17 October 2018

Fractional reserve bullion banking and gold bank runs

Below is a series of post explaining how bullion banking operates, which is necessary for a true understanding of how susceptible it is to a gold bank run, as well as understanding how a price suppression (as opposed to manipulation) would work, in respect of what backs paper gold and how much physical is needed to support the system.

1. Fractional reserve bullion banking and gold bank runs - the setup
2. Fractional reserve bullion banking and gold bank runs - a bullion bank's "assets"
3. Fractional reserve bullion banking and gold bank runs - the model says we are hedged
4. Fractional reserve bullion banking and gold bank runs - unallocated as real (gold) bills
5. Fractional reserve bullion banking and gold bank runs - how can I default on thee? let me count the ways
6. Fractional reserve bullion banking and gold bank runs – inter-bank buddies business
7. Fractional reserve bullion banking and gold bank runs – Frankenstein Free Banking
8. Fractional reserve bullion banking and gold bank runs: the role of central banks
9. Fractional reserve bullion banking and gold bank runs: bank run theory
10. Fractional reserve bullion banking and gold bank runs: a run or stroll?

See also:

Does fractional reserve gold banking = price suppression

The Mystery Of The Missing Australian Gold?

Has the Reserve Bank of Australia lost some of its gold reserves? Martin North of Digital Finance Analytics implies as such in The Mystery Of The Missing Australian Gold where he "discuss[es] the current state of Australia’s Gold holdings, and where 11 tonnes may have gone" with economist John Adams and then raises questions about the audit of Australia's gold in a follow up YouTube.

As is the case with most clickbait type headlines, the gold isn't missing nor is it a mystery, but that doesn't mean John hasn't raised valid questions. I will first address some misconceptions raised in the videos then discuss the audit.

At 15:50 John talks about the bars having a serial number and "emblem of the nation" and that the "Australian crest" will be stamped on the bar. This is not the case. The global standard for bullion traded in the professional gold market is detailed here and requires that bars are stamped with the brand of the refinery that made the bars, a serial number, purity and year of manufacture. Bars do not have any markings indicating who owns them and indeed anyone asking for physical allocation will usually receive a mix of bars from different refineries, as long as they are on the accredited list.

At 18:28 John discusses the interest income of $710,000 the RBA received on leasing out its gold and calculates an effective rate of 0.12%. This calculation is not correct as he is using the 30 June balance when the amount leased during the year may have changed. The RBA annual report does actually provide an accurate "weighted average effective lease rate" on page 177, which for 17/18 was 0.15%.

John and Martin then go on to discuss how this rate is non-commercial and compare it to the treasury 10 year rate. In the chart below I have graphed in blue the average rate reported by the RBA in its annual reports since 1998.

While 0.15% or even 0.40% may seem low to those outside of the bullion markets, they are reflective of gold lease rates in general, which are available here. The chart below is from that link and shows the derived (ie LIBOR - GOFO) gold lease rate for a lease of 6 months duration (note that the chart stops in 2015 as GOFO benchmarks ceased that year and full lease rate data is only available on paid subscription sites with some derived data being produced by Monetary Metals for free if you sign up).

Having said that, the 0.15% in my opinion is too low notwithstanding the RBA is lending on a collaterised basis or to entities with "government support". The red line on the previous chart shows that the RBA was pretty much lending out all of Australia's gold reserves prior to 2005 but sharply pulled out of the market as its longer term (1-5yr duration) leases matured (see this post for charts on the RBA's gold lease duration mix) into a market where lease rates were sub 0.40%. It clearly didn't think the risk/return tradeoff was right at the time and that was prescient considering the GFC hit in 2008. If the RBA is willing to increase its gold leases at 0.15% it must now consider everything has been fixed and financial risks are low!

At 21:50 John talks about what he calls the linchpin question, which is whether the RBA will accept repayment of the lease in non-physical form. If yes, then he believes this means that Australia's 11 tonnes of leased gold has been melted down and this I think is where he gets the idea the gold is "missing". I was intially puzzled at John's logic until I realised that he is probably being confused by the gold industry's use of the term "lease" and naturally would assume a common meaning, that is, that leased goods shoud be returned after use.

When one sees "lease" in terms of gold that really just means "loan" and as with money (assuming someone loaned a person physical cash) the borrower does not keep the physical money but uses it for whatever purpose they sought the loan. In the case of the gold market, central banks generally do get back physical when a gold lease matures, but it isn't the same bars they lent - just as a borrower doesn't (can't) return banknotes with the same serial numbers. As discussed in this post:

"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."

On this point, I think John and a lot of people leaving comments about the RBA leasing gold are like the crowd in the Simpson's take on It's a Wonderful Life.

In John's second YouTube he gets stuck into the RBA's audit of Australia's gold reserves at the Bank of England, tipped off by the work and FOIs of Bullion Baron (see this and this post for the background). John makes a number of valid points, the primary one being that it is not a real audit if the RBA is not able to randomly sample from its bar list without direction/limitations by the Bank of England.

John's issue with the Bank of England limiting the scope of the sample is that it enables them, given the 6 weeks notice the RBA gives, for the Bank to get bars manufactured with the required serial numbers (which it would only have to do if the Bank has been leasing/selling the RBA's gold without its permission).

This scenario is actually close to impossible given how the global refinery accreditation and manufacturing process works. Refineries number bars sequentially, with some numbering since they started refining while others restarting numbering each year (which is why the standard quoted earlier requires year of manufacture on the bar). The entire industry relies upon (and continually audits) refineries to ensure the integrity of the "good delivery" system, as without it global gold trade would break down. Sequential numbering is also a key internal control within a refinery.

It is impossible for the Bank of England to call up more than one refinery (as given the way vaults operate and bars allocated, bar lists usually contain bars made by many refineries) and ask for bars to be fabricated with retrospective numbers. The number of people involved in each refiner from the lowest levels plus internal audit/control to perpetuate this level of fraud makes it unlikely to occur, let alone remain a secret.

Having said that, John misses the key control breakdown identified by Bullion Baron which is that the Bank of England has it own numbering system and it is an open question from the FOI documents whether the RBA was just given this number or the actual serial number on the bar, as the RBA refused to provide this information. If the former, then this mean the Bank could just find a bar of similar weight (difficult but not impossible given the Bank stores 416,000 400 ounce bars) and say this matches their internal number. It is only the actual serial number stamped on the bar, in conjunction with year and refinery, that uniquely identifies a bar.

While the RBA is one of the most transparent central banks in respect of reporting on its gold reserves, Bullion Baron's FOIs reveal that they dropped (still drop?) the ball in respect of managing Australia's gold reserves. A case of 1900s "Mother Country" deference-type attitudes or maybe just because Bank of England is seen as one of the "central bank club" and so you can trust your "mates" to do the right thing?

03 April 2018

Backwardation, the Bank of England, and Falling Prices

I have a post up on Monetary Metals commenting on Jeffrey Snider's observation of the anomalous situation in the gold market between 2013 and 2016 where negative gold forward rates (GOFO) indicated backwardation while the gold price was falling. I expand on Jeffery’s chart which shows periods where the LBMA GOFO rate was below zero, along with the Bank of England’s custody holdings (gold held on behalf of central banks and bullion banks) with Monetary Metal's MM GOFO figures. Read more here.

I also addressed comments on the article at Zero Hedge and Silver Stackers.

17 March 2018

Once in Golconda

Once in Golconda: A True Drama of Wall Street 1920-1938
John Brooks
Allworth Press, 1969

p150: "Its [Wall Street] fixed star-money-had left its regular place in the heavens and begun to wander and dance and lurch. For generations the dollar had been held firmly fixed by a force that was accepted in banking circles as being equivalent to a natural law of astronomy, the gold standard-specifically, by the Treasury's pledge to redeem dollars with gold in any quantity for all comers at $20.67 per fine ounce. Now, with that pledge temporarily abrogated in the emergency, the dollar was free to fluctuate in the world markets at the whim of speculators, just like come humbler currency, or indeed, like some untrustworthy common stock. The [first] hundred days [of Roosevelt's presidency] marked the beginning of a unique, and for many people hair-raising, period of almost a year during which the secure wealth for Americans consistend not of gold, which they were now forbidden to possess except for industrial use or in the form of jewelry, and not in money, every possessor of which found himself involved intentionally or not in a game of chance, but in land or goods."

p155: "Next day [April 19, 1933] came the public announcement that the country was off the gold standard, and, from Wall Street, some astonishing reactions. ... What was most astonishing of all, though, was the swift and decisive approval of Roosevelt's move by the greatest banker of them all. From 23 Wall came a public message signed by J.P. Morgan-apparently the only formal statement of his career, apart from one that had followed British devaluation in 1931: 'I welcome the reported action of the President ... It seems to me clear that the way out of the depression is to combat and overcome the deflationary forces.'"

p162: "But no nation had ever mounted a systematic and concerted attack on its currency, in a time when its gold stocks were ample, for the sole purpose of creating domestic inflation and thus helping debtors. They had not done so because the idea was so outlandish it had never occurred to them. If it had, it would have appeared to their economic ministers as about as sensible as repeatedly hitting oneself on the head with a hammer so it would feel good when one stopped."

15 December 2016

Silver Smoking Gun to Stop Dishonest Dealing

I have an article up on Monetary Metals' website with some thoughts on the amended London Silver Fixing Antitrust Litigation which included damaging chat logs provided by Deutsche Bank that revealed collusion between bullion bank traders to “shade”, “blade”, “muscle”, “job”, “spoof” and “snipe” the silver market. Read more here.

29 August 2016

Central Bank Non-Transparency

Just a quick post on Jan Nieuwenhuijs/Koos Jansen's article on the refusal of the Dutch Central Bank to publish a bar list. The reason given was that "the conversion of internal lists to documents for publication would create too many administrative burdens."

I find this excuse weak when gold ETFs can produce bar list in the thousands of pages, and do so without creating any security issue. Even if the custodians where they have the gold have given them a pdf bar list that for some reason contains information that could be a security risk, it should not be a problem to ask that custodian to modify the report/query on their inventory database to exclude such information, or output only the relevant fields of data as a csv file or spreadsheet. If the problem with doing that is that the custodian does not operate an electronic inventory system then we have some serious questions about the control and safety of that custodian's operations.

I think the real reason for not wanting to disclose the bar list is as some have noted in the comments to the article - when a central bank leases gold out, they get different bars back (see here on why this is case) and thus the changing bar numbers on the list would reveal what percentage of the central bank's gold was lent to bullion banks during the year.

For a central bank who follows correct accounting rules and show leases separately to physical gold (see here regarding Reserve Bank of Australia) a bar list should not be an issue (although see here for blogger Bullion Baron's problems getting a bar list out of the RBA, which it seems was more of a case of interference from the BoE and a lack of courage by the RBA to stand up to them) but for a central bank who reports physical gold and leased gold as "gold" the bar list would raise questions like "why didn't you disclose the difference, how can you pretend that leased and physical are the same" or questions about the risk the central bank is taking and whether the return they got was worth the risk. Whilst I haven't met central bankers personally, I'm guessing they don't take too kindly to having their actions or judgements questioned. Hence the stonewalling.

15 July 2016

Monetary Metals Closes First Gold Fixed-Income Deal at 5%

What was that about gold being a sterile asset?

FREEDOMFEST LAS VEGAS, Nev., July 15, 2016—At FreedomFest, Monetary Metals announces that it has closed its first gold fixed-income deal, to finance the gold working inventory of Valaurum. The initial amount of gold meets Valaurum’s current needs, with room for expansion driven by its growth. The interest rate is 5 percent of the gold, paid in gold.

Read more here and check out the revamped Monetary Metals website.

13 July 2016

Yin and Yang

During gold’s bear market from 2011, the flow of gold out of ETFs drove the popularity of the West to East narrative not just among goldbugs but also bullion market professionals. It was a life raft I suppose that many clung to, to find hope as the price relentlessly fell, notwithstanding how much gold was flowing into “the East”. Today, investors have abandoned the raft as they step out on to the terra firma of $1050 and stagger about basking in the lush tropical greenery of a rising gold price. Read more here.

01 April 2016

The Voldemort Effect in the Gold Market

Gold market analysts have for many years puzzled over the unusual behaviour of the gold market during the 1990s, specifically the bizarrely flat gold price from 1993 to 1996 in the face of sustained selling pressure from central banks and gold miners hedging their production. To-date no one has been able to identify the hidden source of demand that was obviously supporting the gold market during that period. Read more here

12 February 2016

On the absurdity of buying gold

Izabella Kaminska Feb 11 11:18am: "all evidence points to a serious network-wide issue that’s spiralling out of control ... the root cause of the insecurity is the increased pressure on banks to make their systems as user friendly as the systems of non-bank challengers ... even if the latter don’t necessarily have the same quality of checks and balances in place ... the real cost for banks might not even be associated with the rise of successful fraud attacks on the network but rather the missed business opportunities associated with contaminated data profiles"

Izabella Kaminska