Harvey Organ: Get Physical Gold & Silver!

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S Roche,

The similar time line of Venezuala repatriating gold and the spike in the gold price around August of 2011 is something I am focused on

In order to verify whether this idea is plausible, we can take a look at GOFO

http://www.lbma.org.uk/pages/?page_id=55&title=gold_forwards&show=2011

GOFO is the interest rate on an unsecured US$ loan minus the gold lease rate. If GOFO is positive and grows with the term of the swap, the market is in contango. In general (US$ interest rates being fixed), a large and growing contango indicates that the gold price rise is driven by paper gold buying. A small and shrinking contango or even backwardation indicates a shortage of bank reserves, i.e. that these banks start borrowing gold. During the summer 2011, the market had a healthy contango, and so I don’t think Chavez’ action made any difference.

Secondly, I would be surprised if he had unallocated gold with a bullion bank. He most likely held allocated gold with the Bank of England or with the BIS, and this would have always been outside the bullion market.

I have a second comment on the idea that Chavez’ had anything to do with rising prices: "The price action determines the news" rather than "the news determine the price action". By this I mean that depending on the price action, people tend to take those news items more seriously that seem to confirm the price action whereas they tend to ignore or discard other news items that seem to contradict the price action.

I suppose had Chavez repatriated his gold in December 2011, nobody would have made any big fuzz about it.

For instance, do you remember the explicit leak that the BIS was buying gold in early March this year? There is hardly anything more bullish for gold (physical that is). But this happened during a phase of declining prices, and so everyone remembers Chavez, but nobody remembers the BIS (although the latter can easily grab several 100 tonnes of physical without blinking).

I happen to think that those who hold their gold in unallocated accounts, (the most common form surprisingly, according to LPMC Ltd), would learn their lesson and be somewhat anxious to take delivery of their replacement purchases.

A lot of the unallocated gold has its origin in various gold-related financial products that are offered by all sorts of banks. Rather then buying gold in order to hedge their exposure, they just hold an unallocated balance with one of the bullion banks. Their customers don’t even have the option of allocation. If they want to switch to physical gold, they need to sell their financial product first, then take the cash to the coin store and get their physical gold.

Finally, many who hold unallocated gold OTC do so on margin. So in a liquidity crisis they may have to sell because their bank or broker cuts the credit lines, or they get stopped out when prices decline.

Again, there are a number of reasons for why the short squeeze that is promised by the gold bugs may never materialize (although the market may well break one day).

Sincerely,

Victor

 

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I think bbacq hit the nail on the head when he observed that it’s hard to have a meaningful conversation about how a bullion bank "run" might go down unless you first agree on what preconditions would cause such a run. I would carry that thought a step farther, and opine that predicting how the end game goes down involves so many variables that it’s impossible to make meaningful predictions.
Taken in isolation, the concept of levered futures longs having to SELL a lot of notional value of paper contracts in order to raise cash to BUY a much smaller amount of physical bullion seems to make sense. But it begs the question as to what caused the futures longs to suddenly make this change of strategy, and most of the plausible scenarios I can think of involve a situation where a panic is going on and a whole lot of money not previously in the PM market is buying, causing far more upward pressure than the liquidations of leveraged futures are causing to the downside.

In theory, the option of standing for delivery and the buffer of inventory held by the exchange guarantees that "the paper price decoupling from the physical price" is impossible. But that theory only holds so long as the system continues to function as designed. In times of great crisis, governments can usually be counted upon to do the stupidest things possible, as with the short selling bans in 2008, which appear to have been imposed by regulators who literally didn’t even comprehend their implications on the options market. I would argue that in a crisis so bad that everyone is rushing toward the bottom of Exeter’s pyramid, all bets are off. Not only would the enforcibility of paper contracts be up for re-interpretation, but it’s entirely possible that governments could simply decree that all the physical metal in all the vaults is "temporarily seized", until the government can figure out how to "serve the common good", which is a euphamism for changing the rules retroactively to serve the interests of the people with the most power and influence.

The conclusion all this brings me back to is that there literally is no good place to store your gold. I’m dumbfounded to see how many seem to hold the opinion that "Because I paid a big premium to buy PHYS, and it is a PHYSICAL gold trust, I am covered no matter what"! This is ludicrous, because Sprott’s vault is just as vulnerable as COMEX or LBMA’s vaults to "emergency" government action that changes the rules retroactively.

I am strongly of the opinion that holding any significant amount of bullion in one’s home is very, very foolish. Someone will eventually figure out you have it, and they will come kill you and your family to take your gold. Not worth the risk for any amount of wealth. Most pundits used to opine that allocated bullion bank accounts were the best solution, but I think MF Global makes it clear that the rules can and will be changed retroactively, and that such changes will not necessarily be equitable. Safe deposit boxes and private vaulting facilities are obvious targets for seizure if push ever come to shove. In short, I don’t think there is any ideal place to store bullion. Jurisdictional diversification across several allocated accounts seems to be the best option for large holdings, but still doesn’t offer a panacea.

Best,

Erik

p.s. bbacq - you have made several references to tfmetals. Are you the same person who writes under the "Turd Furguson" pseudonym there, or are you someone else who frequents that site?

 

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But, Victor[quote=victorthecleaner]
I am not sure this is realistic. They will see the quoted paper price of gold crash, as Michael H says. Why catch a falling knife, as the investment people say? The problem is that the market may die while it is down and before all these potential new longs get in.
Again, I urge everyone to take this warning seriously. If you just listen to the usual goldbug propaganda and expect a short sequeeze and a rising paper price (in order to make a nice profit in US$), you may be waiting for something that might never happen. Rather, the paper price may crash, most retail investors will be confused and sell or will be forced out of their ETFs.[/quote]
I do not think that governments will act preemtively and bring down paper markets tomorow. More likely, as is characteristic to this crisis, they will drag it out until the last moment. That, minus Your broker going bust, will allow to take paper profits going long on PMs as of now when next QE’s are immininet and actual since  jobs report has set a firm floor for paper PMs in USD,and convert into physical or , pay of debts or spend paper as You wish to purchase assets or whatever  etc for at least 1-2 years , which is better than nothing for many people. The partial default of US debt probably will come first, and that is not far away (2015?) since it grows and wil grow superexponentially with failing economy and growing deficits, and must crash (i.e US debt amount will be reduced in USD by at least 20-30% in very short period of time- <1 year)-which I call partial default, but NOT by debasing currency- by not rolling over, not repaying.
So in between  government closing PM paper markets and checking on populations physical gold there will be long enough time where they will solve the issue with propaganda, since the event of destroying paper PM markets will mean immedeate panic buying of physical and  can destroy the USD vs other commodities as well in the same day. Which is no in the USA interests, I guess, or , may be I am wrong. Would be interesting to hear Your thoughts about the US elite interests short term and longer term. Short term ( 1-2 years) especially.
I also doubt the USA will suceed in bringing down USD fast enough to avoid recession and   default. Which means USD as commodity-reserve currency-will enjoy a period of higher value (again 1-2 years)-against other currencies, not PMs-  as those owning USD tries to get rid of it without creating panic and reserve value drop.
Ivars

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[quote=Erik T.]This is ludicrous, because Sprott’s vault is just as vulnerable as COMEX or LBMA’s vaults to "emergency" government action that changes the rules retroactively. [/quote]The rebuttable presumption being that that Canada would confiscate gold along w the US and UK. I doubt this is a given, don’t think there is any historical precedent. A global agreement to confiscate wouldn’t seem to be perceived as being in the best interest of all nations.
Would like to hear any reasoned opinion on the matter.

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So rather than further discussions of a theoretical nature, I’d be curious to know how the various parties here (Erik T, victorthecleaner, S Roche, bronsuchecki, etc.) are positioning their personal assets (including but not limited to PMs) to best weather the storm.  This site focuses on practical, actionable information so some commentary from that perspective would be most appreciated. 
Also, this question has been posed repeatedly previously but has been conspicuously skirted.  Do the more knowledgeable commenters who have decried Harvey Organ, Ted Butler, and others as charlatans also feel that individuals such as Jim Sinclair and David Morgan are charlatans as well?

Thank you for an interesting and thought provoking discussion…

 

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Now we are starting to get into something interesting. On my to do list is a paper on a bullion bank run or how a paper/physical price divergence would play and this discussion has provided some good material. Problem is that I see that paper being at least 100 pages long, primarily because there are a multitude of actors in the bullion market with different motivations and how each reacts to some trigger event (or no event at all, just a slow melt) and react to each other’s actions is complex to say the least.
I’ll provide some more comment later tonight because now I have to spend time with my partner going "shopping" and she doesn’t see this as more important (crazy huh) but a few points:

  • standard unallocated agreement with a bullion bank has no obligation for conversion into physical and is thus in push come to shove a cash settlement, with that cash settlement likely to be based on the London Fix
  • in a slow melt (no dramatic trigger event) where it is not clear to pro market participants and central banks that a run is developing, bullion banks will meet physical redemption demands (reserve drain) by leasing from central banks.
  • even in a trigger event/obvious bank run, central banks may still lease their reserves to a bullion bank to avoid a gold run triggered bankrupty of that bank
  • with miner hedge book basically zero there is possibly plenty of central bank metal ready to be leased (very low lease rate tells you that) I think it is foolish to assume that huge amounts of central bank metal is leased and thus no capacity there
  • note also that central banks tend to lease on longer terms while demand (futures & forwards, ie leveraged speculation demand) is shorter term in duration. That is, bullion banking has an inverted maturity transformation compared to normal banking (which is borrow short, lend long). Borrowing long, lending short means bullion banks may not have the same some of pressure in a run as cash banking. However, the at call nature of unallocated does mean a fair bit of short term stuff on the books most likely matched in part by longerish lending (backing forwards and futures).
  • ten years ago unallocated accounts with bullion banks were free of charges. a few years ago they started to charge for them. Rates are very low, but they do result in some cost of holding unallocated. Question is why. Leave you with that to think about.
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[quote=ao]how the various parties here (Erik T, victorthecleaner, S Roche, bronsuchecki, etc.) are positioning their personal assets (including but not limited to PMs) to best weather the storm.[/quote]Re precious metals my personal position is not of much use because I work for a mint and thus have immediate access to information about physical flows and behaviour of our Depository clients as well as probably potential regulatory changes (or the Govt may not consult us first and just change) which means I can act right at the last minute to protect myself. I think Erik’s advice is best, which is to diversify.

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Quite interesting indeed, and I strongly encourage you to write that paper, Bron. Something that I’m coming to realize is that "debunking" the people who are promulgating factually inaccurate information and ill-conceived theories does no good - everyone knows that there are very real systemic risks, and the investor appetite for detailed analysis and commentary about them couldn’t be stronger. Pointing out that the information now circulating on the net is BS isn’t sufficient. Nothing could be better for the PM investment community than for people who are actually qualified to do so to start writing significant papers giving reasoned, well-researched perspectives on the same subject matter about which misinformation is now circulating.

Perhaps you can clear something up for us when you write again later. A very common goldbug argument is that if a bullion bank leases gold from a central bank and then uses that gold to deliver on an obligation to Investor "A", this is a travesty of justice because the same gold is now "owned" (i.e. double-counted) by both the central bank and Investor "A". The goldbugs would have us believe that Investor "A" doesn’t really get clear title to that gold, because it is still owned by the central bank that leased it to the bullion bank.
My guess is that the "lease" agreement between the central bank and the bullion bank relies on the fungibility of gold, and calls for the bullion bank to repay the loan with an equal amount of gold, but not necessarily the same gold. Assuming this is true, it appears at first that the goldbug argument is nonsense - and that the central bank has no ownership claim on the specific bullion Investor "A" received. First, Bron, can you clarify that understanding? It is admittedly a guess on my part.
But even assuming my guess is correct, there does appear to be an interesting theoretical question of property law here. Presumably, the bullion bank’s obligation to Investor "A" is to deliver "unencumbered" bullion - in other words, free and clear title. To my own admittedly limited understanding of property law, you can’t convey free and clear title to someone else unless you first own whatever is being conveyed free and clear yourself. If the bullion being delivered to Investor "A" was obtained from a lease, setting aside any fungibility provisions for repayment in that lease, the question remains: where and when did the bullion bank obtain free and clear title to the gold before it was delivered to Investor "A"? Any ideas on this one?
Erik

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Hi ao,
It’s great to see you here. I’m afraid we disagree on the question of what’s most interesting and appropriate. This thread began in reaction to an interview with someone who made numerous assertions - many quite damning and controversial - about the bullion markets, but without any factual or logical backup whatsoever to support those assertions. It has evolved into a discussion of the many fallacious manipulation theories (not only from Harvey but also GATA, Ted Butler, Andrew Maguire, etc.), and most importantly, a level-headed conversation about how these markets REALLY work, and thus why some of those theories are nonsense. In other words, I think the discussion is and should be about what the real facts are in cases where others have promulgated factually inaccurate theories. I find this "theoretical" discussion to be entirely appropriate to this thread, and I have particularly enjoyed Bron, Victor and Jeff’s detailed technical contributions. There are plenty of other discussion threads on this site about what to invest in, and to be honest I find that aspect of your question to be off topic.

"Conspicuously skirted" is an interesting viewpoint. When it was originally posed, I perceived that question as rhetorical sarcasm, and I ignored it because I thought it was both off-topic and irrelevant to this discussion. Solely out of deference and respect for your tenure and contributions as a veteran member of this site, ao, I’ll be happy to answer it for you, despite the fact that I still consider it OT and irrelevant.
I’m not going to use the "C-word" in this thread any more, because so many people seem inclined to read meaning into it that I never intended. So going back to my original point, it is my personal opinion that GATA, Ted Butler, Andrew Maguire, and Harvey Organ, despite probably having the best of intentions, are people who simply do not posess the expert-level knowledge of these markets that they profess to have. I base that opinion on having reviewed their arguments, and finding that their conclusions appear in many cases to be based on a shockingly poor underestanding of basic concepts. The price discovery thing and the 100:1 "leverage" argument are perfect examples. It is always possible that it is I who have misunderstood their arguments, and I could be wrong in concluding that their writings are nothing more than a case of shocking ignorance of the basics being repackaged and sold as "Expert" commentary. It is for that reason that I have repeatedly invited anyone here to explain what the paper-to-physical ratio has to do with leverage, or how Ted’s Price Discovery argument could possibly be anything more than Ted not comprehending the meaning of the phrase price discovery as used in economics. So that’s my contention about these people - that they claim to be experts but critical analysis of their work reveals that they simply don’t have a clue what they are talking about.
In the case of Jim Sinclair and Dave Morgan, I am not aware of either of those individuals making any representations of an "expert" nature that were later disproven or shown to evidence that they didn’t know what they were talking about. I do think of Jim Sinclair as something of a PM permabull, and I don’t always agree with him. But I don’t think of him in the same category as the others I’ve mentioned.
I feel compelled to emphasize again that I see the question itself as completely irrelevant. What’s important here is to understand why a lot of the well-known and widely accepted theories about PM market manipulation are simply not credible.

Again, I see this as off-topic. My own interest in participating in this thread is to discuss the veracity of various PM manipulation theories, as I feel some passion for debunking the misinformation that exists in the blogosphere. But since you asked, I’ll be happy to answer.
My core positions are gold and crude oil. I often speculate in markets as well, sometimes with leverage, but at the moment I have almost no trades on other than core positions. I think we’re in a very hard-to-call phase here because (a) there are HUGE macro risks on the horizon suggesting great caution and downside risk, but (b) it’s an election year and the incentive for the Obama administration to do anything possible to keep the economy propped up thru November is enormous. If not for (b) I would be short the SPX as a hedge against an equal or larger notional exposure to gold. I am out of silver for now because I think the "industrial metal" side of silver’s dual personality is at risk when we experience the deflationary event I expect will come after the election and the realization of higher tax rates Jan 1st. I’m also working on re-engineering my Peak Oil trading strategy to focus on equities rather than crude oil futures. I continue to believe that the commodity price is the better way to play peak oil, but in the wake of the MF Global debacle I’m losing faith in the futures market rapidly.
All the best,
Erik

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I covered this issue in respect of ETFs and claims that the allocated metal they hold could be encumbred in this post over a year and a half ago Gold Chat: GLD, leasing and encumbrances quote:

In my experience most lease transactions are done in terms of unallocated account credits. In this case the lender has lent unallocated and if the Authorized Participant subsequently allocates this unallocated metal there is no direct link between the loan and the physical. The lender has an unsecured exposure to the Authorized Participant under the terms of the original lease. There is simply no legal link to what the Authorized Participant did with that leased unallocated gold. In the case of lenders supplying actual physical bars (usually only be Central Banks) because it is understood that leased metal will be "used" (be that in a physical operation like a jeweller or mint, or for sale to create a short position), the contract cannot practically require the return of the same physical bars that were lent (ie the same bar numbers). If the lease contract was worded on a secured basis (most likely where the borrower is a jeweller or mint) the security would have to be against the general gold stocks of the borrower rather than the bars originally supplied as it is understood that the original bars are melted or sold. Where lease contracts specify the return of physical at the end of the lease, it is acceptable to settle with any LBMA bar at maturity, with any ounce difference (due to the variability of 400oz bars) settled via cash. As a result, there is no legal claim by the lender on the original physical bars supplied to the borrower. Therefore if an Authorised Participant borrowed physical and delivered that to GLD, there would be no claim or encumbrance by the lender to the Authorised Participant on those bars held by GLD.
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[quote=Erik T.]Unless, that is, the system melts down and the counterparty to their hedge trasaction doesn’t deliver, in which case you get the domino-effect that was feared if AIG had defaulted in 2008. The situation gets even more complex if the bank is netting its exposure to include receivables denominated in gold as contingent reserve assets, or using calls to hedge risk of extreme price flutctuation. The big problem I see there is that bankers tend to think in terms of what allows them to manage perceived risk according to the accounting rules imposed on them, not true risk if the system melted down. I doubt they have any credible plan whatsoever for what they would do if the derivative system melted down.[/quote]I think 2008 may have shaken up this attitude, but I’d guess it is still dominant and driven by a bit of ego in risk departments who think they can quantify possibility of default etc with all their fancy formulas and VaR blah blah blah. This is why the issue of an unallocated gold run interests me and its dynamics need to be explored. It is also of commercial relevance to the Perth Mint for contingency plans to ensure our operations are robust to such an event occuring in other market players - eg how can we continue to provide liquidity to mining companies we refine gold for and for our customers on the other end.

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[quote=victorthecleaner]Bullion banking is exactly analogous. Allocated gold is cash. Unallocated gold is an account balance. A gold loan is a loan. The reserve of the bank is physical gold in the vault. If you get a run on a bullion bank, this proceeds entirely analogous to a run on the bank. The holders of unallocated gold request allocation and drain reserves (physical bullion) from the bank. At no point in time is there a premium on allocated gold over unallocated gold. At no point in time is there a reason for the gold price to rise. This goes on until the bullion bank is out of reserves and has to close. At that point, physical gold is worth the same as before, but all remaining unallocated balances are worth zero. Not that the bullion bank is never short gold nor long gold.[/quote]Not exactly analogous, because you can’t print gold, which a central bank can do for fiat and give this fiat to a bank in exchange for its illiquid longer-term assets. As a bullion banker you know that there is a limit on your ability to access physical gold from a central bank, so we would have to conclude that bullion bankers are more conservative than cash bankers in the amount of reserves they hold (notwithstanding their risk manager’s ego I mentioned above).
I have just finished reading George Selgin’s "The Theory of Free Banking: Money Supply under Competitive Note Issue" and I would strongly suggest it is worth your time, all 140 pages. Reason is because I suspect that bullion banking operates very much like the free banking Selgin describes. The key conclusion is that a free banking system is stable and self regulating with regard to the amount of credit vs reserves. This may mean that the bullion banking system is more robust than many think. You will also find it interesting in describing a fiat banking system most likely to be compatible with Free Gold.
As to your point that the remaining unallocated would be worth zero, I would say it will be worth whatever the bank can sell the gold assets that back it. If it is just a confidence run, then the assets are still good, just they mature later than the at call unallocated. If physical cannot be lent with those assets as collateral, then they may need to be liquidated at a discount, but some price will be obtainable.
However, if the run is due to the assets having no value due to counterparty failure on whom the bullion bank has an expsoure, then yes the corresponding unallocated liabilities to clients would be worth zero.

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[quote=Erik T.]The reason I disagree is that if a run on bullion accounts begins, at least initially the bullion banks would need to start buying physical on the spot market to cover their obligations. That’s where the price rise comes from - bullion banks that are operating at 8 - 10% reserve ratio might estimate, for sake of example, that the formative run is going to draw physical out of 20% of their accounts. In an attempt to shore up confidence, the bank would in that situation use other assets to double their reserves (buying on the spot), hoping to avert a full-on bank run. That’s where the price rise comes from. When the run gets fully established and it becomes clear that delivering to the first few guys who ask for allocation isn’t going to shore up confidence, the bullion banks probably stop buying at that point and ask for a holiday from regulators while they try to figure out what to do next.[/quote]I disagree, the bullion banks already have a gold asset, just an illiquid one. They are not short gold, they are short liquidity, so they aren’t going to buy gold as that means they are going long and have to use up cash which would be booked as an expense (ie loss). They would first look to borrow gold which they would then repay when their gold assets mature.
Later as they get more desperate, or concurrently, they may look to liquidate their gold assets at a discount to raise cash to buy gold. This will manifest as backwardation, where future contracted gold (be it a COMEX future or an OTC forward) is selling at a discount to spot physical gold.

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[quote=Michael H]So ‘gold contracts’ will crash in currency price, even as physical gold will soar in currency price – but you won’t see the latter, because physical gold is not quoted (in size at least). Our current gold pricing mechanisms are based on the paper gold price and thus they will break down in a period of confusion. Contracts for gold will not perform. Physical gold will soar in value but there won’t be a market in place to quote a price.[/quote]I disagree. The Perth Mint trades 300t of physical gold a year and we don’t use COMEX or any other exchange. The OTC market, which is just an internet like network of bilateral trading relationships, will (just like the internet if one of it nodes fails) readjust and continue to trade. Keep in mind that for all the paper gold that is being traded (and there is a lot of it and it makes up the majority of the market) there is also a significant amount of physical trading occuring. 

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Bron,
Thanks so much for taking the time to share all these ideas. Your replies are veryt complete and very thought-provoking!

But as much as I myself am freaked out by the thought of playing Devil’s Advocate for the goldbugs, I am still struggling to understand where (from the standpoint of BCL property law) the bullion bank who leased gold from a central bank obtained free and clear title to the gold they delivered to Investor "A" in my example.

I completely "get it" in the sense that I understand the bullion bank’s obligation to repay the central bank is in terms of fungible bullion that may be different bullion. I am not questioning your assertion that the central bank does not have an ownership claim on the bullion given to Investor "A". But I still don’t see how Investor "A" got free and clear title to something the bullion bank never really had free and clear title to. When and how does the bullion bank obtain free and clear title (needed to transfer said title free and clear to Investor "A") to bullion it has leased?

Thanks,

Erik

 

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Thanks Erik for your detailed and informative reply and for your forbearance regarding my request for some practical suggestions regarding investment strategies.  In reading your comments, I realize how it could be seen as OT but for those of us more oriented towards investing as opposed to trading, it was a question that seemed (to me at least) to naturally follow and need asking.  I don’t disagree with you that this discussion is quite interesting nor that it is appropriate but, being a pragmatist, my thoughts just naturally are drawn to how we can find practical application for this information.  And quite frankly, as I am an amateur and not a pro in the investment genre, some of this discussion went over my head initially and required re-reading and further study and investigation on my part.  My intent wasn’t to re-direct the thread, only to learn more and clarify some basic information for myself (and others).With regards to the issue of other parties such as Jim Sinclair, that inquiry did not seem to me to be OT.  Sinclair has long expressed the belief that the gold market is heavily and regularly manipulated and therefore, at least some of his views seemed to be in alignment with the parties you decried.  I was obviously interested in your (and others’) opinions since I’ve come to trust Sinclair as a reliable source of information and want to know if he or David Morgan were viewed in the same light as Organ, Butler, et al by those possessing more knowledge than me.  With regards to him being somewhat of a PM permabull, I guess for this particular secular bull market in gold, he is and I know he has strongly recommended against trading this market in the past year or so.  But, to my knowledge, he was largely or completely out of gold for most of the 80s and 90s so I don’t know if that label is completely valid.
Anyway, thanks for creating this thread and not being afraid to challenge the status quo.
 
As an addendum to this post, I can almost hear the buzzing and crackling of all those high powered neurons in CM’s head processing the information of this thread.  Since his commentary has been conspicuous in its absence, I’m sure we’d all appreciate hearing his views on this thread as well.
 
And as one more addendum, for someone who says he is not a pro, I’ve been very impressed by victorthecleaner’s commentaries.  I’d be very interested in knowing what his background is and how he amassed his considerable nowledge on the issues, if he’d be willing to share that.
 
Thanks all.
   

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ao,I’m also waiting for Chris to jump in and give us his take on the information provided in this thread.

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Erik

Here is an analogy that may shed some light on your question. What I say about cash banking is accurate. I expect the principle applies to gold as well unless the transaction was under a contract that provided otherwise.

One I deposit $1,000 cash (that’s currency, folding money) with a bank in a savings account. This is a demand deposit account, meaning I can withdraw it all at any time. So it’s my money and they are just holding it for me, right? Wrong. I have effectively granted them a $1,000 loan, to do with as they please, callable at any time. But I  no longer own the money. I own a claim against the assets of the bank. If they go under and don’t have it, they won’t pay me, because I gave up ownership when I made the deposit. At that point I hope the FDIC will make me whole.

Two I deposit $1,000 cash (that’s currency, folding money) with a bank to buy a CD with a six month term. When it matures they pay me $1,000 different dollars plus interest in currency. This is analogous to leasing fungible gold as you discussed. But the same principle applies. All I own is a claim against the bank’s assets. They have legal ownership of my paper dollars and can sell them to Investor “A” with a clear title, so to speak.

This might be an answer to your question, but I’m not familiar with the specifics of gold leasing, so I’m not sure.

Travlin

 

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[quote=Travlin]
One I deposit $1,000 cash (that’s currency, folding money) with a bank in a savings account. This is a demand deposit account, meaning I can withdraw it all at any time. So it’s my money and they are just holding it for me, right? Wrong. I have effectively granted them a $1,000 loan, to do with as they please, callable at any time. But I  no longer own the money. I own a claim against the assets of the bank. If they go under and don’t have it, they won’t pay me, because I gave up ownership when I made the deposit. At that point I hope the FDIC will make me whole.[/quote]
Trav,
When you DEPOSIT money in a bank, title to (meaning ownership of) the money is conveyed to the bank at the time of the deposit. As you correctly describe, you no longer own the money - the bank owns the money. You own a credit receivable from the bank.
But in the case of gold leasing, the central bank is not DEPOSITING gold in an unallocated account (an action that would convey title to the bank).
So in order for this system to "work", somehow the act of LEASING the gold to the bullion bank would have to convey title (ownership) to the bank. That is very strongly at odds with the conventional use of the word lease, which typically connotes a transaction where ownership of the asset is not conveyed, as in the case of leasing a car.
What I’m stuck on is that in order for the bank to use the gold to make good on an obligation to deliver "unencumbered" bullion, they have to OWN the bullion they are delivering. The idea that the central bank would enter a transaction that conveys OWNERSHIP of bullion to the bullion bank in exchange for the bullion bank owing an equal amount of gold plus some form of "interest" also makes perfect sense to me, and I see why all parties might want to enter such a transaction. But calling that a lease seems very, very strange to me. I feel like there must be more to this story that I don’t yet understand. Perhaps Jeff or Bron can shed more light on this.
Best,
Erik
 

240

Erik T,
I think there are two ways a central bank can lease gold.

(A) The first is a swap involving allocated gold. Legally this is a repurchase agreement, i.e. when the position is opened, the title to the bars is transferred from the central bank to the borrower. At the same time, the brrower of the gold lends the CB cash (the other side of the swap - serves as cash collateral for the loan). When the swap matures, the borrower needs to return an equal weight of (allocated) gold. In the meantime, the borrower can sell the borrowed gold to a jeweller who melts it down and creates necklaces from it. During the term of the swap, the CB does not own gold, but only has a claim against the borrower (who may default).

In fact, when Drexel-Burnham-Lambert went bankrupt in 1990, the CB of Portugal lost gold in such a swap. As far as I remember, this was actual physical gold.

(B) The second way a CB can lend gold is using unallocated gold. So for the term of the swap, the CB can go short unallocated gold and take cash as the collateral. The borrower is then long (borrowed) unallocated and posts cash as the collateral.

If you compare US$ banking to bullion banking, then (B) is analogous to a refinancing operation. The commercial bank deposits securities (here: US$) with the CB and receives a reserve balance (here: unallocated) in return. (A) then corresponds to a refinancing operation in which the commercial bank does not receive base money as a ledger entry as the reserve, but actual tangible cash.

Note that in the 1990s when the European CBs leased a lot of gold in order to support the London market, both happened, the leasing of unallocated and the leasing of allocated gold. Funny that the Americans are sometimes so pendantic with their statistics. They publish the inventory of the vault at the FRBNY in which the gold of foreign governments and CBs is stored, and you can see from these data that between 1993 and 1999, about 3000 metric tons were removed from this vault. For 1999, there are also estimates that about 10000 to 14000 metric tons of gold were on lease. Apparently at least 3000 of these involved cases in which the physical was moved. The remainder may have been largely paper.

Finally, the Washignton Agreement says there will be "no more sales than those already decided". Then, you see the CBs report some 2000 tonnes of gold sales 1999-2004. The part that belongs to the Euro zone CBs most certainly came from the FRBNY vault. Interesting that the physical was moved before 1999, but the sale was booked only after 1999. You see from these data that the gold was initially only leased and after 1999, the repayment of the loan was effectively waived.

This may also tell you something about the long term chart of the gold price. The low was between 1999-2001. Yet, most sources claim the CBs in aggregate were sellers until 2007 (?) and only afterwards buyers. If you follow the physical, however, you see that the gold was removed from the vaults before 1999 and not afterwards. The movement of the physiscal tracks the price action much better.

Let’s finish with some politics. You see from these data that it was the Euro zone CBs who called the shots with respect to the gold market. During the 1990s, i.e. before the Euro was available, they supported the London market by leasing and then even selling a substantial amount of their own gold. From 1999 on, however, they backed off and left the market alone. This was enough to make sure the price turned the corner and is now in an increasing trend. Basically since May 2001, the gold price in US$ has been rising at a rate of about 19% annually.

Sincerely,

Victor