19 December 2008

Warning on the existing Au and new Ag, Pt & Pd ASX listed ETFs

ETF securities, the issuer of the existing GOLD product on ASX, will shortly issue three more ETFs for silver, platinum and palladium. The prospectus (which also covers the existing GOLD product) has some alarming "features" I thought needed highlighting, and not just because GOLD is a competitor to the Perth Mint's gold warrant, ZAUWBA.

These are the facts, make up your own mind as to whether you consider these products suitable for long term holding or just short term speculating.

1.9 Transaction Documents. The documents which, in addition to this Prospectus, set out the terms and conditions relating to the Metal Securities and the holding of the Bullion comprise: The Constitution of the Company; The Trust Deed; The Custodian Agreements; The Service Agreement; and The Metal Sale Counterparty Agreement.

Comment: as with the US ETFs, you have a lot of counterparties involved that can in the case of a problem, all blame each other. You have to also read all these documents to fully understand the structure and therefore the risks involved.

2.2 Metal Entitlement. The ETFS Physical Gold securities (previously called Gold Bullion Securities) started in early 2003 with an initial Metal Entitlement of 0.10 fine troy ounces. The entitlement currently declines each day at a rate of 40 basis points per annum and will be 0.098118356 fine troy ounces as at 1 January 2009.

Comment: this is how all the ETFs work, except the Mint's warrant. Not so much a risk as an annoying aspect you have to keep in mind when looking at the ETFs price on the ASX and then divide by that (monthly) changing entitlement to work out the actual price per ounce your paying or receiving.

2.2.1 Management Fee. The fee is 0.39% for gold and 0.49% for silver.

Comment: the ZAUWBA product's management fee is 0.15%, why pay more?

2.4.3 Redemptions. A Holder may elect payment on Redemption to be in metal (the Metal Delivery Method) or cash (the Metal Sale Method) but may only elect the former if they have an unallocated metal account with a bullion dealer in London, who is a member of the LBMA or LPPM, to which such metal is to be transferred.

Comment: I don't know about you, but I don't have a London metals account and good luck trying to get one as an individual. Even if you can, you only get metal in London. This effectively means you can't redeem this product for physical. You can redeem ZAUWBA for any Perth Mint coin or bar, in Australia.

3.1 Where is the Metal? All gold and silver will be held by the Custodian at its London vault premises. ... The Custodian will be responsible for the transportation, handling and any costs associated with moving Bullion to or from its London vault premises and between any vaults of sub-custodians. As at the date of this Prospectus the Sub-Custodians directly appointed by the Custodian are the Bank of England, The Bank of Nova Scotia (ScotiaMocatta), Deutsche Bank AG, JPMorgan Chase Bank, N.A., UBS AG, Barclays Bank PLC, Johnson Matthey plc, Brink's Global Services Inc. and ViaMat International.

Comment: That's a lot of people holding your gold and silver, providing lots of finger pointing opportunities if things go bad.

3.2 Storage and Insurance of Metal. The Custodian (or one of its affiliates) may make such insurance arrangements from time to time in connection with its custodial obligations with respect to Bullion held in allocated form as it considers appropriate. The Custodian has no obligation to insure such Bullion against loss, theft or damage and the Issuer does not intend to insure against such risks. In addition, the Trustee is not responsible for ensuring that adequate insurance arrangements have been made, or for insuring the Bullion held in the Metal Accounts, and shall not be required to make any enquiry regarding such matters.

and

5.5 Custody and Insurance. Accordingly, there is a risk that some or all of the Bullion could be lost, stolen or damaged and the Issuer would not be able to satisfy its obligations in respect of the Metal Securities.

Comment: I find this an incredible statement. The custodian does not have to insure it, we don't intend to insure it and the trustee is not responsible for ensuring it is insured. What sort of custodianship is this? What a great business - give me your gold and if it gets stolen, that's your problem, just trust me I'm doing a good job.

5.6 Early Redemption of Metal Securities. The Company may, at any time, upon not less than 30 days’ notice by an announcement through the CAP to the Holders, redeem all Metal Securities of a particular type.

Comment: Now I don't think anyone would expect that an issuer of a product must be duty bound to continue to offer the product or service forever and ever. But 30 days, that's not much time for the investor to get out in an orderly manner. You may be forced to take a capital profit or loss when it does not suit you. Note also you must take cash, unless you have a London metal account.

Compare that to the "escape" clause that the Perth Mint put into ZAUWBA, which can only come into effect if we hold less than 100,000oz in the warrant and we have to give 6 month's notice (clause 12.1(e)). At least you have some time to arrange physical collection or sell at a price advantageous to you. Why couldn't ETF Securities offer the same sort of breathing space.

18 December 2008

London Banker and Speculators

I have been following the London Banker blog for a few months. He is reposting some older comments he did on another site and in his
Famine Futures: Deregulated Markets and Food Insecurity I found this reference by him to a Bloomberg new article in April 08 of interest:

The divergence between CBOT futures and the underlying commodity is so great that some grain merchants have stopped bidding for new crops, said Niemeyer, a member of the National Corn Growers Association board. Others won't guarantee a price for more than 60 days. ''We have a fundamental problem with the markets,'' said Kevin McNew, president of researcher Cash Grain Bids Inc. in Bozeman, Mont., and a former Montana State University economist. ''It is very difficult to operate a grain business when the cash prices are below the futures'' by such a wide margin, he said. The price gap should converge when futures contracts expire and deliveries are settled. Instead, the average premium for CBOT wheat has quadrupled in two years to 40 cents a bushel, compared with 10 cents the prior five years, McNew said. For James McReynolds, who farms 2,000 acres of wheat outside Woodston, Kan., futures aren't worth the risk. ''The differential of what the market should be and what you can actually sell is so far out of line that you aren't willing to do it,'' McReynolds said. ''This is a tough situation. Agriculture is not as healthy as we'd like to think it is.''

London Bankers also notes: Mr Frankfurter reviews the history of “securitized commodity products” and the development of commodities as speculative investments, distinct from their role in production and consumption within the economy. He suggests that something “systemic and possibly more insidious” has altered the benign role of speculators as providers of market liquidity and ties this change to the ill transparency of OTC derivatives arising from The Enron Loophole.

This is also what is happening to gold. This is not to deny any possibility of central bank intervention/manipulation, but just to acknowledge that speculators are also a factor. As a result, I see the spike in gold to $1000 as an aberration, a false dawn. The chart below (from my 29 Oct 08 post) shows that the $1000 run up was way off the multi-year base trend from 2001. Where gold is now is probably where is should have been all along, if not lower. In any case such trend analysis is now mostly redundant as we are in a new investment paradigm - wealth protection, not wealth accumulation - and the scale of this credit crisis means we have no real history to work from. A brave new world for gold.

16 December 2008

Perth Mint to Resume Taking Bullion Coin Orders

11 December 2008 Media Release

The Perth Mint has announced that it will resume taking orders for a popular range of gold and silver bullion coins from 12 January 2009.

The announcement follows an earlier Perth Mint communication advising clients that as a result of unprecedented worldwide demand, it had been forced to close its new order book for gold and silver bullion coins, except its 1oz Kangaroo gold bullion coin. Orders for popular numismatic products and Depository/Certificate products were, and continue to be, unaffected.

Due to its reputation and extensive connections in the bullion market, the Western Australian State-owned Mint continues to have no problem sourcing wholesale gold and silver. The decision to temporarily suspend taking new orders for gold and silver bullion coins was purely a result of the 100 per cent utilisation of its production capacity.

As of 12 January, the Mint will be resuming orders for a streamlined range of 1oz and 1kg Australian Koala, Australian Kookaburra and Australian Lunar silver bullion coins, as well as 1oz Lunar gold bullion coins.

By limiting the range to these coins and the 1oz Kangaroo gold bullion coin, the Mint expects to be able to increase production volumes from existing production capacity.

Where dealer demand continues to outstrip product availability, coins will be subject to an allocation process.

The availability of fractional and other size variations from its bullion coin range will be subject to ongoing review.

The Perth Mint is committed to supplying its customers with as much product as possible and continues to make every effort to satisfy its dealer and customer requirements.

15 December 2008

Gold isn't in backwardation, the USD is in contango

A lot of confusion on gold going into backwardation. I wrote about this in October in this blog where a commentator got confused. Recent articles by Professor Fekete have spawned more confused comments, see Brad Zigler's article for an example (and also my comments to it).

People get all confused about it because they aren't thinking of gold as money. What was the Yen carry trade? Borrow JPY at bugger all, do an FX to sell JPY-buy USD and invest the USD at a higher rate and pocket the difference in interest rates but have exposure to the FX rate. Interest rate differentials exists for all currencies and they are not arbitraged away because there is risk to the change in the FX rate, the FX rate being the "price" of that currency in terms of another. An alternative way I look at it is that differences in interest rates exists because of the markets assessment of the risk of one currency inflating or deflating relative to the other, wiping out the profit from the interest rate differential.

Lets assume USD rates of 2%, AUD rates of 4% and an exchange rate of 0.65.

1. You borrow USD 650 at 2%, which means you have to pay back USD 663 in 1 year.
2. You sell USD 650 / buy AUD 1000 at 0.65 now.
3. You lend AUD 1000 at 4%, which results in AUD 1040 in 1 year.
4. If the FX rate doesn't change, you then sell AUD 1040 one year later for USD 676.
5. Repay USD 663, leaving profit of USD 13.

If you ask a bank for a 1 year forward AUD/USD FX rate, they do steps 1 to 3 and then calculate

4. In one year's time you will have AUD 1040 but owe USD 663, so the FX rate that this equates to is 0.6375.

Now there is nothing stopping you from borrowing AUD at 4% and selling it for USD to invest at 2%, but as you are negative cash flow you really need a big move in the FX rate to come out ahead. This means that the lower interest rate currency tends to have more borrow and sell pressure on it because the higher interest rates of the other currency mean you have a bit of a "buffer" if the FX rate moves against you.

Anyway, just think of gold as a currency (ie money) and the lease rate as the interest rate on gold(money). Therefore, one can borrow gold at lease rate, sell it and invest cash at LIBOR. Therefore the difference in these two interest rates is your profit, assuming no change in the gold/USD FX rate (ie the USD gold price).

For 1 Dec 08 for 1 month at LBMA:

Lease Rate = Gold Interest Rate = 1.69875
LIBOR = USD Interest Rate = 1.91125
GOFO = 0.21250

All this tells me is that there is a slight advantage to borrow and sell gold for USD, but the small advantage does not seem to outweigh the risk of the gold/USD price moving against you (ie up). If gold interest rates go higher than USD rate then what? Well to me this "backwardation" as it is called, just means that there is a slight advantage to borrow and sell USD for gold, as long as you don't expect the gold price to drop.

Probably worth noting here that as at 1 Dec you could have borrowed gold at 1.7% and sold it for AUD, investing the AUD cash at 4.25%. So this means that while USD gold may be toying with backwardation, AUD gold is firmly in contango.

Now interest rates for currencies change all the time and go above and below each other all the time. When that happens it is noteworthy but not exclaimed as extraordinary. Why is it different for gold? Well in my AUD/USD example we are talking about fiat currencies.

In the USD vs gold situation, however, we are not talking about "equal" currencies - one cannot be created, the other can. Think about it, in regards to my earlier comment that "differences in interest rates exists because of the markets assessment of the risk of one currency inflating or deflating relative to the other."

We are so used to talking of 1oz = xxx dollars when it should really be $1 = xxx ounces. Then you see that gold hasn't went into backwardation, but that USD has went into contango. Ouch, my brain hurts, but that is to be expected as we move into a world where you price things in ounces, not dollars.

07 December 2008

The Mint has no gold, again.

Another addition to the ultracrepidarian files. See this Kitco forum topic about the Mint raising yet again that you can't trust the Mint's unallocated. My reply below:

In the latest annual report on their website it states a figure of AUD 1.387 billion worth of metal in its Depository/Certificate programs (note 26b on page 38). There is no split between gold and silver.

Silverthorn is correct about not going broke, minting has to be one of the few counter-cyclical industries (which is why I am happy working there), although to be correct it is not the Mint you have to worry about going broke but the West Australian government, as the Mint is owned and guaranteed by the government.

As for the naysayers, the issue is not the profitability of the Mint or solvency of the government but the belief that the Mint does not have the metal to back its liabilities. What they say is that the Mint takes your money and doesn't buy the metal. It then has ounce denominated liabilities that in dollar terms could increase dramatically if metal price went up but only have a fixed dollar amount in cash against that increasing liability. Then when clients come to sell or collect metal, the Mint will not have enough cash to pay out at the then higher market prices or have the metal for collection.

Now even the Mint's biggest critics would admit that it and AGR Matthey (where a fair amount of the metal is held) must have some physical metal lying around. Considering that Australia produces 250 tonnes a year and all of that goes through AGR Matthey and the Mint made 8.1 million blanks (page 14 of annual report, this number includes blanks used by the Mint for its own coins), I think a conservative case can be made that there must be $387 million worth of metal at least. So according to the naysayers there would be $1b exposure. But the accusation is that the Mint got money for this but did not buy the metal, so how much cash would it have?

If you look at past annual reports you'll see that most of the Depository's growth occurred in the past few years. So lets assume that the average buy in price has been AUD 500 per ounce, or half of the current price. This would mean that the Mint would have half of the $1b exposure in cash, or $500m.

So if the gold price doubles (which I think most would be happy with), then the $1b turns into $2b exposure with only $500m in cash so the Mint will out of the money by AUD 1.5b. This is a big number but in my opinion not enough to break the West Australian government considering it has the power to tax. For example, if it decided to levy a 0.5% royalty on gold for 5 years that would give 250t x 32015oz/t x $2000/oz x 0.5% x 5 = $400 million.

Anyway, the question is why would the government do it? The only benefit they would get is not having to borrow $500m, because they use the $500m that Depository investors gave the Mint instead of buying gold. At an interest rate of 6% that means that the government saved a huge $30m. Compare that to the government's budgeted expenses of approx $18b.

So the naysayers think that it is reasonable that the government would think it is a good idea to risk $1.5b to save $30m a year, so their expenses can be reduced from $1800m to $1770m? Oh, yes and since we have just had a change of government, the new premier and cabinet would also agree that it is smart to continue to carry a $500m shortfall (which could become a $1.5b shortfall) to save $30m a year instead of taking the hit and revealing it, which would do so much damage their political opponents that they would be guaranteed the next couple of election wins?

OK, so I think most people would agree that you would have to be taking drugs to think that the above is a likely scenario. So that then leaves the explanation that the Mint’s management is hiding this from government. Why would they do this? Well the only plausible motivation is money, or in other words boost profits so you get paid a big bonus. But then if you look at the past annual reports you don’t see any huge $30m profits and if you look at page 39 (the page all the staff check out each year) you’ll see that one director earns between $390-400k, which is the CEO (as he is also a director). Last year it was $370-380k, so no massive bonus. So do you think it is reasonable that the CEO would allow a $500m exposure for no personal benefit?

So then the last explanation must be that the CEO and a few others have fraudulently siphoned off the $30m a year. But for this to be true you then have to believe that 4 different auditing teams (the internal and external auditors of both the Mint and AGR Matthey) are either 1) so incompetent that they could not find a $500m hole in the accounts or 2) that they are all part of the fraud and have been paid off. Oh, yes and this would include the Auditor General of the government and that this has been going on for a number of years and continued through the rotation of those 4 auditing teams during that time and of course the cooperation of the accounting staff and CFOs of both organisations and that not one of any of those persons involved would whistleblow any of it.

Does any of that sound reasonable or likely to you?


In response to that, vespuce asked:

On your post I would counter the following:

1) Assume liability of $1bn, fine, but we don't know how much of that is silver, or how high the price could spike. You suggest a doubling of price, wheres the risk is far greater. Let's say 80% silver, 20% gold, and the dollar collapses - silver could quickly move to over $100/oz. PM would be underwater by $7.6bn on just the silver. The point is, perths (or anyone elses) unhedged exposure is infinite in fiat terms.

The rest of the points may be not be relevant, because I think you started with a false premise (ie the potential exposure).

2) Why would government try to save just 6% on $500m (with unlimited exposure) when they have $18bn budget? I say why wouldn't they. First we know they are not rational and efficient institutions. And more importantly it would be another $500m channelled away from the physical gold and silver markets.

3) You say the incumbent governemnt would spill the beans on any discovery of the unhedged exposure? I dont accept this for one second. Most would be oblivious. There are much bigger dirty secrets going on. I really wouldn't underestimate governments ignorance, stupidity or ability to deceive.

4) Reliance on auditors? Two words, Aurther Anderson.


My reply to that was:

vespuce, thanks for the counter arguments, best way to work out all the angles and test one's case.

I only assumed a doubling to be conservative. You are correct, the exposure in infinite, but would this not make it only more ludicrous that anyone would take on such an exposure to only save $30m in interest? The bigger you assume the exposure, the more unrealistic that anyone would do it.

As inefficient and incompetent governments can be, I still don't think they would take on such a risk for such a small return. You sort of implicitly acknowledge this by raising the "more important" reason of suppressing the price.

Firstly, lets assume that all of the $500m is gold. At $500/oz (ie average price clients "think" the Mint bought metal for them), that is only 31t over say 3 years or 10t a year that has been "channelled away" from a market where total world production is 2500t. If you compare that to trading volumes it is even more pathetic. 10t a year is not going to move the price, so why do it?

Secondly, the Mint is not the Reserve Bank of Australia or controlled by the Federal Government, who are the ones in charge of fiat currencies and therefore interested in managing currencies (one of which IMO is gold and silver). The Mint is owned by the West Australian government, and West Australia has a big gold mining industry and these people vote, so why try to depress the price which will only make people unemployed and hurt royalty revenues as well

As to your third point, I can't really say much except that they aren't as ignorant or stupid as you believe. It is somewhat of a trite statement. I have met the officials from the Auditor General and also the three Government representatives we have had on the Board (they are appointed by the Government to keep and eye on us) and they are intelligent and honest people. For example, John Langoulant, who was on the Mint's Board for many years while he was WA's Under Treasurer, recently resigned as CEO of the WA Chamber of Commerce and Industry to become CEO of media mogul Kerry Stokes' Australian Capital Equity. Kerry Stokes is one of Australia's top 10 richest persons and circa #700 in the world. You think Kerry is going to employ someone "ignorant and stupid"?

Auditors - again I would assert that this is a trite statement. Usually auditor scandals relate to suspect interpretations or valuations of unclear financial instruments or other activities. What we are talking about here is a very simple fraud. If you look at page 21 of the Mint's annual report you will see that it says there is $751m of precious metal INVENTORY and $1,080m of leases to AGR held as INVENTORY. I would put to you that the word "inventory" is not subject to much interpretation for an auditor. If the Mint kept $500m in cash and didn't buy the metal then I would argue that it is highly unlikely that an auditor would be that incompetent that they could be deceived that there was $1831m of inventory instead of only $387m and not find traces of the $500m in cash we received instead of only the $23m in cash reported in the annual report. I suppose then that our bankers Westpac and JP Morgan (OK I suppose they would be in on any scam as no goldbug trusts them ) were in cahoots to divert the cash from the auditors.

Furthermore, the auditing teams have at least rotated once, so I think that would cover most of the top tier firms. One or two stupid or corrupt auditors, I suppose, but all of them, over many years?

This really then leaves incompetence or conspiracy by all these people:

1. Two internal auditing teams of say 4 people each rotated once - 16 people
2. Two external auditing teams of say 5 people each rotated once - 20 people
3. CEO, CFO, group accountant, finance manager, accountant and settlements person in each organisation to dodge the books - 12 people
4. Me and Treasurer and similar executives at AGR - 4 people
5. You would need at least three people at the two banks to pull off the misdirection of $500m and probably more, but lets say 6 people
6. Board Directors of both organisations, with changes over 3 years, say 20 people
7. Auditor General and one other official - 2 people
8. Minister and Premier - 2 people

Now I'll be generous and say that you don't need all of these to be involved in the conspiracy, but then you need those that aren't to be incompetent. So 82 people all up and for what? To save $30m in interest and take 10t of demand off the market per year.

I just don't consider any of that realistic. It can only make sense if there is something to be gained and that gain is worth the risk. Do you think a criminal will steal a 30 year of car in front of a police station or a new car in a back alley? $30m and 10t a year is like a 30 year old car in terms of the (non) impact it would have, so why do it?


The focus of the above comments are on the idea that the Mint's unallocated is a scam. I should point out that by doing so I'm not trying to convince anyone that storing with someone else is the only way to go. I understand all the reasons for self storage and if that is what you feel safer with, then great. But there are other people to whom the risks of self storage are perceived as higher than trusting someone else with it. The Mint doesn't really care one way or another whether you like the storage or not because we sell both storage and physical bullion (and are flat out doing so right now), we can make money no matter what view you hold.

When people attack the Mint, it is worth asking if they are a competitor of the Mint. I have found that usually they are either those selling storage services themselves or selling only physical bullion. My view is that the Mint's free unallocated storage/physical metal in operations business model is far too competitive against these, I mean how can you compete against free storage? Therefore they only way they can compete is to sow doubts about unallocated and the Mint.

04 December 2008

Confiscation Update

The text of former West Australian Premier Richard Court's Vista Public Lecture Series 2008 address is now available. It is worth a read and has a handy short history of WA attitudes to Federation. Some key quotes:

"Joel Fitzgibbon, the Federal Member for Hunter and the current Minister for Defence, said in presenting the Inaugural Edmond Barton Lecture this year, that an ideal reform of our Federation would be the abolition of the States.

At the time I said I could offer my 100% support for this proposition with just one proviso – that Western Australia secedes just prior to the States being abolished!"

"So in the three decades after Federation, with a population of around 400,000 there was growing dissatisfaction with the Commonwealth’s fiscal and legislative dominance and control.

1930 we were in the Great Depression and just prior to this discontent coming to a head. In 1932 the Western Australian Government decided to hold a referendum on seceding from the Federation on the grounds of unfair financial treatment.
This referendum was held on 8th April 1933 and it was 2-1 majority in favour of secession from the Commonwealth.

On 24th May 1935 a Joint Select Committee of the House of Lords and Commons resolved it was not proper for the Western Australian petition to be received because the United Kingdom Parliament could – as a matter of Constitution priority – only dissolve the Commonwealth at the request, and with the consent, of the Commonwealth. That consent had not been provided."

"Western Australia accounts for 35% of the nation’s export income."

"I am not advocating secession, but if you read “The Case for Secession” which is very thick and “The Case Against Secession” which is very thin that was prepared in the 1930’s, the case for secession today will be even stronger if this financial imbalance is allowed to continue."

I have updated the original gold confiscation post and will continue to do so as I want it to be the definitive research on the topic.

28 November 2008

Constitution, Confiscation and Gold

I have amended the confiscation blog with the text below and posted it here for those who have already read the blog so you don't miss it.

What if Western Australia did not want to secede or there was not enough public support to do so, but still wanted to stop gold confiscation by the Federal Government. One possibility is for the State to make gold coins legal tender. They would therefore cease to be just gold and become currency.

Section 115 of the Australian Constitution states "A State shall not coin money, nor make anything but gold and silver coin a legal tender in payment of debts." I interpret this as a State shall not coin money, period, but can make (with "make" as make law, not "manufacture") gold and silver coin legal tender.

Now if a State cannot make coins, how does the Perth Mint get away with it. It does so by going to the Treasurer and getting approval to do so under the Currency Act 1965. With the Mint's gold and silver coins, as well as sovereigns, already out there could not a State pass a law to make those gold and silver coins legal tender at their market value, not face value? Interestingly, there is no definition of "coin" so maybe sovereigns and Eagles and Maples could be included, although coin usually means "legal tender" otherwise it is a "medallion".

According to this Wikipedia entry, "Section 51(xii) of the Australian Constitution gives the Commonwealth Parliament the right to legislate with respect to “currency, coinage, and legal tender.” with Section 51 powers able to be legislated on by the states, although Commonwealth law will prevail in cases of inconsistency. Section 115 effectively makes the concurrent power in section 51(xii) exclusive to the Commonwealth. Despite this, coins of the Australian pound were not introduced until 1910. From 1901 to 1910 the states could not issue tender and the Commonwealth had not issued tender, so private currency was used as the common medium of exchange whilst the British pound sterling was the national unit of account."

This then raises the question of whether Western Australia making those existing gold and silver coins legal tender would "inconsistent" with Commonwealth law.

Part V of Reserve Bank Act 1959 states that banks or persons (but no mention of States) shall not issue bills or notes intended for circulation as money but otherwise makes no restrictions on any other legal tender.

I have looked at the Currency Act 1965 and cannot find any section prohibiting a State from declaring gold and silver coins legal tender. Section 22 prohibits persons from making coins. Section 16 says that "a tender of payment of money is a legal tender if it is made in coins that are made and issued under this Act", which the Perth Mint's coins are.

See also the Reserve Bank of Australia's comments on legal tender.

Therefore I see no inconsistency with Commonwealth law if a State passes a law making existing gold and silver coins (at their market value) legal tender. However, there is a catch. Section 23 states that "the Governor‑General may, by Proclamation, call in any coins issued under this Act or the repealed Acts before a date specified in the Proclamation."

So if the West Australian Government attempted to make the Mint's coins legal tender to stop the Commonwealth's moves to confiscate gold, the Commonwealth could just call those coins in.

Now while this investigation seems to have achieved nothing, it does raise one useful point - Section 23 is effectively another confiscation mechanism, but with the implication that it can be used not just to recall gold coins but also any Perth Mint silver coins. Note also that any proof/collectible coins issued by the Perth Mint are also done so under the Currency Act 1965 so numismatic coins clearly have no protection. Therefore, while coins have advantages when moving between countries due to their legal tender status, that legal tender status puts them at risk of confiscation, so one should prefer bars to coins if one is concerned about confiscation.

23 November 2008

Australian Gold Confiscation

Gold confiscation is an important issue that strategic investors need to have a view on – the circumstances in which you are most likely to need your wealth safe haven is also when the risk of a Government wanting to take it away from you may be the highest. All of the discussion on this matter is US-centric and I do not recall ever seeing any commentary on the possibility of confiscation in other countries. It is a pertinent question because a fair number of Americans store their gold offshore on the simple basis that if the US Government did it once, they will do it again.

Having said that, it would be my contention that all countries have a confiscation risk on the basis that we are dealing with politicians after all – QED. The confiscation issue is therefore one of relative risk: which country is less likely to resort to gold confiscation. Being Australian, I can only focus on the likelihood of the Australian (Federal) Government confiscating gold. I would welcome discussion of this issue by locals in other countries, particularly the UK and Switzerland, given the large amounts of gold held in those countries.

The confiscation question was often raised by the clients I spoke to while working in the Perth Mint’s Depository. I should note that most of the USD 1.5 billion worth of precious metals stored by the Depository is held by foreigners. In fact, 45% of the Mint’s Depository clients are American. While some of this analysis will be specific to Australia, there will also be a fair amount that is generic to any country so hopefully this will be of use to those without gold in Australia as well.

Economic Strength

Governments confiscate gold because they need to strengthen their reserves, which is a nice way of saying no one will accept their currency and they need something of value to trade for the things the country needs. This statement raises two factors to consider. Firstly, how strong is the economy of the country, how resilient is it likely to be in the face of a deteriorating and hostile world economic environment? Secondly, how self sufficient is the country?

My simple answer to these two questions is to note that Australia is a commodity currency. We export a lot of raw material commodity stuff and food that other countries want. Sure, like many western countries, we have a reduced manufacturing capability but we can always build up that capability, whereas some countries cannot just make iron ore appear out of their ground. I therefore consider Australia relatively lower risk on this factor. We can be self sufficient. Sure we might have to do without plasma wide screen TVs, but at least we can feed ourselves.

A related issue is what gold holdings will the Government look to control when it decides it needs the asset of last resort. My view is that they are not going to bother with knocking on people’s doors to confiscate private holdings when Australia’s mines can churn out between 200 to 300 tonnes per year. The real threat is the control of mine output (i.e. buying gold at the “official price”) or nationalisation of mines as this is where the real dollars are.

Legal Mechanism

At lot of the commentary on US confiscation speculates on the likely legal form the confiscation will take, such as will numismatic coins be exempt and so on. If laws have to be passed, then opposition may be possible or at least there would be some delay within which you can prepare.

In this respect Australia has a relatively higher risk because Australian law already has a mechanism in place to require delivery of gold to the Reserve Bank of Australia (RBA) - Part IV of the Banking Act 1959. There is no need for the Government of the day to have to rush new legislation through that may attract public comment or opposition. All that is required is the Governor General to proclaim that Part IV shall come into operation. The ease with which this can occur is a negative mark for Australia. A small consolation is that we have certainty as to the legal form this confiscation will take.

As a side note for those not versed in Australian constitutional law, the Governor General is a figurehead role and is not elected. They are appointed by the Government of the day and, by convention, act on the instruction of the Government and Parliament. Most Australians would be aware, however, that the words “by convention” are crucial, as on 11 November 1975 the Governor General dismissed the Government of the day. It is therefore theoretically possible that the Governor General could bring Part IV into force against the wishes of the Government if he/she thought that it was “expedient so to do, for the protection of the currency or of the public credit of the Commonwealth” (Section 40(2)). Having said that, I would consider such a scenario unlikely on the basis that doing so would require the cooperation of the public service and result in radical changes in the operation of the gold industry. As the Governor General does not have any control over the public service or any public mandate, they would need the cooperation of the Government of the day if the proclamation was to have any practical effect.

Before you rush to deliver your gold to the RBA, note that Part IV is currently “suspended”. My blog of 04 August details the suspension by way of a transcription of a press release by the Treasurer on 30 January 1976.

It is worth noting that the Act only refers to gold, not silver. I guess this is because gold is more compact, in value per weight/volume terms, and thus is easier to transport between countries in settlement of transactions. For example, one tonne of gold is equivalent to 75 tonnes of silver (at least at today’s prices). This is positive for silver, and one can imagine that in a gold confiscation scenario that people will flock to silver for wealth/inflation protection if they cannot achieve it with gold. It is therefore likely that the silver price will move rapidly upward relative to gold.

So let’s look at our enemy in detail:

Section 41 – you will not be allowed to export or take gold out of the country.

Section 42 – you have to deliver gold you hold at the time of the proclamation or any that subsequently comes into your possession within one month. Only exemptions are gold used as part of your profession or trade or coins less than $50 in total value. The section mentions “prescribed amount” but $50 is mentioned in the attachment to the press release. Note that the section refers to the “gold content”, not “face value”. In practice this means legal tender coins or numismatic coins offer no protection and given the small value, is effectively full confiscation. The US 1933 confiscation had an exemption for gold holdings below $100 (see this article by Roland Watson for more details. Mr Watson notes that the 1933 confiscation was not confiscation as such, but a prohibition against hoarding. He also speculates that the exemption was a way of getting the average wage earner on board, as it did not confiscate their small holdings, only the "evil hoarders".

Section 43 – gold so delivered is the RBA’s, period. Any interest that someone has in it is extinguished. RBA must pay for it and will pay the deliverer. If you had an interest in that gold, you have to get your money off the deliverer. What this means is that a custodian must deliver gold held on behalf of others, and it will only get money in return, which is all it can return to you.

Section 44 – this has very interesting wording. First off it says the price is the price as fixed by the RBA. This doesn’t sound too good, as it allows for the RBA to set a really crappy price. However it says “... or, at the option of the person delivering the gold, such amount as is determined in an action for compensation ...” In practice this means that you will get the market value, as if the RBA’s price is too low there is a case for compensation.

If you think that getting market price doesn’t sound too bad, it is worth remembering that in the US after confiscation the official price of gold was increased, thereby denying the previous holders the benefit of that increase in value. While there is no official fixed price anymore, some posit that the same will be achieved by central banks first manipulating the price lower then confiscating it at this “free market” price.

In any case this is a bit irrelevant because you only end up with paper money and if you wanted that you would not have bought gold in the first place.

Section 45 – this says that you are not allowed to buy or sell gold, unless authorised by the RBA. The interesting thing about unallocated is that the gold has already been bought and thus it may be legal for the Mint to allow clients to collect their unallocated gold on the assumption that as good citizens they are requesting it so they can dutifully hand it over to the RBA, of course. This will depend upon the interpretation of “or otherwise obtain gold” within the context of the section, which is titled “limitation of sale and purchase of gold”.

Section 46 – essentially restatement of s42(1)(b), OK to have gold you are working on if that is your job. I take this to mean jewellers and other manufacturers are exempt by default.

Section 47 – OK to hold wrought gold. As “wrought” means “made in a skilful or decorative way” I take this section to mean jewellery is exempt. I think this is potentially a significant loophole as those denied bars and coins would create demand for other forms of jewellery that could also be “tradable” that creative jewellers (or a creative Mint) would undoubtedly meet.

Section 48 – the RBA can exempt anyone from any or all of these sections.

In summary, Part IV is very extensive. You can’t buy, hold or sell gold unless it is a legitimate part of your trade or in the form of jewellery. However, the phrasing of the law is all around physical as it mentions “delivery” of gold in your “possession” Combining this with section 46 raises an interesting speculation on interpretation of the law and its consequences for metal held with the Perth Mint.

Under section 46, given the Mint’s role in refining gold that the Government wants and also supplying industry with industrial forms of gold, I think it can be assumed that it would get an exemption from having to deliver its working stocks of gold. Note that this metal is what backs the unallocated precious metal liabilities of Depository clients, so the conclusion is that unallocated metal would not be confiscated. In support of this, unallocated metal liabilities are not “physical” so would fall outside the law as they cannot be “delivered” to the RBA. Certainly the Government may close this loophole, but in the extreme environment we are considering this oversight may be missed by the bureaucrats as they scramble to negotiate with an antagonistic mining industry on how the new system will work and getting real physical gold into the hands of the RBA.

My experience with the implementation of the Goods and Services Tax (GST) some years ago supports my position that unallocated will be left alone, at least initially. In discussions with tax officials the whole concept of unallocated, location swaps and such was considered suspiciously, as some bogus “construct” to hide the real transaction going on. As such they focused on physical metal movements and when title passed. I am confident that the bureaucrats responsible for implementing Part IV will similarly see industry “jargon” as a cover up and instead prefer to take what they will see as a clear-cut approach: do you have a legitimate business reason to hold gold, if not hand it over.

For this reason, and of some irony considering that a number of client’s consider allocated “safer” than unallocated, there is no potential for ambiguity with allocated metal. It is physical and has to be delivered, no matter that it is someone else’s metal as section 43 points out.

As a counterpoint, if people are not allowed to hold gold then the Perth Mint’s operations will be radically reduced as there will be no need for coins or bars (except 400oz bars) and it may be hard to justify holding as much physical backing the unallocated as they currently do. While the Mint may be able to branch out into 24ct jewellery or other product lines to take up the slack, it is doubtful this could be on the same scale as the coin and bar operations.

In summary, the best that can be said is that there is no doubt that allocated/custodial holdings are confiscatable but that unallocated is a grey area.

Management

By “management” I mean how will the senior management of your custodian (which for most people means the Perth Mint) react to the confiscation. For example, in respect of the unallocated question, will the Mint roll over and voluntarily hand over unallocated metal (or the “paper” claims), or will they not bring it to the attention of the bureaucrats.

This is a difficult question to answer and one can only look to the material published by your custodian to infer what their “philosophy” is or how strongly they feel about gold’s role and protecting your rights.

Secessionism

One factor unique to West Australia that needs to be considered in respect of gold held in that state is the highly probable emergence of the idea of self governance or secession from the Commonwealth should the Federal Government confiscate gold. One thing that struck me when I moved from Sydney to Perth was the “them and us” attitude of West Australians, evidenced in their use of “the Eastern States” to refer to the rest of Australia. I have no doubt that enacting Part IV will be seen by many West Australians as confiscation of “their” gold by the Federal Government and not in the interests of the state.

If you consider this farfetched, read the following Wikipedia page http://en.wikipedia.org/wiki/Secessionism_in_Western_Australia. This 2005 TV interview, with veteran state MP Norman Moore, a former Court Government minister, is a neat summary of the feelings of some West Australians:

REBECCA CARMODY: As this issue has cropped up, I’ve heard politicians of both persuasions talking about secession. Would Western Australia be better off just to simply break apart?

NORMAN MOORE: Absolutely. I have no doubt that Western Australia would be one of the most successful countries in the world if it was a separate country.

REBECCA CARMODY: Is this something we should be seriously contemplating?

NORMAN MOORE: Yes, we should be talking about it. We should be talking about it very thoroughly and in a very mature way. Let’s look at what the consequences are for Western Australia if it was a separate country. We have enormous resources. We’ve got a tremendous potential future as separate country if we were to secede. To achieve that would be very difficult indeed because you actually require a constitutional amendment, I understand, which would probably not be supported by the other States because they get 30 per cent of their revenue from Western Australia.

REBECCA CARMODY: You don’t think it is likely to happen, but it is a fallback position for Western Australia.

NORMAN MOORE: There was always a unilateral declaration of independence which has been used in other parts of world. I suspect it wouldn’t happen in Western Australia. I think that Western Australians need to start talking about a future as a seceded separate nation. At the end of the day, under a centralist system in Canberra, Western Australia will always be the biggest loser. We are a long way away - out of sight, out of mind. Federal politicians simply rely on Western Australia to produce a huge amount of wealth, but, beyond that, they would not know much about what goes on here at all.


Consider also this Vista Public Lecture by Hon Richard Court AC, former Premier of Western Australia "How will the Federation look in 2020" where he says “I am not advocating secession, but if you read 'The Case for Secession' which is very thick and 'The Case Against Secession' which is very thin that was prepared in the 1930’s, the case for secession today will be even stronger if this financial imbalance is allowed to continue.” It also has a short history of Western Australia's attitude to Federation and notes that "in 1932 the Western Australian Government decided to hold a referendum on seceding from the Federation on the grounds of unfair financial treatment. This referendum was held on 8th April 1933 and it was 2-1 majority in favour of secession from the Commonwealth" but it was rejected only "because the United Kingdom Parliament could – as a matter of Constitution priority – only dissolve the Commonwealth at the request, and with the consent, of the Commonwealth. That consent had not been provided."

See also this April 2010 report by ABC News: Tax review stokes WA secession whispers

While secessionist sentiments are currently in the minority, it is my view that confiscation would fan the feelings of being “ripped off”. The sort of dire economic circumstances that would induce the Federal Government to confiscate may also be the extreme circumstances in which the State Government, with the likely support of everyone involved in the gold mining industry, would consider it in the best interest of the state to secede. I would further speculate that with significant amounts of gold in the ground, and an operating Mint, there is a good chance that the country of Western Australia would consider a gold backed currency – in times when currencies are failing the only way for a new country to establish the worth of its money would be to back it with gold.

Gold Currency

What if Western Australia did not want to secede or there was not enough public support to do so, but still wanted to stop gold confiscation by the Federal Government. One possibility is for the State to make gold coins legal tender. They would therefore cease to be just gold and become currency.

Section 115 of the Australian Constitution states "A State shall not coin money, nor make anything but gold and silver coin a legal tender in payment of debts." I interpret this as a State shall not coin money, period, but can make (with "make" as make law, not "manufacture") gold and silver coin legal tender.

Now if a State cannot make coins, how does the Perth Mint get away with it. It does so by going to the Treasurer and getting approval to do so under the Currency Act 1965. With the Mint's gold and silver coins, as well as sovereigns, already out there could not a State pass a law to make those gold and silver coins legal tender at their market value, not face value? Interestingly, there is no definition of "coin" so maybe sovereigns and Eagles and Maples could be included, although coin usually means "legal tender" otherwise it is a "medallion".

According to this Wikipedia entry, "Section 51(xii) of the Australian Constitution gives the Commonwealth Parliament the right to legislate with respect to “currency, coinage, and legal tender.” with Section 51 powers able to be legislated on by the states, although Commonwealth law will prevail in cases of inconsistency. Section 115 effectively makes the concurrent power in section 51(xii) exclusive to the Commonwealth. Despite this, coins of the Australian pound were not introduced until 1910. From 1901 to 1910 the states could not issue tender and the Commonwealth had not issued tender, so private currency was used as the common medium of exchange whilst the British pound sterling was the national unit of account."

This then raises the question of whether Western Australia making those existing gold and silver coins legal tender would "inconsistent" with Commonwealth law.

Part V of Reserve Bank Act 1959 states that banks or persons (but no mention of States) shall not issue bills or notes intended for circulation as money but otherwise makes no restrictions on any other legal tender.

I have looked at the Currency Act 1965 and cannot find any section prohibiting a State from declaring gold and silver coins legal tender. Section 22 prohibits persons from making coins. Section 16 says that "a tender of payment of money is a legal tender if it is made in coins that are made and issued under this Act", which the Perth Mint's coins are.

See also the Reserve Bank of Australia's comments on legal tender.

Therefore I see no inconsistency with Commonwealth law if a State passes a law making existing gold and silver coins (at their market value) legal tender. However, there is a catch. Section 23 states that "the Governor‑General may, by Proclamation, call in any coins issued under this Act or the repealed Acts before a date specified in the Proclamation."

So if the West Australian Government attempted to make the Mint's coins legal tender to stop the Commonwealth's moves to confiscate gold, the Commonwealth could just call those coins in.

Now while this investigation seems to have achieved nothing, it does raise one useful point - Section 23 is effectively another confiscation mechanism, but with the implication that it can be used not just to recall gold coins but also any Perth Mint silver coins. Note also that any proof/collectible coins issued by the Perth Mint are also done so under the Currency Act 1965 so numismatic coins clearly have no protection. Therefore, while coins have advantages when moving between countries due to their legal tender status, that legal tender status puts them at risk of confiscation, so one should prefer bars to coins if one is concerned about confiscation.

Also, as one reader has pointed out, the "calling in" could be done at the face value of the coins, which would not normally be much of an issue with base metal circulating currency but obviously a problem for gold and silver coins because the face value is much lower than the market value.

It would be interesting if US law had a similar call in provision regarding its legal tender, as this would put to bed the idea that numismatic coins would be protected from a US confiscation. This article by CMI, which is the most comprehensive I can find on US confiscation, does not mention it but nevertheless concludes that numismatic coins provide no extra protection over bullion coins or bars.

Let Sleeping Dogs Lie?

In closing, I do not feel it is inevitable that confiscation will occur in Australia, or specifically Western Australia. I hope I have shown that the potential political situation is much more fluid. However, we do have dormant legislation that can be brought into existence without any need for debate in Parliament, which I do not consider a good thing. The question I leave you with is should we leave the sleeping dog or agitate for Part IV to be removed?

Asking for it to be removed may draw attention to its existence and provoke a review of it and possible change to remove any loopholes, although this would have the benefit of revealing the Government’s attitude to gold, allowing for individuals to prepare. Leaving it means we know what we will have to deal when/if it happens (this assumes you feel there are actionable loopholes) and in the meantime not draw any more attention to gold ownership.

Other articles on confiscation (this will be added to from time to time, so please check back here if you are interested in this issue).

This article on silver confiscation asserts that silver is more likely to be confiscated because there are no large industrial stockpiles and silver is needed in many industrial applications, causing great economic problems if silver ran out/increased in price significantly.

This correspondence between GATA and the U.S. Treasury Department on confiscation, where Treasury says that the Government "has the authority to prohibit the private possession of gold and silver coin and bullion by U.S. citizens during wartime, and, during wartime and declared emergencies, to freeze their ownership of shares of mining companies" and indeed "to
seize or freeze just about everything else that might be considered a financial instrument"

Adam Hamilton's (Zeal LLC) Gold Confiscation Hydra 1.1 considers the risk of confiscation at 1% because:

1. There are vast structural differences between the gold environment of 1933 and today;
2. It would be the final coup de grace slaughtering the fragile US dollar; and
3. Fearsome social implications from Ruby Ridge and Waco style shootouts between armed goldbugs and "Federal Gold Police".

Confiscation Anatomy - A Different View by FOFOA: "... if the US ever put gold back on the table through another confiscation of its citizens' gold, the BIS would call in all of its outstanding claims in gold at the rate of $42 per ounce ... Under international law, the US is still an OUTLAW when it comes to gold! This is why gold is off the table."

Alasdair Macleod: "Confiscation requires the gold itself to be surrendered, which presumably would be the objective if a government is to add to official holdings. If gold ownership is merely banned, it is a different matter. A bullion bank holding gold in an unallocated account would almost certainly be unable to deliver physical gold if required to do so by the American government, but it would be able to close out the account for cash."

Interesting point about unallocated being closed out for cash in a confiscation. A possible reason why it may happen - if there is a (physical) run on bullion bank unallocated accounts, Governments may confiscate as cover to protect bullion banks from failure rather than any desire for the metal themselves.

Further quote: "The international nature of gold would probably require all G10 or even G20 members to agree to similar actions against their own citizens. It seems unlikely that all governments would agree to this, unless they all had their backs hard against the wall.

Miles Franklin: "But, if the unlikely were to occur, in the very unlikely event that our government issues a recall order, they would want to get the most people possible to comply with the least resistance. Since they can create all the money necessary to acquire it, with a keystroke, it makes sense that they would offer a fair and very high price for the gold – and quite possibly even offer an extra incentive like a provision where no taxes were paid on the gains. This isn’t so far-fetched since many people would be forced to liquidate outside of their own time frame and would face tax consequences that in some cases would not be to their benefit. If they didn’t make it easy and somewhat fair, many people would flaunt the law and the government would NOT get their hands on the gold they desire."

Jim Sinclair: "I am sick of all this confiscation talk of gold and even gold companies. It emanates from gold people who do not know or understand the history of gold. We condemn MSM for inaccurate, false and misleading news. I condemn gold writers who practice sensationalism, who offer their opinions as if they were facts and simply make things up out of thin air as if they were insiders privy to things that no one else is. Right now leaders of this community are printing stuff as misleading as MOPE or MSM ever have.

Eric De Groot put what I have been trying to teach you perfectly today. In the 1930s gold was to the monetary system what QE is today, a means of increasing the supply of money for Fed and Treasury discretionary use. The US Secretary of the Treasury and President Roosevelt set the gold price higher at their daily breakfast together arbitrarily. Higher because to create money then the system required a higher value of gold to have more money outstanding. This is why Roosevelt ordered the confiscation of gold in order to unfold his type of monetary stimulation, his QE. This is what confiscationophiles simply do not know.

Your fears and the outrageous untrue statement by the Scottish hedge fund manager are based on totally wrong reasoning and misunderstanding. Gold was not confiscated because it was going up in price. Gold’s order of confiscation came as a tool of monetary stimulation in order to create monetary creation in order to attempt to increase employment. The order of gold confiscation had nothing whatsoever to do with punishment of the gold holders. It preceded the then big run up in the gold price. Believers in confiscation, because they are incorrect on its basis, are totally wrong in predicting it. Those that predict confiscation of anything gold love sensationalism and benefit somehow from scaring the dickens out of you unnecessarily."

Note 31 Jan 2014: Regarding the physical gold backing client unallocated gold, this gold is on the balance sheet of the Perth Mint, which means the Perth Mint owns the gold and has a liability to Depository account holders. Given our ownership, this means that the State government owns the gold. Part IV only talks about "persons" which I doubt would include State governments.

So for the Federal government to get the physical gold backing unallocated accounts, it would have to use Section 51(xxxi) of Australia's consitution which allows for "the acquisition of property on just terms from any State or person" - so the confiscation would be against the State government and not unallocated account holders directly. This would make it a Federal vs State rights issue and feed any secessionism movement.

John Adams: "Unfortunately, Australia is not immune from its own history of gold confiscation. After declaring war on Hitler and needing to fund the war effort, the Australian Parliament enacted the Gold Tax Act 1939 imposing a 50 per cent transactional tax on gold delivered to the Commonwealth Bank Government above 9 Australian pounds per ounce. This tax, while not confiscating gold outright, confiscated a proportion of the gold used by Australians when redeemed for physical cash. The gold tax was not repealed until 1947."

19 November 2008

Gold Standard

With thanks to Tim Iacono's blog, here are some recent articles on the gold standard he has found that in some form argue for or raise the idea of gold as the solution to the current problems:

The Christian Science Monitor, 17 Nov: Forget Bretton Woods II – we need a gold standard
The Wall Street Journal, 17 Nov: To Prevent Bubbles, Restrain the Fed
The Wall Street Journal, 14 Nov: Stable Money Is the Key to Recovery

Also found by New Kontent blog I follow:

Eric Janszen, President iTulip.com, 16 Nov: A return to the Bretton Woods international gold standard is inevitable

And to The Calgary Herald, 15 Nov I present my Stating The Obvious Award: "But it seems central bankers and governments around the world have already put a stop on a comeback of the gold standard as they prefer monetary policies without being restrained by gold reserves."

17 November 2008

GSUL

Back in the office and just cleaned up the inbox. I'm sure all 52 present at GSUL 5 would agree that it was very productive. All the formal presenters had valuable insights: Professor Antal E. Fekete, Darryl Robert Schoon, Tom Szabo and Nathan Narusis; but just as much was learnt from the insightful questions of the attendees. This is not surprising, as they were, as Nathan so aptly described, "self made wealth, independent thinking" people. I sensed early on that the presenters were initially a bit taken aback at the directness of the questioning, but maybe that is just the Australian way and commendations to the organisers for going with the flow. Also productive were the after session sessions down at the bar. The internet is a valuable technology for communication, but so much more seems to get done face to face - we are social creatures after all.

A few ideas/things I thought needed work on from the session:

1. AUD basis - does this really exist (eg we need to use aussie cash rates and aussie spot price) or since USD trading dominates the gold market, should we really study USD basis and trade/interpret that, only converting profits back into AUD?
2. Confiscation - my speculations on this and the application of Part IV of the Banking Act 1959 (see my August blog for background) seemed to be of interest and I will finish my blog on this shortly.
3. Warehousing of precious metals - what is the real warehousing cost, and particularly the correct relative storage charge between gold and silver? Also consider that where gold can be lent, or stored "free" as with the Mint's unallocated, there is no warehousing cost so how does this affect the basis, particularly the AUD basis?

I look forward to the continuing discussions.

10 November 2008

Gold Standard University Live

Currently in Canberra for the Gold Standard University Live session V. Will post something up if I get time between the sessions and riding the Mt Stromlo mountain bike park.

29 October 2008

Bron's Mega Trend Chart

My response to a few questions on this Kitco forum thread about potential COMEX closure, the spot price and my unrequested speculations on the supply/demand situation:

Any regulated market, be it COMEX or stock markets, are subject to closure/suspension/rule changes. Just look at the no short selling changes for financial stocks and the ability of COMEX to change margin. What will cause it to close? I suspect if trading on it starts to shift significantly towards using it as an actual way to purchase physical and not just some leveraged speculation game where everything is netted out in cash. As long as they can continue to perform the basic function of a futures market, which is to allow people to buy commodities for future “use” (ie delivery), they will be OK. But they need physical to do that, so watch the warehouse movements.

The advantage of the OTC market is that it is not regulated (that is also a disadvantage re transparency) - it is just person to person dealing, much like what is happening on ebay, just at a bigger level and for the big wholesale bars. As a result it can't be closed and will adjust itself as required.

Note that a lot of OTC trading by professionals is just buy and then sell, ie turnover is the game. They are not buy and hold (at least not in the long term); they don't care for gold and are happy to sell it into rallies to make money. This is OK as it provides liquidity. But if you want to move the price, there is only one thing that can spook the professionals and that is physical being taken off the market. By this I mean non-professionals as they care for gold and won't necessarily sell it into rallies. It leaves the OTC "trading game", either in the form of retail coins or bars, or the big bars by high wealth investors.

The problem I think at the moment is that demand for retail stuff is restricted (whether you want to believe it is deliberate policy or industry inertia or industry incompetence I leave for another discussion) which restricts physical being taken off the market. Having said that, a hell of a lot of retail stuff is being made, more so than ever before, everyone is at capacity, so some impact is being felt as manufacturers suck up the big bars to feed their production lines, but it could be more.

While this retail demand continues it will continue to suck physical off the market and at some time it will create a tipping point where physical buying demand exceeds physical selling supply. When? Don’t know because the market is complex, but consider (some) of these simplistic factors over the medium/long term:

S1. Mine supply: let’s assume somewhat constant
S2. Central bank supply: lending has tightened up, which tightens up short selling, also doubt many central banks would be selling gold reserves or have much left to sell, if you believe they have been manipulating the markets for, since, ever and ever. But let’s assume they are still selling what they have
S3. Institutional/hedge fund investors: they have certainly been liquidating all their “commodity” play positions to pay back their debt or cover other losses.
S4. Individual investors: no selling going on here

D1. Jewellery/Industry: by this I mean western, not India because that is really investment purpose. In a recession jewellery & industry demand is going to go down.
D2. India: they are very canny buyers (because they are investing) and even though prices relatively high in their currency, their normal demand returns once they feel prices have stabilised at a level and are unlikely to retreat. In medium term I see this up.
D3. Individual investors: at this time with retail shortages, only way is up.

So which is the key driver for an increasing gold price? Let’s go back in history a bit.

In 2002 the World Gold Council (WGC) appointed James Burton as CEO. Mr Burton was the former CEO of the California Public Employees Retirement System (Calpers) the leading and the largest public pension system in the USA. Any coincidence that the WGC then made a strategic shift away from trying to increase the gold price via increasing jewellery demand towards the investment side? This is why they sponsored the creation of the first gold ETFs and have aggressively rolled them out into 12 countries.

The theory is that jewellery demand, while it may go up and down in line with the economy, is base demand, consistent in nature, and cannot be expected to increase significantly, or at least increase enough to make an impact on price. For that to happen would require the per capita buying of jewellery to increase, which is just another way of saying that jewellery has to increase its “market share” of the consumer’s discretionary income. This requires big bucks to be spent on advertising and other marketing support. WGC tried it for many years and I think came to the conclusion that the “return on investment” did not pay off in terms of an increased price.

Investment demand, in contrast, has the power to go up significantly – just look at the amount of money invested in shares compared to the size of the gold market. It was realised that shifting even small amounts of that money into gold would have a big effect. In addition, the cost of making this happen was lower compared to trying to increase jewellery demand. Creating an ETF may require big bucks, but once done it doesn’t need ongoing expenditures and in a lot of cases you can dual-list, saving more money (at http://exchangetradedgold.com/ you’ll see that there are actually only 4 “funds” trading in 12 countries). Increasing jewellery demand, however, requires continual marketing support to compete against all the new toys (iphones, plasmas TVs etc) competiting for consumer spending.

Now in general I agree with the “investment demand is the key” theory, but the ETF approach is potentially a double edged sword. The question is whether its holders are predominantly the buy and hold type individuals or just institutional types and myopic share traders. At this time we are not seeing any significant holdings drops across the key ETFs. However, my view is that because it targets share investors, they have more potential for outflows compared to personal physical holdings (ie in the form of retail coins and bars), which I feel are more sticky. Therefore I think it is unfortunate that some of the WGC money spent on ETFs was not directed at ensuring the industry’s capability to meet retail coin and bar demand.

My view is that S2 & S3 are the main forces behind the big drop in the gold price as they have overwhelmed the other positive forces. A lot of this would be happening in the OTC market, so isn’t necessarily visible. Whether they have more gold still to sell is the key question, but I’d guess not much more to go. With the key force in the story being “investment” demand, continued D3 demand plus a D2 coming back will tip the balance towards a higher gold price.

For silver:

S1. Mine supply: recession pushes other commodities down, by-product silver also goes down
S2. Central bank supply: no such thing
S3. Institutional/hedge fund investors: same story about liquidating “commodity” play positions.
S4. Individual investors: no selling going on here

D1. Jewellery/Industry: In a recession industry will go down, maybe jewellery up as people switch from gold to silver.
D2. India: 50c premiums on silver into India proves demand strong/supply shortish.
D3. Individual investors: also only way is up, probably more so than gold.

My view is “investment demand is the key” theory also applies to silver, more so considering no massive central bank holdings. Supply story looks good (short) and again, as long as D2 & D3 hold, price must move up.

While I’m bullish on PM’s, it isn’t going to happen overnight. There is big money moving around distorting the base trend and no doubt that a bubble in PMs is working its way out. In all the commentary on the price I’ve seen, very few charts go back past 2005. Too myopic in my view – because gold is not a transparent market you can only play the main trends. See below my Mega Trend Chart :).



The recent few years look like a 1980s bubble to me off the real baseline established from 2001 to 2005. I also find it interesting that the Mega Uptrends all have the same slope. Anyway, my extention of the 2001 to 2005 Mega Uptrend out into the future is what I would expect in a normal market situation: the bubble would come back down to this and probably overcorrect like in 1982 before continuing up. But this credit (or more accurately, trust) crisis may have changed the game. Consumers lose faith in these virtual financial products, and they shift to wanting “real stuff”. PM demand moves to a new level as a result and thus the dotted lines are now where the price will go?

Of course if I'm proved right I will take all the glory and if not, I'll blame the manipulators for having seen this penetrating analysis and reacted to prevent my prediction.

25 October 2008

Closing the 'Collapse Gap'

My favorite/funny quote from this "collapse-preparedness" presentation:

Reliance on doomed institutions is harmful. Government is already useless. Commerical sector will become useless quickly. Since they will be useless to you, you can start being useless to them ahead of time.

Spoke to my brother today who recounted this joke: "This financial collapse has been worse than a divorce - I've lost half my money but still got my wife."

If you've got time, this Chris Martenson presentation is also worth a view but it is about 3 hours in total. Jump to section 19 for a summary/bringing together of his ideas, the sections on money are also good.

23 October 2008

Unallocated vs Allocated

On this Kitco forum thread, a question was asked about whether one should be converting from unallocated to allocated. Many years ago I wrote up the following text on this page of the Perth Mint website:

The Perth Mint maintains finished goods inventory of its coins and bars at all times to meet normal demand from its distributors and Depository clients. Accordingly, unallocated clients will usually be able to convert their metal within a few days of giving notice.

However, it is important to note that if you request a physical product that is not in stock, or a very large quantity, the Mint may need to manufacture it. The lead times for manufacture will depend upon the size of the order, current demand and production capacity. It is because of this uncertainty that some clients choose allocated storage - as their metal has already been fabricated it is ready for collection at short notice.

Clients worried about potential delays in collecting metal in extreme circumstances, but with concerns about the cost of allocated storage, usually take a staged approach:

1. While the world environment is benign, they hold unallocated. They do not incur ongoing storage costs and fabrication charges.
2. When the environment becomes uncertain and risky, they convert to allocated.
3. When the world is at a crisis point, they take delivery of their physical metal.

This approach can save clients significant amounts of money as it may be some time between stage 1 and 2. Clients who do not feel they can judge the shift from stage 1 to 2, or feel it may be sudden and unpredictable, opt for allocated as they are using precious metals as "insurance" and see the storage fees as the cost of that insurance.


Each person will have a different assessment of what stage we are at. One thing to note is that the Perth Mint has a legal obligation to do conversions/collections, so those orders will always take priority over any other orders in the system, which gives some people comfort.

There were a few other questions raised that may be of interest.

"If the demand continues to be high then production capacity will rise and premiums will fall in the end. But will this coin/bar demand ever be big enough to influence the spot more than marginally?"

I have speculated in this blog that the industry will eventually respond, but it won't be quick as two things need to happen: 1 bosses in refineries and mints "get it" that the demand is staying high; 2 takes months to buy and commission equipment. High premiums are here to stay for at least 6 months if demand continues.

I think if the current demand was able to be filled then it would have an impact on the spot price because it would take physical off the market. Coin and bar demand is somewhat sticky. The fact that demand has not be able to be met has resulted in buying power being "wasted" on high premiums instead of on buying more ounces.

There is also no doubt in my mind that the US ETF has also impacted on the price by providing an easy way for the average person to buy gold. That was the whole reason the World Gold Council (run by miners) paid to get it set up - they wanted a easy way for physical to get taken off the market. Problem is that it is also easy to sell, and i think that is what is causing the volatility in the gold price. Compared to coin and bar buyers, ETF investors are more fickle in my opinion. The World Gold Council would have been better off ensuring the industry was ready to meet retail demand for coins and bars, because that also takes physical off the market, but for a much longer time.

"when do you think the paper spot price may be reconciled with the physical spot price + premium? Do you think there is an intentional cornering of retail market by big players, or is it just a priority of serving wholesale customers first. If there is a real shortage, why not charge wholesale customers more?"

In my experience, and this may just reflect the type of clients I've dealt with, but new highs in the gold price drive new account openings so the price drop will cool things a bit, but just a bit as the key driver now is still uncertainty about the financial markets and banks.

There isn't any cornering of the retail market by big players - all "wholesale" deals for coins and bars are to dealer who resell to the public. If a mint is at capacity selling product to a wholesaler or retail customer doesn't actually change anything really, because it all ends up with retail customers in the end. The big private clients I know who go allocated may well buy some smaller coins and bars, but the bulk of their metal is in 400oz and 1000oz bars as they are the cheapest.

22 October 2008

Misinterpretation of Gold Lease Rates

Brian Kelly (founder and CEO of Kanundrum Inc, a private investment firm and research boutique) recently posted an article on Seeking Alpha called Misinterpretation of Gold Lease Rates and Why Gold Could Rise. In the article he says that “lease rates reported in the press are a derived rate and actually represent the amount that can be earned from the gold carry trade” and goes on to posit a relationship between lease rates and gold prices. Unfortunately it is Brian who has misinterpreted lease rates, and has done so quite badly.

The gold carry trade involves borrowing gold at, say 1%, selling the gold, and then investing the cash at, say 3%. If the gold price doesn’t change, you earn a net 2%. The bigger the net difference the more carry trade return you can earn (assuming a stable price) and therefore more attractive short selling of gold should be – as long as there is an expectation that the gold price won’t rise too far to wipe out the profit from the interest rate differential.

The point of a carry trade is, therefore to “capture the difference between the rates” (see Currency Carry Trade for a further explanation). The question then is what are the two “rates” and what represents the net difference. The formula Brian mentions in his article is Lease Rate = LIBOR – GOFO. He therefore assumes that the net difference is the lease rate. However, that same formula can be restated as GOFO = LIBOR – Lease Rate. Which is the net difference?

Regrettably for Brian, it is GOFO, not the Lease Rate. How can I be so sure? Well when I worked in the Perth Mint’s Treasury and we borrowed gold, we were charged the Lease Rate, not GOFO. But don’t take my word for it. I quote from a booklet titled “A Guide to the London Bullion Market” issued by the London Bullion Market Association (who you would think would know what they are talking about): “Forward rate = Dollar interest rate – metal lease rate”

Therefore the fact is that it is GOFO which represents the “amount that can be earned from the gold carry trade”. GOFO is the measure of the net difference, “the amount that can be earned from the gold carry trade”, not the Lease Rate.

As a result not much store should be put to Brian’s subsequent analysis about the relationship lease rates and the gold price. The chart below shows the relationship between the real “carry trade” indicator (I’ve chosen the 6 month GOFO rate) and the spot price. I take a more longer-term strategic view and looking at the chart there is no clear relationship or correlation that I can work with. For example, in 2002-2003 GOFO was low and the gold price rising. But 2004-2006 GOFO was rising but the price also went up. I don’t see any tradable signals one can rely on.



Brian has also developed what he calls the Kanundrum Model of Markets, which explains the way people and markets behave. Below is a summary of his key “stages”:

Discovery – Stage 1

Stage 1 of any emerging trend is first characterized by a change in direction. It is usually preceded by a surge in volume as the asset makes a new low. This is the stage where major investors are establishing new positions.

Disbelief/Confusion – Stage 2

Price retreats after the initial surge and often the retreat is significant. Investors who did not buy when they heard that Stage 1 investors were buying believe that this is the time the Stage 1 investors are going to be wrong.

Belief and Proof – Stage 3

In this stage the asset makes its largest price move. It is by far the most important part of the trend for an investor to be a part of. Volume is huge and price moves are beyond what anyone expects. This part of the trend usually lasts much longer than anyone expects. This is also where almost every type of investor has a reason to be involved in the trade.

Complacency – Stage 4

Price begins to retreat from the unbelievable prices achieved during Stage 3. However few participants are concerned. Market participants are accustomed to the asset price and many investors use the pullback to add to or establish new positions.

Mom and Pop – Stage 5

The price begins to move back up and individual investors invest. The price moves may be less than during Stage 3 primarily because individuals do not have the buying power that larger professional investors have. As well, Stage 1 and Stage 3 investors are taking profits.

In this blog post dated 13 October, Brian believes that gold is currently in Stage 2: Disbelief/Confusion. Now I’m not so sure about his model and the stages one has to choose from but it is an interesting and fun way to view the market. Using his model, I would suggest we are in the middle of Stage 4 (see chart below). What stage do you think we are at?

14 October 2008

Bank Runs

I find the recent Australian Government guarantee of banking deposits (and the Treasury briefing of the leader of the opposition) very interesting. Briefing opposition leaders does not occur very often and I would assume was done because they wanted the opposition leader to know that the problem was serious and not to be used for political point scoring. The problem, then, must have been the real chance of a bank run developing.

Speaking to the Perth Mint's Depository and Shop staff about the reasons why people were buying gold and silver and how they were doing it leads me to believe that Australian banks were seeing the beginnings of a bank run developing. Stories of people not wanting to wait for cheques to clear and going to the bank to withdraw cash so they can get immediate delivery of metal may be reflective of wider cash withdrawals from Australian banks.

This report on ninemsn.com.au certainly would scare your average central banker: "according to Officeworks, the retailer has noticed a 'significant' increase in the sale of personal safes in recent times ... a number of people who feel nervous and consequently are pulling their money out" (see also this report from The Times)

I doubt the cash withdrawals would have posed a significant risk at this time, but I suspect that the banks were seeing abnormally high cash withdrawals and/or a trend developing and wanted the Government to stop it. It is interesting that this was necessary considering that "depositors in authorised deposit‑taking institutions (ADIs) already receive preference in any liquidation" (2 June 2008 press release by Treasurer).

13 October 2008

Maturity Crisis in Gold

Excellent blog at Unqualified Reservations about the lease rate.

It should be noted that the primary driver of lease rates has been miner hedging. Have a look at the chart at this blog and then compare to chart of lease rates.

You will see that as miner hedging increased from 1994, lease rates moved from average 0.75% during early 90s to 1.5% during mid 90s to early 00s. They then drop to historically low levels when miners started to de-hedge, all wanting to meet investor calls for full exposure to the gold price.

Doubtful this time miners will be hedging again so this lease spike totally dependent on when central banks regain confidence in bullion banks. Funny how they are prepared to throw fiat money around to any bank that needs it, but not so keen to do the same with gold.

James Turk says there is no shortage ...

... of wholesale precious metals, that is. In this GATA dispatch, James Turk says "So far the London and Zurich markets continue to operate without problems, but I sense some strains are developing" and "we are giving retail investors the opportunity to buy alongside big institutional firms operating in these markets and to gain the advantages of these markets -- deep liquidity and transparent pricing"

This is what I have been trying to say all along - physical metal in the wholesale markets is not in shortage, it is the conversion of that metal into retail coins and bars that is causing a shortage of retail product, pushing up their prices.

He goes on to note that his clients "are purchasing metal based on the spot price in London and Zurich for both gold and silver. Thus they are able to buy metal without the huge premiums now being charged on eBay, for example, for fabricated product like coins and small bars"

The unfortunate thing for precious metals is that because people don't trust Mr Turk's system or ones like it, they are "wasting", in a way, their purchasing power on premiums instead of on the metal itself. If the spot price for bulk silver is $10 p/oz but is $14 p/oz for retail silver, then those who spend their $14 on a GoldMoney type system create demand for 1.4 oz whereas those buying retail forms only create demand for 1.0 oz.

Could it be that the reason the silver price (or gold) is not as high as some would like is because all this demand to spend fiat dollars is not being fully channelled into silver but partly spent on premiums instead?

I am a strong advocate of holding physical metal, but once you have a reasonable stash if you want to make an impact on the price maybe continuing to pay incredible premiums may not be the way to go. Of course it does come down to trust in these systems, so I understand why people may not want to buy stored metal. However I can't help but think that a lot of dollar buying power is ending up as profit in the hands of coin dealers instead of into silver and gold itself.

10 October 2008

The Price Finding Mechanism

I received this email below today from a long time client:

Bron, Hi.

I trust all is well with you, especially in these turbulent times.

I have a question, maybe you can help with.

What is, or will be Gold Corporation/Perth Mint's position in regard to the valuation of account holder's unallocated storage bullion when the gold and silver paper/futures market deleverages from the physical market and loses its role as the price finding mechanism?

Do I need to explain the question more? If at some time in the future Comex goes into default on physical delivery - say at around $US25.00, how might the Perth Mint ascribe a price to unallocated account holder's holdings?

It seems there is a price premium already emerging for physical gold bullion.

Regards,
Ian


Firstly, not all bullion traders look to COMEX for a price. There are two other markets that are used and will take up the price finding role if COMEX fails:

1) the over-the-counter (OTC) market
2) the London Fix

Both of these are spot markets, by which is meant they are for immediately delivery of wholesale (i.e. 400oz gold, 1000oz silver) physical metal. Actually probably more correct to say “2 day delivery”, as the OTC spot market works on 2 day settlement. If you are looking for the “real” price of precious metals, you need to look at the spot price, not COMEX price as that is a futures price. It therefore does not represent the price for immediately delivery.

Over-the-Counter

This price finding mechanism is simply a trader ringing up other traders to find what prices they are willing to trade at and choosing the best one. The more accounts one has (which is a factor of your creditworthiness) the more traders one can deal with and thus the better the price one is likely to achieve. It is therefore really only a professional/corporate market and is unfortunately opaque to the average investor.

To facilitate this price discovery, various trading platforms and/or information services are used. Traders use a service like Reuters as a bulletin board on which they publish their current bid and ask prices as a way of attracting business. Unlike an exchange, however, such prices are merely offers and not commitments to deal at those prices.

It a lot of case the so-called “spot price” is the price published on these services. I understand that the Kitco prices are a delayed feed from Bloomberg, for example. They are reliable indicators of the price for precious metal but sometimes do not always reflect the actual spot market. This can occur when traders are very busy and do not have time to update their quotes on services like Reuters. One needs to take this into account when using these information sources.

London Fix

I won’t go into the details of how the London Fix works, that can be found at the link above. Important feature of the Fix is that unlike the OTC price, it is a transparent price and is published. This makes it ideal for “valuation” purposes, as it is independent in nature. Also note that the Fix price will, by the force of arbitrage, reflect the spot price at the time of its fixing. Of all prices, it is the “most real”; as it reflects the price actual physical deals were transacted at.

A negative for the Fix is that it is only done twice a day (once for silver). This does not make it suitable for live trading, unlike the OTC price, which is a 24 hour market. However, if one is not too price sensitive and prepared to wait for the fix to occur (and you have a sizable trade that can be put on the Fix), placing an order with your dealer to buy or sell on the Fix is a great way to know exactly what you are being charged. The fact that the Fix is published means that your dealer has to be explicit about what fees they adding to the price. With OTC trading’s opacity, one can never be sure exactly what the dealer is adding to the spot price they are actually paying.

Retail Spot vs Wholesale Spot vs Futures

Just a final word on the “premium emerging for physical gold bullion”.

If by this one means the difference between the prices for retail forms – coins and bars – and the wholesale spot, then I agree. By definition, the spot price is the price for wholesale physical metal - 400oz gold, 1000oz silver. This is gold or silver’s “base price”, the price for the raw material for retail coins and bars. The current inability of the industry to covert the raw material into retail forms to meet the demand has caused a shortage which has caused the price to be bid up.

If by this one means the difference between the futures price and the wholesale spot, then I am not so sure. There will always be a price difference because a futures price is a mathematical function of the spot price plus the “time value of money”, with the price only converging to the spot price at expiry. This difference does not mean it is not “real” or in disconnect. To argue that it is in disconnect means that you believe traders are going to miss an opportunity to earn easy money by not arbitraging the divergence.

This is not to argue against manipulation of the markets or that futures markets may close at some point. Indeed it is essential to believe that futures prices and spot price are kept in alignment by arbitrage, because if they were not then there would be no way to transmit the manipulations in futures into the physical spot market. Indeed, the whole reason a futures market may close is precisely because arbitrageurs see a divergence and seek to correct it by taking delivery to settle their positions in the OTC spot market.