28 July 2014

205,000 or 205 tonnes of gold, why commas matter

Karen Hudes latest refers to "The UBS is holding 205,000 MT under the Global Debt Facility for the benefit of humankind" and she provides a link to a letter from UBS and associated gold certificates as proof of the figure.

The letter says that "... volume of 205,000 Metric Tons issued last June 15, 1977 is unrestricted for collateral ..."

Unfortunately, given that the letter and certificates are issued by UBS, a Swiss firm, and that Switzerland is one of the countries that uses commas as a decimal mark (thanks Wikipedia), then the "205,000" figure is actually referring to 205.000 tonnes.

205 tonnes is approximately $8,567,975,000.00 (or $8.5 billion, just in case anyone misinterprets the commas) and while that is a nice sum, I doubt it will be as helpful to "humankind" (a word I note excludes aliens/reptilian life forms) as $8,567,975,000,000 (or $8.5 trillion).

17 July 2014

How Eastern Gold Demand Is Transforming The Gold Market

GoldSilverWorlds has a good post up summarising my tweets and Al Korelin interview about the LBMA Forum in Singapore. Below are some additional notes I took which I didn't tweet or talk about.

Zhang Bing Nan of China Gold Association (view his slides here) when asked about the West to East flow gave what I think is a classic Chinese answer: the globe is round so what is East and what is West, which got a laugh. Other comments:
  • no matter who you lend your dollars to it is not safe; not the same with gold
  • fortunate we have different perspectives on gold (ie you Westerners want to sell while we want to buy)
  • gold in people’s hand makes them feel safe
  • Asians unlike westerners as don’t have same financial products hence they buy gold
From the Zhang slides I thought the comment that "improving the gold market and pushing forward the gold consumption and the “gold held by people” will play a important role in promoting the gold-content of RMB" shows that for China it isn't necessarily important how much gold they have in official reserves, it is about just increasing the total gold held in the country. Whether that indicates they have a contingency plan to confiscate privately held gold if the world moves back to a gold backed monetary system of some sort, or just that they see the country as more wealthy the more gold its people hold I think is an open question.

Note also that China's development of its gold market is not just about physical: "China is speeding up the legislative process of the gold market, actively developing the gold derivatives quoted in RMB". Zhang also made a point about the China Gold Association being a 5A class national social organization which "ranks the highest level assessed by China's Ministry of Civil Affairs and ranks the fifth in the 177 participating national social organizations", which shows how importantly the Government views the gold market.

While we are on China, I would recommend reading this post by Ben Hunt:

"A number of readers asked if China’s accumulation of physical gold played a significant role in China’s current and forthcoming challenges to the Western monetary policy status quo. Absolutely! It has exactly the same meaning as the recently announced dollar-free natural gas trade agreement with Russia. It’s a fang. It’s a claw. It’s a tool in the construction of an alternative monetary policy regime structure."

Hector Freitas of UBS said that their wealth management division saw clients selling gold for a couple of months post the April gold price crash but that these were opportunistic investors who were now in equities, rather than being longer term diversification holders. He said UBS was seeing demand to shift physical gold to the East for storage and noted that there was more wealth in the West than the East, so if the West begin to distrust currency or war or other events occurred than the West will dominate gold demand. In that situation I can't see the East selling it so not sure where the West will get it from.

Tony Reynard of Singapore Freeport was interesting, saying that they never intended to build the Freeport for gold storage and that it was planned for art but they were asked by the market if they could store gold. Of the 25,000m2 of vault space only 10% is for gold. He said that gold is not a good return for them as they lease space by the square foot and gold doesn’t take up much space (note that Freeport is just a landlord, they don’t operate the vaults themselves, so the money is made by the storage firms who have a fixed lease cost but change a % of value). Of most interest was the statement that they have been asked to build similar facilities around the world including Luxembourg, China, South Korea, Macau, Japan and that all of these were requiring precious metal vault capability, which he took as a sign that the operators see a market for precious metal storage. Related comment from Guy Bullen of Brinks was that they found it physically challenging to handle the 2013 volume of gold going into China.

Regarding the talk about new Asian price benchmarks in competition with the London Fix, I missed who made this comment but they said that whether a benchmark can compete or become established depends not just on its volume but also whether there a big enough premium/discount due to fundamental difference between the location and existing benchmark locations from a physical point of view. For example, if the cost of moving gold from an existing benchmark location like London and the new one is say only $0.20 per ounce, then the market will just continue to use London as a benchmark due to its liquidity and the new benchmark won't get volume. Liquidity will only move if there is a big enough difference.

On India, Rashesh Shah of Edelweiss said that Indians save approximately $500bn each year of which 10% goes into gold resulting in a $40-50bn flow of money into gold each year. One ongoing debate with pro market analysts is whether gold demand will hold up as China and India develop, the theory being that people are mostly buying gold due to a lack of trusted financial and insurance products and as those products become more widespread gold demand will reduce. Rashesh felt that as India's financial sector become more sophisticated Indians will still buy gold but there will be more willingness to buy gold in financial vehicles, so he thought it would be the same consumption of physical gold and the change would just be in how it was bought. He said that currently India’s interest in gold was due to a view that it was the best bet against inflation, was easy to invest in and was a cheap way of "exporting" capital (getting around capital controls) by getting exposure out of the Rupee.

Finally, Harriet Hunnable of CME Group made the following comment on a panel session which she shared with LME and Tocom (it turned into a bit of a competitive pitch between CME and LME for the silver fix):

"We are not keen on financially settled gold contracts, market wants integrity of a physically settled contract."

Only comment I will make is that there is a big difference in "integrityness" between a market with the option of physical settlement and where only a few percent of contracts physically settle (eg Comex) and one where you have to physically settle and there is a 10% penalty if you don't (eg the new SGX kilobar contract).

16 July 2014

Indian monsoon & 12.5% interest gold loans

I have a short post up on the corporate blog on the current state of the Indian monsoon, which matters because poor agrarian Indian farmers are purported to buy over 60% of Indian gold. If monsoon rains are good they buy gold, if not they sell some to buy next year’s crop.

While writing this article came up which is mildly negative for Indian gold demand (as it is only talking 80 tonnes) as it seems the jewellery industry is going to be further crimped by a new rule limiting their gold deposit schemes (ie people lend gold to jewellers to fund their business) to 25% of their assets. The really interesting thing is that the new law also prevents the jewellers from paying more than 12.5 per cent annual returns on those gold loans! Talk about using gold as money. I suppose they have to pay those rates due to the risk of them running off with the gold or going bankrupt.

Just wait to Wall Street finds out about these yields - beats current junk bond rates. With investors desperate for yields in ZIRP environment will we see Wall Street selling Indian Jeweller bonds at 10% (yep 10%, where do you think those bankers bonus come from)?

15 July 2014

GLD amendment refers to "unforeseen reasons" for unallocated failure

GLD has some amendments to its terms up for vote, one of which is "that creations may only be made after the required gold deposit has been allocated to the Trust Allocated Account from the Trust Unallocated Account" (hat tip I Shrugged; see here for an explanation of the existing creation process). What is interesting is the explanation of why they are making this amendment:

"This amendment provides additional security for Shareholders by eliminating potential risks related to issuing baskets of Shares against unallocated gold if the Custodian was to become insolvent or if the unallocated gold was otherwise not allocated for some other unforeseen reason."

My emphasis on the bold bid. The risk they are referring to here is because the Authorised Participants only deliver unallocated to the Custodian and it is up to the Custodian to find the physical to allocate. This puts all the pressure on the Custodian. The amendment does raise the following questions:
  • Why the need to clarify this now, is there something the World Gold Council (who sponsors GLD) knows about the state of the market that didn't exist before?
  • Why would unallocated gold now have a risk of not being allocated?
  • Is there an increased risk of intra-day failures for large unallocated allocations?
  • What are these unforeseen reasons?
  • And why are none of the more excitable gold commentators hyping this up as more proof of the end of the London bullion banking system? :)(Probably because they didn't get the letter as they are smart enough not to hold GLD, which has numerous other issues which only make it suitable for short term trading IMO).
I don't think this is a case of the WGC responding to public criticism, as I haven't seen any commentary on this detail/technical matter of ETF operation. Maybe they just thought they would close up this risk point while they were making changes to the management fee revenue. However, that would beg the question of when did they become aware of the "potential risks" in the creation process and why didn't they fix it earlier?

At this point I would just note it as a data point, rather than a sign of "an imminent LBMA default", which was first predicted by one commentator in April 2013, which, even by the lax standards of internet accountability, is a fail (don't shoot the messenger, but clearly the fractional reserve bullion banking system is more robust than many give it credit for).

For the Perth Mint at the moment wholesale and retail demand are weak at best. Kilobar demand was so low we were considering shipping gold TO London but there has been a little pick up in kilobar interest this week. The recent GLD additions are positive but other ETFs have had liquidations so this indicator is unclear. All considered I don't see this as a situation where London is under pressure.

The other amendment to GLD is a rejig of who pays its costs and gets its management fee. Currently the Trustee pays (by selling gold behind the ETF):
  • Sponsor (ie WGC): 0.15%
  • Marketing Agent: 0.15% 
  • Custodian: approximately 0.066%
  • Administration Fees: approximately 0.03% to 0.04%
  • Trustee: $2 million
The proposal is that the WGC will take on all costs and only charge the Trust 0.40%. It just formalises the existing "Fee Reduction Agreement" by which the WGC was absorbing any costs above 0.40% so that GLD holders only paid 0.40%.

I can't see any material change here. Possibly the WGC feels they may be able to control or reduce costs better now that GLD is established and hence it sees an opportunity to make a bit more profit out of GLD beyond the current arrangement, as noted in the amendment letter "the net amount earned by the Sponsor could be greater or smaller than the fee of 0.15% of the daily ANAV of the Trust it currently earns, depending on the actual expenses of the Trust."

Coincidental this happens when two large South African miners (Gold Fields and AngloGold Ashanti) dropped out of the WGC and thus the WGC lost a big revenue source? While that announcement happened after the amendment letter, the WGC would have know about this move by the miners for some time. Just another move towards the WGC becoming more self funded.

11 July 2014

No Indian gold import policy change explains RBI gold swap

After a lot of speculation about what changes the 2014 Indian budget would bring for gold import policies, we got zip. That now supports my speculation on why the Reserve Bank of India (RBI) announced, ahead of the budget, a combined quality and loco swap of its gold: it was a temporary political fix to the problem of:

1. Making promises to the gold industry during the election campaign that it would wind back gold import restrictions.
2. Reality, once in office, that such relief on gold imports would negatively affect India's current account deficit.

Standard political MO: "Oh, it is a lot worse than we thought, we can't honour our promises, it is the previous Government's fault". Interestingly, on the eve of the budget the Indian gold industry hadn't read the warning signs and thought there would be relief, with Bachhraj Bamalwa, of All India Gems and Jewellery Trade Federation, speculating that the duty would be cut to 6% and even that "the government might remove the 80:20 rule in a gradual, 'phased' manner". This view was probably helped along by statements from the Government like "any action on gold should take into account the interests of the public and traders, not just economics and policy". Well it is clear they sided with economics and policy.

There were some warning signs, with this Reuters article quoting commentators noting that the Government was "moving back and dithering on their decisions, and in a sense playing politics". Another sign was this Report that "India risks losing its investment-grade sovereign rating if it fails to get its finances into shape" with S&P warning "there was a one-third chance of a downgrade [of India] to "junk" without a big improvement in the fiscal deficit and in implementing reforms."

For me, the strongest sign the new Indian government was going to back away from its promises was the RBI gold swap announcement and the local gold industry should have paid more attention to it, because its timing was very unusual: just before the election about gold which had been sitting in RBI's vaults in India for decades. Why was this non-standard gold suddenly an issue?

I think it is a reasonable speculation that the RBI knew in advance that the new Government could not open up the import restrictions and have a flood of gold imports affecting the current account deficit and the country's rating. This gold swap was then a planned action to placate the industry by releasing supply into the local market in a way that would not affect the current account deficit.

The RBI is aware of the local gold supply issues, have loosened the 80:20 rule a little in March by allowing some banks without three years worth of exports to import gold, but only on the basis that they had current customers to export gold to (see this Reuters article).

Sidebar: the clear message from the Indian session at the recent Singapore Gold Forum was that it was the 80:20 rule that halted gold imports and not the duty hikes. On that basis I was expecting some duty cut as that would have made it look like the Government had done something while not making any difference to how much gold could be imported.

So how does this gold swap work and not impact the current account deficit? Firstly, a swap involves two legs, as explained here, in this case being:

1. Sell non-LBMA standard gold loco India
2. Buy LBMA standard gold loco UK

No doubt the RBI had some interest in upgrading its non-standard gold (as it makes it easier in the future to mobilise it in a financial crisis, like it did in 1991) but it could have just sent it to a local refinery. However, this would not have had any impact on local supplies as the gold would have just went straight back into the RBI's vault.

The key is that the swap results in a net supply of gold into the local Indian market, but the replacement gold is supplied from London (or Switzerland, as we will see shortly). The net supply in India will result in a reduction of the local premium (which the public will welcome) but more importantly, it will give the local gold industry material to work with (of which they are starved) and this should increase employment. The reason this swap will not affect the current account deficit is because the cash legs of a swap are netted, so the RBI will only be paying a few dollars per ounce out of its offshore USD reserves.

Regarding the swap, I had a debate with twitter based precious metals analyst Silver Watchdog who thinks the RBI swap would also involve leasing. I see this as unnecessarily complex, which his diagram indicates. The leasing angle only makes sense if you believe that there is a shortage of gold in London (as the second leg of the swap pulls physical out of the London market), so only if the RBI subsequently leases their newly acquired London gold will this take pressure off the London market. Apart from there being no indication that the RBI was intending to do this, Perth Mint does not see any such shortages in London at this time.

I would note here that while bullion banks will probably quote on this swap, the advantage is with the refiners given the quality upgrade required. The one in the box seat is the local Indian refinery PAMP-MMTC who, through PAMP's parent MKS, is capable without bullion bank help to do "options, hedging and EFP’s; location, purity and quality swaps; forward leasing arrangements". PAMP would have no problem refining the gold locally and supplying 400oz bars into London out of its Switzerland operations.

While India has 557 tonnes of gold reserves, there is no indication of how much non-standard gold they hold or are looking to swap. This Reuters article notes that the RBI "would decide further in regard to quantity, swap-ratio [i.e. swap fee], timing etc. of the gold to be swapped". The reference to "timing" implies that the RBI is looking to supply their gold over a period of time, which would make sense if you want to alleviate local gold industry supply problems and help them out for as long as possible.

Whatever amount is involved it will only last for a limited time, in the order of months, not years, given India's appetite for gold. So this is just a short term fix to a political problem and ultimately shortages will resume due to the 80:20 rule.

Of course, it is entirely possible that the RBI's swap is solely about upgrading its gold reserves and the timing is purely coincidental. That would clearly be the case if the replacement gold was going back into the RBI's vaults in India, rather than with the Bank of England as reported by Reuters. However, as we are dealing with central banks, where transparency even on simple matters is rare to come by, we just don't know what the real motivation is and thus have to resort to speculation. I hope you got some value, in terms of how the industry works, out of my speculations even if they turn out to be wrong.