Harvey Organ: Get Physical Gold & Silver!

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41

Ah, guys, what a pleasure to finally understand more about OTC trading, the existence of electronic quotes and prices being transmitted via arbitrage. Thank you.
Things make more sense to me now.

This is one of the most informative comment threads I’ve read in quite some time, especially after reading some of the links in various posts.

I am repeating myself a bit, but I still have questions and I am very suspicious of the many fishy events that occur, for example counterintuitive waterfall price drops before major CB announcements of more printing and/or devaluations. I do wonder whether central banks are entering the markets and trying to use the gold price as a signal at times like those. Comments from central bankers like the one that Volker made about his mistake in not containing gold during the 70’s are not reassuring, plus other comments that have been made by important figures at various times. And one reads of other anecdotes such as Morgan Stanley (I think) having been sued, successfully, for charging customers storage fees on bullion that wasn’t even in the custody of Morgan Stanley, if I remember correctly. It’s the sum total of many little details like those that give people their doubts about the integrity of what goes in the gold and silver markets.

I have to say, one of "gut feel" problems with the idea of central banks relentlessly leasing more and more gold and shorting gold via intermediaries on exchanges to supress the price or JPM mercilessly dumping silver is that if you are going to short something to overwhelm the market with the intention of buying back your shorts at lower prices, why haven’t enough futures market participants cottoned on to this? I don’t believe markets are totally efficient, but surely they should be efficient enough that people would try to antipate these moves, making it more difficult for JPM to get away with it? That mechanism, which I think Ted Butler has written about, relies on the theory that longs, in the aggregate, get "flushed" out repeatedly and without learning from their mistakes and always eventually buy back at higher levels than they sold, does it not? I’m not a futures trader, but it just seems odd to me that they would be able to continually get away with this activity year after year. Also, it means the HFT algorithms are never improved upon. Maybe lots of traders are that stupid though, what do I know.

If JPM does have an advantage would it not stem largely from the fact that they bird’s eye view of the OTC markets and the COMEX, and know exactly how much is really hedged, how much physical bullion is being delivered, what levels speculative interest are at, etc. etc, i.e. they have an asymetrical information advantage and are in a unique position to profit from it? Whether they are going long or short? I dunno. Maybe they would say that’s unethical and they don’t engage in that but who trusts what Wall Street bankers say these days. 

PS Victor, correct me if I am wrong, but gold and silver are the only futures traded commodities whose price is determined by arbitrage on the OTC market, and is dependent on what happens in the OTC market, then doesn’t this make the COMEX gold and silver COT reports totally meaningless? So what if speculators are flushed out of COMEX, and so what if "commercials" are going increasingly net short or not? Without knowing what is happening in the (bigger) OTC market, it’s totally impossible for us puny mortals to see the bigger picture, right? I guess all that the COT can tell you are things like the general level of speculative hedge fund interest in precious metals?

 

Erik, please send thanks to Jeff Christian for taking the time to give an explanation. And thanks for your excellent set of replies.

Hey, I’m a small investor (really, really small) and I’m trying to learn as best as I can.

 

 

42

Hi CPTWaffle,
Glad you’ve enjoyed the exchange, and yes I must say myself that I’ve been amazed at the life this thread has taken on. FIrst Jeff Christian and then Bron Sucheki personally participating in an online discussion forum is rather unprecedented, IMHO. For anyone who doesn’t recognize Bron’s name, he’s one of the head honchos at Perth Mint, and definitely knows the market well.

I’m quite curious to see what Victor’s thoughts are on your excellent question here:

I hadn’t thought about this aspect before, but it’s an excellent point. I could argue it either way myself, and don’t really have enough knowledge to have any conviction on the matter. On one hand, you’re right that if the market price is primarily determined in the London market and transmitted via arbitrage to the COMEX, then COT reports have far less meaning. I wonder if anyone has ever pointed this out to Ted?

But the counter-argument is that COMEX has a life of its own, and a lot of traders operate there. The arbs keep the price in line with the London market, but one could easily argue that the arbs can only do what trades are necessary to close any gap between markets. I can’t see how they could game the COTs to their liking. So the COTs should be a natural and reasonably accurate reflection of the sentiment of that minority of PM traders who operate primarily on the COMEX. I need to think more about this to decide if there is any way to game the COTs to deliver a false signal, if that were someone’s objective.

I’ll let Jeff know his participation was appreciated. Thanks also to Bron for chiming in as well. This thread is suddenly becoming a who’s who of the PM business!

All the best,

Erik

 

 

43

CPTWaffle,
just to make sure there is no misunderstanding. The banks trade gold and silver as currencies. In addition, by some coincidence, the CME also has some futures contracts on gold and silver similar to those contracts on commodities. Since the metals are the same, of course, the two markets are linked by arbitrage. Now it turns out that the OTC market is about 8-10 times bigger (both in terms of paper volume and in terms of physical volume), and so I find it very plausible that the major action is in the OTC market and then this is transmitted by arbitrage to the COMEX.

So, yes, the COT reports tell you a lot about COMEX (10% of the market) and nothing about OTC (90% of the market). Does this mean they are useless? Perhaps not enirely. Firstly, they do tell you the position of the arbitrageurs. Secondly, it sounds plausible that many leveraged speculators at the COMEX and OTC behave in a similar way.

Let me add another warning. I have a rough estimate (measuring the velocity at the COMEX, i.e. daily volume per open interest and then extrapolating this to the OTC market), that suggests that about 95% of all gold trading is paper and about 5% is physical. So it is plausible to think that the paper gold investors are leveraged and trade on margin, and so if there is a liquidity crisis and the prime brokers cut the credit lines of the hedge funds, then the price of gold would drop because the leveraged longs have to liquidate. Of course, physical gold is the ultimate hedge against systemic issues in the financial system, but the price action may be dominated by the leveraged longs rather than by the physical buyers. This is basically what happened in 2008. Everyone was scared and this is why they dropped paper gold. That a smaller number of other people bought physical gold is also true, but did not prevent the gold price from crashing.

I would always keep this in mind. Physical gold is the hedge. But the paper price can behave in a counter-intuitive fashion in the short run. In fact, this makes the gold market highly unstable because there are some who are trying to change their dollars for gold, and if the price drops, they take away more physical gold and drain reserves from the banks. So the gold market may well blow up because of a low price rather than because of a high price.

I wonder whether the U.S. would buy paper gold in this situation, just in order to stabilize the market.

I know that GATA and friends always tell you that "the central banks" want to suppress gold. I know that the U.S. have a serious difficulty with a high gold price because it undermines the role of the dollar as an international reserve, but many foreign central banks (the ECB for example) have no problem at all with a high gold price. In fact, the rest of the world has done a lot of planning in order to smoothly replace the dying dollar with gold as the major international reserve.

Sincerely,

Victor

 

44

Victor said (highlight mine),


I would always keep this in mind. Physical gold is the hedge. But the paper price can behave in a counter-intuitive fashion in the short run. In fact, this makes the gold market highly unstable because there are some who are trying to change their dollars for gold, and if the price drops, they take away more physical gold and drain reserves from the banks. So the gold market may well blow up because of a low price rather than because of a high price.
I wonder whether the U.S. would buy paper gold in this situation, just in order to stabilize the market.
I know that GATA and friends always tell you that "the central banks" want to suppress gold. I know that the U.S. have a serious difficulty with a high gold price because it undermines the role of the dollar as an international reserve, but many foreign central banks (the ECB for example) have no problem at all with a high gold price. In fact, the rest of the world has done a lot of planning in order to smoothly replace the dying dollar with gold as the major international reserve.

This goes to the fundamentals of Gold (and Silver).  Much of what we have been talking about.. whether or not manipulation is happening ...  really addresses another aspect of the investment argument - call it the "manipulation arb".  The idea is that if/when the manipulation schemes break down due to overwhelming physical demand, there will be a big jump in price just due to this breakdown.  I do believe there is manipulation...I think Gold and Silver are being (tape) painted as risk assets, rather than the ultimate safe havens that they are. To be honest though, I have no idea how large I would estimate the manipulation arb differential to be.. and I don't really care to argue about it anymore.  I think we all agree in principle that Gold is a reasonable play for long term wealth preservation.. and that is enough for me.   To Victor's point above; http://thespellmanreport.com/2012/04/21/warren-buffet-and-the-new-calculus-of-gold/ "What we are witnessing is a sea change in which market forces are driving a de facto return to the gold standard. All that is missing for this to be a de jure gold standard is some regulatory and legal recognition and one has been proposed. The Basel Committee for Bank Supervision, the maker of global capital requirements is studying making gold a bank capital Tier 1 asset. This implies banks would be regulatory blessed to operate with less equity capital than is normally required of banks if they held more gold as an asset. Basically,  regulators would allow banks to be more leveraged, meaning the banks would not suffer as much equity dilution to recapitalize after sovereign and mortgage write downs. Not only would gold then be backstopping debt and currency but also be backstopping bank equity capital.  So the realm of gold is expanding to fill the void of other “money good” assets and elevating its demand. The world has gravitated from one gold-backed paper currency to another before, and it likely is happening again. It would depend on whether investors in liquid, default-free, inflation-free paper prefer gold-backed Chinese Yuan to Swiss warehouse receipts or deposits from large international banks with large gold positions that operate with lots of leverage. This is a market choice that will determine the gold linked paper store of value, but the point is that all the paper contenders derive value from the gold backing, and thereby expands the demand for the shiny metal. This is the new calculus of gold. This state of affairs is likely to remain until developed world governments no longer reach for the unreachable and pressure their central banks to finance it."          
45
Cute metaphor, but physical cheese won't be called upon to perform its hedging role in extremis. ... Even though unallocated holders have no claim on physical, do fiduciaries believe their holding hedges them against a government money crisis? If they do, then fractionally-reserved bullion banking is effectively diluting real physical demand, and GATA's argument rings true.
50sQuiff, Victor makes the point about physical gold being the only real hedge and this is correct. However I find it hard to believe that the holders of unallocated accounts with bullion banks do not know exactly what they hold. An unallocated account with a bullion bank is not available to "retail" investors and is only held by large corporate or what many jursidictions call "sophisticated investors". The contractual terms of a metals account agreement with a bullion bank are very clear as to the status of unallocated and it is my view that the holders of these accounts are smart enough to read the fine print and know: 1. Unallocated is a mere liability of the bank 2. Bullion banks do not maintain 100% physical reserves 3. Bullion banks thus lend or use some faction of the unallocated 4. They (the client) is thus taking a credit exposure to the bullion bank 5. Conversion to allocated is normally possible but the bullion bank is not contractually obligated to do so I would suggest therefore that many of the holders of bullion bank unallocated accounts are just interested in cash gains/losses. They are like the futures holders Erik mentioned - paper shorts AND paper longs. They are playing a paper game and they know this. If this is correct, then fractionally-reserved bullion banking is not diluting real physical demand. Regarding point 2, the 100:1 ratio that is often mentioned (and I don't know where that 300:1 came from), this is misunderstood as the physical fractional reserve ratio for unallocated accounts. As discussed in this personal blog post, the 100:1 comment by Mr Christian was a reference to the volume of trading of paper gold versus how much is physical delivery versus cash settled. In that post I have sourced references where Mr Christian reveals that the bullion banks operate at around 10:1. My view is that a 100:1 physical fractional is ridiculous considering the crucial role London plays in the physical market. London unallocated simply could not function on a 100:1 ratio in my view. Those who accept this number do not appreciate to amount of physical delivery made ex-unallocated accounts by the trade.
46

[quote=Erik T.]My understanding is that a big part of Jeff Christian’s business at CPM Group is teaching mining companies exactly what you said - that they don’t need the big bullion bank middlemen and their fees, and can learn to do this themselves, with his help.[/quote]The funny thing about how Mr Christian has been painted by many as one of "them" on the side of evildoers is that actually his business is in opposition against the bullion banks. Consider this statement by Mr Christian in a presentation to the International Cotton Advisory Council in October 2002:
A producer should use an advisor such as CPM Group, which is not trading against the producer. Banks and dealers have a conflict of interest between their own trading positions and the hedges they advise their clients to take.
Or maybe Recent Lessons Learned About Hedging (January 2000):
Hedgers should not rely on their trading counterparts for hedging strategies. These entities take the opposite side of the hedge transactions, have inherent conflicts of interest, and always keep their own best interests in mind, even if these are the short-term best interests and arguably not in the banks’ own long term best interests.
These statements don’t square with one working for the interests of bullion banks. Goldbugs should consider that Mr Christian is more closely aligned with their interest than those of bullion banks.

47

[quote=bronsuchecki]I find it hard to believe that the holders of unallocated accounts with bullion banks do not know exactly what they hold. An unallocated account with a bullion bank is not available to "retail" investors and is only held by large corporate or what many jursidictions call "sophisticated investors". The contractual terms of a metals account agreement with a bullion bank are very clear as to the status of unallocated and it is my view that the holders of these accounts are smart enough to read the fine print and know:1. Unallocated is a mere liability of the bank
2. Bullion banks do not maintain 100% physical reserves
3. Bullion banks thus lend or use some faction of the unallocated
4. They (the client) is thus taking a credit exposure to the bullion bank
5. Conversion to allocated is normally possible but the bullion bank is not contractually obligated to do so
I would suggest therefore that many of the holders of bullion bank unallocated accounts are just interested in cash gains/losses. They are like the futures holders Erik mentioned - paper shorts AND paper longs. They are playing a paper game and they know this.[/quote]
Bron,
I concede that you know the PM market far better than I do, but I have to strongly disagree with you here, particularly on the points emphasized in bold. As you know, unallocated bullion accounts are available to both corporate accounts and accredited investors. But in the Private Banking biz, those accredited investors are more often referred to as easy targets than "sophisticated". I have personally met several HNWIs whose investment goal is to hedge systemic financial collapse risk, and who are proud of themselves for having negotiated zero storage fees in what are actually unallocated accounts. When I have tried to explain to them that they do not own bullion and are actually unsecured creditors in a fractionally reserved system, they not only refuse to believe me, but in some cases have been insulted and become indignant.
I have also been to professional-only conferences, and met licensed wealth management professionals who are completely confused about how allocated and unallocated metals accounts work. I concur with your view that it is their job to read the fine print and know what they are talking about, but that doesn’t mean they do.
I’ve also had an HSBC Private Banker try to sell me an unallocated account, swearing up and down that the no-fee thing was a "courtesy", to the bank’s "most valued" customers, but that the bullion was definitely mine, titled in my name, and free of any credit risk! When I told him he had a deal as soon as he provided me with the bar serial numbers I would be buying, somebody on his metals desk finally explained to him what I already knew. And he was the guy selling this service! FWIW, the guy in question was probably not sleazy but just plain stupid, which is usually the case with "Wealth Management Professionals", more commonly known by their clientele as predatory morons.
When I had to put up a sizable investment in Hong Kong to qualify for an investor resident visa, I told them to put it all in the HSI Tracker ETF (2800.HK). The same guy told me that was a big mistake and I needed to diversify the investment. I told him I didn’t need to diversify because I intended to delta-hedge to flat net notional in my futures account anyway. Put your seatbelt on for his response… He said that was a poor strategy because Airline stocks are not a good hedge for a broader index like the HSI! When I used the phrase "Delta-Hedge", the guy actually assumed I meant I was going to short Delta Airlines stock to hedge the exposure! This was an HSBC Private Banking "Relationship Executive", a/k/a Predatory Moron.
That’s a representative sample of the "professionals" of whom you speak, Bron. When you say these are big boys who are supposed to read the fine print and know their game, you’re absolutely right. But that doesn’t mean they do. They’re mostly financially clueless salesmen who know how to wine and dine their clients, and little else. I know you and your team in Perth are top notch, but you’re the exception, not the norm.
All the best,
Erik

48

Really a pleasure to have you posting here.  Not to butter you up even more… but one of my favorite possessions is my 1 Kg Lunar Dragon…
 

49

Bron and Erik,
I agree with Bron that many holders of unallocated gold are probably the same sort of people who would buy a futures contract on margin. This is why I said that once there is a liquidity crunch, it is understandable that a lot of (paper) gold is sold. This explains the price drop in 2008 without invoking the manipulation meme. In fact, in spring 2008, a fashionable trade was long commodities, gold, oil and short financial sector stocks. When short sales were forbidden later that year and when the prime brokers cut credit lines, the speculators had to sell their (paper) gold.

But I have further comments, too.

Even if, as Bron says, the unallocated does not divert physical demand, it does influence the price. This works as in every currency. If the banking system creates credit, more of this credit can bid for other stuff and thereby causes inflation if the other stuff is mesured in the currency in which we create credit. In our case, the currency is gold, and if you create credit (=unallocated), this credit can bid for other stuff (dollars) as well as physical gold can. This reduces the gold price in dollars.

It seems most people understand the following analogy best. If everyone has to pay cash for their house, the house prices are low. Now the banks create credit. Suddenly, some people who were not able to buy a house with cash, can take out a loan and join the bidding. The result is that house prices go up. In our case, the mortgage is unallocated gold and the house is a dollar.

Apart from the presence of unallocated gold which has an effect on the gold price, the unallocated contracts were used politically in the late 1980s and in the 1990s. Firstly, some oil countries were offered to buy unallocated gold (on the other side was a forward sale by a mining company) so that they were able to purchase gold in size without running the price. At the same time, many wealthy investors were talked out of holding physical gold and were talked into holding gold-like contracts.

There were a few estimates that around 1999-2001, there were more than 10000 tons of gold that had been leased or forward-sold, and so I would expect that a corresponding amount of holders of unallocated were in unallocated for political reasons, i.e. were not speculators. We have no idea how long it took to work this off - perhaps the last bit of these positions is still open.

BTW, I don’t think any country will go back to a gold standard in the sense that their currency unit is backed by a weight of gold. Since the Euro zone is a major trade hub and since the ECB values gold at its market price, nobody would be able to fix the gold price in the long run. Whenever this results in an undervaluation of gold in that currency, this would basically just drain gold to Europe.

Sincerely,

Victor

50

[quote=Erik T.]When you say these are big boys who are supposed to read the fine print and know their game, you’re absolutely right. But that doesn’t mean they do. They’re mostly financially clueless salesmen who know how to wine and dine their clients, and little else.[/quote]That’s good first hand feedback Erik and I won’t disagree. The question then becomes what percentage (by ounces) of unallocated account holders are aware and which aren’t. Any industry players/commercials would be and maybe some hedge funds who only care for their (as Victor says, leveraged) cash returns, those who blogger FOFOA calls the Giants. You feedback would indicate a fair if not all of the HNWI are not. They may be less industry ones than HNWI, but industry would hold some big balances relative to HNWI. We have no way of knowing but I’d guess that it isn’t a case that 95% (by ounces) don’t know, which is what most people think I bet and the basis on which they believe a "run" for physical will bust the system.
I’d just say the percentage who know full well what unallocated is and thus who don’t care about physical delivery and happy to take cash settlement is much higher than many believe. If true, this means the system has more robustness or less risk of a run for physical and thus the game can continue for longer than many think.

51

Erik T,
I like the anecdotes. I wonder how many investors have unallocated gold or some credit notes that relate to the gold price, but who don’t actually own this gold and who don’t know that they have credit risk. I suppose it will be less than 10 years, and we will know. Perhaps less than 5.

FOFOA reported there was a wealthy family who wanted to put some $10mm in allocated gold (details from memory). They approached their adviser Mongan Stanley. It turned out that MS don’t offer allocated, and so MS went to Scotia Mocatta in order to get allocated gold. The problem was that MS drafted the paperwork so that MS owned the allocated at Scotia Mocatta, and the client just had a paper claim on MS.

Now that I think about this story again, perhaps I can propose the following hypothesis. Everyone in North America who thinks they own gold and who has a contract with a financial institution that is not Scotia, JP Morgan or HSBC, probably does now own the gold (assuming that only these proper bullion banks offer allocated).

Victor

 

52

@Bron & Victor
Let’s look at this from another angle. Consider this question: With the advent of the GLD ETF, do unallocated bullion accounts still serve any useful purpose, or are they an obsolete relic of a bygone era?

I would opine that with very, very few exceptions, unallocated accounts serve no useful purpose. You can buy GLD and there is 100% physical bullion backing your claim. Forget the nonsense Harvey was spewing in the 2nd interview about there being no gold there. If you actually read the GLD Custodial Agreement (I think it’s sec. 15 or 16, but that’s from memory), you see that GLD has all the gold, and it’s 100% unencumbered physical bullion. No leases, double-counting, or other games permitted, and it’s audited every year. You don’t actually OWN the bullion, so in a systemic collapse you could easily be victimized like the MF Global clients were, and the government could change the rules on you "for the greater good". But short of that, the bullion is there and the custodial fee is too small for the zero-fee aspect of some unallocated bullion accounts to be a meaningful advantage.

Now consider the unallocated account. You own nothing but an unsecured credit receivable from a big bank. So far as I can see, any intelligent investor should choose GLD shares over an unallocated account. The only exceptions I can think of involve broader relationships between the bank and client, as might be the case with a small sovereign account.

I welcome critique if I’ve missed something obvious here. But it appears to me that GLD is always better than an unallocated account for almost all investors. Unallocated accounts don’t offer leverage or 24-hr trading, so they appear to me to be just plain inferior to ETF shares.

With that in mind, we should ask ourselves, why would anyone want to own an unallocated bullion account, then? The only answer I can think of is that they don’t fully understand what it really is, and what its limitations are.

I suppose there’s an argument for redeemable unallocated accounts, like Perth Mint Certificates. But if that’s your argument, PHYS, if bought when the premium is low, offers redeemability too, and it has real bullion behind it. Also, Perth Mint certificates aren’t really the same thing is an unallocated bullion account. The gold is indeed hypothecated, but only to Perth Mint’s own retail operation, so it’s really a different animal than a bullion bank’s unallocated account. But if we go back to unallocated accounts with HSBC, Scotia Mocatta, etc. I can’t think of a sane reason for anyone to want one, given the ETFs offer a better deal. I therefore conclude that either I’ve missed something, or everyone who has one doesn’t realize its shortcomings.

Am I missing something?

Erik

 

53

Link:  http://gold.bullionvault.com/How/UnallocatedGold

Unallocated Gold

Take care when buying gold from a bank, or in a pool account, or even from some major gold certificate providers
Bank Gold Is Usually Unallocated

As you set out to buy gold the first thing you need to know is that 95% of the world’s gold businesses - especially banks - will automatically sell you the wrong type.

Unallocated gold is the most widely traded form of gold in the world. It hides a way of advantaging the provider - usually a bank - by subjecting buyers to a risk they will frequently remain unaware of until it is too late. The widely quoted ‘spot price’ refers to this unallocated gold, and this is how it works:-

  1. When a bank sells you gold it is almost always 'unallocated'. You become a creditor - i.e. the bank owes you gold which you do not own. The bank is taking advantage of the fact that you are not quite sure what to do with any gold you buy, and it feels logical - to most gold buyers - to put the gold safely in the bank. When you do this you sign a document and become, in law, a depositor of gold. Most people now relax in the belief that they own gold completely securely, and they do not pay the little extra - above the spot - to have their trade formally 'allocated'.
  2. A bank is required by its regulator to hold a proportion of its liabilities as certain types of assets capable of being turned into cash quickly during times of crisis. It is a liquid reserve and it's there to protect the bank from a common type of problem - a liquidity crisis - which occurs when a bank has short term deposits, long term loans, and insufficient cash to meet the immediate demand for withdrawals. Physical gold bars are accepted as a very good form of liquidity reserve because they can be turned quickly into cash.
  3. If a bank has physical possession of some gold which it owes you as its creditor the bank itself is the current owner of the gold. While this gold remains unallocated to you the regulator considers it part of a bank's liquid reserve. This makes unallocated gold an attractive way for the bank to maintain its regulated liquidity, because you have paid for your gold, and the bank is free to use your money, while it is also able to add your unallocated gold holding to its own reserve.
  4. Unfortunately your unallocated gold would be ditched if the bank were in need of cash. It has no choice in the matter because liquid reserves are there to be sold at short notice to protect the bank's general creditors - all of whom, including you, must receive a proportionate share of whatever is raised from the sale of assets should the crisis deepen and the bank become insolvent.
  5. If that did happen you would be in a bad position. Your relationship is with the banks overall pile of assets, not with any specific pile of gold. The bank's small gold reserve would be diluted by non-performing bond portfolios and other assets which don't sell well in a crisis. The last line of defence for bank depositors is deposit protection, which is a state underwritten mainstay of banking confidence in the West. But it does not apply on bullion debts like yours. Deposit protection is there as a confidence-builder for the national currency only, which means unallocated gold actually offers less protection from bank failure than a cash deposit. So having been the provider of the bank's liquidity reserve you will then be in the minority of those offered no protection by the state's guarantee.
  6. So it is important not to be impressed by unallocated gold, or by it being physically stored in a bank's vault, or by it being checked daily by bank regulators. Regulators are checking it to make sure the bank maintains a liquid reserve, and they are not interested in your entitlement as a bullion creditor.
 

Allocated gold is different because you become the outright owner of gold and you are no longer a creditor. Your allocated gold is your property and it cannot be used as the bank’s reserve, so with allocated gold you get proper protection from systemic failure.

Unfortunately with allocated gold your money does the bank no good. And since modern banks reckon to earn 20% each year on capital employed, their loss of use of your allocated gold is disappointing for them. This is why banks usually charge nothing for unallocated storage and at least 1.5% per annum for allocated storage, with the result that professionals in the bullion market reckon that less than 1% of gold traded within financial markets is allocated.

It is not only banks which provide unallocated gold. So do fabrication businesses and pool account providers. In fact anyone who can find another use for your gold is motivated to provide you gold on an unallocated basis. Coin manufacturers - for example - might find it a very convenient way of financing their gold stock (their working capital) on what amounts to an interest free gold deposit from you, because their entire gold inventory can be paid for in this way with your money. Financiers of gold mines have a similar motivation, as they can lend your gold to miners to be repaid out of later production - assuming the mine is successful - though of course this is a relatively high risk way of financing mines.

This is how the huge majority of the world’s owners of bank held gold are, probably unwittingly, storing their personal reserve in a way which fails to meet the most common objective of gold buyers - the security of owned bullion.

54

Jim,
as far as I understand, if a bank operates in an official currency such as dollars or Euros, they are subject to their regulatory reserve requirements. If they lend gold, however, they are toally unregulated. I.e. if they sell 10 tons of unallocated gold to their clients, they are free to hedge this exposure as they like. There is no requirement to hold a however small reserve of physical gold against these unallocated accounts.

Erik,

firstly, you can even redeem GLD. Well, not everyone can, but every authorized participant can take out multiples of baskets (100000 shares = about 10000 ounces = about 310kg). I suppose this is why large investors such as Soros or Paulson chose GLD. They could just ask Black Rock to take their baskets out of the trust.

Secondly, I guess the difference between GLD and OTC unallocated is that the stock market is regulated whereas over-the-counter deals are in the dark. I like exchange traded contracts, but I suppose the fees would be higher. GLD pays storage and admin fees. Also, with stocks, there are specific margin requirements, and so you cannot trade GLD with arbitrary leverage. OTC all this need not apply.  If you trade two different things with the same counterparty OTC, you can certainly offset the collateral. Finally, if you buy unallocated from A and later sell it to B, you need not hold any capital against this position (if both are OTC). For hedge funds, this might be a big point.

You might ask what proportion of unallocated gold holders are clueless private investors who don’t know they have credit risk, and what proportion are speculators who chose to trade on margin.This is a bit circular though. Imagine you are a bank and you offer unallocated gold (some certificates) to your customers. Now you have price exposure. How do you hedge? Don’t you hedge this by buying unallocated OTC from a bullion bank? So all the unallocated of the clueless private investors is part of the aggregate unallocated long position in the OTC market.

Apparently, there are still enough leveraged speculators around who sell their paper gold whenever liquidity gets scarce.

Sincerely,

Victor

 

55

Given the performance of fiduciaries prior to 2008 and their legendary failure to do due diligence, I suspect Erik T’s anecdotes paint an accurate picture. But the more relevant question is, do they even care? Do they understand gold? Is their paradigm one of the physical plane and the gold market of the future or the monetary plane and the $IMFS? I expect the vast majority of fiduciaries have no qualms about unallocated gold, hence the bullion bank paper:physical ratio of circa 18-20:1 (per ANOTHER).
 
 

56

Erik T,
The final result of your intial broadside is one of the best series of comments I have read in a long time. Many thanks to Bron and to Victor, (Victor, I responded to your request on another site for information about trading on Feb 5 2010), as well as to all the others.

However, I found Jeff Christian’s gratuitous attack on Andrew Maguire extraordinary. Mr Christian, I would suggest that you inform your confusing and contradictory commentary about the so called "overnight gold trade" by referring to the people who sparked the debate http://www.skoptionstrading.com/updates/2012/1/14/revisiting-our-proposal-for-an-overnight-gold-fund.html and not Dimitri Speck, who you appear to be addressing. Your final point, that miners sell on the PM Fixing, is a good one and indeed may explain the trade, which at first you appeared to deny. If that is the explanation it would be ironic, placing them on a par with with the HNWI holding unallocated gold. Golden Bookends. 

Erik, your comments improved greatly when you moved back to presenting positive facts from your own experience instead of the ad hominem attack. To help you get off your high horse I will point out that your Feb 29 2012 reference to the release of the FOMC Minutes is wrong (1) and your other comment in regard to price manipulation on that day is uninformed conjecture presented as reasoned analysis. I was trading Feb 29 and anticipated that beat down with the clear signals being sent, I believe, to counter the announcement of the LTRO 2 on that day. I would be happy to share supporting evidence of this with you if you contact me through this site.

These are really minor quibbles in the overall advancement this thread has provided to the amateur PM community.

Thank you

(1) FOMC minutes were released Feb 15 http://www.federalreserve.gov/newsevents/press/monetary/2012monetary.htm . On Feb 29 Bernanke addressed congress and, contrary to all commentary, did not mention QE3 http://www.federalreserve.gov/newsevents/testimony/bernanke20120229a.htm but did mention accommodative monetary policy, an uncertain employment outlook etc. A Q & A followed, for which I cannot find the transcript, but in any event the selling had started well before then.  

 

 

57

Erik,
I would vehemently disagree with you regards to recommending buying GLD.  The way the fund is structured, the sub custodians are the ones actually in possession of the gold, and the custodian distances itself from any liability for any shenigans by explicitly stating that they do NOT audit the sub-custodians and are NOT liable in the event that a sub-custodian doesnt perform.

Instead of GLD, I would recommend PHYS for gold and PSLV for silver.  Both of these are iron clad investment vehicles for the ownership of gold and silver, are audited on a yearly basis and the physical metal is stored with the Royal Bank of Canada. 

GLD is a scam of the highest order - as is SLV.

Just one example is when CNBC was invited to their vault.  One of the bars that was videotaped where the serial number was visible wasnt even listed on their reports.

The prospectus makes clear that they dont assay the gold, they dont guarantee its fineness - it could be gold plated tungsten for all they care.  They are not responsible for any screwups/shenanigans - you, the investor are.

Sprott’s PHYS and PSLV are closed end funds that actually allow you to convert your shares into the physical metal.  For gold you would need to have sufficient shares to trade for a LGD bar.

58

Dear S Roche,
yes, I saw your reply - I just didn’t have much to add, and so I left it there.

Concerning the am/pm "trade". This idea was brought up by Adrian Douglas in 2010 (!) It seems that SK Options Trading (whoever that is) just failed to give credit to him. When I saw the original analysis, I checked the data. Yes, the effect is there. It is statistically significant over long periods. The effect is present in gold since about 2000 and in platinum since about 2000 with the exception of 2008. It is missing in palladium. Although the effect is statistically siginificant over longer periods, I concluded it was not tradeable (after fees). This is because on any one day, the effect is statistically not siginificant. It is an order of magnitude smaller than the average daily fluctuations. Jeff Christian’s idea that it might be due to producers selling into the PM fixing was new to me. I had always suspected it was because of trading in Asia, but then both fixes are for gold loco London, and so this was never resolved.

Finally, concerning Jeff Christian’s comment on Andrew Maguire. I can understand this comment very well, and I have repeatedly compained at other sites (including TF) that I found Maguire’s claims fishy. If at all, he is probably a COMEX trader who didn’t know much about the OTC market until a few months ago. He is definitely not an LBMA insider.

I think I was the one who brought up Dimitri Speck who is, in my opinion, the only one who understands enough statistics and whose analysis I find reliable.

Yes, I agree that the gold miners are one of the major groups who get fleeced in the present system. You need to understand that they behave like companies who sell a product. As long as they make enough profit in terms of US$, they are happy. They are not the right ones in order to speculate on an end of the dollar dominated financial system, but rather part of that system. Also keep in mind that most mines cannot operate without substantial loans from (bullion) banks.

 
you seem not to like GLD because of the fine print. Fair enough. But then, please take a look at the fine print of the Sprott Trusts, too, which is not that different. In particular, Sprott can wind down the trusts at any time he choses. This means that if the gold market 'breaks' because there is a price crash and then the banks lose too much physical and run out of reserves, Sprott can easily wind down the trust when the price of gold is low, say below $1000. His investors then get cash, and he can sell the bullion to anyone he choses, for example to himself or to one of his hedge funds. Given that he has a track record of trading against his own retail investors in his PLSV, I would not rule out this possibility.
If you want to have gold because you think one day, there might be a premium for physical gold, you have to avoid **all** the ETFs.
 
Sincerely,
 
Victor
 
 
 
59

I agree with your comments regarding Sprott - PSLV, et al…
My preferred recommendation is that people buy physical and hold it in their physical possession (if you dont hold it - you dont own it).  I understand however that some people are investing using retirement funds/accounts and as such are forced to use certain vehicles such as Sprotts.

Another vehicle I trust with a good track record is CEF, but, that is a hybrid of gold/silver (roughly 50/50 ratio).

Another question for the more educated gold gang (I like the conversation on this thread).

Is it possible that the mining sector is leading the metals in a long term downtrend - i.e. that gold/silver are headed for a SIGNIFICANT loss of value?  There is the adage that the mining shares lead the metals… Of course the fundamentals would seem to suggest otherwise, but, its hard to discount the 13 year bear market in the miners as a group…

60

You gents have gone where no site has gone before. It has been a joy reading everyone,.The energy has been just great, and the knowledge base just remarkable. It has been a pleasure. Thank you
BOB