In gold we trust

In gold we trust is a special report by Ronald-Peter Stöferle of Erste Group Bank. It is very comprehensive and well worth a read because it covers across its 65 pages all key factors influencing gold prices, leading to their conclusion that:

"The risk/return profile of gold investments remains excellent. ... Our next 12-month target is USD 1,600. We expect the parabolic trend phase to still be ahead of us. At the end of this cycle the price should reach our target of USD 2,300."

In the section "Paper gold vs. physical gold" (pages 36-37) however I would debate the following statements:

"At the moment physical gold commands a premium of up to 20%."

In the wholesale physical market the Perth Mint is not seeing anything abnormal. Even in the retail market premiums are back to normal (subscribers to Sharelynx can see this for themselves at the CoinPremiums page). I have asked Ronald-Peter where he is getting this number from but no response as yet.

"According to Paul Mylchreest the London OTC market trades 2,134 tonnes of gold every day. This is 346 times the daily production and close to the global annual production."

This point is presented as proof of a discrepancy between the physical market and paper gold market. As discussed in this blog post, I don't see any problem with this rate of turnover. In his report Mylchreest concluded that gold's 12.7% turnover "is excessive and doesn’t pass the smell test." My alternatively conclusion is that "the very fact that gold is no one’s liability and cannot be printed means it attracts a disproportionate amount of trading and speculation. ... Could not the 12.7% figure be proof of the special monetary nature of gold, proof that it is the King of Currencies?"

"According to Jeff Christian, founder of CPM Group, the trade on the LBMA is based on a leverage factor of 100:1"

Mr Christian has stated that he was talking about COMEX paper trading versus physical COMEX deliveries. There are some who think he is trying to retrospectively cover up his admission. My view is that a 100:1 fractional is ridiculous considering the crucial role London plays in the physical market. London unallocated simply could not function on a 100:1 ratio in my view. Those who accept this number do not appreciate to amount of physical delivery made ex-unallocated accounts by the trade. In any case, Mr Christian actually confirmed the fractional/leverage ratio of bullion banks at around 10:1. See this blog post.

"The volume of gold derivatives is worrisome as well. According to the Bank for International Settlements, the nominal value of all gold derivatives at the end of 2009 amounted to USD 423bn."

I have often seen the nominal value referred to and while it produces an impressive number the way it is presented is often misleading on two fronts:

1. Common interpretation of these numbers is that the market is short $432bn worth of gold. In fact the nominal value is the summation of both long and short positions, it is not a net figure. If one looks at the BIS figures it can be seen that bought and sold options somewhat net out (although it is not that simple because of differences in dates and strikes).

2. Nominal does not equate to actual value at risk. As per the BIS report: "Nominal or notional amounts outstanding provide a measure of market size and a reference from which contractual payments are determined in derivatives markets. However, such amounts are generally not those truly at risk. The amounts at risk in derivatives contracts are a function of the price level and/or volatility of the financial reference index used in the determination of contract payments, the duration and liquidity of contracts, and the creditworthiness of counterparties."

They note that "Gross market values provide a more accurate measure of the scale of financial risk transfer taking place in derivatives markets" and if one looks to page six of the report it states that the gross market value of the $432bn nominal figure is actually $48bn.

There is also the issue of what is the actual delta-adjusted position (see page 10 of GMFS Hedge Book for an explanation) of the $432bn nominal gold derivatives and its real (past) impact on the spot market, but that is getting a bit technical. The point is don't get over excited by the $423bn figure and assume it means the market is short 10,000 tonnes of gold.

Rory Robertson - Gold Hater

Michael Pascoe is at it again in this story reporting on Rory Robertson's (Macquarie Bank interest rate strategist) most recent article:

"Rather than worrying about US Treasuries or Australian house prices (he doesn't see a bubble in either of those assets for fundamental reasons), punters should be sceptical of gold around US$1,250 per ounce"

"Robertson admits one has to be careful about bagging gold bugs because for a decade they have been right - gold has been a standout performer"

$4 billion of "fear" cash still out there

In late 2008 Australia nearly had a full blown bank run. The Australian newspaper's edited extract from the book "Shitstorm" details the run and is well worth a read:

"It was a silent run, unnoticed by the media. Across the country, at least tens and possibly hundreds of thousands of depositors were withdrawing their funds. Left unchecked, there would soon be queues in the street with police managing crowd control ... It's a long time since Australia has had a serious run on a financial institution, but it's all about confidence, and you cannot allow an impression to develop generally in the public that there is any risk."

The article states that there are "60 storerooms across the country with an average of about $35 million in each" plus "the Reserve Bank has its own cash stash ... understood to be in the region of $4 billion to $5 bn". This gives us a total of say $7b. Over an estimated adult (15y+) population of 17.8m that works out at only $400 per person.

The article also notes that "households pulled about $5.5bn out of their banks in the 10 weeks between US financial house Lehman Brothers going broke ... and the beginning of December ... a year later, only $1.5bn had been put back."

So there is still $4b of what I would call "fear" money out there. Now guess how long people will continue to hold this cash if faced with increased inflation while observing a strong AUD gold price? Would they not consider gold a better store of wealth in such circumstances?

Putting the $4b in perspective, it equals 87 tonnes of gold. Perth Mint refines on average say 6t per week. Now as the article says, the cash was withdrawn over 10 weeks, so you would not see instant conversion into gold. But then consider you would have at that time additional people who weren't freaked out last time starting to withdraw cash out of the banks.

Faced with that sort of local demand, the Perth Mint would be able to draw additional metal out of London, but either way in such a high/hyper inflationary environment I can see Australia's gold production being locked out of international markets for at least 3-4 months. Sorry India, sorry COMEX, we are all out.

Mannkal Economic Education Foundation

For those goldbugs of a libertrian/Austrian economics bent (most seem to be, funnily enough) this organisation is likely to be of interest. Their mission:

We aim to strengthen the free market system in Western Australia and Australia, by promoting ideals of voluntary co-operation, choice, personal rights, limited government and responsible resourcefulness of individuals.

The Liberal Democratic Party may also be of interest. How can you argue with this Econ 101 on the WA branch's site:

9. Prices Rise When the Government Prints Too Much Money. When a government creates large quantities of the nation's money, the value of the money falls. As a result, prices increase, requiring more of the same money to buy goods and services.

10. Government Manipulation of Interest Rates and Money Quantity Causes Booms & Busts. Making money cheap (low interest rates) and abundant leads to excessive short term consumption which leads entrepreneurs to over invest in non-productive assets. Excessive demand for goods from consumers and entrepreneurs then raises the price of goods and money (higher interest rates) which results in the liquidation of non-profitable investments (mal-investments). The destroyed capital and associated production dislocation is the recession.

Why has the WGC bought into BullionVault?

On Monday the World Gold Council (WGC) announced that it and Augmentum Capital had completed a £12.5 million funding round in BullionVault in exchange for an equity interest.

It is an interesting development in their strategy. Until 2002, the WGC strategy was to support those selling gold. The 12 August 2002 announcement by WGC of the appointment of James E Burton (ex-CEO of California Public Employees Retirement System) as their new CEO foreshadowed two important changes:

1. a realisation that investment demand, rather than jewellery, was more capable of driving the price higher; and
2. a shift from supporting the industry to sell gold to developing its own "products" and competing against them.

Perth Mint got first hand experience of this new strategy when it was developing its ASX listed gold product in late 2002/early 2003. At the same time a Mr Tuckwell was developing what would become the first gold ETF in the world. The WGC decided to "take sides" and chose to endorse the Tuckwell product. Needless to say, we weren't too impressed. They then went on to develop and sponsor many other gold EFTs, the US listed GLD being the biggest.

However, I will concede that considering the cost and work involved in launching an ETF, especially on overseas exchanges, it may have been excusable for the WGC to get involved in developing such products since no one else was willing to (Perth Mint and Tuckwell excepted).

But, given the huge success of the various WGC sponsored ETFs, is it really necessary for the WGC to further compete against others in the industry? After all, the WGC ETFs hold 48 million ounces compared to BullionVault's 635,000. Does online gold trading have the potential to match the ETFs for impact on the gold price? I doubt it, so what is the WGC's motivation to extend beyond ETFs?

The Telegraph reports Marcus Grubb, managing director of investment at the WGC, as saying taking the BullionVault stake was part of the Council's strategy of "increasing its portfolio of successful platforms for gold investment". Does increasing its portfolio mean WGC will next buy a refinery to make WGC bars, or open WGC coin shops?

Is it a simple case of management empire building, or has WGC management been told to expand its portfolio with the objective of becoming self funding, or are gold miners (the WGC's members) using WGC as a front to move down the gold value chain without being seen by their shareholders as getting involved in non-core businesses?

I note with interest that IAMGOLD Corporation, a shareholder in James Turk's GoldMoney (one of BullionVault's biggest competitors), is also a WGC member. Note that Durban Roodepoort Deep (not a member of WGC) is also a shareholder in GoldMoney. It will be interesting to see if IAMGOLD pulls out of the WGC as a result of their support for GoldMoney's competitor. It would result in a WGC miners versus non-WGC miners fight in the online gold market.

Visit to Melbourne

I will be speaking at the next ANDA Coin, Banknote and Stamp Show being held at the Caulfield Racecourse, Concourse Ground Level, Caulfield, Melbourne on 3rd and 4th July.

While my talk will be aimed at newbies, I will be holding an unofficial "masterclass" Q&A session on Saturday at 1pm after my talk, primarily for members of www.silverstackers.com but it is open to all. ANDA show details below.

Saturday 3 July

11.00am – Bron Suchecki - ‘Options for Bullion Investment’

2.00pm – Mark van der Sluys - ‘Gold as Money’ and ‘The role of Gold in an Investment Portfolio’

Sunday 4 July

11.00am – Andrew Crellin - ‘Trading Coins for Wealth’

1.00pm – Bron Suchecki - ‘Options for Bullion Investment’

3.00pm – Rob Jackman - ‘Investing in Rare Coin & Bank Notes’

Mark van der Sluys – ‘Gold as Money’ and ‘The role of Gold in an Investment Portfolio’ – Economic and monetary historian and CEO of BULLIONMARK, Mark van der Sluys, will present a, not to be missed, two part presentation covering the subject of ‘Gold as Money’ and ‘The Role of Gold in an investment portfolio’. Important insights that are central to protecting and growing your wealth.

Bron Suchecki – ‘Options for Bullion Investment’ – Perth Mint Senior Analyst Bron Suchecki will present a one hour information session on the variety of ways you can buy gold and silver including coins and bars, certificate programs, storage options and even via the Australian Stock Exchange.

Andrew Crellin - ‘Trading Coins for Wealth’ – Andrew Crellin, Managing Director of Sterling & Currency and industry renowned author, will provide an introduction to his next book titled “Trading Coins For Wealth”, written to give an insight into how successful collectors approach their craft.

Rob Jackman – ‘Investing in Rare Coin & Bank Notes’ – Rob Jackman, Managing Director of The Rare Coin Company, will give investors the benefit of his 26 years experience in the industry with a presentation on the intricacies of Investing in Rare Coins and Bank Notes for private investment portfolios.

The truth: there is zero gold in LME's vaults

There has been a lot of speculation recently about how much gold is held in London against unallocated accounts, see some examples below:

Bix Weir: "... stay away from COMEX/LME good delivery gold and silver bars ..."

Arnold Bock: "... there is little bullion in storage at the London Metals Exchange or New York's COMEX ..."

Bob Chapman: "... Do you really think that the COMEX and LME would deliver the gold even if they had it ..."

John Dizard: "Many of them apparently prefer to have their gold in vaults near where they are, Mr Smith’s “middle of nowhere”, rather than in LME or COMEX warehouse receipts."

Jim Willie: "A clearinghouse held a Letter of Intent to supply the London metals exchange with 250 metric tonnes of gold bullion."

I am now prepared to finally reveal the truth - there is actually NO gold in the vaults of the LME (London Metals Exchange). Now I know this is an explosive claim and I'm sure you'll want to know if I can back it up with proof. Well, go to the LME website and tell me where you see gold mentioned?

That's right, gold isn't mentioned. The LME is a base metals exchange and does not trade precious metals. Problem is this makes the commentators quoted above, who talk about gold on the LME, look foolish. In my opinion, if you do see a commentator make the mistake of thinking gold trades on the LME it is an indication that they don't know what they are talking about with regards to precious metals and you should treat their analysis with caution.

Gold is traded in London over-the-counter, in other words in direct deals between counterparties. There is no gold exchange in London. There is the London Bullion Market Association (LBMA), but that is just a trade association and it does not operate an exchange or have any vaults.

You may think I'm being a bit hard on those who confuse the LME and LBMA. You might argue that it is a reasonable mistake, since they are both in London and both deal in "metals".

To that I would say what sort of credence would you give a commentary by a stockbroker who talked about Pepsi trading on NASDAQ, or Microsoft trading on the NYSE? Would you feel comfortable following stock advice from someone who did not know which exchange a stock traded on?

Confusing LME and LBMA is actually worse than that because the LME is a base metal exchange whereas the LBMA is just a precious metals trade association - a basic Google search would reveal that.

Sorry, I don't think there is any valid excuse. Getting LME, LBMA and gold mixed up is a sure indicator that one has no actual precious metals market experience, an example of ultracrepidarianism. In which case, how can you trust them to know what is really going on, how can you know they haven't made other mistakes in their analysis of the gold market?

Coin shortages coming

I have been going on about the coming shortage of coins due to limited minting capacity in the industry for a while now. This interview with refiner Argor-Heraeus by Mineweb confirms this, see quote below.

Geoff Candy: Are we likely to see a shortage of supply of these sorts of denominations.

Bernhard Schnellmann: A shortage yes, but that's not because of the metal, it's just because of the minting capacity. You have to same situations of the four coins - if the bullion coin - if we are sold out it's not because there is not enough gold around but also because there are not enough minting presses around.

If you believe there will be increased mass market demand for gold going forward and like your minted coins or bars, then stock up now because you will face premium increases and/or rationing. Once that happens small cast bars will be the other economical option and I think it would be a while before industry capacity is maxed out for them.

I would also draw attention to Bernhard's comment that being sold out does not indicate that "there is not enough gold around". The "selling out" of retail size coins and bars is an indicator of mass market demand and is bullish, but it is not an indicator of no gold. If you see any commentator claiming this, then the only thing it is indicating is that the commentator has no precious metals industry experience on the physical side and in my view any basic commercial sense, in which case you should consider carefully any of their other claims. It is a very good indicator of a hype merchant rather than someone trying to give you good advice.

Gold and the Clash of Civilisations by Andy Smith

Well, it’s not ‘the end of history’, as Francis Fukuyama originally forecast in 1989. As events, as much as Samuel Huntington’s 1993 counter-thesis ‘The Clash of Civilisations’, have shown. For Fukuyama, it was ‘the politics’ that mattered. And these ‘ended’ when the Berlin Wall fell and, soon after, victory in the Cold War was declared by liberal democracy, happily “free from such fundamental internal contradictions” that undermined alternative forms of government. For Huntington, it was all about ‘the religious’, ‘the ethnic’. Since history, like nature, abhors a vacuum, ‘politics’ would be replaced by something .... like 9/11, and the Iraq and Afghanistan wars.

What if both are wrong? What if it’s ‘the economic’? And record gold prices (in all currencies) ‘prove’ it? In late 1993 Huntington challenged his critics to come up with an “alternative paradigm that accounts for the more crucial facts in equally simple or simpler terms.” A little late, here goes.

The deepest and most enduring schism in and between societies is that dividing creditors and debtors, and surplus and deficit countries. In turn, these sides champion hard or soft money, deflationary or inflationary policies. In the ‘good old days’ this was an even fight. Indeed, the climax of the ‘Gilded Age’ of prosperity in America at the end of the nineteenth century was marked by three successive defeats for the soft-money candidate, William Jennings Bryan.

The “plain people of this country” were Bryan’s army. And you’d “search the pages of history in vain to find a single instance in which the common people of any land ever declared themselves in favor of a gold standard”, ie hard money. For Bryan “the idle holders of idle capital” (with assets to defend) were pitted against “the struggling masses” (with debts to burn, they hoped). And “where, in law or morals” was the “authority for not protecting the debtors?” Or, as his more memorable rallying cry went: “you shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold.”

This was probably the high water mark for the forces of hard money. Their ‘cross of gold’ discarded in the 1930s, now they have simply been outnumbered by debtors. And in democracies, power is a numbers game. In America today almost half the working population pays no Federal income tax, compared with only a fifth as recently as the late 1980s. What is this great subsidized majority going to vote for? Smaller government and fewer benefits - ‘hard choices’? A strong dollar that keeps inflation low and the real value of their debts up? Or personal profligacy funded by government excess?

The dwindling minority of (‘idle’ but taxpaying) creditors has worked this one out. And it is investing accordingly, in an asset viewed beyond the grasp of the mob or its elected representatives:

• in gold coin - American Eagle sales an 11 year high for May
• in gold bars - the securitized version, gold ETFs; 5 million ounces of the largest of these were bought in the thirty days after the Greek crisis broke, 23 April when Athens officially requested a bail out, more than in the month after the fall of Lehman Brothers, 15 September 2008

Similarly Europe’s largest creditor nation Germany finds itself ‘out-voted’ by debtor members of the euro. Albeit under duress, it has signed up to contribute over a quarter of the capital to the 440 billion euro ‘bail out’ fund – and the euro has reacted accordingly, falling to $1.19, no better than its launch on 1 January 1999. As the world’s biggest creditor, China, jumping from the frying pan of the dollar into the fire of the euro this past decade, will note, painfully. In fact, since the inception of the euro, all major currencies have fallen some 75% against gold. Bryan cannot have imagined that debtors would enjoy such ‘protection’.

A few hard money guerillas survive, in what some might call the backwoods. Ten American states are considering bills to reintroduce ‘Constitutional Money’. Namely, proposals to break the Federal Reserve’s monopoly (of paper currency) and return to Article 1, Section 10 of the 1787 Constitution which forbade states from making “anything but gold and silver coin a tender in payment of debts.” Stranger than the fiction of Ayn Rand? (In whose 1957 novel ‘Atlas Shrugged’ society’s creditors, its movers & shakers, fled a rapacious government to a hidden valley where gold and silver were the basis of transactions and savings.) Or the golden nail in the coffin of Fukuyama’s thesis that democracy is not “prey to ... contradictions so serious that they will eventually undermine it as a political system”?

Demand up, Supply down

Two news stories in my inbox this morning from Sharelynx:

Demand Up: Gold a ‘Good Choice’ for Boosting Global Use of Yuan

"China’s trade in yuan-denominated gold investment products moves the currency closer toward global acceptance and the country should develop more of them, a central bank official said."

Supply Down: South African gold output falls hard

"In an all too familiar announcement in recent years, the South African Chamber of Mines reported the country's first quarter gold production fell 15% quarter-on-quarter, extending the downward slide in output."