15 December 2011

FOFOA, New Vaults and physical/paper price

A couple of weeks ago FOFOA made the following statement:

Do you remember the stories about HSBC clearing out space in their vaults, or JP Morgan building new vaults? What could be the explanation for this if the aggregate gold stock is so stable? Then it occurred to me that unallocated storage is much more space-efficient because the gold sits stacked on pallets. Allocated gold often gets put into cubby holes to assist in recordkeeping. That takes up much more space. So the process of allocation after many decades of non-allocation requires an expansion of vault space. This is how I now interpret these stories.

I left a comment suggesting other reasons for new vaults:

1. Investment's share of demand vs jewellery/industry is much higher now compared to past, thus more going into vaults rather than around necks.

2. ETFs and others (eg Goldmoney) share of investment demand vs coin/bar is greater compared to past, thus more going into vaults rather than backyards.

3. Industry consolidation during gold bear market meant vault closures and thus increase in utilisation of remaining vaults, leaving less spare capacity to absorb above factors before new vaults were needed.

Just to clarify that last point, say there were 10 vaults with capacity of 100oz but each was only holding 60oz. Total spare capacity is 400oz. Then you have 3 vaults close during gold's bear market and metal is moved into the remaining 7 vaults. You now have 600oz in 7 vaults, leaving only spare capacity of 100oz.

Another point is that allocated metal is not "often gets put into cubby holes". Allocated does not rely on physical segregation by client. For example, you can have a pallet of 32 x 400oz bars with 32 owners of each specific bar number on that pallet. My guess is that except for all but the most paranoid client (mostly likely central banks), most allocated at bullion banks is held this way, rather than piles segregated by client.

I also forgot to mention that my guess is that the amount of physical supporting unallocated metal accounts with bullion banks has increased, that is the fractionalisation has declined. This puts further pressure on vault capacity.

Evidence for this is that whereas unallocated accounts were free a number of years ago, there is now a small fee on unallocated. My guess is that the physical turnover/redemptions have increased in line with a more busy gold market and thus bullion banks have needed to hold more physical to back their unallocated to deal with day to day fluctuations.

Of course it could just be the banks going for a fee grab if they felt their clients would just accept it.

And while I'm doing posts on my comments on FOFOA's blog, here is another for those who don't follow the FOFOA blog comments closely - and I can understand that considering some posts get 400+ comments (link here):

Re 1) [major refiners would start posting their own price for physical gold, having their own auctions, making the trading volume public], that is what the Perth Mint already does. The 5 tonne or so per week we refine is currently auctioned. Settlement can be full cash, but mostly is done in London paper gold plus a cash premium. I just watch this premium, it will tell me when paper gold has really disconnected.

BTW, miners sell their metal to us either for cash or swap for paper gold (which they then on trade).

The system will break when miners find few willing to take their paper gold or the price offered is much lower than what we will pay. And in that situation we will always be after to better the offers they get because we are getting better prices for the real physical at the other end.

Because the Perth Mint stands as intermediary between physical buyer and physical seller, the miner is always informed as to the real price of gold.

We are not reliant on the London market to tell us the price, we make a Perth price every day. However currently London is a convenient settlement mechanism for us the miners and the buyers, but it is just to help the flow.


FOFOA said...

Hello Bron,

My point (and it was a point, not a literal assumption) was that the shift from a largely unallocated system to allocation requires a lot more space. I was not proposing that the banks are building cubby holes for all the gold. That would require an exponential explosion in storage space which we do not see happening. But there's a big difference between keeping track of how much gold is in the warehouse and managing who each bar belongs to, and having it located in the location the customer requested.

Changing from a gold standard (pre-71) to commodity gold left the banks still managing a defined quantity of gold. Now, shifting from commodity gold to unambiguous wealth-asset gold is a space-sensitive adjustment for the bullion banks managing this heavy physical asset.

I view the ETFs as a coat check room for gold that was already in the system. But the ETFs do require allocation and, therefore, a little more space (or else you end up showing a bar to a reporter that's not on the registry ;).

How much jewelry was melted down and made it into good delivery bars over the last 15 years, I have no idea. But I struggle to imagine it amounts to new warehouses.

Industry consolidation could certainly account for some of it. But I hope, at least, you didn't miss my point. ;)


Gordon said...

Hi Bron,

A problem that I have with the FOFOA freegold concept and the Euro is that the Euro's gold assets are marked to market and recorded as such every month.

If there is no longer a paper market for gold (when freegold eventually arrives), what market do they then mark their gold assets to?

Justin said...

By paper gold you mean LBMA unallocated, so a credit with a bullion bank? & by cash you mean a dollar denominated account with (presumably) any bank, so bank credit?

Bron said...


I don't think there is much of a shift from unallocated to allocated happening, as in an increase in the % of people holding unallocated vs allocated.

In our business, which is more retail and thus one could argue more likely to be more fear driven, we have only moved from 5% allocated to 15% (http://www.perthmintbullion.com/Blog/Blog/11-05-11/Perth_Mint_Depository_Fear_Index.aspx). My guess is it would be less in the professional/giant end of the market.

Any such increase in the percentage holding allocated in favour of unallocated would be outweighed by new flows and the othe factors I mentioned IMO.

Re the ETFs and coat check room, that reporter stuff up shows that they don't engage in much segregation.

I think if you look at WGC scrap figures they report in the past year 1646t of scrap, which is 60% of mine supply, so it is not insignificant.

It is probably worth putting some hard numbers to this issue to get a handle on the flows and stock.

Justin - yes by paper gold I mean unallocated.

LS said...

Hi Bron,

What's your general opinions towards FOFOA's idea on:
- freegold
- the gold for oil trade
- the current price is not a real physical price of gold because of happenings in COMEX/LBMA

Do you believe the current world affaird will resolve itself towards freegold or something similar?

I'd love to hear from an industry insider on physical gold. Please let me know if you have already made comments on these in other articles.

appreciate it


Anonymous said...

On gold vaulting: In this interview with Kyle Bass he talks about the $1 Billion in allocated gold held by the University of Texas at the Comex(start at 42 mins) He states how he thought it was interesting that when he did an audit he found that the gold wasn't segregated, but that the bars were scattered all over the vault.

Bron said...

Thanks for that, it is a great find and confirmation of how bullion banking allocated works in practice and supports what we saw with the HSBC reporter bar stuff up FOFOA mentions above.

Anonymous said...

You have to wonder how much of a problem Hugo Chavez caused when asking for physical delivery of Venezuela's gold. If it's standard operating procedure that allocated gold accounts are not physically segregated and are palleted and stored together with other allocated and unallocated gold bars, then pulling specific bars for permanent removal from the vaults must be a major job. When Bass asked for delivery (allocation) they apparently just do it "virtually" -- within the computer. Maybe he should have asked for actual physical delivery to Texas.

It's also interesting the confirmation of the fractional reserve nature of the Comex. When Bass questioned the head of Comex deliveries, "What happens if just 4% of the people ask for delivery?" He replied, "Oh, that never happens. But if it does, price will solve everything."

Just a fraction of the Venezuelan gold has been delivered and it's been 4 months since the announcement of it's repatriation. I'm sure most people would question why it just can't be delivered by FedEx in a day or two.

Bron said...

I think you'll find that gold held by central banks for other cental banks is physically segregated, even sometimes in cages.

If I was Hugo Chavez I would not be wanting to move the metal all in one go just from a risk point of view and rather spread it out.