31 January 2014

Central Bank gold reserves transparency

For a physical asset held on behalf of a country's citizens primarily for use in extremis, central bank reporting on gold holdings is woeful. It is impossible for a country's citizens to determine if their central bank is appropriately managing their (as in citizen's) gold such that it can perform its "last resort" function, if necessary, without knowing:

a) the amount of physical gold held under its control and ownership versus how much has been leased (physically, not book)
b) the amount of physical gold held domestically versus offshore

I would argue that gold has a higher standard of disclosure compared to a central bank's fiat activities because if lost, say by the bankruptcy of a lease counterparty, physical gold cannot be printed out of thin air.

Now you may argue that I am being unrealistic, pointing to GATA's freedom of information lawsuit against the US Federal Reserve, or the IMF's 1999 weakening of central bank gold reporting requirements, as examples of central bank opacity. I agree that it is a difficult ask, but in both these cases either the detail sought, or the reporting frequency, opens up lines of arguments that can be used to muddy the waters and give plausible grounds for refusal.

I would argue that one does not deal with bureaucrats as one would in a commercial negotiation, where you go in with your highest (or lowest, if buying) offer, as that just opens up many points for refusal. It is better to go in with your strongest argued case, which will often not be exactly what you want, because it give much less wriggle room, and thus the best chance of success. Secondly, bureaucrats can have an arse covering herd mentality, so appeals to precedent are always useful as no bureaucrat wants to strike out on their own lest they get it wrong.

Given the above, I would propose that the best way to approach central bank gold reporting is to simply argue that central banks follow the accounting standards, that normal commercial organisations do to, when producing their annual reports.

Simple and reasonable. It is also difficult to argue against as central banks, via their oversight and regulation of the financial system, impose those accounting standards on others. It is also hard to argue against it on the basis that it would be market sensitive, as it is only being disclosed once a year and many months after the balance date of the annual report. As a result, one could interpret a refusal to do so as hypocrisy and an indication of something to hide.

You may wonder if this will achieve anything with respect to physical versus leased gold. By way of example, I offer the Reserve Bank of Australia (RBA), which also provides you with a precedent. The RBA has, at least since 1998, been reporting physical gold, gold leases, the duration and risk profile of those leases, and average lease rates, all to accord with Australian Accounting Standards.

For example, an analysis of the RBA annual reports allows us to produce the chart below, which shows how much of Australia's meagre 80 tonnes was held as physical and how much was leased out for which terms.

It is clear that the RBA started winding back its leasing after 2004, due I would argue, to the fact that lease rates by that stage had moved below 1% (and subsequently continued to fall), providing a poor risk/return tradeoff. We can also produce a breakdown of the credit rating of who the gold was leased to.

So we can tell from the above that the RBA is now only leasing 1 tonne of gold for a duration of between 3-12 months to an AAA rated counterparty. Such information, if provided by all central banks, would provide their citizens with the ability to assess how prudently their gold was being managed. It would also provide valuable information to the gold market in general.

So if it is good enough for the Reserve Bank of Australia to report this level of detail with respect of its gold reserves, I think it is fair to say it should be good enough for other central banks.

Technical Note: In point a) I referred to "leased (physically, not book)". The reason is that there is a difference, in terms of whether gold is at risk of counterparty failure, whether a lease involved actual physical shipment to the borrower, or whether it was just leased by way of a book entry with the physical gold remaining in the possession of the central bank.
Thus when looking at gold reserves in terms of its last resort use, if gold is leased by book entry then it is arguable that there is no risk as, in case of a war for example, a central bank can just extinguish the paper claim by the counterparty and retain the gold.
The extent to which central banks have lent gold physically or only via book entry to bullion banks and the different implications of those two methods for the stability of the fractional reserve bullion banking system and its run-proofness is another topic altogether, and one I can cover in another post if anyone is interested (stupid question, of course you do).

30 January 2014

Watching the China 2710 tonne reserves meme creation

It was quite interesting watching a meme happen in real time when the gold blogosphere turn this Bloomberg story, which just said (my emphasis) "China may have vaulted ahead of Italy and France last year to become the third-largest holder of gold, according to a Bloomberg Industries report" into a fact. The chain seems to have been:

Bloomberg article picked up by Jeffrey Nichols (China’s Central Bank Buys Gold on the Sly) which was picked up by Shanghai Daily (China Expected To Announce It Has More Than Doubled Its Gold Reserves) picked up by Zero Hedge and then morphed into a fact by Shanghai Metals Market which was picked up by Max Keiser with this title China Expands Gold Reserves, Surges Past Italy & France in Ranking giving it a much wider distribution and validation.

I got hold of the actual Bloomberg Industries report on which all this was based, which was put out by Kenneth Hoffman. He is the money quote from the report:

A deeper look into China's gold holdings shows its reserves may be more than 2 1/2 times higher than thought. Its last reported holdings in April 2009 were 1,054 metric tons. After adjusting for net imports from Hong Kong and domestic output, the figure is closer to 5,086 metric tons. When taking away gold uses for jewelry, industrial and other categories and adding implied bar demand to central bank holdings, the figure is likely closer to 2,710 mt.

The funny thing for me is that Kenneth's 2710 tonne calculated figure on which all this hoopla was focused, is, in my opinion, flawed. What he has done is just looked at HK imports and China mine production (not factoring in any non reported imports) and only taking away jewellery, industry and other usage. What is left is, as he correctly says, is "implied bar demand". The flaw is he adds all of this to China's reserves. This assumes that no private investors get any gold bars at all. The fact is that some of the implied bar demand went into private hands and if you consider that, then his 2710 tonne figure would be lower.

Next week I will have a post out on what I think China's government controlled holdings of gold are, and how much is held privately within China. I'll work on seeing if I can get a Chinese website to misinterpret my article into a fact to help it go viral.

29 January 2014

The story behind JPM's 10 tonne gold withdrawals

What is JPM up to? A detailed look at the movements in an out of their eligible stock indicates they, or a client, is stockpiling/parking kilobars in a Comex warehouse for later withdrawal, possibly to do with Chinese new year.

Back in October, TF Metals Report noticed some "round number" Comex movements in multiple of exactly one tonne. At the time I noted that 3 kilo bars are acceptable for delivery against a Comex contract and speculated that:

"if we see 99.5 bars going into COMEX then it may be an indicator that Asian demand has eased. Maybe JPM had commitments with refiners to buy their output for a period of time, and if Asian demand had eased then they may have just asked their refineries to make 99.5 (for all we know maybe those deliveries were 99.99 kilo bars) and they are just parking them in their COMEX warehouse, waiting for Asian demand to return ... if there are movements of round ounce tonne lots, indicative of kilo bars, out of the warehouses then it may be an advance bullish signal of Asian demand returning."

Given these two large recent withdrawals, I decided to have a look at all tonne type movements in and out of JPMs eligible stock over the past two years. The first list shows the recent movements, which started in October with eight receipts totalling 20 tonnes. Coincidence that exactly 20 tonnes is then withdrawn a few days before Chinese new year on the 31st? I don't think so.

18 Oct 13 Received 6 tonnes
21 Oct 13 Received 3 tonnes
23 Oct 13 Received 1 tonne
11 Dec 13 Received 2 tonnes
12 Dec 13 Received 2 tonnes
13 Dec 13 Received 2 tonnes
16 Dec 13 Received 2 tonnes
17 Dec 13 Received 2 tonnes
24 Jan 14 Withdrawn 10 tonnes
28 Jan 14 Withdrawn 10 tonnes

The other explanation to my initial one is that JPM contracted to sell 20 tonnes to an Asian client way back in October, hedged that on Comex and then accumulated kilobars over the next 4 months from refineries. That is, the 20 tonnes that was being accumulated was already spoken for. Either way, the two 10 tonnes withdrawals do not look like they were unplanned or unexpected by JPM.

This isn't the first time JPM has done this. Consider this sequence of movements towards the end of 2012 - accumulating 18 tonnes, then 17 tonnes withdrawn:

27 Aug 12 Received 6 tonnes
19 Sep 12 Received 6 tonnes
09 Oct 12 Received 6 tonnes
13 Dec 12 Withdrawn 10 tonnes
18 Dec 12 Withdrawn 2 tonnes
26 Feb 13 Withdrawn 5 tonnes

Chinese new year in 2013 was 10 February, so the pattern is not as strong as 2013, but I would note that the 12 tonnes accumulated in September and October exactly equal the 12 tonnes taken out in December.

Here are some other tonne lot movements back to the beginning of 2012, which is as far back as I went in this quick analysis and that don't seem to be related, just for completeness.

06 Feb 12 Withdrawn 5 tonnes
09 Apr 12 Withdrawn 5 tonnes
12 Apr 12 Withdrawn 5 tonnes
20 Apr 12 Withdrawn 3 tonnes
29 Jun 12 Received 1 tonnes
02 Jul 12 Received 2 tonnes
07 Aug 12 Received 5 tonnes

It is clear from the above that tonne lot movements in Comex warehouses are certainly not unique - a quarter of all JPM eligible movements are in tonne lots over the past couple of years. Seems they use Comex for holding kilobar inventory on a semi-regular basis.

28 January 2014

Diversified Precious Metals Portfolio

A recent note by David Jollie of Mitsui Global Precious Metals on platinum and South African strikes (cliff notes: "any further gains to be small in scale" ie, buy rumour, sell fact) got me thinking about platinum as part of a precious metals portfolio.

I was asked about platinum on Friday in a Reuters Global Markets Forum live chat interview, and declined to give a view, saying that the Perth Mint doesn't follow platinum, as it is a small market, less liquid, and more risky and thus not something you therefore want to push on our generally conservative clients.

However, in 1994 the Perth Mint did recommend some platinum in a portfolio, producing the "Aussie Diversified Precious Metals Portfolio" which was a boxed set of
  • two 1 kilogram Kookaburra silver bullion coins
  • a 2oz Kangaroo gold bullion coin
  • a 1oz Koala platinum bullion coin
It never took off and the sets were eventually scrapped (I salvaged a plastic box, sans the coins) primarily because we charged a premium for the set (ie box) when investors could just buy the coins individually for lower cost. Anyway, the question is: how did that ratio of gold:silver:platinum perform?

Before I get to that, I would just note that our Depository clients are split into three groups. The first are those who only buy gold, the second those who only buy silver, and the third who buy both. What is interesting is almost all of those buying both gold and silver do so on a 50:50 basis by dollar value, say $10,000 worth of gold and $10,000 worth of silver. I'm not sure there is anything scientific about that allocation and probably just comes down to hedging one's bets.

So lets compare the performance of those three groups against the Aussie portfolio, using 30 Dec 1994 London Fix prices to 31 Dec 2013 (throwing in platinum for comparison):

Strategy Return
Gold Only 214%
Silver Only 302%
Platinum Only 226%
50% Gold, 50% Silver 258%
The Aussie 236%

I'd say if you're not too sure about whether gold or silver will be the better performer, the un-"modern portfolio theory" 50:50 strategy seems to have worked out. Of course, the above figures themselves are high unscientific with no real basis for the starting date beyond that was when the Aussie was launched, but hey, what do you want from a free blog? As always, do your own due diligence.

23 January 2014

Gaming the London Fix ... Seat Price

While goldbugs are focused on whether the London Fix is gamed, the industry is watching an equally interesting and delicate game around Deutsche Bank's London Fix Seat.

If you thought that the gold market was opaque, well a seat on the London Fix would have to be a totally dark market. This creates a problem for both buyer and seller as:
  1. there are no public prices for a seat
  2. neither seller or buyer want to be seen as too desperate by approaching the other party directly
  3. the buyer doesn't know how profitable a seat could be, as Fix volumes are not published
Given the above, it is not unreasonable to expect the seller and potential buyers to play some of their signalling/negotiating game via the media. However, to be fair the "sources" mentioned in various media reports could also be legitimate bystanders just speculating, we just don't know. Either way, no need for that to spoil the fun of looking at the various comments made in the media (here and here and here) over the past few days to see how the London Fix Seat price game is playing out.

In favour of the seller
  • the last time a seat was sold in 2004, it cost around 1 million pounds ($1.6 million) [anchoring high]
  • Gold traders say the benchmark still has value, helping them to hedge risk [you make money being a fix member]
  • a seat at the table is prestigious; to say that they're a fixing member carries a certain kudos [the seat carries a premium above the profit made as a market maker]
  • there could be quite a few contenders; Deutsche said it had already begun talks with other banks to sell its role [lots of buyers]
  • a logical possibility would be for another of the London Bullion Market Association's market-making members ... not currently involved in fixing - Credit Suisse, Goldman Sachs, JPMorgan, Merrill Lynch, Mitsui Precious Metals and UBS [lots of serious buyers]
  • a candidate is more likely to emerge among the Asian banks ... as these look to raise their profile in the London market ... Bank of China and Industrial and Commercial Bank of China (ICBC) are already members of the LBMA. ICBC is also about to complete the acquisition of the London commodity arm of Standard Bank [even more buyers]
  • bidders ... may also include other parties with an interest in the gold market such as refiners [a lot more buyers than you think, better rush]
  • The bank said it would ... resign its seat if it fails to do so [but if I can't find a buyer I'll walk away, I'm not desperate]
In favour of the buyer
  • Market participants said the role as a rate setter would be worth around £200,000 and had more value as a mark of status [anchoring low]
  • it's a tough sale at the moment, there's nothing really in it for the banks [there's not that much money in market making]
  • who, after the Libor scandal, will want it; increased scrutiny, with regulators pushing for new rules on commodity benchmarks after the Libor scandal, threatens to outweigh that benefit; if regulators are going to say 'well the fix doesn't work as it is, and we have to find another way of doing it', nobody is going to want to buy that seat [lots of regulatory risk]
  • it is a very old-style, archaic system and it is amazing that such a way of doing business has survived the modern day and age [Fix is old school and will probably fade away so not worth that much in the future]
  • any interested party ... would have to weigh the price carefully against shareholder value [I'm not desperate, won't overpay]
So we have a £200,000 to £1,000,000 price range with good points made on both sides. I think there is a good chance a Chinese bank will buy a seat for the prestige as it gives them the ability to differentiate themselves from their domestic competitors - Deutsche can be expect to work the status benefits point hard to new players in the bullion market or those looking to step up.

On the negative side, Deutsche Bank's biggest problem is the risk that regulators turn the fix from, as Paul Tustain says, a place where "financial trading principals [win] what traders call 'order-flow' from customers, principals (who sell gold to you)" where you can make money working your book, into a place where the holder of a Fix Seat is just an "agents (who buy gold for you)" and who can only earn the $0.20 per ounce Fix fee spread.

22 January 2014

Wealthy Chinese short sellers a source of future demand?

Koos Jansen latest piece on gold leasing and short selling within China is a must read. There seems to be two basic "gold trades" used by wealthy Chinese:

Finance business by Lease and Hedge

1. Lease gold from bank
2. Sell gold on SGE
3. Post 15% of cash from #2 as margin against long gold futures
4. Use remaining cash from #2 to fund your business
5. At end of lease, take delivery of futures and use physical to repay lease

The article says that the effective interest rate on the amount of cash left over from #4 works out at 6.7% compared to around 9% for a conventional loan.

Finance business by Lease and Short Sell

1. Lease gold from bank
2. Sell gold on SGE
3. Use cash to fund your business or other investment
4. At end of lease, buy back gold (which has hopefully fallen) and repay lease

Needless to say, the second method is highly risky and is more a combination of financing your business plus a speculative bet on gold prices. Here are some interesting quotes that give a different insight into the thinking of some wealthy Chinese that is at odds with the common view (narrative) about how Chinese view gold (which is that they are buy and hold investors):
  • "these business owners, in the background of gold’s 28% pullback in 2013, remain bearish on gold ... hope to buy back the same amount of gold to repay and get the spread when gold falls further to their targets in 2014"
  • "A business owner signed a 3-month gold lease agreement at the end of last year and sold the gold at $1300/oz. He said he would buy back and return the gold when gold fell to $1150/oz in Q1 2014 and pocket the $150/oz difference."
  • "some rich people even use the funds through gold lease to invest in high yield real estate trust products to achieve “getting something from nothing”. The spread between the yield on trust products and gold lease rate is risk free in their eyes."
While banks limit gold leasing to those legitimately involved in the gold business who need to finance their physical inventory, it appears that some gold merchants have excess physical stocks. They are therefore willing to lend this out to private investors (who put up cash margin and real estate as collateral). Alternatively, it seems people can create fake gold business to access this market.

Koos' article is similar to a trade identified by FT Alphaville in August, where "Chinese firms have been able to benefit from cheaper US interest rates by using various commodities with high value-to-density ratios, such as gold, copper, nickel and “high-tech” goods, as collateral. The deals were motivated by the fact that borrowing US dollars in this collateralised fashion was cheaper than borrowing in the domestic Chinese market."

See also this GFMS note "our information collection from various trade sources indicated that these Hong Kong export numbers have been highly inflated by growing round tripping between mainland China and Hong Kong whereby local companies used gold to engage in currency and interest rate arbitrage transactions" This would make sense in light of Koos' research that says that the same bar cannot be traded back on to the SGE - maybe a way around this is to export gold out of China and reimport as "new" gold (I have been able to confirm that bars are being exported out of China as part of this trade).

There are a number of implications from this story:
  1. How much of the gold that we have seen being imported into China is just tied up in these trades?
  2. Has this Chinese short selling impacted negatively on the gold price?
  3. When will the unwinding of these short selling deals happen?
  4. What will be the impact on the gold price when these short selling deals are unwound?
The FT Alphaville article noted that the copper collateral scheme may have raised between $35-40 billion. Gold is a lot more value dense than copper, so realistic to think that the gold collateral trade is of the same or greater size?

I would also note that exports from China to Hong Kong (the round tripping trade) really began to pick up in March 2012, when it was clear that the gold price had peaked. The quotes above indicate that some wealthy Chinese took a bearish view on gold and maybe March was when this short selling trade started to pick up. It is also interesting that this chart of Koos shows big differences developing between SGE withdrawals and all known supply in April 2013, on the price smash. Did the price smash encourage more bearish bets, which would have resulted in gold within China held by industry users being released and sold on the SGE? Maybe Koos can run this chart back a few years so we can see if this gap only developed once gold peaked.

Koos article closes with the observation that "many real estate investment products are facing default risks and on the other, gold lease arbitrage is facing the volatility of gold price. If these 2 risks occur at the same time, this seemingly risk-free arbitrage could be in fact “picking pennies in front of a bulldozer.”"

I am sure that is the majority view of Chinese and this short selling is limited to a few, but China is a big market and this trade could still be significant in terms of the global gold trade. Maybe we have just found another source of potential future demand should these Chinese short sellers come to the view that gold has bottomed.

How accurate are the LBMA gold & silver forecasts

I've got a post up on the corporate blog on the LBMA 2014 forecasts, which are predicting a pretty flat year. I was a bit underwhelmed by them, so I went back to 2007 and graphed their forecast against the actual yearly average to see how accurate the contributors, as a group, were. Unfortunately they are pretty good, but I'm hoping for another repeat of their poor 2013 effort. Make up your own mind whether you want to pay attention to them for 2014.

21 January 2014

The Bundesbank & the Narrative of Central Bank Omnipotence

My post yesterday on the German gold repatriation got a lot of comments pro and con. GATA picked up on my post and said that I didn't seem to think that the secrecy around it implied that something was wrong (central bank secrecy and transparency deserves its own post). I also got people telling me that it was easy to ship all the gold over in one go and therefore that lack of doing so was proof there was no gold. Before I address these issues, I want to explain my post from a different angle, which may help in people understanding my point.

Unfortunately, I was late catching up on Ben Hunt's latest piece, which I would have used as my intro to yesterday's post as it mentions gold specifically in relation to the trust and central banking club point I attempted to make.

Ben observes that "the meaning of gold [within the mainstream, goldbugs have their own narratives] has shifted from an alternative store of value to insurance against Central Bank policy error. ... gold prices will go up on ANY news – even deflationary news – IF that news creates a worker bee perception that the queen bees are rattled by the news. And vice versa, gold will go down on ANY news – even inflationary news – IF that news improves the perception that global central banks are large and in charge."

Ben has noted in past articles that a new narrative has established itself: the Narrative of Central Bank Omnipotence, where central bankers use "communications as a policy tool, and this is what Yellen (and Draghi and Abe and everyone else in the club) will continue to do ... use public statements to play the Common Knowledge Game and drive market outcomes by proxy."

The Bundesbank is part of this club and if they are seen as distrusting another central bank then they open up questioning of the Narrative of Central Bank Omnipotence, and doing so undermine their own power as well. I cannot see why they would want to make themselves impotent.

Now while I believe that the German central bankers have drunk their own kool-aid and trust the US, or as Ben Hunt says, they have internalised their behavior, "falling into what Kant called a 'dogmatic slumber'", in does not actually matter to explaining why they are repatriating in an excessively languid manner. Even if the Germans do not trust the US and wish to get their gold back as soon as possible and even if it is all there, they would still drag out the repatriation . The reason is because to request it all immediately questions the Narrative of Central Bank Omnipotence.

Victor The Cleaner pointed me to an exchange he and Motely Fool had with some Zero Hedge commenters (paraphrased by me) which explains it in another way:

"What possible action could the Bundesbank have taken that would invite more notice and speculation. The only other is asking for everything immediately as it would show an extreme lack of trust at international level between some of the most powerful entities that exist. To others it would imply that the Bundesbank knows something they don't and perhaps that the Bundesbank expected an imminent collapse. That would have sent others scrambling for gold that would crash the gold market (and others) immediately. Even though the Bundesbank would get every ounce from the Fed, just this action of asking will break things."

So unfortunately for those looking for proof that the US doesn't have their or others' gold, the rate of German repatriation does not provide this proof as the German central bankers would act the same way whether the gold was there or not, or whether they trusted the US or not.

Now on to some of the other questions raised.

Shipment Logistics

Those who think Germany could put 300 tonnes in a big plane or warship and move it in one or a few days have been watching too many Die Hard movies. As I noted yesterday, Venezuela took 4 months to get its 160 tonnes. Do you think Hugo trusted the central bankers? Don't you think he wanted to get his gold ASAP? That would translate to around 8 months in German's case.

Alternatively, consider that an armoured truck can carry only a couple of tonnes or so of gold. From an insurance point of view you couldn't get coverage for more than that anyway. So 300 tonnes at 2 tonnes a day equals 150 working days or 7.5 months. Certainly you could do two trips a day without attracting attention, so 4 months, just like Venezuela.

Some may argue that you could use non-secure trucks with heavy security. Even so we are talking 20 tonnes or so maximum weight carry capacity per truck. That is 15 trucks. Hard to secure a convoy like that I think - Google maps tells me that the trip from the Fed to JKF is 20 miles and 30 minutes. OK, so we will shut down 20 miles of roads in busy New York for this convoy with military escort. Yes that will not attract any public attention or present a Die Hard-style security risk.

However, even if this was possible, we have an additional problem. Go and watch this National Geographic documentary on the Federal Reserve, the stuff on the gold vault is at the beginning. Note the following:

1. At best they could fit two armoured trucks in their dock. No room for a big rig - are they going to forklift the gold pallets into the truck sitting out in the open on the street?
2. Look at the rabbit warren of corridors and lifts. The lift would fit only 2 tonnes of gold per go.
3. Look at the checking off process for each bar.

JohnM in the comments to yesterday's post noted that Germany's gold in the Fed "consist of 82,857 according to the report bullion stored mostly in sealed containers with 50 bars, which are kept in four separate locked safe boxes. Part of it (6183 bar) stored on open shelves, therefore in a separate vault – the so-called gold chamber."

Even if we ignore the massive amount of time it would take to just pack the open shelves gold on to pallets and then check and seal the 82,857 bars (at 15 seconds to pick up and check off each bar it would take 43 days at 8 hours a day) and ignore the fact that the Fed probably doesn't have room to store 300 x 1 tonne pallets of gold ready to ship, it would still take say 5 minutes per pallet to get "ready to ship" gold pallets out of the Fed basement and loaded on to trucks. 1500 minutes is 25 hours or 7 days. Just to load. With no breaks.

While I'd like to think the above will put an end to the idea that Germany (or anyone else) can move hundreds of tonnes of gold in a few days, I'm not hopeful, because, you know, they would have got away with it in Die Hard if it wasn't for Bruce Willis.

Now I agree that 4 months or so is a lot faster than 7 years. But as argued above, just because Germany could do it quicker, doesn't mean they would want to.

Gold Pawning

An anonymous commenter noted that "The Bundesbank also objects to this notion for another reason. It says the gold is supposed to act as an emergency buffer. In the extreme situation of a currency collapse, the bankers say that the gold bars could easily and quickly be exchanged on location for pounds or dollars to pay urgent bills."

Here the Bundesbank is talking about pawning their gold, although central bankers like to call it "swapping" as it sounds a lot more dignified. I agree with the commenter that while London and the US are major gold trading centers, for the purposes of "dollar liquidity" Germany could record an ownership change in a swap by putting book entry into the name of the US or other central bank while the gold stayed in Germany. No different to the US changing the name on Germany's gold held with them to another central bank who is "temporarily" lending Germany some cash.

If you are planning on permanently selling your gold, then yes you may need to have it in a location with a lot of trading liquidity. Even so, it is bread and butter business of bullion banks to do location swaps. But for inter central bank swaps that is not necessary (especially given the swap will be unwound in the future and the gold becomes Germany's again).

I therefore don't really see any need for any country to hold gold in trading centers if all they are looking to do is use it for swaps.


Note the un-LBMA form in which the current gold is held in at the Fed. Given the Bundesbank has argued that they need gold in the US for possible future swaps, then that assumes that they could get a swap on this non-LBMA gold. Therefore the state of the gold is not relevant to swap needs and refining/recasting of the gold into LBMA standard bars is not justified on that basis.

Nor is there a need to refine/recast as an audit/checking process. There are many non destructive tests as well as random sample bar refinings that could be performed to ensure the purity and weight of the bars.

While it would be nice to have the gold in LBMA form, that would only really matter if you were intending to sell it. Even then, bullion banks are more than happy to buy non-LBMA bars (at a discount reflecting refining cost). I can see no point in refining now when there may never be any intention to sell. The Bundesbank was happy with non-LBMA bars in the Fed all these years, why can't the non-LBMA bars happily sit in Germany's vaults?

Bar List

Carl-Ludwig Thiele, Bundesbank Board Member, said that "we have at our disposal fully documented lists of the bars, and our partner central banks send us every year confirmation not only of the bars’ existence but also of their quality."

I see no reason why this bar list could not be made public without any location or other identification information of a security risk nature. Again, a bar list of weight and purity should be sufficient for swap, LBMA or non-LBMA.

In closing I would also direct readers to the following additional points made in a Bullion Vault article:
  • Bundesbank says the program only began in the autumn because contracts had to be arranged with shipping companies and refiners
  • Employees of the Bundesbank supervised the bars' removal from the New York Fed crossing those bar numbers off the vault's inventory lists
  • Converting non-LGD bars into market-acceptable form was done in Europe
  • Bundesbank agreed to accept non-LGD gold bars into its New York Fed account in the 1960s because the run on America's gold had depleted the Federal Reserve's stockpile of Good Delivery metal and the Fed compensated the Bundesbank for both the costs incurred from the melting process and the discrepancy in the weight of the bars.

20 January 2014

Why the Bundesbank is (slowly) repatriating (some of) its gold

I'll take it as given that my readers are aware of the German gold repatriation, which was driven by the release in October 2012 of a report by the Federal Audit Office that contained criticism of the way the Bundesbank managed its overseas gold reserves. The goldbug spin on this is that it shows that Germany doesn't trust the US or the Fed.

I agree with Jim Rickards, as paraphrased by GATA, "that Germany's Bundesbank really doesn't want any of its gold returned from the Federal Reserve Bank of New York and has arranged for the return of a small part of it only as a political sop to agitation in Germany's parliament." (see this story CDU Politician Wants to Bring German Gold Home for an example of that political agitation.)

It is worth noting that "the Audit Court can only give recommendations and can't legally force the Bundesbank to act" so they could have ignored the calls for repatriation. However, as a result of the political fallout of the auditor report, the Bundesbank decided that "despite our different view of the law, the Bundesbank will, where possible, take up the audit court's suggestions".

In support of Jim's idea that it is just to pacify local domestic politics, consider this speech in New York in November 2012 by Dr Andreas Dombret (Board Member of the Bundesbank). If you read the whole thing it certainly doesn't sound like there is any distrust. Some key quotes:
  • bizarre public discussion ... on the safety of our gold deposits ... driven by irrational fears
  • conducting a “phantom debate” on the safety of our gold reserves. The arguments raised are not really convincing
  • the excellent relationship between the Bundesbank and the US Fed
  • looking back at sixty years not only of fruitful cooperation in many fields and international fora, but also of storing gold and trading via the New York Fed
  • we have never encountered the slightest problem, let alone had any doubts concerning the credibility of the Fed
  • Bill [Dudley, of the FED], I would like to thank you personally. I am also grateful for your uncomplicated cooperation in so many matters.
  • Bundesbank will remain the Fed’s trusted partner in future
  • we are confident that our gold is in safe hands with you
Some may say that this is just what is said in public, but that behind the scenes they really don't trust the US Fed. Possibly, but I think that central bankers are all of the same mindset and values, part of the same club - Andreas wants to thank his mate Bill personally. I doubt that the German central bankers put on a show to their fellow central bankers but really believe in the gold standard. In his talk, Andreas says that gold is important but that "we have to combat a crisis of confidence in the euro area. This is the task we need to concentrate on". Confidence in fiat is more important to these guys.

This then leads me on to the amount and timing of gold being repatriated. I cannot find any evidence that the rate of repatriation was at the Fed's insistence - this seems to be an assumption by goldbugs. Considering they trust their mates at the Fed, and are being forced to do it politically, my view is that the rate was decided by the Bundesbank.

As Deutsche Bank analysts said, "we believe that the slow transfer of gold ... is partly a reflection of its wish to avoid any perception of a change in confidence in the US Fed". Confidence is what is important, and confidence in the US dollar is realted to confidence in the Euro as they are both fiats.

Also, consider that the logistics and security of moving gold are complicated and expensive. As Forbes notes:

"the gold coming from the U.S. will probably have to be flown in. This will probably have to be done in 3 to 5 ton shipments, the maximum insurance companies will cover, meaning it will take between 60 and 100 flights. In 2011, Venezuela’s Hugo Chavez brought 160 tons of gold from New York to Caracas at an estimated cost of $9 million." (Note it took Venezuela 4 months to get that gold.)

Then you have the issue that most of the gold they accumulated was during the 1950s and 1960s (see Andreas' talk) so the bar would not meet current wholesale market standards. Again, the Deutsche Bank analysts: "We believe much of the gold held in NY is old, known as ‘Fed Melts’ or ‘Deep Storage’ bars and may not be acceptable as is for transaction without additional processing" and that a "secondary factor could perhaps be the reluctance to put undue strain on the gold refining sector". As a side point, if "they have no intention of selling gold" (link) then I think it is worth asking why does the gold needs to be recast to current standards?

So if you step into the shoes of a central banker, who enjoy their "independence" of politics, you can see that the audit report and the resulting political storm could be considered an annoyance and affront to their independence. They then see that there is significant cost and security risks to moving the gold so naturally there is resistance to having to concede to the demands for repatriation, the arguments for which are "not really convincing" to them.

As final proof of this reluctance ("where possible [we will] take up the audit court's suggestions"), we now have reports that they only took 5 tonnes from the US and 32 tonnes from France. Does that rate of actual repatriation sound like someone worried about their fellow central banking mates?

Should they keep their reserves in Germany? IMO all countries should. Does it make sense that the Fed doesn't allow viewings "in the interest of security and of the control process" when they allow tourists to see the vault? IMO no. Is it acceptable that the Bundesbank just trusts a custodian and accepts as an appropriate auditing process:
  • "in 2007, "following numerous enquiries," Bundesbank staff members were allowed to see the facility, but they reportedly only made it to the anteroom of the German reserves."
  • "auditors from the Bundesbank made a second visit in May 2011. This time one of the nine compartments was also opened, in which the German gold bars are densely stacked. A few were pulled out and weighed."
IMO no. But it is clear to me that their public statements and (lack of) action reflect the fact that they consider the repatriation as "irrational" rather than showing any distrust in the US or France central banks.

17 January 2014

What Bafin's König really said about precious metals manipulation

The gold blogosphere is getting all excited by this Bloomberg article on comments by the President of Germany's financial supervisor which they presented (spun?) as "possible manipulation of currency rates and prices for precious metals is worse than the Libor-rigging scandal". Some goldbugs are spinning the spin as if Germany's supervisor stated that the gold price is manipulated.

So I did something rare in the gold blogosphere and went looking for the source. Thanks to journalist Ananthalakshmi at Reuters, here is what König actually said, via Google translate:

"Another issue holding us into the new year, the fidelity: the accusations of manipulation around important reference rates. Were initially LIBOR, Euribor & Co. in focus, also allegations were later loudly in the determination of reference values ​​for currency and precious metals markets, it was not received with the right things. These allegations are particularly serious, because such reference values ​​are based - unlike LIBOR and Euribor - typically on actual transactions in liquid markets and not on estimates of the banks.

That this topic in the public beats so high waves, is understandable: It is the financial economy is dependent on the confidence of the general public that it is powerful and it makes honest work. The central reference values ​​seemed beyond doubt - and now the suspicion is in the air, they had been manipulated. Supervisors are busy, work up the past, which is far from trivial and will take some time to complete world.


Who will keep an eye on that these private control bodies are actually independent? And to check if Referenzzinsätze be determined in an honest manner such instances? I have my doubts. The markets for money market operations, foreign exchange and precious metals are decentralized. Trading takes place on a large scale rather than bilaterally and not traded on exchanges or exchange-like platforms. Private supervisory bodies may therefore observe and monitor only a relatively small part of the market.

We must therefore go a step further market transparency and market control are only possible if the countless streams are centralized in the markets concerned. One therefore would have to trade in these markets move as far as possible in a transparent and directly or indirectly state-supervised trade places. What is possible with over-the-counter derivatives should also be possible in the related spot markets."

So she just made reference to "allegations" and "suspicions" about manipulation and that these allegations are serious because these reference rates are based on actual trades, not estimates like LIBOR. Not really much new news in this.

I have noted that Bloomberg has been running pretty hard on this story, even organising academics to comment on it. It is worth noting that the allegations are around the WM/Reuters FX fixes. Hmm, nothing maybe to do with the fact that Reuters is a competitor of Bloomberg and that it has a dominant position in the FX reference rates area?

I would also note that the "supervisors are busy" and it "will take some time to complete" the work. Now where have goldbugs heard that before? That's right, the infamous CFTC silver investigation. That certainly took "some time" to complete, and how did that work out?

Certainly, the extent of the LIBOR manipulation means I would not be surprised if collusion between precious metals dealers is revealed, but the CFTC experience should caution goldbugs against counting their chickens before they are hatched. Actually, by the excited blogging and twittering on it, it may be more accurate to say they are sitting at the table with knife and fork licking their lips in anticipation of PM Manipulation Chicken for dinner. Based on past experience, they could go hungry for a long time.
PS - note the reference to decentralised precious metals markets and how the OTC spot market should be moved into state-supervised exchanges. Do you think that would just stop at the professional market and not be extended to cover your retail sales? Goldbugs may want to be careful celebrating and promoting these supervisors and their agendas as they may end up being the chicken.

16 January 2014

How to know when there is a real physical-paper disconnect developing

FastMarkets are reporting intermittent shortages of 400oz bars in London with premiums for physical delivery "as high as" $0.50 an ounce. In May 2013 I reported that

"We have heard that 99.99% purity bars are getting a sub-one dollar premium, which makes sense as they can directly melt them down and convert to kilo bars for Asia where 99.99% purity bars are getting a premium. Interestingly, we have confirmed that the bullion banks aren't paying a premium to obtain 99.99% 400oz bars (or 99.50% 400oz bars), which is not indicative of desperation for physical on their part."

I therefore put a question in to FastMarkets via Twitter to clarify if the premiums are for 9950 bars, which would be much more significant than if it was just for 9999 bars and am waiting for a reply. The detail is important here, particularly when another source quoted in the article says that "there is gold available in London."

The Perth Mint has not seen such premiums and certainly the bullion banks aren't paying a premium to acquire 400oz bars from us. A journalist at Reuters told me today that "We spoke to one of Switzerland's biggest refiners yesterday and they said that business is quiet at the moment. No mention to shortage of any form of bars." (guarantee you aren't going to hear that on KWN).

This report is a good opportunity to discuss how to know if there is a real physical-paper disconnect occurring. The key is to look at the premium above spot for wholesale metal, which is 9950 400oz bars for gold and 9990 1000oz bars for silver.

Shortage of retail forms of gold and silver, that is anything less than 400oz/1000oz, does not necessarily tell us about whether there is a real shortage, and thus price disconnect, in the wider precious metals markets. A lot of people really struggle with the concept that coin shortages may be the result of production capacity shortages, see here and here, for example. You have to rule out production issues first, which in my opinion will be hard to do as when we get some real retail demand I don't think the industry can cope, as I discussed here.

The reason premiums on wholesale forms is the indicator is because the spot price is the price for unallocated, that is, paper gold in London. That is how most trades are settled and if you want physical then a separate physical redemption instruction is issued. As such the industry works on premiums to spot for whatever form and in whatever loco (as spot gold has different prices in different locations).

The problem with this way of pricing (spot + premium, or pay me unallocated gold + $ premium for physical) is that it "hides" any physical-paper disconnect that may be occurring.

For example, say the gold price is stable at $1200 but 400oz bars start to become rare and hard to get, and the premium to acquire them reaches say, $10 an ounce. Then what will happen is dealers will be buying unallocated gold at a "spot" of $1200 and redeeming the unallocated and paying $10 premium separately. However, what will be reported by Reuters and Bloomberg data feed services (on which all the websites rely) is just $1200, not $1210.

This idea of unallocated spot + premium is heavily embedded in most of the industry. To them, loco premiums/discounts and premiums for various forms of physical are normal. They do not think about a physical-paper disconnect and initially may just see premiums on 400oz as unusual but not extraordinary. They certainly won't initially see the premium as a potential precursor to a bullion bank run and so may not consider it worthy to write or commentate about - their frame of reference is that the existing system has survived in the past and thus will continue to survive.

Unless you are in the professional market you won't see this occurring. I will endeavour to report on it if we see it, but you don't have to rely on me as there is another indicator. I would suggest keeping an eye on Bullion Vault or GoldMoney. These two services are backed by 400oz bars. If there is a real shortage of 400oz bars and thus premiums being asked, then you should see one or both of these being reported by these two services:

1. A widening of their normal buy/sell spread, or additional fee on purchases, to cover the premium they are being charged on 400oz bars.
2. They stop taking in new clients due to an inability to acquire 400oz bars.

Now some people, like Jim H, may think that I am not "really here to support me, the common man, [but] the State, who ultimately holds the key to your paycheck" and thus you can't believe what I say about shortages or premiums in the wholesale market, but I doubt anyone thinks that James Turk and GoldMoney are part of the Cartel, so I think you're safe watching them for signs of that a real physical-paper disconnect is developing. Anything else is probably rumor and hype.

15 January 2014

Use narratives, not just charts, to tell if gold's bottom may be near

To determine if gold may be bottoming, I think Ben Hunt's game theory approach to investment decisions is a useful framework to use. First, a quick summary of Ben's theory, mashing up his words from this article:

"Game theory is a methodology for understanding strategic decision making within informational constraints where each player’s decisions are made in the context of expectations regarding the other player’s decision-making process. In other words, playing the player, not the cards.

The secret of effective market game-playing is to recognize that the market game hinges on the Narrative, which is a set of public statements made by influential people about the market. These statements create Common Knowledge - what everyone knows that everyone knows."

Goldbugs have their own narratives to explain gold price movements but as I discussed in this post, what matters is the narrative that mainstream investors are hearing as that is what is driving their investment decisions and money flow (in or out of gold).

Over the past year the mainstream narrative has been that "gold is in a bear market and shows no sign of ending". The focus for this narrative was the reduction in ETF balances, with each subsequent redemption validating the thesis, acting as a negative feedback loop. On top of that you had the idea that the US economy was turning around and the associated taper talk.

For example, see this Gulf News article where it says that gold buyers (my bolding) "were put off by gold price’s sharp decline and did not want to be seen buying when there was every chance that it could drop further" or analysts falling over themselves to forecast a lower gold price bottom than the last forecast.

Recently, however, I've noticed the emergence of a different narrative, one that asks whether gold's bottom may be near. See these recent examples:

Now this narrative is not bullish and more cautious but that in itself is significant because it is the precursor to more bullish narratives. It also gives confidence to smart money to start to get into the market, as we can see from that Gulf News article where it notes that "with gold prices seeming to have settled in at the $1,200 an ounce mark, buyers are heading back to the shops."

I would also note Rick Rule's recent observation that "it appears big money is circling the physical sector as well. The money has not yet ‘landed,’ but it is important to know what might happen to those markets if the ‘big money’ begins to settle. We believe it would not take much demand for physical delivery on the futures exchanges to create a very unsettling experience for the large institutions that are short the trade."

When the gold price bottomed at $250, there was talk of it going to $200 or below, which was mine cost at that time. It never got there because the smart money realised that at those prices gold miners would start to close and the supply reduction would push prices up. I believe they started to buy ahead of that, and those actions provided support and the basis of a new narrative for gold.

We could be seeing the same dynamic in play today. I'd suggest keeping an eye on the mainstream narrative around gold, just as much as the charts, if you want to work out if gold is bottoming.

14 January 2014

Why Gold Can Never Be In A Bubble

I have a post up on the corporate blog discussing a Harvard Business Review blog which attempts to get to the bottom of what constitutes a bubble.

If a bubble is when price exceeds an asset’s fundamental value, and according to people like Barry Ritholtz gold doesn’t have a fundamental value, then its price doesn’t have anything to exceed and hence it can never be in a bubble.

That is a bit of a flippant argument and and click baitish, but it was an intro in a quote by Eugene Fama from the HBR blog that I was more interested in:

“During the dot-com era … the high prices of startups like Amazon.com and Pets.com could be justified as rational gambles in the face of great uncertainty. It wasn’t crazy to think that a couple of these companies might end up as big and as profitable as Microsoft, and since it was hard to tell which ones it would be, high prices across the board made some sense.”

Isn't gold just a “rational gamble in the face of great uncertainty” about whether a country (or the world) can get itself out of its financial mess without unintended inflation or some other economic blow up?

Therefore arguing that gold is in a bubble is just arguing that people are paying too much for the insurance against uncertainty as they see it. That IMO is just a judgment call and who can claim they know their judgment is right and another’s is not?

13 January 2014

Gaming futures and stocks

A short note on this FT Alphaville article on a 1921 (US) Federal Trade Commission report on the grain trade. I think it is a must read follow up to my post on Comex stocks. This is the money quote:

"Private elevator companies with houses that are “regular” under exchange rules are often in position to influence the course of the futures market through their control of a large quantity of deliverable grain. A large elevator, or a group of elevators, may make heavy deliveries on the first day of a delivery month with a view to such manipulation. By this manoeuvre, long buyers of futures who do not wish to bother with the cash grain will be impelled to sell hastily, thus depressing the current-delivery future price relatively to the price for the next delivery of futures.

The elevators will then by able to transfer their open hedges to the next delivery on the basis of a profitable spread between the two options, buying in the current option and selling the next option. They may also be able to buy back the cash grain at a sufficiently depressed price to give them a larger carrying charge. Similarly, if the elevators withhold delivery on a large block of open future sales until the end of the delivery month, smaller traders may become apprehensive and start selling for fear of a reaction when delivery is made. A large elevator company is usually on the alert for opportunities to make profits by spreading between options, and is sometimes in position to make such opportunities. The elevators with large stocks of grain hedged and storage available for additional supplies have advantages over speculators not so equipped; and if such elevators operate together they may sometimes control the local situation."

Now grain and gold are different markets (grain doesn't have 60+ years above ground stock) but it is just another caveat on interpretation of visible data sources and ignoring what may be occurring off market or in OTC market.

10 January 2014

Coin shortages and rationing are in our future

The extraordinary demand for precious metals coins following the 2008 global financial crisis caught the minting industry by surprise, resulting in never before seen coin rationing and shortages.

It seems not much has changed, with recent reports that the UK Royal Mint ran out of 2014 Sovereign gold coins due to "exceptional demand", as well as the continuation for over one year of an allocation program first put into place early 2013 by the US Mint on its ever popular silver Eagle bullion coins.

While these recent events have been limited to specific coins, with availability of other leading bullion coins like the Perth Mint’s gold Kangaroo not affected, it does seem to indicate that worldwide minting production capacity is still unable to meet demand surges. I have been talking about this issue for some time, as in this July 2012 interview and here.

The 2008 global financial crisis did result in private and public mints expanding their production capacity. The Perth Mint, for example, has spent over $50m since 2008 on improvements to existing machinery as well as new and expanded facilities.

However, it is little appreciated that the bottleneck in the global coin minting process is blank (planchet) manufacture. This is a far more complex process than simple stamping of a coin, particularly around purity and accurate weight control. As a result, blank manufacture is a process that benefits from economies of scale and thus few mints these days make their own blanks, outsourcing the process to a limited number of private and public suppliers, of which the Perth Mint is one.

If you dig deep, you will find that many of the coin supply problems come from underestimation of demand and the resulting exhausting of blank inventories. Often, blank suppliers are mints themselves and can face conflicts where they earn more by prioritising blanks for internal use rather than supply externally. Running higher blank inventories is often not an option, due to the cost of funding the high dollar value of the inventory.

To get an idea of how high coin premiums can go when coin demand overwhelms production capacity, consider this chart from Nick at www.sharelynx.com

The 2008 premiums were celebrated by some at that time as a proof of a physical-paper price disconnect and a "good thing". The fact is that there was plenty of supply of the raw gold or silver (the Perth Mint at one stage was shipping in 20 tonnes of silver each week for weeks on end from London with no problems). High premiums are actually not a good thing, because it means that the same money buys (and takes off the market) less ounces.
Notwithstanding the capacity expansion by blank suppliers over the past five years, in my opinion there is no way the industry can meet the demand that would occur were precious metals to see even a small bit of interest from the mass market. While cast bars are a lot easier to make and refiners have much more casting production capacity, I am not even sure if it could meet sustained mass market demand.

For now 2008 style shortages and rationing don't seem to be on the horizon but the fact that the UK and US Mint are having supply issues on a few of their product with metal prices at these low levels is an idicator that as prices rise and (re)attract investor interest, shortages and rationing may become a reality of coin buying life again.

09 January 2014

Are increased Indian scrap levels actually smuggled gold?

This theory was emailed to me by a reader and I thought it worthy of a wider audience. The chart below shows the WGC's estimates of supply of scrap inside India. Note the sudden increase in the third quater of 2013, which is significantly above the usual amount.

The last time this amount of scrap came into the market was in Q1 2009. The WGC explained at the time this way:

"When the gold price initially spiked in late 2008/early 2009, the local media were talking of a sizeable correction (not just in rupee terms, but also in $US terms). This is a key reason why recycling activity was so strong at that time - local scrap dealers reported queues stretching for blocks. The magnitude of this selling back reflected a belief that the jewellery could be repurchased at more attractive price levels at a later date."

With the gold price at lows, and gold hard to to get in India, I can't see there being a similar motivation for Indian's to sell their gold this time. Therefore my readers theory is that:

"Indian Jewelers will not want the Indian Government to think their gold import tax policy is not working. Thus, gold purchased from smugglers will be increasingly reported by jewelers as Scrap/Recycled and they will report record demand of Indians turning in their old jewelry to be updated to new, fashionable designs."
I find this explanation compelling, considering that a jeweller acquiring smuggled gold needs a cover story to explain how they got that gold, and claiming it was scrap is a good (and unverifiable) way to do that.
I will be interesting to see the amount of Indian scrap the WGC reports in their Q4 2013 Demand Trends report when it comes out in a couple of months.

08 January 2014

In the land of the goldbugs who choose to be blind, the one-eyed blogger is king

I have a post up on the corporate blog about Comex stocks coverage (owners per ounce) talking about yet another example of the one-eyedness (a mind not open to all the data and varying interpretations) I discussed in yesterday's post. The post is a rework/expansion on this personal blog post on Comex stocks.

The interesting thing to me about those bloggers who have been using Nick Laird's owners per ounce charts for registered gold and its current 80:1 ratio is that to get to that chart you have to scroll past the chart for total gold stock and its 5:1 ratio. In other words you have to wilfully ignore the 5:1 ratio and the big difference between this and the 80:1 ratio.

Now I can admit that maybe such bloggers disagree with my views that you have to look at both eligible and registered stocks (although I fail to see how when there is over 5 million ounces of conversion volume between the two categories during 2013) in assessing the likelihood of a Comex default or shortage of gold, but surely anyone who isn't one-eyed would want to at least discuss/explain the 80:1 and 5:1 discrepancy to their readers?

For those who like to use both of their eyes, consider these points from the corporate post:

1. people only keep metal in a Comex deliverable form and in Comex warehouses because they are expecting to sell it back in the futures (if they took it off eligible there would be costs to get it accepted back as eligible) and they will sell it if the price is right

2. sellers may try and "hide" their intention to sell by holding eligible (making it look like gold is not available for delivery and thus get the price bid up) then at the last minute instantly change their gold to registered status

3. Silver Doctor's theory that “the owners [or eligible] would likely be strong-armed or forced into converting their eligible supplies into registered should things become desperate for the cartel

4. 2.6 million ounces (80 tonnes) was converted from eligible to registered, indicative of point 2

5. 3.2 million ounces (100 tonnes) was converted from registered to eligible, indicative of strong hand longs standing for delivery?

With some points from this post:

5. you can deliver 3 kilo bars against a Comex futures contract (note there is a cash adjustment for any over/under ounces as the result of delivery of odd weight 100oz bars or kilo bars against a futures contract)

6. BBs have been proven to deliver tonnes of kilo bars into Comex warehouses, this could indicate weak markets where they park metal until demand returns (see here: " the owner may simply want to vault their metal securely, before using it to meet demand elsewhere – for manufacturing, or from investors in another marketplace, such as Asia")

7. consequently, movements of round ounce tonne lots, indicative of kilo bars, out of the warehouses may be an advance bullish signal of Asian demand returning

And this interesting story from Martin Armstrong:

8. "To create the fundamental, they moved inventory from New York to London. They were manipulating silver as always. Playing games with the inventories. They were moving silver from New York to London where the Buffett orders were being executed. This made the US warehouse inventories drop sharply." to give the impression of a shortage of silver

And finish with this interesting point made to me in an email by a Mr D:

9. A BB is only legally obliged to deliver from registered stock. Failure to deliver eligible gold wouldn’t be a default. So this eligible gold could be safely used as the basis for a lot of transactions outside Comex that are completely opaque while it the gold remains on show to the Comex punters

I think all the above makes a strong case for looking at the total Comex stocks (both eligible and registered). I personally think the Martin Armstrong story is the most telling. By focusing on the 80:1 ratio bloggers may well be (hopefully innocently) helping those playing games with reported warehouse stocks.
I'd like to think that after this gold bear market the eligible stocks are now mostly held by strong hands rather than just being BB inventories, and thus a squeeze is in play, but I'm keeping my mind (and both eyes) open to the fact that the figures may be gamed. I hope you also choose to not be blind.

07 January 2014

The secret gold demand indicator

In yesterday's post I had a footnote on reports that Perth Mint sales were up 41%. That figure got a lot of coverage and was taken as a general positive statement on gold demand. However the figure is only part of the story and highlights a deficiency in understanding demand in the gold market.

To restate, the figures reported were just in respect of our minted coins and minted bar sales. These represent at best 10% of the volume of gold we sell each year. As such, the 750koz we sold of minted products can only be taken as an indicator of positive retail demand.

The follow up question that Kid Dynamite asked me was how much of a percentage increase did we have on the remaining 90%, the majority of which is sold in tonne lots as kilobars into the Asian markets.

Now I bet most people would expect me to report some similar large percentage increase, given all the coverage of how much gold is imported into China and traded on the SGE. Unfortunately we don't reveal those hard figures but I can tell you that circa it was not up or down by much. Why?

The reason is that the Perth Mint sells pretty much the same amount of gold each year, because the mines that refine with us mine it at a pretty consistent rate. Now we also refine scrap, which changes a lot in response to price, so our total throughput (and the resulting "sales" of the refined gold) does change.

But, can we really consider sales of gold from scrap sources as "demand", when there was obviously a seller dishoarding it at the other end. That is surely a wash, is it not? But also, doesn't that logic apply to the sales of gold from newly mined sources, as there is a miner selling (supplying) on the other side of the demand?

For example, would it make sense to say that demand was up for Apple stock today because more shares (volume) were traded today compared to yesterday? Of course not, as the total number of Apple shares is the same and all that has happened is that ownership of those shares has changed hands. Volume is certainly a useful metric, but it doesn't tell you about demand.

Since all the gold that has been mined still exists, gold is like a company stock - it is just the ownership that is changing. Some may argue that newly mined gold adds to this stock, so this is the demand. But the problem with that is that mine production is relatively consistent. Saying that newly mined gold = demand would just have you reporting demand of 1-2% every year. That is not useful.

My point is that for every buyer (demand), there is a seller (supply), so just reporting a volume sold figure doesn't actually tell us if demand is "up". Selective reporting of one segment of the gold market that "sales in ounces of X are up" is just PR spin, or narrative building. It is not actually telling you if demand is up or down at all.

So how can we determine the state of gold demand? The only real way is to look at the intraday order book listing the volume for all bids and offers in the market and observing whether there were more bids (buyers) or offers (sellers). But I've rarely seen journalists or bloggers refer to this when they say demand is up or down. Reason is it is hard to get and analyse such data.

Plus you have the problem with the gold market that most of the trading is not done on exchanges, so you don't know the depth of the bids or offers on gold around the world. So how can we work out if demand for gold is up or down?

Well there is another shortcut measure to get around this problem and tell us what is going on with gold demand. I will now reveal this secret indicator. It is secret because right now I don't see many goldbugs using it at all.

This is how it works. If you have more people bidding to buy than there are people offering to sell, then the gold price will go up. This indicates more demand (buying power). And if there are more sellers than buyers bidding, the price will go down and indicate less demand.

Excuse the sarcasm, but price tells you about demand vs supply. Of course the permabull goldbugs cannot accept this because the gold price has been falling and that is a negative. They can only deal in positives (as you aren't going to sell a newsletter or coins with negatives) so they ignore price (except when it is going up) and construct a narrative on the basis of selective information.

The gold price is down because demand is down. Get over it. I own gold but do you see me crying about it? If you are so insecure about your gold investment and the reasons why you bought it that you can't accept the negative price action and look for reassuring bedtime stories about how demand for gold is great even though the price is going down then you shouldn't be in gold in the first place.

Gold is a tough, opaque and volatile market. Whether you are holding gold as insurance or a trade, it therefore requires an mind open to all the data and varying interpretations and some adult maturity, otherwise those just looking for positive data and cognitive bias will get screwed. Time to man up, or woman up, and stop acting like a baby.

06 January 2014

Reinhart and Rogoff: 1933 US gold reprice was a debt default

In this IMF Working Paper by Reinhart and Rogoff "Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten" they state that

"... the United States had already defaulted on its sovereign debt in April 1933 to domestic and external creditors alike. The abrogation of the gold clause in conjunction with a subsequent 40 percent reduction in the gold content of the U.S. dollar (January 1934) also amounted to a debt haircut amounting to about 16 percent of GDP."

Nice to see mainstream economists calling a spade a spade and a handy link to use next time someone says the US never defaulted on its debt (links from goldbug sites don't count, we are all biased you know).

The rest of the paper is a depressing read, with Reinhart and Rogoff concluding that a "mix of austerity, forbearance and growth" will not get advanced economies out of their debt overhangs and that they will have to "resort to the standard toolkit of emerging markets, including debt restructurings and conversions, higher inflation, capital controls and other forms of financial repression."

While this is all stuff gold followers are aware of, it is the continued appearance of this financial repression narrative and related bail in and other talk in mainstream circles that I think is more important. As it becomes accepted wisdom that this the path we are on, then we will see money move into gold. However, while the mainstream continue to believe that we don't have a big debt overhang and with a bit of taper here and there it will all end up peachy pie, we are going to see gold languish.

PS, if my mum saw the reports of Perth Mint sales up 41%, then no doubt you have as well. Just some caveats: the figures reported are just our minted coins and minted bar sales, and do not include volumes from our Depository business or cast bars (ie kilobars) sold into China etc. They thus represent less than 10% of the metal we refine and is more of an indicator of retail demand. Having said that, we are currently achieving solid premiums on kilobars ahead of the Chinese New Year.