Niall Ferguson on gold

Sharelynx drew my attention to this 13 May 2010 lecture by Niall Ferguson at the Peterson Institute for International Economics titled Fiscal Crises and Imperial Collapses: Historical Perspective on Current Predicaments. The following is on the last page of the transcript:

Finally, I guess one just has to ask oneself what’s going to happen in the world of dodgy paper currencies, of fiat monies, because you could quite easily get burned if ultimately we do get a crisis not just of the euro but of fiat currencies generally. And I keep thinking that maybe I should be valuing my portfolio not in terms of this or that currency but in terms of the barrel or the ounce—in terms of commodities like oil and gold.

Maybe one of the lessons of history is that periodically paper currency loses credibility so much that we have to revert to commodity standards, and I think that may well be happening. When you look at what’s happening in the gold market, it’s not so much fundamentals that are driving gold up from a $1,000 towards $2,000. It’s a fact that more and more people feel that they should hold gold as perhaps 10 percent of their portfolios. If everybody thinks that, if that becomes a standard investment strategy, then gold is going to go a lot further than its present price. So I’ve really re-thought my attitude towards gold almost on that momentum basis.

Note that this is a presentation made to the "elites", mentioning ideas that were once considered crazy goldbug talk.

Bank of England holds 4700t of gold

Stumbled on the value of gold the BOE holds on custodial basis from a link in a Golden Sextant article.

Unfortunately, the annual reports only list gold value from 2005 onwards (note that BOE financial year end is 28 Feb):

Year, GBP value, ounces (based on GBP london PM fix on 28 feb)

2005, 25b, 110,368,454

2006, 35b, 110,035,903

2007, 43b, 126,857,129

2008, 72b, 147,283,237

2009, 102b, 152,282,217

Interesting that it was stable from 05 to 06, then starts increasing. 152 million oz = approx 4,700t, or 3% of all gold ever produced (160,000t). Hard to read anything into it as the holdings include central bank metal (reported in other figures) as well as other bullion bank and institutional metal, so you couldn't just add it to other reported figures as it would result in doubling up.

However, it is another indicator of increasing interest in gold as well as giving us an insight into the amount of metal held in London. On that last matter, consider that total COMEX registered and eligible stocks are currently 10.74 moz compared to the BOE stocks of 152.28 moz.

How to identify a gold bubble

There is no bubble in gold. Watch the first past of this news story on gold buying in China. When you see similar crowds in Western countries desperate to hand over paper banknotes for gold then you'll know we are in a bubble.

h/t to Sharelynx

Errors in Rob Kirby Article

I'm just come across Rob Kirby's Forensic Examination of the Gold Carry Trade. When I get time I will respond to it, but in the meantime an exercise - can you find the errors in his article.

It is not the first time he has done it, see Backwardation: Facts from Fiction

If you need some help, my article Misinterpretation of Gold Lease Rates.

Update: this evening I get home and find more confusion about lease rates, forwards and gold carry in the comments to a Zero Hedge article. The comment is by one "Cheeky Bastard" who is a contributor to Zero Hedge, wonder if that means I'll never be able to get anything published there?

He is not alone, however. Brad Zigler made the same mistake in his article on backwardation in Dec 2008.

I keep on leaving correcting comments, but no one seems to be paying attention.

Gold is a crowded trade

Below is an exchange of comments to an article about gold I found amusing:

a fed serf: "The gold trade is way, way too CROWDED, Weisenthaw said it yesterday. On CNBC believe it or not, they were saying it is a great time to get into equities and the market is cheap."

imkeithhernandez: "only an idiot looks to "trade" gold... those w/true intelligence look to hold it; and it's crowded in the same way that lifeboats were crowded when the titanic sunk"

Also, the article says "JP Morgan's John Bridges believes the latest breakout for gold was a huge positive sign for the metal. Euro weakness fears, coupled with dollar weakness fears, could lead to an enormous amount of demand."

What is JP Morgan doing pumping gold, I thought they had a massive naked short position?

h/t to Sharelynx for the article.

What happens if Perth Mint becomes insolvent?

Perth Mint Depository was recently asked the question below and I thought you may find my answer of interest.

“Should Perth Mint become insolvent, for whatever reason, do clients receive gold or cash? Also, what is their seniority in terms of the Mint's liabilities?”

The usual definition of insolvency means cash flow insolvency, that is, unable to pay debts as they fall due. In that sense the Perth Mint itself can never be insolvent, because it can always borrow funds from its 100% shareholder, the Government of Western Australia. When one asks what happens if the Perth Mint is insolvent, one is really asking what happens when the Government is insolvent, which is really another question.

As Wikipedia says, “a government cannot be insolvent in the normal sense of the word. Generally, a government's debt is not secured by the assets of the government, but by its ability to levy taxes.” The question the client asked was flawed in the sense that it was trying to analyse/assess the Perth Mint as if it was a distinct corporate entity standing on its own. While it is a commercially focused entity, it is nonetheless an extension of the Government and as section 4(3) of the Gold Corporation Act 1987 says “is an agent of the Crown in right of the State and enjoys the status, immunities and privileges of the Crown, except as otherwise prescribed.”

Having dealt with the cash flow issue, there is still the case of a balance sheet insolvency, a nice way of saying the Mint has lost the gold “for whatever reason”. Now the reason is important because if it is theft, then the Mint will first go to Lloyds to claim on its insurance policy. Only if they fail to pay does the Mint have a problem.

An alternative reason is that unknown to Government, the Mint never bought gold with the money clients gave it, in other words went short the gold price. In this case we are talking about fraud as that is contra to what they say they do "The Mint purchases an ounce of precious metal from the spot market for every unallocated ounce it sells to clients. Accordingly every unallocated ounce is 100% backed". The idea the Mint would want to keep client cash and not buy gold is one I consider lacking in any commonsense, as discussed in this blog.

Anyway, lets assume a shortfall in gold to back Depository liabilities. If the loss is small, the Mint would book the loss and if larger than cash reserves, would borrow the necessary remaining money from the Government to buy the replacement gold.

However, if we were talking about a huge loss, say $500 million, then one isn't going to be able to sneak through a loan from the West Australian Treasury. In that case Clause 22(1) of the Gold Corporation Act 1987 is invoked, which states that "The payment of the cash equivalent of gold due, payable and deliverable by Gold Corporation, the Mint or GoldCorp under this Act and all moneys due and payable by Gold Corporation ... is guaranteed by the Treasurer, in the name and on behalf of the Crown in right of the State." This put the Government on the hook for any loss at the Mint.

Now the interesting wording is "cash equivalent", which gets to the rub of the client's question. This wording, I guess, was put in because a government's power to tax can only be in terms of money, therefore its obligations have to be expressed in monetary terms.

In practice what would occur is that the Mint would, as soon as it knew about the loss, work out the market value of the lost gold, request that "cash equivalent" from the Government, and immediately buy the replacement gold. The end effect is that the client would receive gold, not cash.

As to whether the Mint would be able to obtain sufficient gold, consider that it refines around 300 tonnes per year, say $13 billion. Total Depository liabilities are a bit over $2 billion (which is not all gold). Either way no problem getting hold of physical.

Ultimately, when you deal with the Perth Mint, you are taking an exposure to the Government of Western Australia. One may then ask can the Government handle a large gold loss. Again, consider the $13b worth of metal refined each year. All the Government has to do it apply a special "Perth Mint stuff up royalty" on gold production.

Consider also that it is near impossible for there to be a loss of the entire $2b, either as theft or fraud. With theft they would have to clean out the entire operation at both city and airport sites, including semi-finished product and dissolved gold in chemical solution mid-refining, for example. I can't see how even Hollywood could come up with a plausible plot for that gold heist. Plus we have to have the insurers renege as well, remember.

In the case of fraud the management simply cannot not have bought no metal with client funds, as that would mean there was not one ounce of physical gold in the mint or refinery. Just a little suspicious wouldn't you think and not what you want if you are trying to pull off a fraud.

So lets assume half of it is lost, $1b. Government could fund that with a five year 1.5% "Perth Mint stuff up royalty" on annual gold production. That isn't unrealistic considering that the current royalty is 2.5%.

I think the question is not what would happen if there was insolvency, but whether insolvency is even realistic, considering a) the likely probability of loss, b) the realistic maximum loss, and c) the capability of the Government to fund a loss.

Counter to Ben Bernanke's The World on a Cross of Gold

Extract from Gold Standards and the Real Bills Doctrine in U.S. Monetary Policy by Richard Timberlake. The references to "Bernanke 1993" are to Ben Bernanke's 1993 article "The World on a Cross of Gold" in the Journal of Monetary Economics.

Ben Bernanke, in a laudatory review of Golden Fetters, agrees with its main thesis. “Eichengreen,” Bernanke states, “has made the case that the international gold standard, as reconstituted following World War I, played a central role in the initiation and propagation of the worldwide slump” (Bernanke 1993, 252). “In this masterful new book,” he notes approvingly, “Barry Eichengreen has gone well beyond his previous work to marshal a powerful indictment of the interwar gold standard, and of the political leaders and economic policy-makers who allowed themselves to be bound by golden fetters while the world economy collapsed.” The United States, especially, absorbed and sterilized gold, “largely reflecting conscious Federal Reserve policy. . . . Monetary policy became tight in the U.S. in 1928. . . . High returns on both bonds and stocks attracted gold into the U.S., but the Fed, intent on its domestic policy goals, sterilized the inflows” (Bernanke 1993, 253-258).

Bernanke’s words, much like Temin’s and Eichengreen’s, contradict his argument. If central banks could absorb and sterilize gold, “reflecting conscious Federal Reserve policy,” the central bank, not the gold standard, was running the show.

...

Bernanke finally poses a very apt question that he leaves unanswered. “Why was there such a sharp contrast between the stability of the gold standard regime of the classical, pre-World War I period and the extreme instability associated with the interwar gold standard?” (Bernanke 1993, 261).

Here are two commentaries that may help answer his question. The first is from Lionel D. Edie, a prominent economist of the time. At a conference of economists in early 1932, he stated,

The Federal Reserve Act cut the tie which binds the gold reserve directly to the credit [money] volume, and by so doing automatically cut off the basic function of the gold standard . . . in an essential respect we abandoned [the automatic money supply function] some time ago. . . . We are not now on the gold standard . . . and we have not been for some time . . . it is time to recognize that the Federal Reserve mechanism does not constitute an automatic self-corrective device for perpetuating a gold standard. (Edie1932, 119-128)

And Leland Yeager in 1966 described the “gold standard” of the 1920s in these words:

The gold standard of the late 1920s was hardly more than a façade. It involved extreme measures to economize on gold. . . . It involved the neutralization or offsetting of international influences on domestic money supplies, incomes, and prices. Gold standard methods of balance of payments equilibrium were largely destroyed and were not replaced by any alternative. . . . With both the price and income and the exchange-rate mechanisms of balance of payments adjustment out of operation, disequilibriums were accumulated or merely palliated, not continuously corrected. (Yeager 1966, 290)

These commentaries provide the answer to Bernanke: “The” interwar gold standard was not a gold standard. It was an entirely different system than the pre-1914 gold standard that had existed for 100 years.

Also quoted in the article is the following from Joseph Schumpeter's 1954 History of Economic Analysis:

An ‘automatic’ gold currency is part and parcel of a laissezfaire and free-trade economy. It links every nation’s money rates and price levels with the money-rates and price levels of all the other nations that are ‘on gold.’ It is extremely sensitive to government expenditure and even to attitudes or policies that do not involve expenditure directly, for example, to foreign policy, to certain policies of taxation, and, in general, to precisely all those policies that violate the principles of [classical] liberalism. This is the reason why gold is so unpopular now [1950] and also why it was so popular in a bourgeois era. It imposes restrictions upon governments or bureaucracies that are much more powerful than is parliamentary criticism. It is both the badge and the guarantee of bourgeois freedom—of freedom not simply of the bourgeois interest, but of freedom in the bourgeois sense. From this standpoint a man may quite rationally fight for it, even if fully convinced of the validity of all that has ever been urged against it on economic grounds. From the standpoint of etatisme and planning, a man may not less rationally condemn it, even if fully convinced of the validity of all that has ever been urged for it on economic grounds.

War, gold and American Express

Surfing around I found this excerpt from the history of American Express interesting:

During the summer of 1914, approximately 150,000 American tourists were stranded when war engulfed Europe, many without access to funds. Banks had ceased to pay against foreign letters of credit or any other form of foreign paper. Panic-stricken travelers lined up inside and outside the offices of American Express in whatever city they happened to be visiting. American Express was able to cash all travelers cheques and money orders in full, enabling quick passage home for thousands. Many of those remaining were able to book passage home soon after a decision by American Express and a consortium of nine U.S. banks to ship $10 million in gold to Europe so that local banks could once again honor foreign drafts.

During 1938 and 1939, as the prospect of another world war loomed over Europe, there was still a sizable group of longtime American Express managers and employees who had worked for the company 25 years before, during World War I. Their past experiences – and their advance planning, in this instance – helped the company survive World War II. Even before the official declaration of war, American Express had mounted extensive preparations to protect its financial and real estate assets, including its principal offices in Berlin, London, Paris, Rome and Rotterdam. Throughout Europe, American Express offices continued operating until the last possible moment in countries about to be invaded – often long after American embassies and consulates had been ordered to evacuate.

The history is interesting not for the reminder that in war fiat is worth nothing, but that AMEX had an organisational memory of WW1 that enabled them to prepare for WW2. The two events were close enough that those who had experienced the first were still employed and had not retired.

I think that what is necessary for an organisation (which is really just a collection of individuals) to see the need for "advance planning" is not experience of a crisis, but experience of the period prior to a crisis. Only then can one see similarities between the period that preceded a crisis and one's current situation and thereby identify the potential for a future crisis.

I also think that what is important is direct experience. One has to have personally experienced the pre-crisis environment - it makes for a strong imprint on the mind. Indirect experience is not the same. Reading the history of a period that draws parallels to now does not have as powerful a call to action. Words on a page can also be rationalised away.

For example, do you think giving Paul Mylchreast's 4th May Thunder Road Report history of the US and Sterling crises during the Johnson and Nixon administrations in the 1960s and 70s (pages 24 to 35) to someone in their 30s raising a young family will result in them buying gold? It is too distant and academic.

I would also argue that the minimum age for direct experience of economic/financial events to really register would be no younger than say 20 years old. This means that the youngest person to have experienced the 1970s and punishing inflation and a real gold bull market is now 60 years old. Anyone younger than that would probably not really "get it", at a visceral, emotional level that only direct experience can give.

My only "economic awareness" memory of the 70s would be my father suggesting I invest the $200 worth of Christmas and birthday money I had squirreled away up to my then 10th birthday into State Rail Authority of New South Wales bonds at 15% (my father was a train driver and they were offered to staff first). Getting a $30 cheque each year for 5 years seemed like a good deal. I remember being disappointed that I didn't hold out longer, because subsequent bond series peaked at 18%, if my memory is correct.

That is the extent of my experience of inflation, as a 40 year old. It makes me reflect on where I would be now if I had not made that fateful decision in 1994 to take a job with the Perth Mint. It is likely that my economic literacy would be negligible, my awareness of the potential for inflation and the role of gold as a wealth preserver in an investment portfolio, zero.

I am interested in what is your story. Why are you reading this blog? Is your interest in gold because of direct experience of the last gold boom, because someone close to you passed on their experiences, or because you are simply an inquiring mind? Please leave a comment.

New Perth Mint LBMA Bar Mark

The new Perth Mint bar mark as registered with the LBMA. Smaller bars will have the same swan mark but words around it in a circle. The bar pictured is a 400oz bar, 9960 being the purity (99.6%) and the year and bar number (see Good Delivery rules). Weight is specified on a bar listing as per LBMA rules page 9:

"It is strongly recommended that weights should not be stamped on Good Delivery bars. The reason for this is that when bars are weighed in London by an LBMA approved weigher their weights, which may be different, will prevail, and also any adjustment to the weight of a bar caused by future handling or sampling would necessitate alteration to the mark. If bars are so stamped, the unit of weight must be shown."



Below is picture of a bar stack for you to drool over.