23 April 2009

Snarling the gold-leasing machinery

This article by Ambrose Evans-Pritchard in the London Telegraph has got a lot of runs in the past few days. This statement in it caught my eye

Low real interest rates have caused the process [mine hedging] to reverse, creating a shortfall of about 500 tonnes. The process accelerates as rates turn negative, leading to a scramble by market players to find physical gold.

My understanding of what drove mine dehedging was that investors were demanding no hedging so they could be fully exposed to the gold price. I didn't think real interest rates had anything to do with it. I was intrigued that maybe Charles Gibson of Edison Investment Research had found some correlation, so I dodged up the following chart, creating the real interest rate figure from the federal funds rate less CPI.

I can't see any correlation at all between the consistent miner dehedging and real interest rates. I think there must have been some misinterpretation by the journalist in trying to simplify the report into a brief news article.

The other statement that "this is what occurred in the late 1970s, driving gold prices to $850 and ounce" I would also disagree with. As you can see from the chart, mine hedging really only got going in the late 80s. I am speaking without direct experience but I don't think there was much, if any, lease market in the 70s/early 80s. Maybe it was meant that the forwards/futures machinery was upset in the late 1970s.

16 April 2009

Martin Armstrong

If you have not heard of Martin Armstrong, it is worthwhile having a look at his work. http://economicedge.blogspot.com/ is a good place to start.

Some interesting comments regarding precious metals by Martin were made in http://fofoa.blogspot.com/2009/04/martin-armstrong-on-goldman-sachs.html that I have reproduced below:

During the late 1970s, the silver market was claimed to be "cornered" by the Hunt Brothers. That was far from true, for what they failed to understand, was that the attitude of the major brokerage houses was not that you were a pure trader-customer, but someone to pick—off for profit. During the 1980s, I had to take on some hedging projects that were awesome. One was in platinum. When you are the largest trader in a narrow market, they watch everything you do. If I was to sell, they assume the whole lot is being sold and jump in front. You suddenly find yourself trapped. I was a witness to the Hunt collapse. They couldn't get out of the market at any price. The dealers were selling in front of them taking short positions looking to buy back when the Hunts were in a state of panic dumping at any price.

I learned early on that to professionally hedge, one had to navigate the brokers. The only way to deal with them, was to play one-off-against-another, use related markets to confuse and hide your strategy, or else fall prey to the Investment Bankers. In other words, if you had a large position of gold that you wanted to sell, you go to a broker asking for a market in silver. He gives you a quote, and you then buy taking what will become an intentional loss. You go back to the same broker and now ask for a quote on the real market you are trying to sell - gold. He will anticipate you intend to buy because of the silver, shifting the quotes to pick up extra profit assuming you are a buyer. when you sell the gold, you just got a higher bid, you are out of the position, and he is scrambling to cover with other brokers. If you hit all the brokers the same way at precisely the same time, they are all now short, and are trapped trying to get out selling back gold that they just bought from you.

These games are at times necessary in the cash markets because the brokers themselves are not satisfied with just making a real market. They need to create an edge. So when you are the 800 pound gorilla, you need defensive measures. It helps to understand the method to the madness of the game.

The market manipulations that really began back in the 70's with force, became intermixed among the Investment Bankers with technology. we began to see grouping of houses by the later 1980s and early 1990s. Perhaps at first, they were looking for another Hunt. They needed to sell some billionaire on the virtues of cornering and manipulating a market.

The first real coordinated scheme began back in 1993 that I could verify. The target market was silver, and the central player, broker-dealer, was Phillips Brothers who were a big commodity outfit in Connecticut, picked up by Salomon Brothers who was later absorbed as well. This ms known as PhiBro of the same fame relating to Marc Rich.

PhiBro had a huge client who they were acting for to buy up the silver market in 1993. This was an aggressive professional strategy. The Commodity Futures Trading Commission could easily see where the buying was centered in real force. They went to PhiBro demanding to know who their client was. PhiBro refused to give up the name. The CFTC ordered PhiBro to just get out of the market. They did. They just dumped everything at the market wiping out small investors in the blink of an eye.

The CFTC just walked away. Had this been a small broker or money manager, he would have been criminally prosecuted. But the CFTC is notorious for never even once bringing a complaint against a major house. The sources I relied upon, gave me the name of the client —Warren Buffett. Based upon this information and belief, when his name came up again in 1997, it is not a shock.


We kept track of what the "club" was doing and warned our clients whenever their antics were conflicting. One of the big ones that blew the lid off, was again silver. In 1997, I warned that silver was going to rise from $4 to $7 between September and January 1998. I was even invited to join them, and told to stop fighting, and put out false forecasts. I declined. Their strategy became insane.

At first, a friend of mine who had been Prime Minister Thatcher's economic advisor became a board member of AIG in London. He called one day and asked if he could drop in to Princeton the next morning when he arrived from London. I naturally said OK. To my surprise, he arrived with the head trader from AIG London who then proceeded to try to convince me to stop talking about the manipulations. I told him I would not ever reveal any names, and the government didn't care anyway.

Things got insane thereafter. An analyst on the payroll of PhiBro had a main contact at the Wall Street Journal. They decided to slander me and get the press to target me claiming I was trying to manipulate the market. It was an interesting strategy, but one I cared nothing about since I was primarily a institutional and corporate advisor, and they were not really interested in silver.

The journalist from the Wall Street Journal called me. He accused me of this nonsense and we argued. It got quite heated. He said if silver was being manipulated, then give him the name. I told him he wouldn't believe me anyway. He demanded the name and so I said fine, go ahead, let me see you print it, knowing he never would. The name I gave him was Warren Buffett. He laughed. Told me everyone knew Buffett did not trade commodities I told him that was how much he knew.

The Wall Street Journal published the article. The London newspapers were fed stories by the "Club" that I was now the largest silver trader in the world. This became all a joke to me. Even the CFTC could look at positions and knew I was not a big player in silver.

The mistake made by the "Club" by turning out the press against me, was they actually created such a worldwide story that the CFTC was forced to call me. They knew I was not the source. They asked me, where was the manipulation taking place? I told them it was in London, out of their jurisdiction. They told me that they could pick up the phone and find out. I told them that they had to make that clear decision. I hung up. Never did I expect that they would really do anything.

A few hours later, my phone rang. It was a good source in London who also was helping to monitor the "Club" actions. He told me that the Bank of England had called an immediate meeting of all silver brokers in London in the morning. I was shocked. The CFTC had made the call. But then again, I had given them no names so perhaps in their mind, this was fair game.

Within the hour, Warren Buffett made a press announcement. He admitted he had purchased $1 billion worth of silver, in London. He denied he was manipulating the market. Claimed the silver was a long—term investment. Everyone was shocked that Buffett was suddenly exposed as a commodity trader after all The next day, the wall Street Journal called me. The writer asked — "How did you know?" I told him it was my job to know! Silver thereafter declined and made new lows going into 1999. So much for the long-term investment.


There have been major manipulations of markets such as rhodium and then there was the manipulation of Platinum. Cornering a supply is far too risky. What the "club" did was to join forces with Russian politicians. The deal struck was to recall the Russian supply of platinum to suddenly take an inventory. Platinum soared in price. Of course the long positions were already laid in before the announcement. Russia had never before recalled its entire supply to take an inventory. Nevertheless, it worked. They were able to force platinum up for the auto—industry were buyers. At the top, the "club" sold their long positions, reversed into short positions, and then instructed the Russians to end the inventory. Platinum crashed. Even Ford Motor Company sued over that one.

09 April 2009

Storage Risk

Tom Szabo of silveraxis.com has followed up on my post yesterday with some further detailed comments and a new category - Pool Allocated. he is right to split my Segregated Allocated into Allocated and Pool Allocated, as this can be important in some countries as to whether the "foreign account" is reportable to tax authorities. I interpret what Tom is saying as essential that in both the gold is physically put aside in a vault and title is with the holders (ie it is not on the balance sheet of the custodian), the difference being in whether this gold is then further separated by client.

I think it be best be thought of with the example of a person A buying 10 x 1oz coins and 10 x 10oz bars and person B buying 5 x 10z coins, both of them storing with the same custodian. In Tom's "Allocated", the custodian puts person A's coins and bars together in a pile/box with their name of it and then a separate pile/box for person B's coins.

In "Pool Allocated", the custodian has a pile of 15 x 1oz coins and a spearate pile of 10 x 10oz bars and has a ledger indicating that person A has 10 of the 15 coins and person B owns the remaining 5 and that all of the 10 bars belong to person A. As Tom points out, this can only be done with products that are the same, and not with 400oz bars or 1000oz bars, or indeed with 1oz legal tenders coins as they have different years on them (but can be done withing each year, to further confuse).

Most will see little difference between the two, as the key thing is that everything is 1:1 backed and not in the assets of the custodian. As Tom notes, Pool Allocated is more operationally efficient so should have lower costs (there is no difference in insurance cost for the custodian). It can matter, however, in how some tax laws define a reportable account. Some may be very specific that any "mixing" as in Pool Allocated makes it an account. Other may simply require the physical and title separation from the custodian's other business (if any).

With this further categorisation clarification, Tom also asks what the Perth Mint's "Allocated" is? For the most part it is Pool Allocated. I should point out that in respect of our legal tender coins, the segregation is by year. This means that if you buy 10 coins in 2005 and 10 in 2007, we have those years in storage because we make the coin in that year and put it in the allocated vault. Once put in, it stays there. But it is pooled in that if there are 10 clients with 10 2005 coins each, there is a pile of 100 2005 coins.

It gets a bit messy with numbered bars and the LBMA bars, because Tom says that "pool allocated accounts aren’t possible with good delivery bars". When you buy a numbered bar (whether consistent ounces like kilo bars or odd weight like LBMA bars), we put that specific numbered bar into the vault and allocate that number to you. But again, for practical storage purposes, the numbered bars are stored together. For example we will have a 1 tonne pallet of 80 x 400oz bars of varying weights, but even though they are together, if you pulled a specific bar out we know exactly who owns it.

Once we've worked all these variations out, maybe we need some agreed industry storage taxonomy so investors know exactly what they are getting. Marketing can sometimes get in the way of strict legal definition.

08 April 2009

Gold and Silver... How Do I Own Thee?

On 5th of April Safe Haven posted an article by a James Macfarlane titled Gold and Silver... How Do I Own Thee?... Let Me Count The Ways.

On thing I really like about the article is the way he distinguishes between physical and paper. His position is that if you don’t hold the physical yourself, you have a counterparty exposure, period. It is a position I hold but have seen very few, if any, make this point. Reading stuff on the internet gives me the feeling that a lot of people seem to think that because allocated is involved in whatever they are buying that somehow it is magically super safe!

The article then comprehensively discusses all the various paper options in a fairly balanced way (unusual these days). However, there are a few inaccuracies in his treatment of the Perth Mint which I discuss below. I have emailed James with the comments below and he was happy for me to publish them here and he will review/respond. The sections quoted in italics are from the article.

I also think the article could breakdown the paper options in a bit more detail. My view is that the risk hierarcy of paper gold products would be (there would be sub risks within the categories depending on the associated legals and trustworthyness of the provider of the service/facility):

Segregated Allocated - physically segregated specific coins and bars (including numbers) in your name.

Unsegregated Allocated - physically segregated gold (usually in bar form) in the name of the storage service provider where title resides with the holders as a group but no one bit of gold is exclusively identified as owned by a specific holder. Examples would be GoldMoney, BullionVault, Central Fund of Canada. ETFs can be included if you believe they have the gold, although considering the lack of accountability in the legals of some they may not qualify for this category from a risk point of view).

Unsegregated Physical Backed - an unsecured claim on a provider where the claim is backed 100% by physical in various forms. This is the strict definition of the Mint's unallocated. No different to unsegregated allocated except that title to the gold does not directly reside with the holders. Has to be ranked below the one above because the lack of direct title means you are relying on no other problems in the provider's balance sheet, even if they have 100% gold. In this sense you have true counterparty exposure as commonly understood. In retrospect, the Mint should never have used "unallocated" as this is commonly understood as defined below, which is not what we do.

Unallocated Fully Hedged - an unsecured claim on a provider where the claim is fully hedged by one or all of physical gold, futures, options etc. You are relying on this ability to hedge this properly - physical gold 1:1 is a perfect hedge, anything else is less perfect as it may not be able to be timed exactly with actual liquidations.

Unallocated Unhedged - an unsecured claim on a provider where the provider may or may not hedge the exposure, eg just hold your cash if they think the price is going down, hedge it if they think it is going up, they keep all the profits, if they make losses you are relying on the strength of their balance sheet.

Anyway, my comments to the article are:

“An allocated account is very different. In an allocated account the bullion must exist, and the amount you purchase is stored in your name. You hold actual title to your precious metals. The dealer in this case is guaranteeing that it has the same amount of assets in bullion as there are claims against those assets.”

I would pick a technical detail with this statement about the dealer holding the “same amount of assets”. This is not the strict definition of allocated, which is specific bars or coins in your name. In its most common form, this means you have specific bar numbers allocated to you. This is different to what he then leads in to discuss regarding GoldMoney etc. In fact, allocated at the Mint (or another other depository, eg Delaware Depository) would have to be safer than GoldMoney type systems because clients have title to specific bars or coins, not an “undivided interest in” allocated bars (from GoldMoney’s user agreement). Being undivided, one could argue that GoldMoney is really an unallocated allocated system! I would suggest that for completeness and accuracy true allocated should be separated from “undivided interest in allocated” systems. This is not to say that I think there is any problem with the GoldMoney or Bullion Vault type systems, on the contrary, just that they are different to true allocated in the traditional sense.

“from the Perth Mint in Sydney, Australia”

I think there has been some confusion here as the Perth Mint does not have an office in Sydney, it is based entirely in Perth. I note that at the bottom of the second part of the article the link to the Perth Mint has one of our Perth Mint Certificate dealers who is based in Sydney, so that might account for it.

“there is precious little on the mints' website indicating how rigorously the allocated accounts are audited, particularly the independent verification that the amount of bullion in storage matches the number of certificates issued. It appears that at least some holdings may be audited by a third party, but the mint never responded to a query as to the details”

The Mint's FAQ page says “Allocated precious metal holders may inspect or collect their deposits at The Perth Mint … a third party nominated by you will be permitted to audit your deposit on presentation of an acceptable instruction from you to the Client Relations Executive of the Perth Mint Depository. The unsegregated nature of unallocated deposits, which are backed by the working inventory of the Mint, means it is not possible for an individual to audit them. Unallocated investors will need to rely on the Mint's audited Annual Reports, which are signed off by the State Auditor-General to ensure compliance with the Financial Administration & Audit Act 1985 and the Gold Corporation Act 1987”

Now on looking at our website and annual report, I note that there is no mention of who the State Auditor-General gets to do our audits, which is a bit remiss of us. One can be left with the impression that the Auditor-General’s Department does it, which I would concede is not as strong as an audit by a party independent of the Government. For the record, both our internal and external auditors are independent “big 4” audit firms. In this sense we are therefore no different to GoldMoney and Bullion Vault. In fact, having the State Auditor General appoint an independent auditor adds another layer of control, as the auditor’s work is then reviewed by the State Auditor General.

“the Western Australian government has a law already on the books that allows for all gold to be confiscated”

It is a Federal law, not state. To be balanced I think the article should also have mentioned that this applies to any other storage service as most countries have this risk, whether a law exists in a suspended state as in Australia or a new law needs to be enacted.

“For one thing, you cannot take delivery of your gold without first converting to an allocated account and paying additional fees”

These “additional fees” are simply fabrication and delivery costs, the same that you would pay if you bought allocated in the first place.

“The Perth Mint will not be liable or responsible for delivery delays due to causes beyond its control”

This text is a standard type of force majeure. I would point out that it refers to “delays”, not failure to do it at all. The nature of force majeure is that when the condition that brings it into play has finished, the obligations come back into existence – it is only referring to temporary events. For comparison, note the following similar clauses in the GoldMoney user agreement:

Net-Gold shall not be responsible for errors, negligence or inability to execute orders, nor shall Net-Gold be responsible for any delays in the transmission, delivery or execution of the User's order due to breakdown or failure of transmission or communication facilities, or to any other cause or causes beyond Net-Gold's reasonable control or anticipation including (without limitation) volatile markets or trading disruptions.

Whilst GoldMoney makes its best efforts to prevent unauthorised or fraudulent use of its system, GoldMoney disclaims itself from all liability for loss or damage, of whatever nature, caused as a result of the unauthorised or fraudulent use of a User's Holding number and Passphrase to the fullest extent permitted by law but excluding unauthorised or fraudulent use by GoldMoney and Net-Gold

GoldMoney shall be relieved from its obligations under this Agreement if and to the extent that it is unable to carry out all or any of its obligations hereunder owing to: i. Wars, civil commotion, vis major, act of God, strikes, riots, lockouts, governmental controls or restrictions, non-availability of any equipment or telecommunications or computer systems or any other causes beyond the reasonable control of GoldMoney

I think if one digs into any of the other storage services they will find similar force majeure clauses. This is standard business practice and is not at all sinister. I don't think people should interpret these as the Mint, GoldMoney or others as trying to get out of their obligations permanently.

Personally I think the article makes the differences between the Mint and GoldMoney and Bullion Vault too wide. The five part process described for GoldMoney also applies to the Mint:

1. The Mint is regulated and supervised just as much if not more than private companies. We have to comply with the same laws that apply to private companies plus the additional requirements of being part of a Government.
2. All bullion we hold is LBMA standard and/or internationally accepted and in the case of work in progress, we can easily make it into LBMA standard.
3. We store it ourselves, so there are fewer counterparties involved and to argue with in the event of any problem.
4. All our metal (unallocated and allocated) is insured by Lloyds, in addition to being guaranteed by the West Australian government.
5. Our accounts are audited by big 4 firms, the audit including verification of physical stocktakes and corresponding unallocated and allocated liabilities.

Nothwithstanding the above, I think the article is worth reading and should be reference material for first time gold buyers, as long as it says nice things about the Perth Mint of course :)

04 April 2009

Mad Witches' Dance

An extract from the book Money by Hartley Withers, 1935:

Since, then, it seems to be true that prices vary with fluctuations in the quantity of money, and since the quantity of gold, and consequently of gold-paper money, has certainly varied considerably in the past, and price have varied with them, the critics of the gold standard have logic on their side when they argue that stability in buying power has not been secured by it; that money is defective as a measure of value when the amount of commodities that it will command is subject to variation; and that it would be just as sensible to use, for measuring lengths of timber or pieces of land, a yard-stick made of an elastic material.

But having thus seen that there is much truth in the premises of the critics' argument, is it necessary that we should follow them to their conclusion and abolish the gold standard? It is a long step from admitting that the gold standard has not been perfect to replacing it by one which, when tried, has shown the same imperfection in a highly exaggerated form. During and after the war we had no gold standard, but money that was paper, issued, at the will and pleasure of governments, by governments or by central banks acting at their bidding; and prices whirled up in a mad witches' dance. It is true that the circumstances were enormously exceptional, but the experience has left, in the minds of most of us, a deep mistrust of any change that would leave our money in the hands of politicians who could multiply its amount whenever they preferred that mode of paying their way to taking money out of our pockets by taxation.

It is so easy and tempting, and politicians are so human. In fact, Mr. Stanley Baldwin, an austere but kindly judge, has stated publicly that there was no government on earth that he would trust to manage a currency, and the one outstanding advantage to his mind of a gold currency was that, so far as anything in the world could be, a gold currency was knave-proof. Moreover, recent exceptional experience has shown that the power of public authority to endow pieces of paper with buying power fails if it is worked too hard. A government can make certain money legal tender for the payment of debts, but it cannot compel shopkeepers to party with their goods in exchange for it if they do not want to, as was shown in Germany when the printing press was producing its most monstrous effects, and the trade and business of the country began to be done in dollars and other foreign currencies.

For the present the gold standard, in spite of the hard truths that are behind many of the criticisms with which it is bespattered, holds the field as a working scheme, under which, during the century before the war, immense and unprecedented progress was made in improving the material conditions of man's existence. The circumstances which led to its collapse in 1931, chief among which were panic in America and political funk in Europe, seriously though unreasonably discredited it. But its loss showed how valuable was the work that it did, in steadying rates of exchange, and so promoting commercial and financial intercourse between the nations.