queues in the street with police managing crowd control ... It's a long time since Australia has had a serious run on a financial institution, but it's all about confidence, and you cannot allow an impression to develop generally in the public that there is any risk."

The article states that there are "60 storerooms across the country with an average of about $35 million in each" plus "the Reserve Bank has its own cash stash ... understood to be in the region of $4 billion to $5 bn". This gives us a total of say $7b. Over an estimated adult (15y+) population of 17.8m that works out at only $400 per person.

The article also notes that "households pulled about $5.5bn out of their banks in the 10 weeks between US financial house Lehman Brothers going broke ... and the beginning of December ... a year later, only $1.5bn had been put back."

So there is still $4b of what I would call "fear" money out there. Now guess how long people will continue to hold this cash if faced with increased inflation while observing a strong AUD gold price? Would they not consider gold a better store of wealth in such circumstances?

Putting the $4b in perspective, it equals 87 tonnes of gold. Perth Mint refines on average say 6t per week. Now as the article says, the cash was withdrawn over 10 weeks, so you would not see instant conversion into gold. But then consider you would have at that time additional people who weren't freaked out last time starting to withdraw cash out of the banks.

Faced with that sort of local demand, the Perth Mint would be able to draw additional metal out of London, but either way in such a high/hyper inflationary environment I can see Australia's gold production being locked out of international markets for at least 3-4 months. Sorry India, sorry COMEX, we are all out.

24 June 2010

Mannkal Economic Education Foundation

For those goldbugs of a libertrian/Austrian economics bent (most seem to be, funnily enough) this organisation is likely to be of interest. Their mission:

We aim to strengthen the free market system in Western Australia and Australia, by promoting ideals of voluntary co-operation, choice, personal rights, limited government and responsible resourcefulness of individuals.

The Liberal Democratic Party may also be of interest. How can you argue with this Econ 101 on the WA branch's site:

9. Prices Rise When the Government Prints Too Much Money. When a government creates large quantities of the nation's money, the value of the money falls. As a result, prices increase, requiring more of the same money to buy goods and services.

10. Government Manipulation of Interest Rates and Money Quantity Causes Booms & Busts. Making money cheap (low interest rates) and abundant leads to excessive short term consumption which leads entrepreneurs to over invest in non-productive assets. Excessive demand for goods from consumers and entrepreneurs then raises the price of goods and money (higher interest rates) which results in the liquidation of non-profitable investments (mal-investments). The destroyed capital and associated production dislocation is the recession.

22 June 2010

Why has the WGC bought into BullionVault?

On Monday the World Gold Council (WGC) announced that it and Augmentum Capital had completed a £12.5 million funding round in BullionVault in exchange for an equity interest.

It is an interesting development in their strategy. Until 2002, the WGC strategy was to support those selling gold. The 12 August 2002 announcement by WGC of the appointment of James E Burton (ex-CEO of California Public Employees Retirement System) as their new CEO foreshadowed two important changes:

1. a realisation that investment demand, rather than jewellery, was more capable of driving the price higher; and
2. a shift from supporting the industry to sell gold to developing its own "products" and competing against them.

Perth Mint got first hand experience of this new strategy when it was developing its ASX listed gold product in late 2002/early 2003. At the same time a Mr Tuckwell was developing what would become the first gold ETF in the world. The WGC decided to "take sides" and chose to endorse the Tuckwell product. Needless to say, we weren't too impressed. They then went on to develop and sponsor many other gold EFTs, the US listed GLD being the biggest.

However, I will concede that considering the cost and work involved in launching an ETF, especially on overseas exchanges, it may have been excusable for the WGC to get involved in developing such products since no one else was willing to (Perth Mint and Tuckwell excepted).

But, given the huge success of the various WGC sponsored ETFs, is it really necessary for the WGC to further compete against others in the industry? After all, the WGC ETFs hold 48 million ounces compared to BullionVault's 635,000. Does online gold trading have the potential to match the ETFs for impact on the gold price? I doubt it, so what is the WGC's motivation to extend beyond ETFs?

The Telegraph reports Marcus Grubb, managing director of investment at the WGC, as saying taking the BullionVault stake was part of the Council's strategy of "increasing its portfolio of successful platforms for gold investment". Does increasing its portfolio mean WGC will next buy a refinery to make WGC bars, or open WGC coin shops?

Is it a simple case of management empire building, or has WGC management been told to expand its portfolio with the objective of becoming self funding, or are gold miners (the WGC's members) using WGC as a front to move down the gold value chain without being seen by their shareholders as getting involved in non-core businesses?

I note with interest that IAMGOLD Corporation, a shareholder in James Turk's GoldMoney (one of BullionVault's biggest competitors), is also a WGC member. Note that Durban Roodepoort Deep (not a member of WGC) is also a shareholder in GoldMoney. It will be interesting to see if IAMGOLD pulls out of the WGC as a result of their support for GoldMoney's competitor. It would result in a WGC miners versus non-WGC miners fight in the online gold market.

20 June 2010

Visit to Melbourne

I will be speaking at the next ANDA Coin, Banknote and Stamp Show being held at the Caulfield Racecourse, Concourse Ground Level, Caulfield, Melbourne on 3rd and 4th July.

While my talk will be aimed at newbies, I will be holding an unofficial "masterclass" Q&A session on Saturday at 1pm after my talk, primarily for members of www.silverstackers.com but it is open to all. ANDA show details below.

Saturday 3 July
11.00am – Bron Suchecki - ‘Options for Bullion Investment’
2.00pm – Mark van der Sluys - ‘Gold as Money’ and ‘The role of Gold in an Investment Portfolio’

Sunday 4 July
11.00am – Andrew Crellin - ‘Trading Coins for Wealth’
1.00pm – Bron Suchecki - ‘Options for Bullion Investment’
3.00pm – Rob Jackman - ‘Investing in Rare Coin & Bank Notes’

Mark van der Sluys – ‘Gold as Money’ and ‘The role of Gold in an Investment Portfolio’ – Economic and monetary historian and CEO of BULLIONMARK, Mark van der Sluys, will present a, not to be missed, two part presentation covering the subject of ‘Gold as Money’ and ‘The Role of Gold in an investment portfolio’. Important insights that are central to protecting and growing your wealth.

Bron Suchecki – ‘Options for Bullion Investment’ – Perth Mint Senior Analyst Bron Suchecki will present a one hour information session on the variety of ways you can buy gold and silver including coins and bars, certificate programs, storage options and even via the Australian Stock Exchange.

Andrew Crellin - ‘Trading Coins for Wealth’ – Andrew Crellin, Managing Director of Sterling & Currency and industry renowned author, will provide an introduction to his next book titled “Trading Coins For Wealth”, written to give an insight into how successful collectors approach their craft.

Rob Jackman – ‘Investing in Rare Coin & Bank Notes’ – Rob Jackman, Managing Director of The Rare Coin Company, will give investors the benefit of his 26 years experience in the industry with a presentation on the intricacies of Investing in Rare Coins and Bank Notes for private investment portfolios.

14 June 2010

The truth: there is zero gold in LME's vaults

There has been a lot of speculation recently about how much gold is held in London against unallocated accounts, see some examples below:

Bix Weir: "... stay away from COMEX/LME good delivery gold and silver bars ..."

Arnold Bock: "... there is little bullion in storage at the London Metals Exchange or New York's COMEX ..."

Bob Chapman: "... Do you really think that the COMEX and LME would deliver the gold even if they had it ..."

John Dizard: "Many of them apparently prefer to have their gold in vaults near where they are, Mr Smith’s “middle of nowhere”, rather than in LME or COMEX warehouse receipts."

Jim Willie: "A clearinghouse held a Letter of Intent to supply the London metals exchange with 250 metric tonnes of gold bullion."

I am now prepared to finally reveal the truth - there is actually NO gold in the vaults of the LME (London Metals Exchange). Now I know this is an explosive claim and I'm sure you'll want to know if I can back it up with proof. Well, go to the LME website and tell me where you see gold mentioned?

That's right, gold isn't mentioned. The LME is a base metals exchange and does not trade precious metals. Problem is this makes the commentators quoted above, who talk about gold on the LME, look foolish. In my opinion, if you do see a commentator make the mistake of thinking gold trades on the LME it is an indication that they don't know what they are talking about with regards to precious metals and you should treat their analysis with caution.

Gold is traded in London over-the-counter, in other words in direct deals between counterparties. There is no gold exchange in London. There is the London Bullion Market Association (LBMA), but that is just a trade association and it does not operate an exchange or have any vaults.

You may think I'm being a bit hard on those who confuse the LME and LBMA. You might argue that it is a reasonable mistake, since they are both in London and both deal in "metals".

To that I would say what sort of credence would you give a commentary by a stockbroker who talked about Pepsi trading on NASDAQ, or Microsoft trading on the NYSE? Would you feel comfortable following stock advice from someone who did not know which exchange a stock traded on?

Confusing LME and LBMA is actually worse than that because the LME is a base metal exchange whereas the LBMA is just a precious metals trade association - a basic Google search would reveal that.

Sorry, I don't think there is any valid excuse. Getting LME, LBMA and gold mixed up is a sure indicator that one has no actual precious metals market experience, an example of ultracrepidarianism. In which case, how can you trust them to know what is really going on, how can you know they haven't made other mistakes in their analysis of the gold market?

11 June 2010

Coin shortages coming

I have been going on about the coming shortage of coins due to limited minting capacity in the industry for a while now. This interview with refiner Argor-Heraeus by Mineweb confirms this, see quote below.

Geoff Candy: Are we likely to see a shortage of supply of these sorts of denominations.

Bernhard Schnellmann: A shortage yes, but that's not because of the metal, it's just because of the minting capacity. You have to same situations of the four coins - if the bullion coin - if we are sold out it's not because there is not enough gold around but also because there are not enough minting presses around.


If you believe there will be increased mass market demand for gold going forward and like your minted coins or bars, then stock up now because you will face premium increases and/or rationing. Once that happens small cast bars will be the other economical option and I think it would be a while before industry capacity is maxed out for them.

I would also draw attention to Bernhard's comment that being sold out does not indicate that "there is not enough gold around". The "selling out" of retail size coins and bars is an indicator of mass market demand and is bullish, but it is not an indicator of no gold. If you see any commentator claiming this, then the only thing it is indicating is that the commentator has no precious metals industry experience on the physical side and in my view any basic commercial sense, in which case you should consider carefully any of their other claims. It is a very good indicator of a hype merchant rather than someone trying to give you good advice.