30 July 2009

Multiple Anomalies Detected In Silver ETFs

Tyler Durden of Zero Hedge has posted an analysis of SLV's bar list by "Project Mayhem Research" (PMR for short) that concludes:

During our research into the inventory lists of the iShares SLV and London-based ETFS physical silver funds, we discovered multiple anomalies which cannot be easily dismissed. These included the presence of internal duplicates, rough internal duplicates, weight duplicates, statistical clustering, and cross-reference duplicates.

It would probably have helped perceptions of impartiality if PMR hadn’t made references to "world silver price management and a functional oligopoly for the elite" and “one might expect Western governments and megabanks to be openly hostile towards silver” in their introduction, but I suppose in these times it is best if one is transparent about one’s biases. In that spirit, I should point out that as an employee of the Perth Mint, the gold and silver ETFs are competitors of our Depository facility so it would be in my/our commercial interests for SLV or GLD to be revealed as a scam.

Unfortunately, I operate under the ethic of reciprocity, otherwise known as "do unto others as you would have others do unto you" so I'll have to be fair and factual in my analysis of this analysis. This may mean that, shock horror, I say some things in defence of SLV.

At this time I would also like to issue a warning that what follows is some technical nit picking probably only of interest to myself, PMR and a few other nerds, done on the basis that the PMR analysis is a working paper. If this sounds a bit too boring, and you are of a conspiracy bent, may I suggest this article to reinforce your prejudices. For those who think gold and silver “enthusiasts” are nutters, you’ll find this article more to your liking.

Firstly, it is worth noting the London Bullion Market Association’s (LBMA) delivery standards for 1000oz silver bars, as this is the standard to which the bars on the lists have been produced:

Minimum weight: 750 troy ounces
Maximum weight: 1100 troy ounces
Minimum purity: 99.9%
Weight rounding: rounded down to the nearest 0.10 of a troy ounce
* Brand
* Serial Number
* Year of Manufacture
* Purity
* Weight (optional on the bar but not on the bar list of course)

PMR makes reference to a choice of “primary key”, in other words, how does one uniquely identify a bar? I think it would be obvious to most that Brand and Serial Number together are needed, as we cannot assume that each manufacturer uses a totally unique numbering range or system.

However, it is crucial to note that many manufacturers restart serial numbers each year. By way of explanation, I quote from a letter dated 8 Dec 2004 from Johnson Matthey to the World Gold Council:

I am writing to confirm the marking protocol for Johnson Matthey Good Delivery Gold bars produced in the UK. Prior to 2002 all bars were stamped with a two letter code and number, i.e:– BT 12345 for a bar produced in 1999, CT 12345 for a bar produced in 2000. Therefore, some bars will have the same numbers but with different Pre-Fixes. Both the letter AND number combination need to be taken into account to identify the bar. After 2002 we moved to a year stamp i.e. 2003 and a number sequence.

This means that we must ensure a year designator is included along with the Brand and Serial Number in our Primary Key. In the case of the pre-2003 Johnson Matthey gold bars, the inclusion of the two letter prefix performs this function for us; for post-2002 bars, we would have to ensure there is a year prefix in the serial number.

Now this is where we come into a problem. A scroll through the 7000+ page SLV bar list reveals many occurrences of the same Brand and Serial Number but different weight (see page 509 for an example). The different weight implies that these are different bars and that the person originally recording the bar’s details failed to include the year prefix (either as letters or the actual year) in the serial number or as a separate field in the bar list. This means we are unable to conclusively create a unique identifier.

I would note at this point that it is necessary to know which manufacturers restart serial numbers each year and also their serial number/ marking protocol. This is the only way to know if a serial number we see for a bar on a listing is complete or is missing the year prefix.

As an alternative to contacting each manufacturer for their serial numbering protocol, I would suggest combining all published silver bar listings and then analysing for what PMR calls “Internal Duplicates” (common Brand and Serial Number). Manufacturers with no restarting policy would show no (or few, if you’re expecting fraud) duplicate serial numbers. Those with many duplicate serial numbers and differing weights would imply a restarting policy (Britannia Refined Metals is one clear example). Further analysis may reveal patterns in the serial numbering enabling confidence which part of the serial number represents the year.

At this point I would also make a small point about human error. In the last audit of GLD Inspectorate International Ltd did a random check of 7772 bars out of a total of 88445. They found 22 bars with incorrectly recorded serial numbers (a 0.28% error rate). I quote this not to make excuses, but as a reminder there is such a thing as human error. In a case of duplication we must therefore consider the possibility of recording error. What is a reasonable error rate can be debated, but I would note that in the surface finish of 1000oz silver bars can be heavily pitted, resulting in digits of the serial number or weight not stamping clearly. In my previous roles in the Perth Mint I have done many stocktakes and can confirm that the quality of some manufacturers leaves a lot to be desired and have had some difficultly confirming bar markings.

Given the above, for those manufacturers with no restarting policy, one can confidently use a Primary Key composed of Brand and Serial Number only. Therefore I would suggest that PMR first needs to prove/establish which manufacturers have no restarting policy. Then, if they find the existence of an identical weight for such branded bars, they have clear proof of a duplicate, or double counting.

The rest of the discussion below focuses on those manufacturers with a restarting policy. In this case one first has to look at the recording accuracy of the serial numbers. A cursory look at the SLV list reveals that Britannia Refined Metals, Cominco Ltd Tadanac Canada and Russian State Refineries operate under a restarting policy due to the existence of many duplicate serial numbers with different weights. Therefore, for these manufacturers the occurrence of a duplicate serial numbers with the same weight is not conclusive proof of itself that we have a duplicate bar, as the serial number may be incorrectly recorded.

As a result, I do not feel that PMR’s "Perfect Internal Duplicate" (identical brand, serial number and weight) rate of 0.0242% for SLV (69 bars out of 285479) is not conclusively proven at this stage. I would note that removing the three manufacturers mentioned above brings this duplication rate down to 11 bars.

One way around the problem of restarted serial numbers, but incomplete recording of year to distinguish duplicated serial numbers for a manufacturer, is (apart from custodians producing a decent/detailed bar list to start with) to look at the frequency of what PMR calls “Rough Internal Duplicates” (identical brand and weight with an almost-identical serial number (eg AB1024 vs 1024). Effectively this is the process of stripping out the year identifier from the serial number so that all serial numbers for that manufacturer are on “equal footing”, so to speak.

PMR makes reference to the technique of removing prefixes in this comment and this comment. But for this to be valid PMR must first prove/establish which manufacturers restart their serial numbers each year and then their serial number/ marking protocol. If for a certain manufacturer the prefix is not a year designator but just part of the sequential serial number, then removing it creates false duplications. It would be the same as removing the first digit from identical weighted bars with serial numbers 1234 and 2234 and concluding they are the same bar.

It is worth noting at this time that the LBMA standards round down actual weights to the nearest 0.10 of a troy ounce. This means that two bars with a reported (bar listing weight) of 1001.1 could actually be two different bars with weights of 1001.11 and 1001.19 when put on scales. This complicates things so lets park this to the side for now.

PMR notes that “To find the same manufacturer with an identical bar weights is not unusual, but beyond some expected statistical occurance it is”. This statement depends on one crucial assumption – the normal distribution of bar weights. As PMR says, “If these exceed what would be predicted by the Gaussian bell curve, one explanation which may be considered is bar ‘cloning’”. I would caution here that normal distributions assume random variables.

Remember that the LBMA standards accept bars with weights between 750 troy ounces and 1100 troy ounces. The reason for this is that is make manufacture of the bars cheaper as one does not have to accurately weigh out granules/shot of silver for each bar – these are industrial wholesale bars after all.

The minimum of 750 is in reality too low and in my experience the distribution of weights is not so wide. One commentator has noted that “there seem to be two categories of weights, one with target weight of 970 oz., the other one 1030 oz”, which does not surprise me. The point I would like to make is that I think a proper statistical analysis of the weight distributions will show that they are not normally distributed and have a material amount of skewness and peaks around certain weights.

To understand why this is the case, consider that pouring bars is much like making cupcakes or muffins. You have standardises moulds in which you pour your cake mixture. One can expect that first time cooks will put too much or too little in, and their resulting muffins are too big or too small. However, over time one builds up skill to the point that we would observe that each muffin is very much the same size.

There is no difference with pouring bars. If you have an experienced pourer, you can expect that they sequence of bars they pour have little variation in weight. You can also expect that some pourers err on the side of underweight bars (too much and the silver may spill on the floor) whereas other more experienced pourers are confident with attempting to fill the mould. If you had an entire sequence of serial numbers, you may also find a group where the bar weights are all over the place – this being when the apprentice pourer had their first go. Wide bar weights could also indicate a workplace where the staff don’t have any pride in their job, so don’t care about accuracy, or maybe where the expected work rate is high so it is not possible to be accurate.

The result is that even within manufacturers their may be significant variances in what constitutes a “normal distribution” of bar weights. I am sure statisticians have ways around this, and PMR needs to get a bit more sophisticated in this regard if it is to make a conclusive case.

Finally, I’d like to make some comments on the three other types of duplicates PMR referred to in their analysis.

Weight Duplicate (brand and weight): Of itself, this is the most useless of the duplicates. Considering the weight variances discussed above, it is inevitable that for any manufacturer over many years of production there will be many duplications of weight. The real use of this is to establish the distribution of weights (histogram) for a manufacturer as a basis against which to check whether an observed frequency of duplicate weights is “normal”.

Internal Duplicate (serial number and brand): Given that some manufacturers restart numbering each year, the lack of a year designator (either as letter prefix or year incorporated into the serial number) means that this duplicate is of no use in proving double counting. It is clear from the Britannia bars (see page 509 of the SLV listing) where there are many occurrences of duplicate serial numbers (but different weights) that the year or year prefix has been left off the bar listing. This use of this duplicate is in determining which manufacturers restart serial numbering and which do not.

Cross Reference Duplicate (brand and serial number on two different ETFs): Again, because we have established that serial numbers are not consistently incorporating the year of manufacture, this duplication is not conclusive proof. For those manufacturers with restarting serial numbers, you also need the addition of weight. I would also note that both lists are not issued at the same time: ETFS bar list is dated 29 July 2009 whereas SLV bar list is dated 24 July 2009, which does allow for the fact that bars redeemed by market makers out of one ETF could have been reallocated to the other ETF (note that both ETFs store their metal in London and allow for sub-custodians, so it is possible that one custodian holds bars for both ETFs).

24 July 2009

Isaac Newton and the madness of people

Great quote by Isaac Newtwon from this Bloomberg story about a new book, “Newton and the Counterfeiter”.

In 1720 Isaac Newton lost millions in today’s currency in the infamous South Sea Bubble. He hated being reminded of any mistake. The only reference that people have found to his South Sea losses is in the comment:

“I can calculate the orbit of a comet, but I cannot calculate the madness of the people.”

21 July 2009


Received the email "parable" below today. Interesting that I received it just after reading Chris Leithner's latest newsletter (yesterdays post) - synchronicity?

An economics professor at a local college made a statement that he had never failed a single student before but had once failed an entire class.

That class had insisted that socialism worked and that no one would be poor and no one would be rich, a great equalizer.

The professor then said, "OK, we will have an experiment in this class on socialism. All grades would be averaged and everyone would receive the same grade."

After the first test, the grades were averaged and everyone got a B.

The students who studied hard were upset and the students who studied little were happy.

As the second test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride too so they studied little.

The second test average was a D! No one was happy.

When the 3rd test rolled around, the average was an F.

The scores never increased as bickering, blame and name-calling all resulted in hard feelings and no one would study for the benefit of anyone else.

All failed, to their great surprise, and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great but when government takes all the reward away, no one will try or want to succeed.

Could not be any simpler than that.

20 July 2009

Leithner and Macfarlane

Interesting newsletter, as always, from Chris Leithner on Crusoe Economics, but not for those who like Kevin Rudd (the Poindexter of the title): Poindexter: Philosophical Mediocrity, Economic Illiterate and Evil Political Genius

Also worth a read is Jame Macfarlane's article If The Future's So Bright How Come I Don’t Need Shades?:

"... rumors of the economy’s rebound have been greatly exaggerated. And that’s the thrust of this article. I wish to argue that we are not now, nor will we soon be, in a recovery. This point will be made simply by demonstrating that we are not actually in a recession. Rather, we are in a depression. I present this thesis on the basis that information is power, and that being forewarned allows one to become forearmed."

15 July 2009

2009 isn't 1979

Many commentators like to draw parallels between the run up in the gold price in 1980 and now, or to look for matching patterns. A perfect example of this is a chart by www.zealllc.com where he overlays 1971-1981 over 2001-2009, but I can't find the link at the moment.

When reading Martin Armstrong's Practical “Laws” of Global Economics (26 Nov 2008) this bit got me thinking about drawing parallels:

Before fax machines, the analysis I produced was delivered by Western Union via telex and in the early 1980s, sending just one telex on one market cost $50 to the middle east. Every day, each market was covered in the financial group including precious metals, stock indexes, and all major currencies. The cost to take all the subscriptions could exceed $200,000 just in telex fees that adjusted for inflation in 2006 dollars would be $1.6 - $2 million. So the audience just happened to be the major institutions and government around the world.

Compare the slowness, and limited distribution, of information at that time to what the Internet now provides us with. As a result I can see no validity in trying to deduce what will happen to the gold price by analysing movements from the 1970s, apart from generalisations. Information flow and feedback are hyper accelerated. So will be the rush to gold if (when) confidence in fiat is lost.

The Story of the Gold Standard

While this Australian Radio National program on the Gold Standard is a bit one sided, worth a read. Summary:

Once upon a time currencies were backed up by gold - piles of gold bullion sitting in bank vaults. When the gold standard was abandoned during the Great Depression, there was public panic, and the end of Western civilisation was predicted. Luckily that didn't happen, but could the present crisis be a reason to return to the gold standard?

06 July 2009

AUSTRAC Identification Rules

Further to my post on AUSTRAC rules on identification for bullion transactions, I can report that the Perth Mint has just received an approval to set the limit above which some form of identification for a bullion transaction is required from $2,000 to $5,000. This now gives some more room for people to privately acquire gold and silver.

Looking at page 11 of the Anti-Money Laundering and Counter-Terrorism Financing Rules Amendment Instrument 2009 (No. 2), it appears this approval is for every bullion dealer, not just the Perth Mint. If you are having problems with bullion dealers wanting to ID you for deals under $5,000, maybe handy to show them this Amendment Instrument.

02 July 2009

Is a deflationary gold standard bad?

I've never really got why a gradual deflationary bias was a problem. Consumers know, for example, that just about any electronic good (computers, plasma screens etc) will get cheaper in the future, yet this does not seem to stop them from being made and bought. The fact that only those people who really really want the good will buy it and those are no so enthused will wait until it gets cheaper does not seem to stop business from making money.

If it was conspicuous consumption fueled by debt (and an inflationary bias) that got us into this mess, then would not a system with a deflationary bias be the solution? It has a built in frugality: your money will have more purchasing power in the future, so only buy today what you actually need. People would also only want to take on debt if they were actually going to be productive/efficient rather than just trying to bubble up asset prices. Now maybe if we can convince Greenies that a Gold Standard would work against consumerism and thus be good for the planet, we've got a chance.

The above thoughts were prompted by these comments left at this article Gold Standard ... Debunked or Another Bubble?:

Dirk, on November 24, 2008 at 12:58 pm, said:

I’m happy someone gets it- that constraining global economic activity based on a single metal that doesn’t really correlate to economic activity makes no sense.

Clearly, the gold standard is deflationary in absence of either major gold finds, or major negative economic shocks. More goods and services chasing a fixed money pool will create massive downward pressure on prices. And downward pressure on prices and assets equals lower incentives for investment, more difficulty paying off debt, and a negative wealth effect that creates real economic stagnation.

Inflation, on the other hand, creates pressure to invest money- not hoard it. As long as a currency promises a future redemptive power, it will keep its value. Perhaps fixing currency values to a “total energy” metric- the sum of all oil, coal, gas, solar, nuclear, etc. reserves- would allow for both economic growth and a guarantee of some future redemptive power for something really useful.

16 Stanley Pinchak, on November 25, 2008 at 2:03 pm, said:

Wow so much muddled thinking in one place. It is amazing that my browser didn’t pop up a warning.

1) Any stock of money sufficient to be accepted by the public as a money and selected as the medium of exchange is capable of serving as money. There is no need to grow the stock of money. Despite this false criticism, the gold stock does grow at a predictable (by mining engineers) and low rate between 1% and 3% per year.

2) The purchasing power of a money is related to the stock of money and the demand for money. Its purchasing power is also related to the supply and demand for all other goods in society for which it is exchanged. Thus as productivity increases, the purchasing power of a stable or slowly increasing money will increase. This has the effect of making daily expenses of those with debts easier to bear.

The only time a debt would become harder to pay off would be if the debtor was in a field of employment where his pay decreased in line with the increase in purchasing power of money. This might be a possibility, but at the same time that human actors today judge their debt burdens based on future expectations of income, those operating under a regime of increasing purchasing power of money would be capable of determining their expected future debt load capabilities. Those who guess wrong in such a situation are no different than those who bite off more debt than they can chew under our inflationary regime.

The biggest improvement that increasing purchasing power has is for savers and those on fixed incomes. Savers would earn interest + the difference in purchasing power between when they started saving and when they start consuming. This is the opposite of today where the difference in purchasing power subtracts from the interest and reduces the incentive to save. This will have the effect of greatly encouraging saving and the stock of loanable funds, driving interest rates to natural and sustainable low levels. This will benefit the saver/consumer in the future as well as the entrepreneur and the durable good consumer in the present.

Inflation on the other hand encourages debt based financing. It favors instant gratification, but since there are fewer savers since debt is the preferred method of financing, the purchases of today are not sustainable. The increase in consumption fueled by new money is not fully offset by the preferences of a ever shrinking class of savers who abstain from present consumption. This results in a business cycle like we see continuously under a system of bank credit expansion (ex nihlo). Inflation encourages capital consumption and not investment as Dirk claims. Empirical evidence of this is present in the dilapidated factories and rotting machinery of the American Rust Belt.

3) All business cycles (as in repeated and not caused by something like war or famine) are the result of fractional reserve banking and its concomitant ex nihlo credit expansion. There can be no stable and sustained economic growth under a fractional reserve banking regime. There will always be over-expansion combined with malinvestment, and and then retrenchment as the bad investments are liquidated. Attempting to tie a money to a commodity standard while maintaining a fractional reserve banking system is unsustainable. There will inevitably be calls for the creation of a central bank and lender of last resort as the bust causes bank runs.

The only viable solution is to realize that fractional reserve banking on demand deposit money is clearly a case of conflicting views of a contract and thus an untenable and invalid contract. How can a depositor demand a physical object which the banker (rightly?) assumes is lent to him for his purposes. A physical object must have a clear owner and can not be subject to control simultaneously by two parties of differing opinion under which direction to place the object. Thus demand deposits must be maintained in a warehouse fashion with 100% reserve maintained at all time. This eliminates the possibility of a bank run (in the historical sense and in the practical sense of potential damage to the depositor). Furthermore by limiting bank loans to funds deposited in time accounts (i.e. true saving) there will cease to be a business cycle.

4) The idea of a world central bank is superfluous with a free monetary system and 100% reserve banking. The main purposes of the central bank are to ease governmental expansion and to act as a lender of last resort. A world central bank will only lead to world bureaucracy. If banking is on a firm economic and legal foundation, there is no need for a lender of last resort. A world central bank is only an excuse for the establishment of world government. It can not prevent world wide business cycles while maintaining a fractional reserve banking system. Furthermore, if it maintained a 100% reserve banking system, it would still be subject to political considerations in open market operation and would still cause misallocations of resources, though not of the intertemporal kind as explained by the business cycle theory. The misallocations would result in privileged borrowers being able to bid resources from those who obtain the increase in the money supply last.

5) The myth that a gold standard would limit growth is preposterous. One of the greatest periods of economic (and population) expansion was obtained under a gold standard and under a period of increasing purchasing power of money (Cf. the 19th century). There is no theoretical nor physical restriction on the growth of economy based on a sound monetary system besides the subjective actions of individuals to save which allows for the implementation of longer and more productive production techniques.

The claim that unemployment is higher under a gold standard is also ridiculous. All non voluntary unemployment is the result of artificial restrictions on the movement of labor or its price. One must be careful not to make the mistake of comparing the unemployment rates of a central bank and fractional reserve banking boom period to an average or bust phase unemployment rate under the fractional reserve banking system which has persisted in the United States prior to its inception. Under a free market, all labor wishing to be employed will be. All state intervention attempting to reduce the ranks of the unemployed can only be obtained by reducing the well being of other actors in the economy. As such interventionist attempts to reduce unemployment, though they may increase productivity (doubtful), will not be optimal as compared ex ante in terms of the satisfaction of wants of all economic actors. On utilitarian and natural rights grounds, state intervention in the labor market is counterproductive, misguided, and should be avoided.

6) The idea that there is not enough gold to back all of the fiat currencies of the world is the most foolish statement of all. Logically one can take the stock of gold available and divide it by the weighted sum (by exchange rate) of the currencies of the world. This could provide backing for every single dollar, ruble, yen, etc. However, this is a bad policy, for the market should be left free to choose its own money, it should not be instituted from on high via state decree or central bank policy.

All that needs to be done is to eliminate legal tender laws and taxes on market selected monies. Since we have several thousand years of history showing that Gold and Silver are typically selected as money, we should start by eliminating taxes on them. If there is a push for a different medium of exchange, it should be treated in the same fashion. At the same time, all fractional reserve demand deposit banking must be subjected to traditional legal principles regarding property rights.

This means a reversion to 100% reserve banking. From these two changes, the market will perform the transition to a sound money with the minimum disruption and transfer cost. A state imposed system can only result in higher costs, as well as a retention of particular privileges for the state, most commonly in the form of a central bank, liable to interfere in the money supply through open market operations and subject to the political whims of demagogues.

01 July 2009

Money, an essentially useless substance?

Dmitry Orlov recently posted an article titled Definancialisation, Deglobalisation, Relocalisation.

For those not familiar with Dmitry, he is the author of Reinventing Collapse, which is all about "prepar[ing] for life without much money, where imported goods are scarce, and where people have to provide for their own needs, and those of their immediate neighbours."

In this article, Dmitry has a go at money and suggests barter can do the job but then suggest this is probably a better solution:

One option is to organise as communities to produce certain goods that the entire community wants: food, clothing, shelter, security and entertainment. Everyone makes their contribution, in exchange for the end product, which everyone gets to share. It is also possible to organise to produce goods that can be used in trade with other communities: trade goods. Trade goods are a much better way to store wealth than money, which is, let's face it, an essentially useless substance.

I can't say I share Dmitry's belief in this socialist nirvana. The catch for me is “everyone makes their contribution” bit. Anyway, my main beef is with his belief that trade goods are a better way to store wealth and that money is essentially useless. Now I'm not going to discuss why money is better than barter (either between individuals or “communities” it doesn't matter), as I think most people reading this get it. I'm more interested in why Dmitry would be so negative on money given its obvious efficiency it brings to exchange. The explanation is in this statement later in the article:

When we use money, we cede power to those who create money (by creating debt) and who destroy money (by cancelling debt). We also empower the ranks of people whose area of expertise is in the manipulation of arbitrary rules and arithmetic abstractions rather than in engaging directly with the physical world.

This has to be one of the best examples of the infiltration of the idea of fiat into society. This guy's whole shtick is about radically challenging society yet he can't conceive of money as anything but debt, so much so that he proposes returning to barter rather than retaining the benefits of money, but money which is directly engaged with the physical world – gold.

Another example of this misguided thinking is his statement that a lack of money “makes it more difficult to hoard wealth”. Professor Fekete has often debunked this demonisation of hoarding. Dmitry himself is confused on this matter – he thinks it is OK to hoard wealth in the form of trade goods, but not money.

I considered replying to Dmitry's article on these matters, but thinking about how brainwashed (I can think of no better word) he is on money, I considered it a futile task. I could see a stereotypical negative perception of gold as some goldbug doom and gloom eccentricity. I see a need to condense Professor Fekete's work into an easy (and quick) to understand case for sound money. Another one for the to-do list.