Interview with Argentus Maximus at TF Metals Report

Forgot to mention that on December 5th I had an interview with Norman Greene who runs a newsletter service Rhythm 'n Price and a blog on TF Metals Report under the pseudonym Argentus Maximus. You can download the Skype interview here. Topics covered in the 42 minute interview include:

• The monetary nature of gold
• Backwardation and carry trades
• Bullion banks’ arbitrage role in the gold market
• Highly competitive refining industry
• How Perth Mint’s backs its unallocated storage with working inventory
• What Perth Mint would do if gold gets scarce and cannot be sourced
• Demand from China and other Asian countries
• Impact of hot money flows on gold market and need to be cautious on next run up in price

The difficulty of proving manipulation

When the CFTC announced in September that it has closed its investigation into misconduct in the silver market, the predicable response was that a finding of no manipulation was to be expected as US regulators and government are corrupt and they had to protect JPM blah blah blah.

 

However a closer reading of the announcement indicates that the CFTC did not actually find there was no manipulation. They said that "based upon the law and evidence as they exist at this time" there was no "viable basis to bring an enforcement action". That wording can also be read as saying they have evidence but based on the law, they don't see any chance of success.

 

Certainly it was not for want of evidence, as this September 2009 statement by Bart Chilton noted that the silver investigation had "invested over 2,318 staff hours ... 32 individual interviews ... approximately 40,000 documents have been reviewed" and by November 2011 the number of documents was 100,000. At the end they had spent 7,000 staff hours on it.

 

As this Reuters article notes, US regulators face high hurdles in proving cases of market manipulation and while "the CFTC has levied heavy fines for trading rule violations ... only once in its 36-year history has it successfully concluded a manipulation prosecution: a 1998 case concerning electricity futures prices." I would also give as an example the lawsuits against JPM and HSBC for silver manipulation, which failed "to show that the bank 'intended to cause artificial prices to exist' and acted accordingly".

 

Proving manipulation is difficult give the complex rules and regulations the CFTC has to deal with. As I said in this blog post, "when regulations get this complex market fairness and transparency is actually harmed, and the only ones who benefit are those big enough to have lawyers able to work out the loopholes."

 

I do find it hard to believe that there was only one case of manipulation in 36 years across all the markets the CFTC monitors. Therefore I am was not be surprised that the CFTC closed its silver investigation, nor do I expect them to provide much help in this respect in the future.

 

PS, in the CFTC announcement there was this classic: "the complaints pointed to differences between prices in the silver futures contracts and prices in other silver products, including retail silver products. The complainants generally asserted that because the prices for retail silver products, such as coins and bullion, had increased, the price of silver futures contracts should have also experienced an increase." I fail to understand how people can think that the price (per ounce) of a 1oz coin should relate to the price (per ounce) of a 1000oz bar, when the 1oz coin's price (and rate of increase) is affected by the capacity limitations of minting 1000oz bars into coins (see these Shortage posts for more background).

Tapering now gives a chance for bullish sentiment

David Jollie from Mitsui Global Precious Metals had a note out yesterday discussing the impact of tapering on gold and silver. David's notes are written for the pro market and they are not distributed as they can't be seen to solicit retail investors. My cliff notes summary is:

• tapering could drive futher bearish sentiment but much of the tapering could already be in precious metal prices
• gold's decline more to do with an increase in risk tolerance from investors seeing improving economic environment (which was in play before taper talk)
• as QE shrinks market will depend more on their own dynamics
• tapering might result in the precious metals decoupling from each other, with PGs and silver possibly outperforming gold
• still possible for QE to result in serious inflation in the future, driving continued gold buying
• also possibile for deflation to occur [if QE not enough to cover debt deflation], in which case gold will be more attractive as other assets will struggle

David sums up by saying that next year "we should expect some new ideas to start moving these markets. With tapering no longer an ongoing concern, we feel that there will now be at least a chance for bullish sentiment to develop in the precious metals complex." Lets hope so.

India planning gold confiscation and gold market interventions?

Gold investors are well aware of the restrictions India imposed on its gold market, like increasing import duties. In this post I want to step back and have a look at what India has done, and more importantly, what policy options it may still have up its sleeve.

Our starting point is the Reserve Bank of India's January 2013 Report of the Working Group to Study the Issues Related to Gold Imports and Gold Loans by NBFCs. Within its 224 pages are the following recommendations (direct quotes):

• further hike in the import duties may have to be contemplated to dissuade gold imports
• restrictions on carrying of gold and gold jewellery by incoming Indian community from abroad ... may also have to be reviewed to ensure that bringing gold into the country less attractive option
• entities importing bulk gold through banking and non-banking channels can be asked to an export obligation based on a certain percentage of imports of the gold
• bank finance to purchase gold may be prohibited
• Modified Gold Deposit Scheme (gold taken as a deposit is recycled for meeting domestic demand and given back at the time of maturity)

The above points have now been implemented, below are those which have not yet been implemented.

• Inflation Indexed Bonds ... introduce savings schemes and instruments that can provide real returns with high liquidity
• Gold Accumulation Plan (the product is a saving plan catered to even small buyers of gold in which the gold imports are deferred till the time of actual delivery of gold)
• Gold Linked Account (the entire transaction takes place outside India and import of gold is not involved)
• Gold Pension Product (the customer surrenders gold to the bank on agreement to receive streams of monthly pension till his death)
• Setting value or quantum limits for canalising agencies and banks to import gold
• trying to channel the existing supplies of scrap gold in the country into the financial system
• Gold Bonds and Gold Deposits Schemes that may encourage gold holders to deposit their idle gold holdings with banks
• expanding financial inclusion in extending gold jewellery loan

In respect of all the various paper gold type products, it is worth noting this story which reports that the Indian central bank had "sent letters to some of the country's richest temples asking for details of their gold". The head of an opposition party "said the RBI wanted to 'take possession' of the gold and maybe sell it for dollars" but the central bank said there was "no proposal under its consideration to convert idle gold into bullion at this juncture".

The general rule, of course, that politicians first deny what they later introduce, just as the Finance Minister said on January 30 that there were "no plans for additional taxes or curbs on gold imports".

Furthermore, a Reserve Bank of India regional deputy general manager was quoted as saying that there interest extended beyond temples" “We sought the details as part of a statistical exercise to gather details of the gold in the possession of all places of worship and other public bodies. We started the process with temples. We had planned to cover the places of worship of other communities, trusts and establishment in subsequent phases".

Some temples do already deposit gold with Indian banks, earning interest of around a few percent. Below are the amounts held by three temples I've picked up from various reports:

Tirumala Tirupati Devasthanam - 116,643oz / 3.6t

Tirupati - 72,339oz / 2.25t

Sri Krishna - 16,075oz / 0.5t

So there is a fair amount of gold just held across many temples, let alone private individuals. The reported objective of these gold schemes is to lend the gold to the extensive Indian jewellery industry, which hold significant amounts of gold as work in progress stock. This I don't see as a problem, because the gold is not being sold and stays within the country. It also helps to consolidate gold as money.

However, utilising investor stocks of gold this way does not really solve India's import problem, as all it is doing is replacing gold loans given to importers and jewellers from overseas bullion banks with internally funded sources. This only provides a one off benefit as the gold flows out of India only as the bullion bank loans are repaid. Thereafter India still needs to import gold on an ongoing basis.

This leads to the key, in my mind, recommendation from the report, which was the "setting up of Gold Corporation or Gold Bank in India". The purpose of this entity is to (direct quotes, my emphasis):

• provide refinance to institutions lending against the collateral of gold
• retailing functions in gold including pooling of idle gold in the system
• be empowered with wide-ranging activities related to the entire spectrum of gold policies
• make official purchases and sales of gold
• may issue gold bonds and collect the gold stocks
• be to mobilising domestic non-official gold holdings; channelise them into a centralised pool over a period of time and to deploy them in a productive manner in the best interests of growth and development of the country
• be authorized to buy and sell gold on their behalf and on behalf of their clients
• be empowered to handle the country's gold reserves
• be given powers to import, export, trade, lend and borrow gold and deal in gold derivatives

One could argue that if you plan to "mobilise" (cough cough) domestic gold holdings, then you first need to know where and how much gold is held in places of worship, trusts and establishments. Then you can utilise this gold to implement the "entire spectrum of gold policies". Lets just hope India's CAD improves, otherwise the Reserve Bank of India may feel it needs to implement more of the report's recommendations.

Implications of ETF redemption in physical gold coins

In August ETF Securities announced that shareholders of its gold ETF would be able to redeem their shares for physical bullion coins from the British Royal Mint.

The Perth Mint's ASX listed gold product, code PMGOLD, had physical redemption in any Perth Mint bullion bar or coin built into it from its start in 2003. Good to see ETF Securities catching up ten year later :)

Perth Mint and ETF Securities are now the only ETF issuers with real retail level redeemability - other funds that do allow physical redemption (many don't at all) like Sprott's PHYS do so only in 400oz bars, which is unrealistic for normal investors.

I haven't seen any further follow up or media about this option, so assume they haven't been inundated with requests.

 

The question it raises for me is that if more ETFs start offering this feature, it will put additional pressure on the mints during high demand periods. As I've blogged here many times, there is limited production capacity worldwide in the minting business, so expanding the ease with which ETF investors (who I would assume are generally not physical holders) can convert into physical will just make the production capacity issue even worse when there is an uptick in interest in physical. The result will be longer shortages and higher premiums.

ETF redeemability into coins is also a potential threat to coin dealers and online businesses like Bullion Vault and Gold Money. An ETF that becomes a full service gold vendor could be a very appealing alternative, given that the buy/sell spread on an ETF are much tighter than those offered by dealers. The only thing protecting the dealers is the somewhat cumbersome nature of the redemption process.

No high premiums for suggested gold miner cartel

Yesterday The Gold Report published an interview titled Miners Should Launch a Gold Cartel or Risk Losing Everything, Advises Stephan Bogner.

In it Stephan suggests that "mining companies should collectively refrain from selling into the market at spot prices but should instead find buyers themselves, as there are definitely investors worldwide—especially from Asia, as well as the Middle and Far East—that would pay high premiums on the spot price to get their hands on physical bullion."

I think this suggestion is simplistic in a number of ways. Firstly, while premiums can develop in certain geographical markets from time to time due to various factors (see this interview with Al Korelin where I explain the impact of restricted Chinese import licenses and quotas) in no market is anyone paying $1900 an ounce - "high premiums" at best means tens of dollars, not hundreds of dollars (see this William Kaye interview). The fact is that Chinese demand exploded in April because the price dropped, and a lower price is the miner's problem.

Secondly, the gross premiums being quoted are not necessarily what the bullion banks are getting. In that William Kaye interview, he says that "senior members in China’s government, probably in the State Council, basically decided that they were sick and tired of the premiums that the Chinese people were having to pay over the London price for gold", which accords to what we heard, but William gets it wrong when he says that "they (Chinese officials) recognize that the bullion banks, at the expense of the population and the jewelers, have been making arbitrage profits". The real story is that it is the limited number of licensed Chinese importers who have the upper hand over the bullion banks, who compete to supply (and extend credit) to the importers, so a good part of the premiums were going to the importers, not the bullion banks. So miners would not get all of the reported high premiums.

Thirdly, the actual gross premiums paid by importers are just that - gross. From that you have to take off the costs of selling, which would include management time spent by each mining company finding and negotiating with each buyer, shipment costs to refiners, fabrication costs, shipment costs from refiner to buyer, and in most cases of the main distributor/importers, the cost of interest in funding the sale as these business often want 180 day payment terms or consignment stocks. The end result is that the reported gross premiums end up as a much smaller profit.

The idea of miners finding buyers themselves is like saying farmers should deal directly with individual supermarkets. There is a reason industries like milk (and gold) have processors who aggregate volumes, and distributors who manage sale to many retail outlets. It is just more efficient than producers trying to deal directly with every buyer. Gold distributor/importers for example, prefer to deal in tonnes at a time as that keeps shipment costs between countries down.

The only way it could work is if a group of miners got together and pooled their output and negotiated with a refinery for fabrication and distributors for sales at a scale that made sense. But then that organisation is just doing what bullion banks do. In addition it would need to raise capital from investors to fund the gold tied up until they eventually got paid, and miners are having problems raising money. There is also credit risk associated with who you are selling to, if they don't pay. These are not skill sets many mine managers have.

I'm not trying to dissuade miners from forming such groups - it doesn't make a difference to the Perth Mint, for example, whether we deal with a bullion bank or a miner group. Just pointing out that there is no easy money in these "high premiums" that are seen from time to time. Gold distribution is a competitive business and the marginal profit earned is not going to solve miners' current financial problems, which require prices hundreds of dollars higher, not tens of dollars.

The only way gold miners can really impact price at the margin is to withhold supply. Stephan suggests this, saying that miners "should use gold and silver as the functional currency for the industry ... look for ways to bank their gold as cash assets or take out gold loans, not dollar loans. They should buy physical gold and silver and store it outside the banking system. When they require cash, they can sell part of their holdings." David Baker, of Baker Steel Capital Managers, has been talking about miners holding gold on their balance sheet and gold dividends as well. Perth Mint fully supports such initiatives (see this Korab Resources announcement for example).

However, the problem with the idea of holding gold is that at this time the most miners are strapped for cash and don't have the ability to not sell and simply hold gold in the quantities necessary to impact the price.

I don't know what the solution is to gold miner's current problem, but suggesting that there is some pot of easy high premium gold waiting for producers just creates a false hope.

About being part of a psyops program to infiltrate and undermine gold discussions

On the Silver Doctors website someone accused me of being part of a psyops program to infiltrate and undermine gold discussions. I left a comment that is currently in moderation, but I reproduce it below FYI.

I think the manipulation of internet discussions and disinformation is something we should all be aware of but I don't think it is a problem in the gold space - it seems to me from the many places I've frequented since I started blogging in 2008, that in general the gold internet sites aren't overrun with pro fiat/govt trolls and there is a very active defense against anyone disagreeing with any goldbug theory or narrative.

"Why would a guy who works a full time job in such a high position for the Perth Mint, who’s not allowed to even get in to details about the Mint, as he’s stated, be joining discussion forum(s) such as goldismoney2, and make a personal blog, that’s not really even promoting investment to the Perth Mint?"

Not sure what you mean about "not getting in to details about the Mint", which details are you referring to? I talk a lot about the Perth Mint, but not about competitively sensitive stuff, which I wouldn't think is surprising.

As to why I comment on forums (I actually have over 20 "identities" http://www.perthmint.com.au/research_about.aspx) and have run my own blog since 2008, well same reason you comment here, because I'm interested in gold and want to talk about it. Just because I work for a mint means I can't talk about the market?

And while the blog is personal, everything I do does reflect and have some small impact on the Perth Mint. But anyway, if I didn't work for the Mint I would still be on the forums, not everything has to have a profit motive.

"He claims it’s not on behalf of the Mint."

A personal blog is by definition not official. I say that on my blog so it is clear I'm not representing the Mint and thus I can speak more freely. Isn't that a good thing, that I'm transparent about that and that I can express an opinion, or would you rather no one from the industry provide any insight into what goes on?

"Moreover, why even post using your real name AND photo in a first post on a discussion forum? That’s not the standard on how higher-ups do things on the internet (as well as the rest of us too), unless they’re running and promoting a business such as retail or newsletter or consulting, where verification of who the person is may be sought out by perspective clients, before purchasing their services."

When setting up my personal blog I considered doing it anonymously but I thought that would be dishonest. I thought it was necessary for people to know who was writing so that they could be on guard for any bias or agenda I might have. No it is not the “standard” for how higher-ups do things on the internet, are you saying you would want less involvement by the industry? Also, as I said above, while the blog is personal, there is some small promotional/representational aspect I cannot divorce myself from, so again, being upfront about who I am I thought was necessary.

“However, Sucheki isn’t selling anything on behalf of the Mint, and nor is he selling consultation or newsletter services. In other words, what’s in it for him to post on a discussion forum, while providing his real name and photo? I may be wrong about this, but it all smells kind of fishy.”

Part of my job going forward will be to take on some social media aspects, so my stuff on the internet will have a “selling” component.

“The first time this guy ever showed up was ~ 1 year ago on the goldismoney2forum.”

I’ve been blogging and commenting on forums since 2008.

“In his first post, showing his real name and photo, he defended the position/government propaganda line of a troll.gov like zman. Strange indeed. That’s the general pattern I’ve observed, and many others too.”

Can you provide a link to that post. If you read my blog you will find plenty of non troll stuff. I am not a cheerleader for everything written about gold on the internet, but just because I might disagree or provide another view doesn’t make me a troll.gov either. I had similar claims made about me on TF Metals Report, maybe the answers to their questions may give you a more rounded picture of my views http://goldchat.blogspot.com.au/2013/05/questions-from-tf-metals-report-readers.html.

“Is there really a man named Bron Suchecki? Probably so. Does he really hold the position he states at the Perth Mint? Probably so. Does he really look like the man in the photo? Probably so.”

Most certainly I am real.

“Does he really run a blog and make posts on a discussion forum? Probably NOT. I suspect that the real Suchecki has given his permission (to those who compensate him well for the priviledge ) to those that run the Cass Sunstein-designed program of infiltrating and undermining internet discussion boards (that discuss topics contrary to US government interests), to post on his behalf.”

Absolutely incorrect. I started the blog myself and its content and all the content of the identities at http://www.perthmint.com.au/research_about.aspx are my personal work, there are no ghost writers. I don’t know if there is a psyop program directed at precious metals markets, but neither I nor the Perth Mint are involved or engage in such behaviours, either for (we make money by selling gold products) or against gold.

“The reasoning is logical if you’re running a psyop as stated by Sunstein. You strengthen the government propaganda position via getting a ‘guru’, who’s presented as the real deal (real name and photo included), to agree with the troll.gov posts. Moreover, you get the troll.gov posters to refer to the information presented by the ‘guru’ Suchecki, in their attempt to validate the propaganda position. Given that Mikeyj was validating Suchecki AND ztroll.gov, it’s no surprise to me that ‘Bay of Pigs’ has taken an intelligent approach as to his suspicions regarding whether Mikeyj is in the same infiltration program. Good job, ‘Bay of Pigs’, at spotting these psyop techniques!”

I think anyone who looks at the entire body of my blog and comments elsewhere on the internet since 2008 would, if it was a psyops program, have considered it very ineffective and asked for their money back.

If you want to charge me with being a psyops program, then please provide evidence that I engage in all of the behaviours listed here http://www.washingtonsblog.com/2012/08/the-15-rules-of-internet-disinformation.html or http://pastebin.com/irj4Fyd5 which is more comprehensive. I think it is important to be aware of these techniques because I’ve seen some of these behaviours, although I’m not sure it is a psyops program and just general troll behaviour you see anywhere.

Twitter

I've started to use my previously parked Twitter account @bronsuchecki. I will be mostly using it to let people know about any new posts I do here or on the Perth Mint website, as well as FYI/of interest on stuff that doesn't warrant a full blown post.

Doubtful I will be using it to do much following as I already have over 20 other identities to keep track of.

Anyway, for those who prefer to keep in touch via Twitter, that is now an option.

More on Comex producer/merchant long position

Further to my Dec 6th post, Gene reposted it on his site and it drew a number of comments there as well as at on my post. Some additional commentary on those questions below.

One point was about the impact of miners. However the GFMS hedge book analysis has had miners slowly dehedging over time and has pretty much stopped, so that I don't consider a driver behind the position.

There were a lot of comments about demand in Asia and other places worldwide, however I was discussing Comex producer/merchants. It may come as a shock to Americans, but Comex is not the centre of the gold world. There is a lot of OTC hedging going on as well. So my assumption was that most of the Comex producer/merchant category is US/Western refiners/fabricators/distributors. Therefore, given the point about miners, understanding producer/merchant category is about understanding the downstream value adding process.

There was also some comments about how "if demand has dried up, the inventory should be up, not down, because demand normally drops much faster than production. Only when the producers manage to close down their mines will the inventory then drop but this usually takes a long time [so] inventory accumulating in the producer. So for the entire group of producers/merchants, if demand has dried up, the inventory should be up not down."

Firstly, producers/miners do not stockpile gold, they sell it as soon as they get it - they have tight margin and need cashflow. Downstream fabrication businesses also do not have the financial resources/funding to stockpile large amounts of gold in anticipation of demand (apart from the bullion banks themselves) hence they only hold what they need to support current sales.

All the gold produced is sold to investors one way or the other. The refineries are set up to produce 99.5% 400oz bars in bulk and cheaply. They process and clear this into the market efficiently where it ends up sitting in vaults owned by some investor - the industry itself does not sit on gold waiting for buyers, because there is always a buyer at the spot price.

There is a base amount of working inventory needed to support this "core" process. It is when you start value adding to that gold, refining it to 99.99%, casting it into smaller bars, or making blanks and then minting, that the industry's working inventory needs increase, because it is taking longer to transform the gold.

Hence when demand rises in these value added areas the "merchant" inventory and hedging needs will increase. When the demand reduces, the inventory reduces down to the base needed to support only 400oz bar manufacture.

Now this explanation is not meant as the sole reason why the producer/merchant category has went long. While the Perth Mint does not speculate on price, maybe it is common for other "merchants" to do so, although if that was the case, then why was the short position relatively stable during 2009-2010-2011 while a bull run was in place?

My point is that I think in the case of little producer hedging, merchant inventory needs (or lack thereof) would be a base macro trend/driver for the short position of this Comex category.

A metallic standard to save the economy and one central bankers will accept

Forget the gold standard people, central banks are never going to go for that. However a UK professor has unwittingly identified a metallic standard a central banker can live with - from this BBC article on why humans have always tended to choose gold as currency:

"Take iron. In theory it looks quite a good prospect for currency. It is attractive and polishes up to a lovely sheen. The problem is rust: unless you keep it completely dry it is liable to corrode away. 'A self-debasing currency is clearly not a good idea,' says [professor] Sella."

Not a good idea? Hasn't he heard of inflation targets - debasement is the stated policy of central banks. So forget this talk of a Gold Standard, an Iron Standard is what we need.

One great advantage of an Iron Standard is that everyone has some rusted piece of metal lying around, so it would be a form of QE/monetisation for the common people. Everyone will be instantly wealthy, that has got to get everyone's animal spirits going and turn the economy around. Every country also has iron, so it should get worldwide support. China's got a lot of it, just knock down those empty apartments.

It will also market well with the public - iron is "strong" - and I'm sure Obama's political advisers will see the spin/MOPE benefits of the following announcement:

"An indispensable element in building a new prosperity is closely related to creating new jobs. We must protect the position of the American dollar as a pillar of monetary stability around the world.

Accordingly, I have directed the Treasury Secretary to sell all of America's gold reserves, which is a soft, ductile and wimpy metal, and institute convertibility of the dollar into strong Iron, in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.

Now, what is this action — which is very technical — what does it mean for you?

Let me say that this new Iron Standard will make all Americans, who buy American-made products in America, wealthier and your dollar will be worth just as much tomorrow as it is today. The effect of this action, in other words, will be to strongize the dollar."

To sex it up a bit, politicians might also want to consider Izabella Kaminska's idea of central banks issuing their own digital crypto currencies. Iron is heavy to carry around, so do away with physical coins and notes and issue BitIron instead.

Finally, an Iron Standard will encourage a lot of recycling, which is a Good Thing. It will also probably result in people scrapping perfectly good goods to monetise the iron in them - economists will love that as it is similar to Keynes' idea of filling old bottles with banknotes, burying them, and having people digging them up.

There is one potential problem with an Iron Standard, being that iron's debasement rate, or rustment rate, is constant and thus out of control of the central bankers. However I think an Iron Standard is a fair compromise between the hard money advocates and meddling central bankers who think they alone know what the one right interest/inflation rate is for a massively dynamic and complex economy. Come on guys, compromise. Central bankers - give up your omniscient delusions and omnipotency. Hard Money - give up your rigid money stock, a little rustment will discourage hoarding and encourage people to spend spend spend, and what could be wrong with that?

Tight physical supply

Readers have asked me to comment on Koos Jansen's report of tight physical supply. There are a few interesting observations made in the article I have some comments on.

1. "sometimes when they get gold in, it’s coming from the back corners of the vaults. He knew this because these were good delivery bars marked in the sixties"

This is not unheard of. In June 2006 the LBMA issued a note saying that "in the past year, an increasing number of gold and silver bars have been re-appearing in the market after having been held for many years in vaults (whether in London or elsewhere) ... some of these “deep storage” bars may no longer be regarded as acceptable, either because of physical defects or poor marking." They followed this up in Oct 2007 with another clarifying note.

Unfortunately, Warren James has not had time to develop an aging analysis of the bars in the ETFs from his bars database, and the age of those being redeemed, which would provide additional information on how far down the barrel the scraping is happening.

Given the first reports of deep storage bars come from 2006, it is not surprising that "sometimes" refiners see old bars. If they had said they "often" or "frequently" got old bars, then that would be a lot more interesting.

2. "there have been several times this year on which they were unable to source gold, this shocked me. They’re bringing in good delivery bars, scrap and dore from the mines, basically all they can get their hands on. This gentleman has been in the business for 37 years, he was there during the last bull market in the late seventies. I asked him when was the last time this has happened, that he was unable to source gold, he said never"

All I can say is that the Perth Mint hasn't heard of any problems sourcing 400oz bars out of the bullion banks ex-London at this time, so I'm not sure what to make of it. The quote is third hand, I wonder if "unable to source" was meant as "unable to source at par" but that subtlety was missed. I reported in May that 99.99% 400oz bars were attracting a premium, maybe it meant 99.5% bars are getting a premium now? The wording however seems clear about outright inability to source.

3. "They put on three shifts, they’re working 24 hours a day, and originally he thought that would wind down at some point. Well, they’ve been doing it all year. Every time he thinks its going to slow down, he gets more orders, more orders, more orders. They have expanded the plant to where it almost doubles their capacity. 70 % of their kilobar fabrication is going to China, at apace of 10 tons a week. That’s from one refinery, now remember there are 4 of these"

Perth Mint is seeing good demand for kilo bars from China, but nothing like the premiums we saw earlier this year. We refine around 5-6 tonnes a week, so those numbers accord with what we are doing.

4. "in China there are 6 LBMA refineries but he has never seen a Chinese gold bar, they’re keeping it all"

Warren confirmed this when investigating Dominic Frisby's statement from HSBC about it, and in this follow up. Of all the ETF bar lists that Warren downloads he hasn't see one Chinese gold bar yet. No doubt no newly mined gold is getting out of China.

5. "What I do know is that we are on the threshold of a situation that has never occurred before. A squeeze is imminent, it could take 3 months or 6 months, but all I know is that it’s coming, and I know that with 100 % certainty."

I've seen a lot of 100% certainty that the fractional bullion banking system is about to blow up, starting in 2008 from the financial crisis. What I watch for is bullion banks desperately bidding on our refining output, as I said in this post or "just watch Bullion Vault and Gold Money - which are backed by 400oz bars and which deal in that market every day - for reports of difficultlies in getting 400oz bars and restrictions on how much gold can be bought, and/or if they start to add on a "special" premium to their spot price." I'm not seeing that desperation by bullion banks, nor premiums from Bullion Vault or Gold Money on 400oz bars, so at this stage no confirmation.

Producer/Merchant net long is not necessarily bullish

Gene Arensberg has a good post up on the rare occurrence of COMEX Producer/Merchants category going net long. He sees it as a bullish sign but I would suggest another interpretation which could be more ambivalent.

Gene notes that the producer/merchant "class of traders is dominated by actors who are hedging price risk of their own physical or financial exposure to precious metal, so they are usually more short than long futures" and that it includes "producers and miners, refiners, large jewelers, large bullion merchants". He also observes that for most of the time this group runs at around 160,000 contracts (circa 500 tonnes) short (see the chart below from Gene's site).

Now the interesting this about this is that this group stays pretty much consistently short right through a huge bull run in gold, in pink. Don't you think that is unusual? As the losses mounted, wouldn't they have lightened up? How to account for this behaviour logically?

The key is, as Gene says, that they are hedging their own physical. All of the types mentioned -  miners, refiners, jewellers and bullion dealers - have a lot of gold in the working inventories of their businesses. They own this metal (are long) and thus go short to hedge themselves. Their business is about buying gold and transforming it into another more valuable product and then selling it. They are not interested in making money on the gold price itself.

Indeed, if they weren't hedged then as a group holding around 16 million ounces they would have lost around $11 billion dollars in the drop from $1900 to $1200. I'm pretty sure you'll agree that they are unlikely to be making so much profit making coins/jewellery or as coin dealers to wear that sort of loss.

So that is why we see a stable short position for this group, with smaller ups and downs as their sales and inventory fluctuate in response to changes in demand. If demand surges, then their inventory gets run down and they would take short hedges off and the short position would reduce. As they restock inventory, the short position should increase.

We now have a basis on which to explain the 2008/2009 and 2013 divergences from the long run average of 160,000 contracts short.

My explanation for the reduction in shorts from 160,000 to 27,000 in late 2008 is that the financial crisis caused an unprecedented surge in retail demand for gold. The industry was not geared up for that sort of volume so inventories were run down, resulting in a coin premiums surging. As the industry geared up and put on extra shifts etc the producer/merchants were able to restock and hence we see their short position increase again.

Continuing with this inventory based analysis, it suggests the interpretation for the 2013 reduction in short positions to 6,000 long is that the industry is running down its inventory. In 2008/09 the inventory run down was due to a demand surge, but was only temporary. In 2013 the run down has persisted. An explanation for that is that demand and business has dried up - if you aren't selling as much product then you don't need to hold, and can't justify holding, as much working inventory as you used to.

Consider that during 2006/2007 the producer/merchant short position hovered between 50,000 and 100,000 contracts (see this chart, which goes back a bit further than Gene's). The 160,000 average that Gene mentions is from 2009-2010-2011, which is the bull run in gold. An interpretation is that the extra demand during that bull run resulted in the industry needing to run higher inventories, so we see another 60,000+ shorts being added. With the $1900 bust, maybe the industry as a whole got stuck with higher than normal inventories so worked them down to their average of 75,000.

What is interesting is that the rapid reduction from 75,000 short to 6,000 long started after the April 2013 price smash. That event certainly knocked sentiment from the market in the West. It resulted in cash for gold scrap business drying up (therefore less metal tied up in inventories by dealers and scrap merchants) and if you look at US Mint gold coin sales, they drop right off from that point as well, so again coin dealers etc have reduced inventory needs.

To further back up this analysis, consider that US Mint silver coin sales have not reduced like gold and coincidentally the silver producer/merchant short silver position shows no reduction like gold as the silver market is still strong.

So I'd argue that the producer/merchant position is just reflecting the lack of Western interest in physical gold investment (as also demonstrated in gold ETF reductions) rather than them "believe[ing] the path of least resistance is higher for gold." Having said that, I wouldn't say it is necessarily bearish, as Gene is right in that it is a rare signal so could indicate a turning point. I just don't see it as a slam dunk bullish sign either, as this lack of interest in gold is likely to continue until people realise that, no, the economy isn't on the mend and the problems fixed. Until that mainstream narrative changes, we could see speculators testing the gold market to the downside.

Note: I have linked to a number of Nick's Sharelynx charts in this post. Just sign up for the free trial to get access to them, they are invaluable to understanding what is going on in the market, as hopefully this post demonstrates.



Gresham’s Law, Suicidal Strategies and Pure Speculation on China

Gresham’s Law for Interest Rates

Lars Schall has an interview with Dr. Tom Fischer covering the ground in his Faux Gold Arbitrage article. The Q&A format forces Tom to compress his ideas down into short paragraphs and the interview is worth a read IMO. One quote:

"Gold is not just another commodity. It historically has the role of a world currency that cannot be inflated into oblivion. It is a financial safe haven. However, for currencies like gold, the Dollar or the Euro, contango or backwardation follows from a difference in their interest rates. For instance, because of that interest rate differential, usually either the dollar is in contango towards the Euro and at the same time the Euro in backwardation to the Dollar, or vice versa. Now replace the word “Euro” by “gold” and you get the picture. So, gold is in backwardation when its interest rate, which is also called the “gold lease rate”, is higher than that of the Dollar. The question is now: why should the interest rate of gold be higher than that of the Dollar? In my opinion, the answer is obvious: gold is the much better currency, so, you should have to pay up to get a loan in it. I would call this a version of Gresham’s Law for interest rates."

From this interest rates perspective, futures markets for currencies like gold are effectively lending (for a backwardation or decarry trade) or borrowing (for a contango or carry trade) trades. See this blog post for more detail.

Suicidal Strategies

James Turk has an interview with KWN where he asserts that "the attempt to shake out physical metal by driving the price lower is a suicidal strategy" as it "increases the demand for physical metal more than the weight of metal sold on to the market."

Now I agree with his statement that the bullion banks may well be hedged so they don't have any exposure to gold prices and that their real risk is more likely physical liquidity maturity mismatches. James notes that "we don’t know the size of the fraction of available metal backing delivery obligations" but sees the episodes of backwardation and drawdowns on "visible inventories of the ETFs and on the Comex" as evidence of their liquidity risk.

I would take exception to the quality of this evidence. Note the use of the word "visible". As I noted in this blog post years ago, the ETFs and COMEX are a minor part of the total investment stocks. We have evidence in terms of UK to Swiss to HK import/export figures that part of the visible inventory reduction is going to Asia, but we don't know where the massive amount of invisible inventory is going, if anywhere. If it is staying in London or other western warehouses, then we have to consider the possibility that there is sufficient physical liqudity for the bullion banks.

In any case, even if the above analysis is incorrect and these attempts to shake out physical are not working, don't you think the bullion banks know this? I mean, bullion banks have extensive webs into all aspects of the gold market so would they not be the first to see the impacts of their strategies? In that case why would they persist with it when it threatens their existence? I can see some validity in the shake out theory regarding April's price smash, but given the Asian response, I can't see validity of the theory that the bullion banks are suicidally repeating this strategy. If they were that stupid they wouldn't have survived as long as they have.

Pure Speculation on China

Nice to see gold making the mainstream papers in Australia in a positive way with this quote sent to me by a reader (you'll need a subscription to read the whole article):

"So here's the latest Pure Speculation gold theory: there will be no gold surplus in 2014 (as there never has been, unlike with most metals), China will keep taking advantage of the subdued price to buy both metal and the foreign mines that produce it, and one day, probably too late, Western investors will wake up to the fact that China controls so much of the world's gold and is using it to back the yuan as a reserve currency."

Central banker pop quiz on gold

Q1. If you say that gold "is an asset that people want to hold when they’re very fearful about potential financial market catastrophe or economic troubles" or that gold is an "asset that people hold as a sort of disaster insurance" and someone points out that you hold around 70% of your reserves in gold, you should:

A. say that you are not fearful at all because "under the wise and skillful leadership of Chairman Bernanke, the Fed helped stabilize the financial system, arrest the steep fall in the economy, and restart growth."

B. say "does 70% allocation to gold sound like I think everything is peachy pie, you moron?"

C. just say that "it is tradition, a long-term tradition" to hold gold as "a form of reserves" and tell them to keep calm and carry on doing what you say and not what you do.

D. Note the person's name and forward it to the NSA.

Q2. If you say that "nobody really understands gold prices and I don’t pretend to understand them either" or that you "don’t think anybody has a very good model of what makes gold prices go up or down" and someone points out that it isn't very smart to invest 70% of your reserves in an asset you don't understand, you should:

A. say that when you have "a lock on the economics world" and don't allow "room for other views", you don't need to understand anything nor does it matter if you get it wrong.

B. say "that was just to scare people off investing in gold, because do you really think we don't understand gold when we employ over 300 Ph.D. economists and have written hundreds of papers on gold, you moron?"

C. just say that "it is tradition, a long-term tradition" to hold gold as "a form of reserves" and tell them to keep calm and carry on doing what you say and not what you do.

D. Note the person's name and forward it to the NSA.

Answer key: anything exept B.

So who are the The Liars and Cartel Apologists?

Craig Hemke (TF Metals Report) had a recent post where he asked:

"Who is Jeffrey Christian and what is his business? How about his pals ErikT, Bron and Kitco? What are their motives? What about sites like Screwtape and "personalities" like Kid Dynamite? Who supports them and what drives their interest? ... Who is Kid Dynamite? Who really are Jeanne d'Arc, the crew at Screwtape and the bloggers of the Kitco boards? What are their names and what are their real jobs? What is Jeffrey Christian's background and who are CPM Group's clients? Who are his sources and from where does he get his information? What is CPM's business model and how do they profit? How about Kitco and The Perth Mint? Perhaps they can explain how pooled, unallocated accounts work. I'm not alleging fraud or malfeasance but I do think that folks need to know where there might be conflicts of interest in this fight."

I responded to Craig's questions in respect of the Perth Mint here, and a copy of the text is appended to this post for the lazy. The other people mentioned can answers for themselves if they care, but for what it is worth, below is what I know of who they are. As an overarching comment, none of them are related to each other/co-ordinate/work together or have "support" from shadowy forces as far as I know.

I suppose I should also "confess" that I am in email contact with the people below from time to time. This may be confusing to some, but I don't have a problem corresponding with people even though I may disagree with some of the things they say/believe - and I don't agree with everything Erik, Kid, Warren or Jeff say. Everyone has different experiences and thus brings different facts to the table, so I am happy to engage with people I disagree with as I may learn stuff. In fact I seek out people who disagree with me as I think that is an important way to ensure one does not fall into group think and make sure you are getting to The Truth.

Erik Townsend

I suppose Erik was mentioned because of the editorial "Debunking the Post-CFTC Precious Metals Fearmongering Campaign" on Financial Sense and for the comments on this Peak Prosperity article (in which Jeff also comments).

There is nothing secretive about Erik from what I can tell from his website, he "is a retired software entrepreneur turned hedge fund manager. Erik has actively traded energy, grains, and precious metals futures markets since 2008."

Erik interviewed me on arbitrage in June 2012 for Financial Sense. Since the Perth Mint doesn't trade futures, I see Erik as one source for information on gold futures from a traders point of view, which he provides on Financial Sense each week.

Kid Dynamite

Kid was a "a trader at a major Wall Street investment bank" for eight years and appears to have retired I guess. Traders aren't known for being shrinking violets, hence Kid's sometimes aggressive blogging style when "trying to correct erroneous hype all over the internet" which gets under the skin of most of his targets.

Kid is not a goldbug and just sees gold as a trade, and I value that non perma-bull non perma-bear agnostic approach when everyone seems to be in one camp or the other. His trading experience at a big bank is also useful to understand how trading desks work, which helps in working out what the bullion banks are/could be doing.

I'm not sure how Kid got on to precious metals BS, but my take is noob investors getting mislead by BS into positions that aren't right for them is one of his hot button issues.

Warren James (Screwtape Files)

Firstly, Screwtape is a group blog but that doesn't mean that they all agree with each other or endorse each other's blog posts. I don't know the other Screwtape bloggers much, but have met Warren in person a few times.

Once can best understand Screwtape Files by their work on Wynter Benton, which they say "was a defining moment for this blog - at first we were believers of the message" but they came to the conclusion that it was a fraud and "could be considered one of the most successful silver pumpers of 2011". The Screwtape Files bloggers were initially driven by a theory that a number of websites were part of a coordinated pump and dump scheme, which is similar to what Craig implies with his question of "who supports them"? Screwtape eventually came to the conclusion that the websites were just run by regular people.

Warren originally contacted me about the ETF bars lists as he had seen the claims the bars lists were fake and thought he could prove it via statistical analysis of a history of all the bar lists. I didn't think they were fake and I suppose I could have ignored him as I disagreed with him, but he was serious enough to come to Perth on his own dime to talk about it, so I thought I should meet him. We spent a few hours on it and I went through what signals/trails the data should show up if they were fake, what Warren called vectors for investigation.

I kept and open mind on it and thought well if he can find evidence than that will be huge news, so was happy to give him as many vectors to look at. While Warren didn't find any evidence of fakery, his bullion bars database has provided some very interest insights into the way bullion bank run vaults and I his work on it is essential reading for anyone trying to understand how bullion banks work.

Warren is a real person (see his photo in this post) and just an average guy working in IT and I'm four nines (ie 99.99%) sure he has nothing to do with The Cartel.

Jeffrey Christian

Craig has a lot of questions directed at Jeff, which I find puzzling as the answers are all available on his website, such as his background, his clients (producers, consumers, investors, governments), his business model (consultants/advisors fee-based). The funny thing is that Jeff is far more closely aligned with Craig and other goldbugs than with bullion banks. Hard to believe? Consider these examples:

Against conflicts of interest: "commodities research and advice is best delivered by independent experts who do not work for banks, brokers, mining companies, or any other entity that has interests that could conflict with the best interests of the clients"

Alerting people to the fractional reserve bullion banking system (Feb 2000): "Banks treat their metal deposits in much the same way as they do deposits denominated in money, as the reserve asset against which they lend additional money to borrowers."

Competes against bullion banks, highlights their conflicts of interest (Oct 2002): "A producer should use an advisor such as CPM Group, which is not trading against the producer. Banks and dealers have a conflict of interest between their own trading positions and the hedges they advise their clients to take" and (Jan 2000) "Hedgers should not rely on their trading counterparts for hedging strategies. These entities 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."

Jeff also says in this discussion forum that he has sued Goldman Sachs, "testified on four continents and written extensively about the need to regulate OTC derivatives" (see here and here), "denied re-entry into their home country as a form of harrassment, had their computers hacked into and files deleted, and their phone tapped".

 

I would bet that if I gave Craig the above quotes without mentioning it was Jeff, he would be very interested in interviewing the guy. Seems to me like there is common ground between the two. If Craig is after The Truth, then surely he can ignore/put differences aside to interview Jeff on bullion banks' conflict of interest and what regulations are needed, his suing of Goldman Sachs and harassment. I know there is zero chance of that, but at least I tried to build some bridges.

 

Appendix: Response to Craig's questions in respect of the Perth Mint

You asked what the Perth Mint’s “agenda” is and to explain our Depository accounts. First up, the Perth Mint was created by the West Australian government to (key bits from section 10 of Gold Corporation Act):

• to recover, extract, process, smelt, sample, refine, assay and work gold and anything containing gold;
• to mint, make, issue, buy, sell, distribute and otherwise deal in coins
• to provide storage and safekeeping facilities to international standards for gold and other valuable objects;
• to maximise the value added to and export income derived from gold production through the development and marketing of things containing or relating to gold;
• to promote and develop markets for gold in Australia and elsewhere;

Those are our motives. We sell more gold and make more profit if the gold price is going up, that is our conflict of interest. We have been government owned for 114 years because gold mining employs a lot of voters, and thus our job is to do the above to keep the industry strong. We are also state government owned, not federal, so neither Australia’s federal government or central bank controls us or tells us what to do – we exist to benefit the state of Western Australia.

Unfortunately, the Perth Mint’s government ownership means we are public servants and thus cannot comment on policy matters or be critical of our own or other governments policies or actions – as public servants should not be using what are the public’s assets as a platform to advance their own political beliefs – and in the end holding gold as reserves and using it and other currency reserves to manage exchange rates and the economy is a policy decision, politics. This is why you don’t see us commenting on these matters or being involved in organisations like GATA. Indeed my personal blogging activities push this line somewhat and have on occasion caused angst internally.

You may legitimately be cynical about this, but as the only truly commercially focused West Australian government entity, with not one bureaucratic government appointment in the organisation, be assured that we are aware we would sell a hell of a lot more coins and bars if we were privately owned and could do and say the things Eric Sprott does, for example. We keenly feel that restriction on our ability to market gold (as there is a modest bonus if we exceed budget), but know it is not our role to advocate policy and thus we focus on adding value to Western Australian gold production.

As to the Depository, it is but one part of the Perth Mint and we make more money from our refining and coin/bar businesses, but it seems to attract attention. We offer three storage types:

Allocated – this is the real deal. As I said in an earlier comment, you can come in and look at your bars and if you want to be sure we aren't just doing a switch, scratch or write on them with a texta so you can tell if you get to see your exact bars back again. Few allocated services will allow you to do that.

Pool Allocated – this is the same as GoldMoney, a pile of bars backing client accounts with a published bar list.

Unallocated – this is our working inventory backing client accounts, 100% backed and not lent our, explained on our website here:

“Unlike other depositories, which are merely warehouses, The Perth Mint is a manufacturer of precious metal products and one of the world's largest refiners. Accordingly, the Mint has a substantial requirement for physical metal to support these operations.

To fund this work-in-progress inventory, the Mint traditionally borrowed metal from bullion banks, at cost. At the same time, there were investors storing metal with bullion banks and others, at cost.

The Mint realised that if it took deposits directly from investors, it could cut out the intermediary and create a win-win situation: the Mint wins by obtaining free funding for its inventory and investors win by getting free 100% backed storage.”

So our unallocated cuts out the bullion banks and denies them leasing revenue from us and storage fees from investors. Maybe you might now understand why I get confused when people think I’m part of “the cartel” especially since anyone bothering to read my blog, where I’ve covered fractional bullion banking, confiscation and manipulation for years, will see I’m far from an apologist.

Interview with Al Korelin on China

Forgot to mention that I did an interview with Al Korelin on the weekend chatting about China with Rick Rule. Goes for about 10 minutes and you can download it from here, segment 4.

While I'm posting, will mention this post from Miguel Perez-Santalla of Bullion Vault about Star Trek and gold - makes a good point about gold's enduring value:

"It just so happens that in this Star Trek episode which was aired November 11, 1989, the Ferengi, an aggressive profit centered alien culture show up at negotiations with a bag full of gold bricks. This episode to me expresses two things. First is that the writers for Star Trek believe that thousands of years into the future gold will have value. Secondly, that 24 years later after having aired the show gold still holds value."

More on bullion bank reserves, delta hedging and coat checking

Below is a response to FOFOA's seven part comment to me here on his Gold as a FOREX currency post.

 

FOFOA: “You can call the slack in the flow their "stock" if you want to, but if there's more flow coming in than going out, then the BBs will accumulate reserves. If there is more going out than coming in, then their reserves will decline.”

This statement makes it sound like BBs are benevolent entities that manage the difference in flow for the market. If investors do not want to buy (sell) unallocated, then the BB will not accumulate (divest) reserves. There is also a separate borrow/lend market, and again, the impact on a BB’s reserves is driven by client action, not the BB.

As you say, the unallocated account holders bear the burden of funding the BB’s reserves, from which it logically follows that BB accumulation/divestment of the “flow” is dependent on unallocated account holder willingness to hold unallocated (or futures etc).

FOFOA: “unallocated credits are not necessarily lent into existence such that the offsetting asset is automatically a promissory note from a borrow, especially ever since the price of gold started rising in 2001 and it no longer made much sense to borrow in an appreciating unit.”

Interesting comment. Certainly the miner hedging has declined over that period, hence the drop in lease rates. I would note that this comment contradicts the goldbug theory that CBs and BBs lend paper gold into existence to supress the price of gold.

FOFOA: “So around 32 LBMA bullion banks which maintain ounce-denominated books (the very definition of a bullion bank) have their reserves stored in the vaults of the 6 bullion banks which are both LBMA-recognized custodians and also the clearing members of the LBMA. Talk about pooling reserves!”

No, this does not follow at all. The non-clearing BBs only need to hold balances with clearing BBs sufficient to settle their net trading with other non-clearing BBs. No BB’s physical or paper (ie on-call liquid) reserves HAS to be held in London with a clearing BB.

The point of the non-clearing BBs is that they have competitive advantages and specialisations with certain client bases in different geographical areas and so deal worldwide and hold physical gold outside of London (as do the clearing BBs).

Loco swaps, for example, are a common transaction and can be settled without needing any clearing in London. For example, Soc Gen could have metal in a Swiss bonded warehouse but have a client in HK who wants to buy. They could call ANZ, whose strategic focus is the Asian region, and do a loco swap of COMEX gold for gold that ANZ holds in HK. EFPs perform a similar function on futures markets.

So non-clearing BBs could hold all their reserves in physical outside of London and only need run some unallocated balances with clearing BBs.

FOFOA: “Are Goldman Sachs' gold reserves, which are deposited at JP Morgan, physically allocated to GS or unallocated bookkeeping credits? The answer is that they are obviously unallocated credits. … Why would the reserves of 30+ non-custodial bullion banks be held in allocated storage in the 6 clearing members' vaults? They wouldn't, of course.”

I don’t see “obviously” and “wouldn’t, of course” as arguments. I don’t see you explaining why it is obvious. Non-clearing BBs could easily hold allocated with a BB if they have exceeded their credit exposure to that bank. While the limits these banks grant each other are large, and they have netting or set-off arrangements, there are still limits and those limits can be used up by other divisions of the bank. In such situations the bullion division of a bank may therefore have to resort to allocated, as I noted here.

FOFOA: “I'm sure you'll dismiss or at least dispute this notion as well, but just think about it. It makes perfect sense, even if it doesn't fit into your limited view of the gold market from your little corner that happens to be mostly physical.”

Very condescending: “limited view” and “little corner”. As they say, if you can dish it out: I’m sure you’ll dismiss the notion that it is not obvious that non-clearing BBs’ reserves are unallocated credits with clearing BBs, but if you think about it, it makes perfect sense, even if it doesn’t fit into your limited view of the gold market with no practical experience of working in the industry and sitting in your little blogging corner making theories up from behind a keyboard.

FOFOA: “They would be unallocated bank-to-bank credits much the same as domestic commercial bank reserves held at the Fed are unallocated dollar credits. … non-custodial bullion banks are essentially depositors or deposit holders at the 6 LBMA clearing banks just like commercial banks have a reserve account at the Fed.”

So I assume that your proof that non-clearing BBs’ reserves are unallocated credits with clearing BBs is that this is how fiat money works. The problem with the analogy is that Fed reserves system works because the banks know that there can never be a shortage of reserves – the Fed can just digitally print them. That does not hold in bullion banking, as you can’t print physical gold. I would suggest that this one significant difference means that bullion banking dynamics and institutional structures will be different to those of fiat banking.

My best guess is that bullion banking operates along free banking lines, which I have discussed with costata and Michael H on your blog here. I found it interesting that you never engaged in that discussion, or remember you ever considering the idea elsewhere. Maybe because free banking means the system self regulates the amount of paper gold and thus won’t blow up?

 

FOFOA: “the system as a whole could be much more thinly reserved since 84% of the banks' reserves are fractionally reserved on a different level, the LBMA interbank clearing tier, for which we have only very limited insight.”

So we have a limited insight into the LBMA interbank clearing tier, but “obvious” insight that the non-clearing BB’s must all hold their reserves as unallocated? To the extent that a BB holds unallocated with other BB’s instead of physical as reserves, then yes it is tiered and the overall fractionalisation is higher. However we have no idea of how much physical reserves clearing or non-clearing BBs hold.

FOFOA: “I don't think I've ever seen you give your explanation for the astonishing volume. I have, in the post above, but I've never heard what you think explains an average of 170 trades per bank, per day, each averaging almost a tonne per trade.”

I’m surprised you are surprised. Your post just said that paper gold traded in FOREX markets and had carry (and funny in a post about carry trades no mention of GOFO was made, which is the carry rate). What is the big deal, any online FX service lists XAU as a currency to trade, the fact that it has an ISO currency code, these two should tell you gold is part of the FX market. As to volume, I covered that in this 2009 post:

“the very fact that gold is no one’s liability and cannot be printed means it attracts a disproportionate amount of trading and speculation. Why is it assumed that 12.7% is excessive and unreasonable? Could not the 12.7% figure be proof of the special monetary nature of gold, proof that it is the King of Currencies?”

That post and the 12.7% turnover figure was pre-survey, which reported daily turnover of 5,400t a day. Latest GFMS figures have CB stocks at 29,597t and investors holding 34,820t. 5,400t by 64,417 stock gives 8.4%. If you said that half of that stock was long-term holders and thus not traded and should be excluded, it gives a turnover of say 17%. When compared to similar figures for fiat money it is not “astonishing” at all and is a great indicator of gold’s liquidity.

As to the number of trades per bank, well I do consider that astonishing - astonishingly low. Knowing how many trades we do with clearing BBs each day, there is no way that is actual number of trades given the number of counterparties the BB deal with at that top tier. There is some sort of aggregation going on in the LBMA survey to give such a low number. Just another reason I am no so quick to draw conclusions or extrapolations from that survey until I understand the methodology.

FOFOA: “such tremendous volume, especially if the BBs are, as Christian says, only leveraged 10:1?”

I am not sure I understand the link between turnover and fractional reserve ratio (which is what the 10:1 is referring to). You can have a 100% reserve system and still have many multiples of turnover. Leverage, yes, will increase turnover, but leverage and fractional reserve ratio are different things.

FOFOA: “what could possibly be offsetting their net exposure given that the volume is ten times higher than the gold futures markets (and 100 times higher than GLD's daily volume)? Physical?”

Again, I don’t get the link between turnover and net exposure. Anyone could buy and sell back the same ounce multiple times during a day and be left with no net exposure at the end of the day. The BBs could intermediate (make markets) between FX desk traders all day and have no exposure.

I would argue that the greater the leverage employed (and these FX platforms and contracts for difference market themselves on the leverage you can use) the less likely these speculators are to hold a position overnight. They add a lot of turnover and liquidity but at the end of the day do not add the sort of massive net positions you think they leave BBs with which require BBs to “delta hedge”.

FOFOA: “Do you even understand how the banks use these? Here's an email from FOREX Trader which I posted back in June of 2012 … The only answer I can think of is that they hedge it by going long correlated (but not identical) assets. What's correlated with paper gold? Silver, copper, euros, crude oil, interest rates, yield curve spreads, whatever.”

“I can think of” – sounds like he is guessing at what it is? If you read through FT Alphaville’s articles and associated links it is not clear that it is totally about using correlated assets. A lot of it is using derivatives of the underlying asset to synthesise the underlying asset’s performance.

It is easy for your FX trader to say “I made a quick delta-0.7 using some regression and eyeballing” and another thing to actual implement it for the sort of volumes you are talking about and sustain that without slippage/loss.

Indeed, as this Reuters article says: “traders say that much of what happens at "Delta One" desks -- the focus of the UBS loss -- and in other parts of the business is driven by banks betting their capital to make a profit in what is known as proprietary, or "prop," trading.” That is, Delta One desk are no more than speculative trading, gambling. No surprise that UBS’ and Soc Gen’s blew up.

FOFOA: “This is the age of complex derivatives, and to dismiss them being used in the "gold" market, especially given the incredible volume reported in the LBMA survey, simply because you don't see them being used in your little physical corner of the market, is simply silly.”

There you go again with the condescension. The Perth Mint may not deal in this sort of risky stuff, but we have deep contacts into the BB market. I’ve asked a BB dealing desk managers about this delta hedging in another context and it was laughed at. He said he had enough trouble getting his middle office (risk) to approve an offset of gold in different locos, let alone something as unstable as complex mix of unrelated but partly correlated assets. You believe your source (by the way, has he/she ever worked on a bullion desk) and I’ll believe mine.

FOFOA: “this coat-check room view since January of 2011, but I didn't come up with it. … But it is obviously the correct view if you give it proper consideration.”

Who cares the source, you’ve endorsed it and appropriated it as part of your view of the market. And again with the “obvious”, I mean I think what I’m saying is obvious but that line of argument doesn’t seem to persuade you for some reason.

As I said, I can see ETFs (any of them) being drawn upon via stock borrowing, but I dispute that a BB can park reserves in it.

FOFOA: “The coat-check room view only applies to GLD, and not to any other ETFs, gold or otherwise. It's not an ETF thing, it's only a GLD thing, because GLD is the LBMA's gold ETF. … because the LBMA is head and shoulders above all other gold selling organizations. And that's very simply why GLD is 10 times larger than other gold ETFs. Not because of marketing (PHYS arguably has better marketing), but because it's the LBMA's gold ETF, and the LBMA had that much gold to put into its ETF!”

What do you mean by “GLD is the LBMA’s gold ETF”. The WGC is the one who sponsored (funded) GLD and created it. The reason it is the biggest is because it was the first and the WGC had been marketing to institutions well in advance of its launch (indeed, some US and UK money was funnelled into the Australian gold ETF because GLD was delayed). It is crazy to say PHYS has better marketing, you have no idea of the machine that the WGC deployed at the institutional level to sell GLD.

And can we please not use “LBMA”. The LBMA does not have any gold, or run vaults or trade. Please be specific. Are you talking about all the BBs, or just the clearing BBs, or only a few of those?

FOFOA: “If someone wants to capture a GLD discount-to-NAV arbitrage opportunity, it suffices to buy GLD and sell spot unallocated (XAUUSD). Then you wait until the selling pressure in GLD has abated, and you square your position. No redemption necessary. GLD is so large that, even if institutional investors dump it, someone else, including the bullion banks, will take it instead of allocated if it is cheap enough. But why redeem?”

The BBs redeem because they have to pay 0.4% management fee on GLD when holding unallocated with a clearing BB cost them a lot less than that and if you have your own vault, the cost of storing the physical yourself is zero. In that case, why wouldn’t they redeem?

FOFOA: “It's one way a bullion bank could turn a dead asset (surplus reserves) into a live one. …”

You didn’t need to go to all that trouble with the T accounts, as steps 1-2 are what DP said and you have answered my question “so you're saying collectively the BBs went naked short 2000t of ETF gold” with a yes, but they delta hedge themselves, which is what I guessed in my response to DP. So the whole coatchecking IN thesis rests on delta hedging. Given I don’t think delta hedging is reasonable for that amount of gold and for the time period involved, we’ll just have to disagree.

Can you just clarify one thing – how much of GLD are you claiming came from excess reserves, that is, how much of it was delta hedged (at its peak)?

FOFOA: “Before GLD, there was a storage cost associated with sitting on excess reserves, but the banks had no choice but to eat that cost.”

As I said to DP, “the marginal cost to a bullion bank to hold physical reserves is zero (vaulting is primarily a fixed cost business), there was/is no pressing need to create ETF's to save costs by parking metal in an ETF structure.”

FOFOA: “now there was also an opportunity cost in addition to the storage cost of sitting on "excess" reserves.”

Not sure what you mean by opportunity cost. I’m guessing the fact that you can invest the excess cash from selling GLD shares less the lesser amount needed for that perfect delta hedge. Have you considered as well that under your theory the BBs didn’t need GLD to manage any excess reserves as they could have just delta hedged any client long positions rather than accumulating physical (and it is just as easy to borrow physical gold as it is to borrow GLD). GLD coatcheck in theory requires delta hedging, but once you believe in delta hedging you don’t need GLD coatcheck in theory.

FOFOA: “the LBMA could be using GLD shares in its internal clearing process, only redeeming them when the underlying physical is needed to restock the subterranean stream, that is, for physical allocation or delivery. No need to redeem simply for interbank clearing, just transfer the shares.”

No, the LPMCL Clearing software, AURUM, and the associated SWIFT metal instructions do not allow for equity transfers, it is a metal (ounce) system only.

FOFOA: “I realize that you're trying to be Bron-the-Debunker, superhero destroyer of precious metals charlatans and defender of rational analysis, but with this GLD drain issue, I sometimes wonder if you really can't see how irrational your physical arbitrage view appears, or if you're just sticking to your guns.”

It seems pretty irrational to me for you to stick to your guns about a complex coatcheck/GLD/delta hedging when there exists another Occam’s razor explanation: after 2008 gold developed a narrative among institutional investors that it was an uncertainty hedge, lots of money piled in, pushed gold price and ETF holdings up, the narrative changed now that everyone thinks the economy is getting better and the money (and gold) flew out.

FOFOA: “And yes, I did see your latest post asserting that PHYS redemptions might be due to an arbitrage opportunity rather than a general shift in preference toward physical.”

I said “It is a bit hard to say if it is arbitrage or just a holder(s) from long ago getting out” the latter being a shift in preference toward physical. So it could be either.

FOFOA: “PHYS lost what, a little over one tonne in the last 5 months? GLD has lost an average of 46 tonnes per month for the last 10 months. That's well over a third of its holdings in less than a year.”

What interests me, is if BBs are desperate for physical and failure the fractional reserve system is imminent as some claim, why are we not seeing much physical redemption from PHYS, especially when a BB is paid to do so?

FOFOA: “I must admit, I don't envy you gold sellers right now.”

Thankfully the Perth Mint doesn’t “sell” gold, so I don’t envy them either. Insurance/protect wealth reasons for buying gold are boring and don’t attract clicks but are evergreen. Those who went for clicks and dramatic headlines and tried to sell gold on other reasons now face a credibility problem.

FOFOA: “in general, what is your argument for buying physical gold right now?”

Because even “if you don't expect a financial, economic or currency crisis”, you can’t be 100% sure at this time. Nor can you know if Freegold is right. If either happen then you have some protection. If neither happen, then any loss was just your insurance premium.

FOFOA: “We can resume the survey discrepancy debate if you want.”

I’m just going to have to find the time to write it up in an appropriate way and send questions to the LBMA, that is the only way to resolve it.