Upcoming cardinal climax good for gold

I bookmarked this Seeking Alpha article from March this year Rare “Cardinal Climax” Planetary Alignment This Summer Puts Stocks at Risk, says Veteran Sky Watcher. To quote:

On August 1, give or take a week, we’ll have the most five-planet alignments in perhaps thousands of years. Known as the “Cardinal Climax,” this is the meanest, nastiest, most challenging and most transformational of any planetary phenomena in all of written history!

I looked at records going back to the 1800’s, and this is the most difficult alignment I found. When I was at a conference in Boston last month, someone said this was the most difficult alignment they have seen in the last "1,000 years." Another person told me this is the worst alignment in "10,000 years."

Worst cases include a nuclear accident. Nuclear war. Massive societal collapse. Maybe a pole flip, which can wipe out nearly everything.

One week "minus" 1st August is next week, so you have been warned :) Of course if this does eventuate I'm going to have to eat humble pie.

Chart Mysticism

It is always good to get different perspectives on the markets. Bruce Edwards has worked in the refining game for many years, currently with Sabin Metal Corp. As a way of keeping in touch with his former and current clients he has a web site where he posts his Chart Mysticism on the markets.

He has a chart at the bottom of the page called Gold Shares and Industry Ranking. Bruce explains it thus: "The chart is an index of Gold Mining Company Shares (upper line) and a 10 week moving average of their relative performance when compared with 98 other Dow Jones Industry Groups. I have been keeping this chart since 1993 and it has been excellent predictor of the future relative performance of gold and gold mining company shares. When the lower line is at the high end of its range everyone loves mining company shares and gold. When it is at the lower end of its range everyone hates the group. A long term investor should sell when the lower line is high and buy when it is low."

Coin & bar sizes

Below is a doc with actual (approximate) sizes of the Perth Mint's coins and bars. Consider that these coins and bars, which fit on an A3 page, are worth over $200,000. A great example of the "value density" of gold.

Perth Mint coin/bar sizes

Opening up gold's distribution channels

Nick from Sharelynx forwarded two announcements to me today, one on Sprott's new Silver fund and Japan’s first precious metal ETF (actually four of them) where the metal is stored in Japan. The Mitsubishi series name is "Fruit of Gold", gotta love that.

I have been tracking all of these ETFs as well as other publicly reported storage facilities (eg GoldMoney) since 1999. I gave this proprietary data to Nick to combine with his extensive data sources to create a unique time series of these products, which you can find here if you are a subscriber (and if you're not you should be otherwise you are operating in the dark re data on the precious metals markets).

I'm sure we will shortly have some article by the gold haters that the growth of these ETFs are another bubble top indicator. I disagree, and would answer by quoting from a strategic paper I wrote for the Mint's Board in 2001, which probably sounds a bit old hat now:

The demonetisation of gold led to an emphasis on gold as an investment and this was reinforced further with the development of the Krugerrand and subsequent coin programs. However, from this promising start, gold has failed to move with its financial competitors and has thus lost its "market share" of the average consumer’s investment dollar.

What occurred with other investments was a shift from physical to virtual. For example, consumers moved from cash to credit cards, from bank passbooks to account statements, from physical share certificates to electronic registration of holdings. Consumers clearly became comfortable with the virtual form of investments and the convenience they offered. In contrast, however, gold remained physical and therefore became relatively more difficult to purchase and hold.

The result of gold remaining physical was that fewer and fewer intermediaries were willing to offer it to their customers. The two key intermediaries – banks and brokers – stopped offering direct investment in gold because other investment classes, such as shares and mutual funds, were easier to sell. This shrinking of gold’s distribution channels (in some countries it is only available from coin dealers) is it considered to be a contributing factor in the marginalisation of gold as an investment class. Hence, it is not surprising that gold is no longer considered part of a consumer’s investment portfolio.

The arrival of the Internet is accelerating the move to virtual investment categories. Customers will expect to interact through the Internet, especially for "low touch" products such as shares, insurance, and gold bullion. Customers will also increasingly move their banking and investment management online. However, this move will still involve intermediaries, it is just that the intermediaries themselves will become virtual, mirroring the change that has occurred in the financial products they sell. For example, instead of telephoning their broker, investors will trade shares directly with ComSec or Charles Schwab.

If gold is to regain a position on the average investor’s portfolio it must be on the intermediary’s "product list". The response of the gold industry to the move to virtual forms of investment does not address this issue. Virtual gold is only available via direct-to-consumer models, such as Perth Mint Depository Services or online from businesses such as Kitco. However, this approach requires consumers to find and set-up an account directly with the business concerned. These services are also not suitable for use by key intermediaries such as banks and brokers. As a result, gold is not truly "online" as far as average investors are concerned – it needs to be one of a number of investment options available when consumers ring or log on to their broker.

To do this gold needs to be virtual, as shares are. The difficultly is that, unlike shares or mutual funds, gold is inherently physical – failure to insist on physical backing against customers’ holdings leads to the temptation to issue more "paper gold" and with infinite supply, the price and value of gold becomes meaningless. Physical backing is the key to marketing gold as safer than mere paper assets, as something with intrinsic value.

The listing of ETFs on stock exchanges in my view begins the process of legitimising gold as an investment class in the minds of the average investor. However it is a necessary but not sufficient step - a case still has to be made for gold, it still has to be promoted. But at least it is "on the shelf".

The other advantage of ETFs is that they bring transparency to what is an otherwise very opaque market. While ETFs only account for 6-7% of estimated privately held gold, this percentage will increase over time, giving greater insight into the mood of gold investors. Well possibly greater insight, depending on how well analysts read the entrails of changes in ETF holdings.

GLD contango strategy, or not?

A reader asked me to comment on A GLD contango strategy by Izabella Kaminska. It talks about Paulson & Co earning a return on its $3.4bn woth of GLD shares.

Holding GLD, meanwhile, is cheaper and more cost efficient than buying bullion outright.

I would note that most gold ETFs have management fees around 0.4%. Considering that Bullion Vault's storage fee is 0.12% and that Paulson would likely be able to get better rates than that from a bullion bank on $3.4bn worth of gold, it would be clear that GLD is not cheaper.

is it actually beginning to vacuum the world’s known gold supply float? Gold supplies, which previously, we might add, would have been put to work by central banks and bullion banks that owned them.

If you look at all ETFs and other storage services for which we have public numbers, together they only total 6.5% of all privately held gold. On top of that you can add the 30,000 or so tonnes of central bank gold. GLD is hardly vacuuming "known gold supply float".

Given the low costs associated with holding GLD versus pure bullion, as well as the permanent contango in the market — it is quite clear the asset lends itself favourably to the ever popular contango storage strategy

Because GLD is at least 4 times more expensive to hold than an allocated account for someone of Paulson's size, I'm not sure he could out arbitrage other players.

you buy GLD (perfect proxy for gold, but with no storage costs) you create a hedge by selling front month gold futures. You then lock in the spread further down the curve, and sit and collect the contango premium.

Firstly, GLD does have "storage costs", that is the 0.4% management fee. The problem with the strategy she proposes is that by selling a futures contract she has hedged the GLD long position. So while you may earn the contango, you won't make any money on the increase in the gold price because if the gold price increases, then you are losing on your short futures contract.

She has confused trading the basis (gap between spot and futures) with trading the price. You are either doing one or the other, but can't do both at the same time with the same capital.

My fustration with GATA

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Gold holds its value

On a recent trip to Sydney I visited the Reserve Bank of Australia's Museum of Australian Currency Notes. From the displays comes the following interesting information about prices in "the 1900's":

6 shillings a week for meat
16 shillings a week for groceries
25 shillings a week for rent
£250 for a Model T Ford
House equal to 10 times annual earnings
During war years average weekly earnings were £3

Given that there are 20 shillings in a pound and a pound is equal to a sovereign, which is equal to 0.2354 ounces, we can convert those prices at say AUD 1400 ounce into today's money:

$99 a week for meat
$264 a week for groceries
$412 a week for rent
$82,500 for a Model T Ford
$514,800 for a house

Of course this is a bit imprecise given the prices are as at "1900's" and wages are as at "war years", but it is a reasonable holding of value and certainly more than if one had just held on to paper money for a hundred years. See also this post on the same theme regarding the 1966 50c coin.

Debtors vs Creditors

Those interested in this issue, which I have covered in this and this post, will find FOFOA's latest post useful.

FOFOA agrees with Marx that "the history of all hitherto existing society is the history of class struggle" but says that he got the classes wrong:

The two classes are not the Labour and the Capital, the rich and the poor, the proletariat and the bourgeoisie, or the workers and the elite. The two classes are the Debtors and the Savers. "The soft money camp" and "the hard money camp". History reveals the story of these two groups, over and over and over again. Always one is in power, and always the other one desires the power.

What is the relevance of this to gold? FOFOA argues that:

... when the soft money guys are in power the transfer of wealth happens slowly and gradually, and wealth flows from the Savers to the Debtors. But when "soft money" collapses - and it ALWAYS collapses - there is a very RAPID transfer of wealth in the other direction, from the Debtors back to the Savers.

... By selling your debt-financed paper savings and buying physical gold today you are making the conscious CHOICE to join the camp of the true Savers.

Unfair coin ban for SMSFs

The Cooper Super System Review has been looking at the issue of collectables held in SMSFs and has a preliminary recommendation that:

a) the acquisition of collectables and personal use assets by SMSF trustees be prohibited;

b) SMSFs that own collectables or personal use assets be provided a transitional period,

up to 30 June 2020, in which to dispose of those assets; and

c) APRA‐regulated funds be exempted from these changes.

Their examples include paintings, jewellery, antiques, stamp collections, wine, exotic cars, golf club memberships, race horses and boats. The list is based on and makes reference to the ATO's definition of ‘collectables’ and ‘personal use assets’ and this definition includes “coins or medallions”.

The inclusion of coins, stamps and medallions and the requirement they be sold within 10 years has caused great concern within the numismatic community. It is the view of coin dealers that the market cannot absorb disposal of the volume of numismatic product held in SMSF over 10 years, resulting in a negative impact on market prices.

Now it is possible for a SMSF to “sell” their collection to the individual(s) who benefit from the SMSF, thereby avoiding any impact in the market. However this assumes that such individuals have the cash to pay their SMSF. In addition, the book sale would result in tax consequences for the SMSF.

I would note at this point that those who hold bullion coins through their SMSF should not have anything to worry about. The super review's reliance on the ATO's definitions for tax purposes means that bullion should be excluded due to the very clear difference the ATO makes between bullion and collectables for GST purposes in this ruling. I cannot see the super review going against this because it would result in the super treatment conflicting and disagreeing with the ATO's arguments around bullion/collectables, opening up all sorts of issues for the ATO. The primary problem would be that individual bullion items under $500 would not attract capital gains tax! I can't see the ATO letting that happen.

So on what basis has the super review determined that collectables are not a suitable investment? Initially they say that they believe “that there are certain types of assets that should not be regarded as investments that build retirement savings”.

Now this is contradicted by the fact that their recommendation excludes APRA regulated funds. If collectables were not good enough for SMSF to “build retirement savings” then logically they should also not be good enough for APRA regulated funds. The fact that they make this illogical statement indicates to me they are clutching at justifications for their position.

Later in their document they give the real reason: “The principal concern is that the cumulative regulatory and compliance complexities outweigh the potential benefits of allowing such a liberal investment menu to a sector that is not directly prudentially regulated.”

Now what this is really saying is that they suspect people are abusing the system but it is too much trouble to enforce compliance with the rules so lets just punish everyone and ban it all outright. But what really gets to me is that they are making this ban retrospective. They could have recommended disallowing further investment in collectables rather than forcing the liquidation of existing collections. There is no justice in retrospective law.

The fact is that it is bureaucrats who drafted the detailed legislation that allowed the loophole but instead of admitting their mistake and living with it, they want to perform a 1984 Orwellian expunging of collectable from SMSFs so they can pretend the whole thing never happened.

And the result? Forced sales that will depress prices and thus the value of those SMSFs. So much for helping people “build retirement savings”, Mr Cooper.

AIG Precious Metal Manipulator?

Further to this Zero Hedge post note the following from CPM Group's Mr Christian:

Bullion Banking Explained (dated Feb 2000):

Many banks use factor loadings of 5 to 10 for their gold and silver, meaning that they will loan or sell 5 to 10 times as much metal as they have either purchased or committed to buy. One dealer we know uses a leverage factor of 40. (Long Term Capital Management had a leverage factor of 100 when it nearly collapsed in 1998.)

So CPM Group knew of a 40:1 precious metals leveraged firm in 2000, who were they? Mr Christian tells us in his April 10 2010 interview with Jim Puplava of Financial Sense at the 44 minute mark:

AIG was not a bank, was not a commercial bank, and under the US laws non-commercial banks don't come under the law, the guidance of the office of the controller of the currency. AIG used a leverage factor of 40, so if people gave them a million ounces of gold to hold for them, they could lend out 40. I mean, I have friends who are metals traders who were looking for job years ago and, you know, they went to AIG and AIG said “we use a leverage factor of 40” and the trader is a seasoned guy and he's worked at major banks and investment banks, he said “I can't operate at that level of leverage its just too risky more me” and AIG trading said “well this is what we do”, right, so there is a loophole in our regulatory system, its doesn't really have anything to do with gold and silver per se but it allows non-banks to participate in banking activities in a way that skirts banking regulations that are designed to promote stability in the banking system.

Interesting that in 2000 CPM Group could publicly talk about “one dealer we know” having 40:1 leverage and it was not considered an issue (although he didn’t publicly mention is was via a "loophole") – sign of those times I suppose. Question is, has anything changed?