13 July 2010

My fustration with GATA

Regular readers of my blog know my main objective is to educate. Unfortunately, this often finds me having to take objection to something GATA has written.

In Adrian Douglas’ latest dispatch he says that "the process by which only a portion of an investment is used to purchase bullion -- what is politely called "fractional reserve bullion banking" -- is fraudulent because it acts against the investor's interests. ... because the consequence of fractional-reserve bullion banking is undeniably price suppression."

This is a dramatic, but exaggerated and somewhat misleading statement typical of GATA. I understand their motivation to generate passion in their readers, but I don't think it excuses imprecision with the truth.

Fractional reserve bullion banking is not necessarily or inherently against an investor's interest and means price suppression. For example, an investor buys 100oz from a bullion bank, who then buys 100oz of physical. If the bullion bank then lends 50oz of that physical to jeweller, it has engaged in fractional banking as there is now only 50% of the investor's claim on the bank backed by physical. However, the other 50% of physical is with the jeweller and, most importantly, it has not been sold.

Yes, the investor is exposed in that the bank's lending has "locked out" 50oz of physical to the jeweller for the term of the loan as well as the possibility that the jeweller may go bankrupt (assuming the bank has no form of security). However, this sort of fractional banking does not result in a sale and therefore there is no price suppression.

My point is that it is the use (or to whom) the bank puts the metal backing its unallocated liabilities to that determines whether fractional banking = price suppression. Of itself, fractional banking does not necessarily mean price suppression as Adrian would have you believe.

Having said that, I should note that the majority of lending of metal (and I do not know the exact percentage) ultimately involves the sale of that physical to back some sort of short instrument (eg a miner selling forward). On this basis Adrian probably feels his black and white statement that fractional = price suppression is justified. I don't think it is. You may consider I'm being picky but I have a problem with this sort of rhetoric for two reasons:

1. GATA is a “tax-exempt educational and civil rights organization”. It is supposed to be about educating people. I think this is important, because a lack of understanding about how the market operates can lead people to exposing themselves to risks they may not be aware of. However by making these types of black and white statements, GATA is furthering misunderstanding. How difficult would it have been to say “because the majority of fractional lending is for short selling, it is a form of price suppression that acts against the interests of the (long) investor”? These sorts of qualifiers do not detract from the point being made, but give notice that the issues are more complex.

2. Adrian laments that “attempting to convince industry insiders … meets a lot of resistance”. Have GATA considered that simplistic statements and conclusions are interpreted by industry insiders not as rhetorical devices but read as ignorance of how the market really works. GATA therefore appears to insiders as lacking credibility, making it easy for them to ignore GATA and label what they say as “rants”.

This is the crux of my frustration with GATA and I don’t think it does them, or investors, any good.

As an aside, I note the dispatch refers to an earlier dispatch where Adrian Douglas says "a document published by the CPM Group in the year 2000 came to my attention recently". The document is "Bullion Banking Explained" and I made reference to this document in my London unallocated: Fractional Fubar or Benevolent Banking? post of 11 April. I considered it an obscure document, buried in CPM Group's website and had not seen it referenced to before. If you search google for "Bullion Banking Explained" with a date prior to 11 April there are only two other references to it in 2001 and 2004.

Coincidence that it comes to Adrian Douglas' attention in his 10 May dispatch one month after I reference it? By the way, this FOFOA blog attributes my post in a discussion of fractional gold banking in a discussion about whether the backing of fractional unallocated is actually physical or just further paper.

Another claim I was particularly intrigued by was when Adrian Douglas says that "as a consequence of my article it appears that Christian has realized how damning his paper was, and while it was posted at the CPM Group Internet site for 10 years, it recently was removed mysteriously." I was disappointed to find that it was just a website reorganisation. The document still exists at this link.

It would have been most amusing if CPM Group had been prompted to remove the paper as a result of GATA. Possibly Mr Christian no longer reads GATA – he did vow recently to never engage with them again after the debate on Financial Sense. Personally I think the paper CPM Group should remove is the two I reference at the end of my post on fractional banking where they say that bullion banks "take the opposite side of the hedge transactions, have inherent conflicts of interest, and always keep their own best interests in mind, even if these are the short-term best interests and arguably not in the banks’ own long term best interests." Mr Christian is the expert on the gold market, who are we to argue?


  1. Mr Christian is the expert?
    Now I know why I hate all fucking experts.
    Have a good day, Mr. Expert!

  2. Well he is a self proclaimed expert.

    The funny thing is that in his recent stuff he had been saying that there is no problem with the fractional system, but then he himself says don't trust the bullion banks. But then they run the fractional system. I'm confused, isn't that a contraction?

  3. Expert or not, who cares nowadays?
    If ETFs, bullion banks and their alikes do have a fractional system, they should be obligated to MENTION that in their prospectuses, inform their investors what happens with the unallocated bullion. We know that money in the banks is mostly digital and fractional. Same should be with bullion. Therefore I find it correct that GATA exposes this.Mr. C. is anyway just a tool. Gold and dollars are a matter of geostrategy for the criminal USA!

  4. I think it is a bit of stretch to say the ETFs are fractional as they are explicitly forbidden by their prospectus to lend their holdings.

    As to bullion banks and their unallocated, anyone opening such accounts do not get a prospectus as they are private contracts. The contact wording makes it clear that such accounts are unsecured creditors, so anyone using them had been "informed".

  5. I agree with you, Bron. GATA can be a good source of information on some things but they spoil their own arguments by going over the top on subjects about which they know little, and choose not to investigate properly before hyperventilating.

    This slack, unprofessional sensationalist approach can also serve to lessen the impact of well considered analysts such as Ted Butler since all are lumped together by GATA critics. There was a good critique of the GATA errors over at iTulip which you might still be able to find.

  6. I trust your post is fair criticism among friends?

    GATA is doing a great job and need our (your) assistance and expertise.

    While I also do not like their (American) way of communicating, they are the only ones fighting against gold and silver price manipulation.

    The issues they are fighting against are colossal and worth while some breathing problems a few times per year.

  7. The lending of custodial gold lowers the lease rate, which makes short-selling of gold cheaper/less risky.

    If gold was not available to be leased, jewellers would have to purchase the gold for their working stock, so demand would be greater.

    So doesn't fractional reserve gold (or any gold lending at all) suppress the gold price either way?

    And isn't the fabrication working stock really a very small amount anyhow?

  8. My view is that the borrowing of gold (ie demand) by manufacturers actually increases the lease rate. The current low lease rate is because there is too much supply from central banks wanting to lend.

    What you are proposing by saying that jewellers should not lend and instead have to buy metal for their working stock is that they are not allowed to hedge their exposure to price.

    Manufacturers are just pass through entities whose job is to add value to gold. They should not have to go long and be exposed to the price if they don't want to. You are forcing them to be value adders plus speculators.

    I do not know how much gold is held in all the jewellers and other manufacturers across the world, but it would have to be substantial. Would it be greater or less than gold borrowed for short selling? I don't know and that is something I'll have a look at one of these days

  9. I'm not advocating an end to gold leasing for the purpose of fabrication. I don't mind if gold lending continues for this purpose because I don't think it could ever be large enough to put a serious dent in the gold price.

    It just seems like gold lending for whatever purpose reduces demand for gold.

    Hence Mr Douglas' is correct: fractional reserve gold = price suppression.

    I don't have the economics training to work out all the equations to determine the marginal effect of buying vs borrowing gold. So maybe Mr Douglas is wrong but I don't see how.

  10. As per this post http://goldchat.blogspot.com/2008/06/gold-value-chain-part-iii-manufacturing.html leasing as we are discussing is just a form of hedging. Logically therefore you are against hedging, because that also involves selling.

    This to me is anti-freedom. You are denying manufacturers of gold products the ability to hedge themselves from price volatility. This will only cause to increase their costs (because they will have to markup their prices to cover potential losses) which increases the cost of gold products.

    If gold products (be they jewellery or coins) are more expensive, this reduces the demand for gold because people get less ounces for the same money and this pushes down the gold price.

    Allowing speculators to take the risk of metal price changes off a manufacturer reduces the manufacturer's risk and therefore encourages more production of gold products at cheaper prices.

  11. I'm not advocating an end to gold leasing for the purpose of fabrication. I don't mind if gold lending continues for this purpose because I don't think it could ever be large enough to put a serious dent in the gold price.

    That is, price suppression caused by lending is OK in small amounts, as it is a necessity in the bullion trade for fabrication purposes.

    Fractional reserve gold accounts with LBMA members could not be leveraged 40 times over if they weren't backstopped by central banks. In a free banking system without central banks the govt should merely oblige banks to undergo physical audits and publish reserve ratios, so that is what I am advocating in the bullion market.

    That should put an end to most of the fractional reserve lending. Then the only lending would be by people who fully acknowledge the gold is being lent to fabricators and others and hence has some chance of disappearing. Fractional reserve lending would mostly be replaced with lending from fixed-term deposits. It would be a clear for each gold account whether the owner is a secured creditor or an unsecured creditor. The gold lease rate would be higher as a result and should ideally more than offset storage fees. A higher lease rate would disadvantage fabricators on the face of it.

  12. trevbus, I don't agree that leasing to a manufacturer is price suppression. That statement assumes that it is a valid business model for a manufacturer to have to be long their working inventory.

    Wearing the gains/losses of being long gold may be OK for an investor, but that is not the business model of a manufacturer. You need to think of a manufacturer's working inventory of gold as another "storage location" for an investor's gold. In this way it is price neutral.