31 August 2008

FUD. Fear, uncertainty, doubt.

“FUD. Fear, uncertainty, doubt. Salesmen, politicians, markets thrive on it and create it whenever possible” - TinyTim, 28 Aug 02:12 PM, comment on Sorry, There Is No Silver Conspiracy

A fine little dispute has recently been stewing on the net around what is happening in the gold and silver market, prompted by the heavy correction in their prices. I’ve been following it here:

The Disconnect Between Supply and Demand in Gold & Silver Markets – James Conrad, 18 Aug
Gold Refining Squeezes Silver Bar Production? – Jason Hommel, 21 Aug
The Strange Case of Dr. GLD & Mr. Bullion – Graham Summers, 22 Aug
Ignoring the Free Market Causes Shortages – Jason Hommel, 23 Aug
The Disconnect Between Supply and Demand in Gold and Silver Markets, Part II – James Conrad, 25 Aug
Sorry, There Is No Silver Conspiracy – Otto Rock, 27 Aug
Independence Day: Decoupling Gold and Silver from the Dollar – James Conrad, 27 Aug
The Great Gold, Silver Conspiracy Explained – Mike Shedlock, 27 Aug
How to Explain Fiat Currency to Silverbugs – Otto Rock, 28 Aug
Conspiracy Theory Psychology – Mike Shedlock, 28 Aug
Gold Sale Spurs Manipulation Talk – Mike Shedlock, 30 Aug
Where are the insider admissions about gold? Right here – Chris Powell, 30 Aug

People seem to sit on either end of a number of propositions (doesn’t seem that shades of grey or agnostic positions are accepted), some agreeing with all, some disagreeing with all, some picking and choosing:

  • There is a shortage of retail forms of gold and silver.
  • Prices for retail forms of gold and silver are high.
  • COMEX price is different from retail prices, therefore COMEX price is “fake”.
  • Conspiracy to manipulate the gold and silver markets (by bullion banks for profit, by bullion banks on behalf of central banks).
  • Etc, etc

A lot of the hype stems from the interpretation that because it is difficult to get hold of retail forms of gold or silver (e.g. 1oz coins, 100oz silver bars) that there is a “shortage” of gold and silver. I think it has now been accepted that there is no shortage of gold and silver in the wholesale markets (that is, for 400oz gold and 1000oz silver bars). This should be obvious if you consider the fact that miners churn out 2000+ tonnes a year. What we have is a shortage of retail forms. It is also worth noting that demand and supply is also localised in the gold and silver markets. So you really need to be specific instead of just saying “shortage” – you need to indicate of what form and in what location.

Anyway, this is understandably frustrating for the retail buyer and naturally leads to questions, and attempted answers, as to why this has occurred and why manufacturers are not responding, say by auctioning off the limited quantities they have, or increasing production. I mean, they are profit seeking entities, are they not? Why would they be missing out on extra profit from all this demand?

Now one thing I can agree on is “profit seeking”, these businesses are not going to pass up profit. So how to explain their behaviour? For those who are puzzled, they only explanations can seem 1) they are idiots or 2) they are part of some conspiracy. Let me suggest an alternative explanation (and I use gold here to also include silver).

The gold industry's production capacity, distribution networks, and client base is set up to service a certain ratio of retail versus wholesale volumes. This is to be expected - if you are making big dollar decisions on equipment you will do so based on past demand patterns. There are long-term relationships in place with major distributors and clients. Production processes are set up to service this demand and with a bit of flexibility to service the shifts in this demand in response to price movements.

Now I don’t doubt for a moment that the demand has increased for retail forms of gold – there is plenty of proof of this in the above articles and discussion forums. With a sort of fixed production plan at the source manufacturers and some lead time/delay from source to end buyer, it is not surprising that retail coins and bars can run out from time to time. Now don’t get offended if you are a retail buyer, but in the big scheme of things all of your purchases added up are not that important volume wise. So the initial response by the industry is, short-term blip, it has happened before, production will catch up with demand, backlog orders will be cleared and thing will be back to normal before too soon. From my side of the fence, I’ve seen these surges in demand occur (plenty of times without running out of stock) and then subside. This is the nature of the market, it responds to prices, or drives them. It is difficult to compare this market to other goods (eg milk), because their prices don’t fluctuate like precious metals. When demand is stable, so are prices and so is supply.

OK, so based on past experience, people in the industry don’t get all excited when they run out of small coins and bars. This explains their lack of response to the initial demand. Then the demand continues, and the backorders increase, delivery times increase. Why does the industry not respond now? Well they are still not sure if this increase in demand will be sustained. Also consider that they don’t spend their time reading all these commentaries or watching ebay, so they don’t see the initial increase in premiums. The price signals are not getting through. But even if they are aware of the increasing interest in retail forms of gold (and increasing prices), they still don’t response. Why?

Manufacturers of gold and silver have long-term customers who buy in volume. Maybe the price they are receiving from these customers is lower than what they can sell their retail products at, but they have a difficult decision. Sure they could sell to retail buyers, or make their long-term customers compete at auction for their production with the retail buyers, but they worry that when the demand declines (as they have seen occur in the past) you retail buyers won’t be there anymore but their long-term customers will, and they will remember how the manufacturer “screwed” them and they will either take their business elsewhere or screw them back in turn. So the manufacturer, based on past experience of the fickleness of retail demand, decides to continue to supply their long-term customers. You also have to consider that some may have supply agreements, either for volume or at a price, that they cannot break.

Some manufacturers may have relatively flexible production processes and can switch production capacity to retail forms, but there is still a cost involved. Again, the delay in responding may be a result of the executives of these firms not being sure about the longevity of the demand and switching capacity also means that they have to cut back on some other products, products that they supply to their long-term customers.

What about putting on extra capacity? As you can imagine, capital expenditure decisions and bringing on new capacity is not like turning on a tap, there is a big lag in getting additional the machines delivered and operational. Again, the question that executives in the refineries and other manufacturers would be asking themselves is whether the increase in retail demand is permanent or temporary. If temporary, they don't want to waste money on capacity that will be left idle.

Given the above, the question then becomes: how long before the industry responds? This is hard to say. I see us at a crossroad - the future will take one of two paths:

Scenario 1

Given the natural conservatism described above and the continuing retail demand we see continuing shortages of retail forms of gold and silver, probably occurring in a stop/start fashion as one supplier catches up and then another runs out. This erratic supply increases premiums for retail bars and coins. This fans further hysteria about "shortages", driving more retail demand. Industry executives see the demand and premiums and finally see profit and decide to ramp up production. During the delay in getting capacity online (some quicker than others depending on how their production process are set up) the hysteria continues, increasing retail physical demand.

The retail shortage “story" is picked up by more commentators and increasingly by mainstream media, who in their ignorance create the perception of a shortage of wholesale physical. Fanned on by retail dealers who are making a killing from marking up bars and coins, conspiracists who think this will be the straw that will break the (short) camel’s back, and those who recommended investors into gold and silver, this drives average investor and speculators into the ETFs (because they are comfortable with this investment form and don’t have any idea how to buy physical even if they wanted to) which drives the gold price even higher. Eventually capacity will come online and retail bars and coins are supplied and stories of shortages dry up. Now there are two possible end games:

a) The hysteria process reverses as product is easily available. Perceptions change, there is now "oversupply" of gold, talk of similarities with the 1980s bubble, demand contracts and price drops, savagely. Lots of egg on certain faces.

b) Product is easily available but that has no effect. Retail demand is at a new level and remains there, the “shorts” have been broken, gold has moved to a new “level”, reclaimed its inflation adjusted price. The public are aware of the gold and silver again, distrustful of fiat currencies. A new Golden Age has dawned. Lots of egg on certain faces.

Scenario 2

Retail demand for gold and silver, while significantly higher than in the past, is not significant compared to the wholesale physical market to really move the physical spot price. Combined with the possibility that suppliers may be more flexible in production capacity than we suspect, product is brought onto the market in a few months. "Shortage" stories dry up, retail demand drops. Lots of egg on certain faces.

Either way, someone is going to be wrong. Unfortunately, only time will tell so we will have to wait to find out who. The second half of 2008 will certainly be interesting.

24 August 2008

"The" Gold Price

The recent US Mint coin production suspension has, unsurprisingly, resulted in a bit of a premium developing on small forms of gold and silver. A few people have interpreted this as an increase in the "real" price of gold compared to the "fake" price (ie COMEX) and proof of manipulation.

My view is that coin prices are not the real price of gold and should thus not be accorded too much weight in trying to analyse what is happening in the gold market, particularly as it is small compared to the overall market. There are various prices for gold:

1) Spot Price. This is the price for wholesale 400oz bars for immediate delivery (actually, the market works on 2 day settlement) usually ex-London as traded in the over the counter (OTC) market. This is the "real" physical price and is the basis on which all the other prices are set.

2) Futures Price (eg COMEX). This is the price for delivery in the future (ie whenever the next contract is). Americans love to quote this price like it is "the" price of physical gold. It is not, it is a future price. It is related to the spot price, with differences reflecting the relative costs of borrowing cash and gold. COMEX type prices are just an exchange traded version of the OTC forward price, which is a lot more flexible as you can set any date of maturity and amount.

3) Exchange Traded Fund Price (eg GLD). This is a proxy for the spot price, because it is based on physical gold in 400oz bar form. Because any significant dealer can deliver physical (or take delivery) in exchange for shares (or deliver shares) its price will never significantly diverge from the Spot Price except to reflect the costs associated with the share creation/redemption process.

4) Retail Price. The price for small, non-wholesale amounts of physical gold (coins and bars). It is usually priced based on the spot price plus an additional fee to reflect the cost of turning 400oz bars into smaller sizes. This is a physical price of sorts, but it is not the spot price and can diverge from it if manufacturers don't forecast demand correctly and run out of or get too much inventory. All that is occurring is that the premium to the underlying gold value (based on the spot price) is changing based on shortage or excess of small forms of gold. Until the manufacturers can get metal from the spot market and convert it into small forms, the retail price will continue to diverge from its normal price.

The first three prices, because they can be traded in large quantities for wholesale forms of gold, will always stay in alignment. Why can I be so confident? Because I am relying on one of the few certainties in life - people like to make money. As the first three prices are for forms of gold that can be interchanged with little cost and delay, they are easily arbitraged. You can be 100% sure that no bullion market dealer is going to forgo easy profit for any length of time. Therefore there is nothing "fake" about the COMEX or ETF price - they are intimately linked to the spot price.

In contrast, the retail market price will diverge from the other three prices because wholesale forms of gold are not quickly or cheaply convertible into small forms of gold that the price represents. Arbitrage will still occur as manufacturers are not going to sit by while large coin/bar premiums go begging, but the response will be sluggish due to the lead times in making retail products.

Also note that what we see happening in the retail physical market or GLD or COMEX is but a small part of the overall market. As discussed in this blog what we can see represents about 2% of the entire gold market. By far the majority of trading occurs in the OTC market. If you want to know what is really happening, you need a contact in the industry who deals in large volumes. For most commentators this is not possible, so all they have to work with is GLD or COMEX or the US Mint's little problems. Unfortunately, this lack of information means people are over emphasising or extrapolating what happens in the markets they can see, resulting, in a lot of cases, the wrong conclusions.

21 August 2008

The Global Speculator View

I’ve just had an interesting chat with Troy of www.globalspeculator.com.au who I have a lot of time for. His response to my hedging chart is illuminating:

“It is worth considering that many gold producers are still struggling to turn a reasonable profit. Their costs have risen astronomically and some companies have actually folded (especially the ones attempting to bring old mines back into production). The ones that locked in a gold price have been the most vulnerable to collapse (massive balance sheet problems – hedge liability related), so I do not think that a mining CEO would be all that keen on taking on hedging again anytime soon. On the other hand if the gold price has a prolonged collapse hedging may be the difference between surviving and not. What we are seeing around the gold industry both here and internationally is not consistent with a peak in the gold price in my opinion. Gold supply is flat if not falling.

Your point about where the gold demand is going to come from once dehedging has run its inevitable course is a pertinent one and I think Central Banks hold the key. Central Bank selling of gold is trending lower with the Washington Agreement Quota of 500 tons p/a not being filled for the last two years (including this year although we have another month or so left). Many non-western central banks have actually begun buying (Russia, Middle East and Asia etc). I agree that it is probably not your average mum and dad retail investor which holds the key for the gold price moving forward. Once fiat currencies start coming into question and people get a better appreciation that the US dollar is not the only questionable currency, things will start to get interesting and somewhat clearer. At the moment there is just shifting from one currency to the next and gold is still very much linked to the US dollar’s fortunes.”

Producer (de)Hedging

Every quarter www.gfms.co.uk release their Global Hedge Book Analysis. I've been tracking it for a while now as it makes for a very interesting chart (see below). Quarter 2008 report was released last week.
Seems to be a very strong correlation between the decline in the hedge book (producer de-hedging creates demand for gold) and the rise in the gold price. "What," you say, "the increase in the gold price is not entirely due to the fall in the US dollar and the massive huge demand for US Eagle coins?" Yes, that is correct apprentice goldbug, things are not a simple as some ranters, sorry commentators, would have you believe.

Interesting to note that the de-hedging for the first six months of this year has been 8,000,000 ounces. Sales of US Eagle for the 7 months of this year have been 311,000 ounces. Now don't get offended American coin buyers (and I think it is good you are buying physical) but YOU DON'T MATTER when it comes to making an impact on the gold price.

This chart raises two questions:

1. De-hedging cannot continue forever, it is the lowest it has been since 1987, as it runs down to zero it will remove a source of demand that has been there since 2001.
2. When sentiment changes and producers decide to hedge again, watch out.

Maybe this recent fall has been exacerbated by a miner deciding it is time to lock in these historically high prices? Maybe not. Either way they aint gonna tells anyone beforehand and once the announcement is out, it isn't going to be pretty. About time market commentators started to analyse the statements of the CEOs of producers for hints of their intentions and provide their subscribers with forwarning.

11 August 2008

AUSTRAC update

It appears that advice from AUSTRAC was wrong (see post of 27 July), we have alternative adivce that only cash transactions of bullion above $10,000 will need to be reported. It is also possible that the limit above which identification is required will be above $1,000, but not sure what it will be at this stage. Will keep you informed.

Promised article on gold confiscation is coming, a bit more involved than I first expected so is taking some time to write.

08 August 2008

Teaching Children How Debt Is Good

"Cent$ational Harry and the Balance of Life" is a play for primary schools to improve children's financial literacy. It was initiated by Ethical Investor with sponsorship from the Bank of Queensland.

Very admirable, but I was concerned when reading the "plot" or storyline of this educational play. I'll quote the sections of concern:

"They must first learn from Harry the way earthlings move, talk and dress so they can embark on their quest. But, Harry tells Ali and An, to achieve anything of value on earth you must first have money. “What’s money?” the ET’s ask. Harry must then teach these na├»ve characters the basic concepts of what money is and how it works.

However, each money making scheme, such as labouring, earning interest, making a profit and so on, requires time, and the aliens tell Harry, they need money NOW, for in 5 days they will expire. The only way to spend money without first making it, Harry realises, is through the use of credit, and he undertakes to use his credit card to make the journey to find the Berkelium.

Harry, however, mismanages the challenge, being seduced into purchasing unneeded computer games, mobile phones, fashionable garments and accessories, and he falls into the pit of despair and hopelessness."

So the message I would read into this if I was a kid was that you don't have to wait for money and work hard first, if you want something NOW, go and get credit. Now from the last paragraph it appears that there is a lesson coming about wasting money on useless things, which is good, but then we get:

"Harry must learn that he can only balance his finances if his expenditure equals his income plus his savings. He can't over spend on his credit card if there is insufficient money coming in to cover his repayments."

So it appears to me that the end point or lesson is not "don't get into debt" but assumes you are going to be in debt and that this is OK, so "learn to balance income and expenses". Where is the "pay off the debt" message? Couldn't the storyline be reimagined to show how debt is bad and to be avoided and that patience and savings are good?

Naive expectation of course, considering that it was sponsored by a Bank. I'm sure they love the central theme that credit cards play in the story. Sometimes I despair about where society is and where it is heading.

04 August 2008

A History of Gold Controls in Australia

Below is the text of a press release and attachment that deals with a topic that you won't find much information about on the internet. I'm typing it out so that it becomes available and searchable. Next week I'll discuss what this means for the likelihood of gold confiscation occurring in Australia. In the meantime, I'll leave you to ponder the fact that Part IV of the Banking Act 1959 has only been "suspended".


EMBARGO 6.00pm



The Treasurer, Mr Phillip Lyncy, said today that Commonwealth restrictions on the freedom of Australian residents to own, buy and sell gold in Australia had been removed.

He added that current restrictions on the purchase of gold coins had also been removed.

Australian residents could now export and import gold subject to normal exchange control and customs procedures.

Mr Lynch pointed out that legislation existed in some States to regulate gold buying and some dealings in gold.

The Treasurer was commenting on the effect of the suspension of Part IV of the Banking Act 1959-1974 by His Excellency the Administrator in Council on 30 January.

In terms of this part of the Banking Act, gold, apart from wrought gold and gold coins to a limited extent, had to be delivered to the Reserve Bank of Australia within one month of its coming into a person's possession.

The legislation had restricted the sale of gold in Australia only to the Reserve Bank or a person authorised by the bank.

It had also prohibited the export of gold without the Reserve Bank's permission.

Mr Lynch said the reasons for these restrictions on gold dealings by Australians no longer existed.

The role of gold in the international monetary system had declined substantially in recent years.

Similar restraints were not placed by the Commonwealth on dealings in silver, precious stones or other like forms of investment.

He noted that several other developed countries, including the United States and Japan, had removed restrictions on the private ownership of, and dealings in, gold.

A number of European countries also had no restrictions on gold holdings.

The Treasurer also pointed out that the Industries Assistance Commission, in its report on the "Production of Gold" dated 5 Jun 1975, had expressed doubts that the continued existence of the restrictions on gold transactions in Australia served any useful purpose.

Submissions received from the Gold Producers' Association (GPA) had pressed for removal of restrictions on gold marketing in Australia.

The Association welcomed the Government's decision to suspect Part IV of the Banking Act.

The Reserve Bank had been holding discussions with the GPA, the Banks and gold refiners to ensure that the marketing of Australia's gold was not disrupted.

The Treasurer said that gold producers, for the time being, would still be able to take their gold to banks or to refiners as they had done in the past.

However, if they wished they could now also sell their gold in other ways.

The industry would, in future, have greater flexibility in the disposal and marketing of its output.

Mr Lynch mentioned that investment in gold was not risk free and it involved significant costs such as storage, insurance and assaying.

An outline of the history of gold controls in Australia is attached.

30 Jan 1976



Australia, like most countries was on the Gold Standard before the First World War. Currency notes were circulated alongside, and were freely convertible into, gold coins. There were no restrictions on the import or export of gold. Legislation existed in some States to protect gold miners and to regulate the buying and smelting of gold.

The War disrupted the operations of the Gold Standard because of the physical difficulties of shipping gold and the special problems involved in financing the War effort. In 1915 Australia followed the United Kingdom in leaving the Gold Standard. Gold exports except with the Treasurer's consent were prohibited until Australia returned to the Gold Standard along with the UK in 1925.

In 1929 falling export prices and the cessation of long-term borrowing abroad called for special measures to conserve Australia’s overseas funds. The Commonwealth Bank Act in 1929 provided for the Bank (of which the Reserve Bank of Australia is the legal successor) to requisition all Australian gold in return for Australian notes. Formal action was never taken under this legislation but it marked the beginning of the end of holding of gold by banks and the public in Australia. In fact, there were no Commonwealth restrictions on the ownership and sale of gold between 1925 and 1939. Banks voluntarily accepted deposits with the Commonwealth Bank in return for their gold.

The outbreak of World War II again called for special Commonwealth gold controls. In 1939 regulations under the Defence Act provided for the acquisition by the Commonwealth Bank of newly won and other gold; regulations under the Customs Act prohibited the export of gold from Australia without authority.

After the war these controls were continued in the Banking Act and with some modifications were exercised by the Reserve Bank until today.

Until 1931 new-mined gold was added to the Commonwealth Bank’s stocks. The Bank made gold available to meet domestic industrial demand; exports were strictly controlled. The effect was to centralise gold in the Commonwealth Bank’s hands as part of Australia’s international liquidity.

In 1951 a premium over the official IMF price for gold emerged in world markets. Arrangements were made for Australian producers to obtain this premium for gold sold overseas. The Gold Producers’ Association was formed specifically for this purpose. In practice the Commonwealth Bank allowed the Association to repurchase the gold for sale overseas provided the foreign exchange earnings were returned to Australia and thus added to our international reserves. The Bank continued to retain sufficient gold to meet domestic demand.

In the 1960’s the gold premium rose markedly. For a time the major countries (not including Australia) sold gold to the free market to keep the price down. This was abandoned in 1968 when the major central banks agreed (Washington Agreement) not to add gold to their official reserves by way of purchases from the private markets. Australia was not a party to the Agreement but co-operated in it. Hence, the Reserve Bank held Australia’s gold reserves virtually constant and although the legislation required newly-won gold to be delivered to it, in practice the Bank returned it to the producers. Gold producers were permitted to export gold and sell to domestic industrial users. These arrangements continued until the suspension of Part IV.


One effect of suspension is that gold producers (and the Reserve Bank) are freed from the requirement to pass newly-mined gold bank and forth between them.

More importantly suspension widens the market for sales of gold by the producers. Hitherto, they have been free to meet export demands but have been limited domestically to sales for professional and trade purposes. Now, so far as Commonwealth Law is concerned, they may sell to any person within or outside Australia. Concurrently of course, the previous Commonwealth restrictions on who may buy, hold and deal in gold are withdrawn. Although imports were not controlled, imported gold was subject to delivery to the Reserve Bank. Gold may now be imported free of this control.

Restrictions on the holdings of gold coins also have been withdrawn. Hitherto holdings of coins with an aggregate gold content of more than $50 required the prior consent of the Reserve Bank. The Bank administered their provision so as to enable genuine collectors to improve their collections and to permit dealers to meet the needs of genuine collectors.

While the Commonwealth restrictions have been removed there is still legislation in some States dealing with gold. Essentially legislation in Victoria, South Australia and Western Australia requires gold buyers or gold smelters in those States to hold a State licence. Certain classes of industrial users of gold are exempted from the licensing provisions. It will, of course be up to individuals wishing to buy gold to comply with State legislation.


The Reserve Bank has been in touch with the main parties concerned with the handling of Australian gold to ensure a smooth transition to the new situation. These parties are the representatives of the producers themselves (the GPA), the four refiners (including the Perth Mint which is the major refiner) and the Australian banks who have handled the transmission of much of the gold from mine to refiner.

In practice, newly-won gold hitherto has been sent by the producers to the refiners either direct or through one of the Banks. The refiner paid the producer the official price less assay and refining costs; the refiner received the official price for the gold from the Reserve Bank. Similarly, the Reserve Bank informed the Gold Producers’ Association of the gold available for sale and recouped from the Association the official price. The GPA then sold the gold domestically or overseas at the ruling market price and passed the premium over the official price back to the original producers.

In future, the steps involving the Reserve Bank will be omitted, and, as a technicality, the refiners and banks will not be agents of the Reserve Bank in this connection. Otherwise, there will be no essential change in the handling of newly-won gold because of suspension of Part IV. Eventually, of course, the greater freedom in gold trading may lead to new practices.

20 January 1976