July 2010 - foorex2day

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Speaking at Sydney ANDA coin show

I will be doing a how to invest in gold presentation at the Sydney ANDA coin show on 14 & 15 August, details can be found here. I would ...

Chimps, Champs, and Chumps

Understanding negative lease rates

<div align="justify">The <a href="http://www.lbma.org.uk/pages/?page_id=55&title=gold_forwards&show=2010">reporting</a> by LBMA of negative lease rates is often misunderstood, resulting in some commentators coming to incorrect conclusions. Given my recent discussions with FOFOA on backwardation, some explanation of negative lease rates would probably be useful.<br /><br />In the real world the cost of borrowing gold outright is never negative – no bullion bank will pay you to take gold. In fact, I am aware that some lenders have a minimum rate below which they will not lease. Makes sense, would you risk lending 1 tonne of gold worth $37 million on an unsecured basis at 0.1% for 3 months just to earn $9,400?<br /><br />So why does the LBMA report negative lease rates? Our starting point is how the lease rate is calculated:<br /><br />Lease Rate = LIBOR – GOFO (see the <a href="http://www.lbma.org.uk/assets/OTCguide20081117.pdf">LBMA’s Guide</a> for why this is so)<br /><br />First point to note is that the lease rate is calculated from LIBOR and GOFO; the LBMA does not question its market making members for their actual lease rates. It is therefore based on the accuracy of LIBOR and GOFO. If we look at how these two rates are determined (see <a href="http://www.bbalibor.com/bba/jsp/polopoly.jsp?d=1627">here</a> and <a href="http://www.lbma.org.uk/pages/index.cfm?page_id=52&title=statistics_faqs">here</a>) then we see a number of differences:<br /><br />1. Set at different times – GOFO rate submitted at 10:30am and fixed at 11am, but LIBOR rates are requested between 11.00am and 11.20am and fixed shortly thereafter.<br /><br />2. Set on different sides – LBMA’s website GOFO is the rate “at which the Market Making Members will LEND gold on swap against US dollars”, which involves using the USD interest bid rate. For LIBOR banks are asked “At what rate could you BORROW funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size”, that is the USD interest offer rate.<br /><br />3. Set by different banks – LIBOR is set by 16 banks, GOFO by 8, with 6 common to both. LIBOR drops the top and bottom quartiles before averaging, GOFO drops the highest and lowest before averaging. It could therefore be possible that the 4 banks use to set LBMA’s GOFO (which they would calculate/relate to their estimate of LIBOR) don’t have their LIBOR rates included in BBA’s LIBOR. Probably worth noting that within a bank LIBOR and GOFO would be set by different desks.<br /><br />Now these are minor differences as we would not expect rates to move too much between 10:30am and 11:00am, or much difference in the bid/offer spread, or too much divergence between banks on their rate so the dropping of high and low rates should not affect the average too much.<br /><br />However, I think when rates get close to zero, these differences could have a material impact. Consider also that questions have been raised about LIBOR’s usefulness at these low rates, see <a href="http://ftalphaville.ft.com/blog/2008/05/30/13450/bba-and-libor/">here</a> and <a href="http://www.ft.com/cms/s/0/22478a70-5061-11de-9530-00144feabdc0.html">here</a>.<br /><br />The fact is that GOFO and LIBOR are not “in alignment”. The resulting calculated lease rate is therefore just an approximation based on two averages. Caution should thus be exercised when trying to draw conclusions from it.<br /><br />GOFO, however, should be able to be relied on. It should relate to the basis, although not equate to the basis as the basis is calculated from futures prices whereas GOFO is a forward rate - the economics of those two are slightly different.</div>

The reporting by LBMA of negative lease rates is often misunderstood, resulting in some commentators coming to incorrect conclusions. Given...

Degrees of distrust

<div style="text-align: justify;">My last blog was ultimately about trust and that maybe the basis is telling us that there is still trust in the system. After writing it I remembered the presentation I made to the 2009 Gold Standard Institute seminar in Canberra. Below is the conclusion from that presentation, where I proposed four phases, or degrees of distrust:</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;"><span style="font-weight:bold;">1st Phase</span></div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">We start to see increasing investment in gold reflected by increasing balances in COMEX or ETFs or GoldMoney etc, but the majority of people still hold fiat and stocks/shares. In respect of gold, people have no problem with storing their metal in "the system".</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;"><span style="font-weight:bold;">2nd Phase</span></div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">We start to see occassional backwardation which comes and goes and it usually only between cash and shorter futures/maturities - 1 to 2 months. This backwardation is arbitraged away by longs who still have belief in the system(s) so are willing to take the risk to make a profit. Gold is still held in the system but growth in reported balances is slowing.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;"><b>3rd Phase</b></div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">We see more backwardation periods, prolonged and now not just shorter maturities but maybe 3 month going to small backwardation. It demonstrates less interest by longs to take the risk. Possibly start to see reported balances of ETFs and less reputable custodians starting to stablise even though gold price still rising, which would puzzle ignorant commentators. A physical squeeze is developing.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;"><b>4th Phase</b></div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">Now backwardation persists, it is a permanent state in shorter maturities, increasing to longer maturities. Reported ETF balances are declining. A clear signal not all is well. Gold is being pulled and stored outside the system. The strong hands are in the majority, the squeeze is really on.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">I'd say we are just starting in the 2nd Phase.</div>

My last blog was ultimately about trust and that maybe the basis is telling us that there is still trust in the system. After writing it I r...

The basis does not lie!

<div dir="rtl" style="text-align: right;" trbidi="on"><div align="justify">My answers to FOFOA’s response.<br /><br /><em>I think an accurate definition of "paper" and "physical" is important to the accuracy of your statement: "I am reasonably confident that paper and physical are bound together."</em><br /><br /><br /><em style="text-align: right;">But what if you could play the arbitrage (closing the gap) game without actually putting any physical at risk of delivery? Would this change the accuracy and credibility of the basis signal?</em><br /><br />I assume you are talking here about using unallocated. OK so lets scenario it. Assume a stable supply/demand for both cash and futures so without the actions of an arbitrageur the cash price would remain at $1200 and Dec futures at $1195 for a period of 6 months. Hedge fund notices this and wishes to profit from it but it does not want to (or have) physical gold it wants to risk.<br /><br />Hedge fund contacts their friendly bullion banker and asks to lend gold. Bullion bank conjures out of thin air some fake unallocated gold, merely recording an asset in its books (loan to hedge fund) and a liability (unallocated owed to hedge fund). Let us assume the amount of ounces is enough to move the price in our otherwise stable market by $3.<br /><br />Hedge fund’s first step is to buy the Dec futures at $1195 but in doing so its price increases to $1198 (lets say that is the next offer price). Secondly they have to sell spot. Say they find a trusting investor who is willing to accept a transfer of the fake unallocated gold for $1200. Again, this action decreases the spot price to $1997 (next marginal bid price) and the market is now in contango. So far so good.<br /><br />But what happens in six months? The hedge fund only has two choices – cash settle or physical settle.<br /><br />If they cash settle then they have to sell back their Dec futures contract, but doing so will cause the price to decrease from its new equilibrium price of $1198 to $1195. Likewise, they have to buy unallocated to repay the loan to the bullion banker, but that will increase the spot price from $1997 to $1200. All that cash settling has done is delay the appearance of backwardation but not eliminated it.<br /><br />If they physical settle then they get their gold from COMEX and deliver it to the bullion bank to repay their loan. Now this would have no effect on prices. However, the bullion bank now has physical 1:1 backing its unallocated liability to the trusting investor. If that investor asks for delivery, it will have no effect on price because the bullion bank has the physical. In a roundabout way the hedge fund eventually did sell real physical gold to the trusting investor.<br /><br />Now your retort may be that the fact that the trusting investor was willing to accept fake unallocated allowed the manipulation of the basis to turn backwardation into contango. You would be correct, and that is the point of my scenario. The basis is therefore reflecting reality, the reality that there are idiots prepared to accept paper gold.<br /><br />The basis IS telling the truth. It is not the hedge fund or the bullion bank who have “manipulated” the basis, it is the trusting investor. But in a sense the basis has not be manipulated, arbitrage is ensuring it reflects reality, that there are idiots who are prepared to bid dollars for paper gold.<br /><br />If that trusting investor was not so trusting, then the hedge fund would not have been able to execute their arbitrage because there would be no one willing to accept their paper gold. The cash price would have remained at $1200 and the market in backwardation, and the basis would reflect reality, the reality that people were only willing to bid dollars for real gold.<br /><br />You said “If gold stops bidding for dollars (low gold velocity), the price (in gold) of a dollar falls to zero. This is backwardation!” My reply would be that even if all (real) gold stops bidding for dollars, but there is plenty of paper gold bidding for dollars which are being accepted, then there is no backwardation.<br /><br />My logic therefore leads me to the conclusion that the basis does not lie, that it cannot be manipulated. Professor Fekete was right all along, long live the basis. However, I don’t feel totally confident in this statement, as I said I’m not an expert in futures so there is probably a flaw in my scenario and logic. If so what is it?<br /><br /><em>Over time, group 1 will swell and end up holding most of the above-ground physical gold in the world. Group 2 will shrink and end up holding mostly paper gold. Group 3 will be financially sucked dry by the vampires in group 4. And group 4 will ultimately find it has no more markets to churn.<br /><br />This is the theoretical process that gold backwardation should represent. A healthy and REAL gold contango SHOULD send this process into reverse, perhaps slowly at first, but reverse nonetheless.<br /><br />So the question I am asking is which direction are we heading right now in this process? How close are we to the end of this process? And why aren't the market signals matching the rest of the picture?<br /><br />If group 1 already has most of the physical gold and is now a one-way flow, is that not the state-of-the-market that backwardation should signal? And if the state is present but not the signal, what does that say about the signal?</em><br /><br />Following from my conclusion that the basis does not lie, then the “signal” must be correct, which means “the state” of group 1 strong hands having most of the physical gold is not correct and we not close to the end of the process you describe. This is consistent with the defence by goldbugs to claims we are in a gold bubble that investment in gold is still a fraction of portfolio allocations and the mass market is not buying gold. Dollars are not being bid for gold, real or paper.<br /><br />If you don’t like the conclusion, then you must find a flaw in my logic about the basis. I am more than happy to be proven wrong. Well, maybe not just yet, I'd like to pick up some more cheap gold :)</div></div>

My answers to FOFOA’s response. I think an accurate definition of "paper" and "physical" is important to the accuracy of...

Follow up to FOFOA

<div dir="rtl" style="text-align: right;" trbidi="on"><div style="text-align: justify;">FOFOA has hit me with a lot of questions in this comment. It is 11pm in Perth, so this will be brief, but they are interesting questions and I will cover off on them over the next few days.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">When it comes to COMEX FOFOA, I also am a "conceptual thinker and a fundamental analyst-blogger". This is because my gold market experience has only been with the Perth Mint and the Perth Mint has never traded on COMEX, and nor can I see any reason why we would in the future. It is a position you can take I suppose when you refine 300 tonnes of physical per year. I mention it so it is clear where my expertise lies and where it does not. This won't stop me from theorising however, because that wouldn't be any fun.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">You question the reality of COMEX. Certainly the fact that one does not have to put down full cash and only margin means that there may well be many technical traders playing with computer digits, and they may be in the majority. However there are also real physical players like miners and manufacturers.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">However, I am reasonably confident that paper and physical are bound together. To make that statement I rely on one thing - arbitrage, or greed. Greed as a motivator is something I feel pretty confident relying on. I just don't consider it believable that a bullion bank or hedge fund or other big trader would leave profit on the table.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">We cannot discount manipulations or games being played with cash or future prices. But to manipulate one of those means that the gap (ie the basis) between the market you are manipulating and the one you aren't widens or shrinks. If the manipulation goes too far then that will present an arbitrage opportunity to other players, which if we rely on greed as a motivator, they will take. That action closes the gap.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">Now as one can "trade" the basis (for another day) as distinct from the price, it must therefore be possible that the basis itself can be manipulated. However trading the basis involves two "legs" - eg buy spot, sell futures or sell spot, buy futures - which again widens or shrinks the gap/basis, presenting arbitrage opportunities to others.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">The game of trading to my mind is a "base" of real price setting physical deals with that price pushed and pulled by competing manipulators, speculators and arbitragers, of both paper and physical price. Price may go up, it may go down. Both cash and futures prices may go up, but the gap widen. Or both prices go up and the gap shrinks.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">I see it like an elastic/rubber band being stretched and then bouncing back. That stretching is the "noise" I mentioned in my last post. It is fun to watch and I'm sure such watching can give you an insight into the games being played, but what matters is when it is stretched to far, and breaks.</div></div>

FOFOA has hit me with a lot of questions in this comment. It is 11pm in Perth, so this will be brief, but they are interesting questions and...

When does backwardation matter?

<div align="justify">FOFOA started a little excitement with <a href="http://fofoa.blogspot.com/2010/07/red-alert-gold-backwardation.html">his post</a> on backwardation. Professor Fekete <a href="http://www.professorfekete.com/articles/AEFGoldBasisScrewedPP5.pdf">responded</a> and Zero Hedge <a href="http://www.zerohedge.com/article/antal-fekete-responds-fofoas-speculation-gold-backwardation-manipulation">weighed in</a> as well.<br /><br />I would not be surprised that for many this backwardation thing makes their head hurt and perceive it as all very theoretical and of no practical use. But this is not true and backwardation is a potential profit opportunity for those holding gold. However, it is also being overplayed.<br /><br />Backwardation is when the future price is less than the cash (spot) price. Consider you are a long term holder of gold expecting to sell it in a couple of years when the price peaks. One day you wake up and note that the price of gold six months into the future is being quoted on COMEX at $1150. You check with your local coin dealer and he is quoting to buy your gold at $1200. What does this “backwardation” mean to you? See below (numbers for purposes of calculation simplicity, not real costs).<br /><br />You work out that it will cost you $100 to ship your 100oz to the dealer. He will pay you $120,000. You deposit $20,000 of that with your broker as margin (plus extra to cover fluctuations) and buy the $1150 futures contract, plus brokerage fee of $50. You deposit the remaining $100,000 cash in the bank for 6 months at 0.5%. On maturity of the futures contract you stand for delivery and incur $50 brokerage and $100 shipment cost. Your profit on this is $4950, composed of<br /><br />* Sale of gold: +$120,000<br />* Purchase of gold: -$115,000<br />* Interest on cash: +$250<br />* Brokerage and shipment costs: -$300<br /><br />Now this is a great deal. At the end of the 6 months you still have physical gold but you have earned additional money while you wait for your eventual sale in a couple of years. Why would you not take up this opportunity?<br /><br />Well, the deal is saying “Sell us your gold now and (trust us) ... we will have it to sell back to you in the future for less!” You are exchanging your current physical gold for a future claim to gold. You have “counterparty risk”, to COMEX, to the short on the other end of your 6 month futures contract.<br /><br />Of course, such a wide difference between cash and futures prices does not normally occur, because faster and bigger players see the profit opportunity and get in first. Their action of selling lowers the $1200 cash price and their buying of the 6 month futures increases the $1150 price and thus eventually the gap (and profit) disappears. That is arbitrage.<br /><br />But if you did see such a big difference in prices, it means the big players aren’t taking up the deal. The cash-futures gap is telling you that people don’t trust COMEX, they don’t think they’ll get their gold back in the future. What backwardation is telling you is that people don’t want to give up their gold, even for a little while. As FOFOA says: “gold stops bidding for dollars”.<br /><br />This leads to my closing point, which is best summed up by Tom Szabo’s December 2008 <a href="http://silveraxis.com/todayinsilver/2008/12/28/response-to-professor-feketes-forward-thinking-on-backwardation-part-1/">comment</a>: “Let’s talk if and when the backwardation is large enough that the arbitrage was there and yet still nobody chose to go after it. That would be truly something!”<br /><br />For example, if the cash price was $1200 and 6 months futures $1199.25, in my simplistic (and unrealistic from a cost point of view) example, that would mean a profit of $25. That is technically backwardation and technically a profitable one. But could you (or the big players) be bothered with all the work involved in selling gold, buying futures and then taking delivery, all for $0.25 per ounce profit?<br /><br />Therefore, the only backwardation that matters to me is backwardation that:<br /><br />a) means reasonable profit and<br />b) no one is willing to take that profit (that is, it is persistent).<br /><br />Any other backwardation is just noise and has no “information value” by itself.<br /><br />If this topic interests you, the following two services specialise in tracking the gap between cash and futures (known as the “basis”):<br /><br /><a href="http://www.metalaugmentor.com/">The Metal Augmentor</a> (Tom Szabo)<br /><a href="http://www.bullionbasis.com/">Gold Basis Service London</a> (Sandeep Jaitly)<br /><br />These services look at the bigger picture and don't get distracted by instances of technical backwardation. They look at the trend in the basis, trying to identify in advance when significant and persistent backwardation will occur.</div>

FOFOA started a little excitement with his post on backwardation. Professor Fekete responded and Zero Hedge weighed in as well. I would n...

Red Alert: Gold Backwardation!!!

Why Investing In Gold Is An Illuminati Trap

<div align="justify">There are a lot of "why you should buy silver instead of gold" advocates out there, but this blog <a href="http://www.thepatriotscave.com/2010/07/why-investing-in-gold-is-illuminati.html">Why Investing In Gold Is An Illuminati Trap</a> is, well, in a league of its own:<br /><br /><em>Welcome to The Patriots Cave, I am Joel the K. And yes, that is correct, the Illuminati wants you to waste your money on gold. Gold coins, gold bullion, gold stamps and gold of every sort. ...<br /><br />This is what I believe the NWO is planning to do with gold. They will scare the middle and upper class into sinking their money in gold, and then they will pull the rug out from under it all. Gold will plummet as panic selling ensues. Gold will fall to under $300/ounce. And then people will realize, that like diamonds, gold too, is just something pretty to look at, and that it has very little inherant value.<br /><br />So say I am correct in my speculation. What then would be the smart move? Oh that is easy when you think with your instinct and intuition. SILVER. Silver will become worth MORE than gold. Mark my words. Brethren and sistren, for over 6,000 years silver was like gold, a pretty metal to make jewelry and spoons out of, and coins and bullion bars. However, in the last few decades, silver has been found to posess qualities unlike any other metal. Silver is now being used to make computers, electrical appliances, medicine, cars, planes, boats, machines, and millions of other things.</em> </div>

There are a lot of "why you should buy silver instead of gold" advocates out there, but this blog Why Investing In Gold Is An Illu...

FOA on Hyperinflation

Upcoming cardinal climax good for gold

<div align="justify">I bookmarked this Seeking Alpha article from March this year <a href="http://seekingalpha.com/instablog/234091-hewitt-heiserman/61457-rare-cardinal-climax-planetary-alignment-this-summer-puts-stocks-at-risk-says-veteran-sky-watcher">Rare “Cardinal Climax” Planetary Alignment This Summer Puts Stocks at Risk, says Veteran Sky Watcher</a>. To quote:<br /><br /><em>On August 1, give or take a week, we’ll have the most five-planet alignments in perhaps thousands of years. Known as the “Cardinal Climax,” this is the meanest, nastiest, most challenging and most transformational of any planetary phenomena in all of written history!<br /><br />I looked at records going back to the 1800’s, and this is the most difficult alignment I found. When I was at a conference in Boston last month, someone said this was the most difficult alignment they have seen in the last "1,000 years." Another person told me this is the worst alignment in "10,000 years."<br /><br />Worst cases include a nuclear accident. Nuclear war. Massive societal collapse. Maybe a pole flip, which can wipe out nearly everything.</em><br /><br />One week "minus" 1st August is next week, so you have been warned :) Of course if this does eventuate I'm going to have to eat humble pie.</div>

I bookmarked this Seeking Alpha article from March this year Rare “Cardinal Climax” Planetary Alignment This Summer Puts Stocks at Risk, say...

Gold: The Ultimate Wealth Consolidator

Chart Mysticism

<div align="justify">It is always good to get different perspectives on the markets. Bruce Edwards has worked in the refining game for many years, currently with <a href="www.sabinmetal.com">Sabin Metal Corp</a>. As a way of keeping in touch with his former and current clients he has a web site where he posts his <a href="http://home.comcast.net/~dedwards-1/Markets.htm">Chart Mysticism</a> on the markets.<br /><br />He has a chart at the bottom of the page called Gold Shares and Industry Ranking. Bruce explains it thus: "The chart is an index of Gold Mining Company Shares (upper line) and a 10 week moving average of their relative performance when compared with 98 other Dow Jones Industry Groups. I have been keeping this chart since 1993 and it has been excellent predictor of the future relative performance of gold and gold mining company shares. When the lower line is at the high end of its range everyone loves mining company shares and gold.  When it is at the lower end of its range everyone hates the group. A long term investor should sell when the lower line is high and buy when it is low."</div>

It is always good to get different perspectives on the markets. Bruce Edwards has worked in the refining game for many years, currently with...

Coin & bar sizes

Below is a doc with actual (approximate) sizes of the Perth Mint's coins and bars. Consider that these coins and bars, which fit on an A3 page, are worth over $200,000. A great example of the "value density" of gold.<br /><br /><a href="http://www.scribd.com/doc/34411510/Perth-Mint-coin-bar-sizes" style="margin: 12px auto 6px auto; font-family: Helvetica,Arial,Sans-serif; font-style: normal; font-variant: normal; font-weight: normal; font-size: 14px; line-height: normal; font-size-adjust: none; font-stretch: normal; -x-system-font: none; display: block; text-decoration: underline;" title="View Perth Mint coin/bar sizes on Scribd">Perth Mint coin/bar sizes</a> <object data="http://d1.scribdassets.com/ScribdViewer.swf" height="500" id="doc_661199145496932" name="doc_661199145496932" rel="media:presentation" resource="http://d1.scribdassets.com/ScribdViewer.swf?document_id=34411510&access_key=key-zh59t264inlk70pix1z&page=1&viewMode=list" style="outline:none;" type="application/x-shockwave-flash" width="100%" xmlns:dc="http://purl.org/dc/terms/" xmlns:media="http://search.yahoo.com/searchmonkey/media/"> <param name="movie" value="http://d1.scribdassets.com/ScribdViewer.swf"> <param name="wmode" value="opaque"> <param name="bgcolor" value="#ffffff"> <param name="allowFullScreen" value="true"> <param name="allowScriptAccess" value="always"> <param name="FlashVars" value="document_id=34411510&access_key=key-zh59t264inlk70pix1z&page=1&viewMode=list"> <embed id="doc_661199145496932" name="doc_661199145496932" src="http://d1.scribdassets.com/ScribdViewer.swf?document_id=34411510&access_key=key-zh59t264inlk70pix1z&page=1&viewMode=list" type="application/x-shockwave-flash" allowscriptaccess="always" allowfullscreen="true" height="500" width="100%" wmode="opaque" bgcolor="#ffffff"></embed> </object>

Below is a doc with actual (approximate) sizes of the Perth Mint's coins and bars. Consider that these coins and bars, which fit on an A...

Opening up gold's distribution channels

<div align="justify">Nick from <a href="http://www.sharelynx.net/">Sharelynx</a> forwarded two announcements to me today, one on Sprott's new <a href="http://www.sec.gov/Archives/edgar/data/1494728/000104746910006332/a2199292zf-1.htm#bg70602_table_of_contents">Silver fund</a> and <a href="http://www.mitsubishicorp.com/jp/en/pr/archive/2010/html/0000010535.html">Japan’s</a> first precious metal ETF (actually four of them) where the metal is stored in Japan. The Mitsubishi series name is "Fruit of Gold", gotta love that.<br /><br />I have been tracking all of these ETFs as well as other publicly reported storage facilities (eg GoldMoney) since 1999. I gave this proprietary data to Nick to combine with his extensive data sources to create a unique time series of these products, which you can find <a href="http://www.sharelynx.com/gold/TransETFs01.php">here</a> if you are a subscriber (and if you're not you should be otherwise you are operating in the dark re data on the precious metals markets).<br /><br />I'm sure we will shortly have some article by the gold haters that the growth of these ETFs are another bubble top indicator. I disagree, and would answer by quoting from a strategic paper I wrote for the Mint's Board in 2001, which probably sounds a bit old hat now:<br /><br /><em>The demonetisation of gold led to an emphasis on gold as an investment and this was reinforced further with the development of the Krugerrand and subsequent coin programs. However, from this promising start, gold has failed to move with its financial competitors and has thus lost its "market share" of the average consumer’s investment dollar.<br /><br />What occurred with other investments was a shift from physical to virtual. For example, consumers moved from cash to credit cards, from bank passbooks to account statements, from physical share certificates to electronic registration of holdings. Consumers clearly became comfortable with the virtual form of investments and the convenience they offered. In contrast, however, gold remained physical and therefore became relatively more difficult to purchase and hold.<br /><br />The result of gold remaining physical was that fewer and fewer intermediaries were willing to offer it to their customers. The two key intermediaries – banks and brokers – stopped offering direct investment in gold because other investment classes, such as shares and mutual funds, were easier to sell. This shrinking of gold’s distribution channels (in some countries it is only available from coin dealers) is it considered to be a contributing factor in the marginalisation of gold as an investment class. Hence, it is not surprising that gold is no longer considered part of a consumer’s investment portfolio.<br /><br />The arrival of the Internet is accelerating the move to virtual investment categories. Customers will expect to interact through the Internet, especially for "low touch" products such as shares, insurance, and gold bullion. Customers will also increasingly move their banking and investment management online. However, this move will still involve intermediaries, it is just that the intermediaries themselves will become virtual, mirroring the change that has occurred in the financial products they sell. For example, instead of telephoning their broker, investors will trade shares directly with ComSec or Charles Schwab.<br /><br />If gold is to regain a position on the average investor’s portfolio it must be on the intermediary’s "product list". The response of the gold industry to the move to virtual forms of investment does not address this issue. Virtual gold is only available via direct-to-consumer models, such as Perth Mint Depository Services or online from businesses such as Kitco. However, this approach requires consumers to find and set-up an account directly with the business concerned. These services are also not suitable for use by key intermediaries such as banks and brokers. As a result, gold is not truly "online" as far as average investors are concerned – it needs to be one of a number of investment options available when consumers ring or log on to their broker.<br /><br />To do this gold needs to be virtual, as shares are. The difficultly is that, unlike shares or mutual funds, gold is inherently physical – failure to insist on physical backing against customers’ holdings leads to the temptation to issue more "paper gold" and with infinite supply, the price and value of gold becomes meaningless. Physical backing is the key to marketing gold as safer than mere paper assets, as something with intrinsic value.</em><br /><br />The listing of ETFs on stock exchanges in my view begins the process of legitimising gold as an investment class in the minds of the average investor. However it is a necessary but not sufficient step - a case still has to be made for gold, it still has to be promoted. But at least it is "on the shelf".<br /><br />The other advantage of ETFs is that they bring transparency to what is an otherwise very opaque market. While ETFs only account for 6-7% of estimated privately held gold, this percentage will increase over time, giving greater insight into the mood of gold investors. Well possibly greater insight, depending on how well analysts read the entrails of changes in ETF holdings.</div>

Nick from Sharelynx forwarded two announcements to me today, one on Sprott's new Silver fund and Japan’s first precious metal ETF (ac...

GLD contango strategy, or not?

<div align="justify">A reader asked me to comment on <a href="http://ftalphaville.ft.com/blog/2010/07/12/283141/a-gld-contango-strategy/">A GLD contango strategy</a> by Izabella Kaminska. It talks about Paulson & Co earning a return on its $3.4bn woth of GLD shares.<br /><br /><em>Holding GLD, meanwhile, is cheaper and more cost efficient than buying bullion outright.</em><br /><br />I would note that most gold ETFs have management fees around 0.4%. Considering that Bullion Vault's storage fee is 0.12% and that Paulson would likely be able to get better rates than that from a bullion bank on $3.4bn worth of gold, it would be clear that GLD is not cheaper.<br /><br /><em>is it actually beginning to vacuum the world’s known gold supply float? Gold supplies, which previously, we might add, would have been put to work by central banks and bullion banks that owned them.</em><br /><br />If you look at all ETFs and other storage services for which we have <a href="http://goldchat.blogspot.com/2009/08/gold-etf-league-table.html">public numbers</a>, together they only total 6.5% of all privately held gold. On top of that you can add the 30,000 or so tonnes of central bank gold. GLD is hardly vacuuming "known gold supply float".<br /><br /><em>Given the low costs associated with holding GLD versus pure bullion, as well as the permanent contango in the market — it is quite clear the asset lends itself favourably to the ever popular contango storage strategy</em><br /><br />Because GLD is at least 4 times more expensive to hold than an allocated account for someone of Paulson's size, I'm not sure he could out arbitrage other players.<br /><br /><em>you buy GLD (perfect proxy for gold, but with no storage costs) you create a hedge by selling front month gold futures. You then lock in the spread further down the curve, and sit and collect the contango premium.</em><br /><br />Firstly, GLD does have "storage costs", that is the 0.4% management fee. The problem with the strategy she proposes is that by selling a futures contract she has hedged the GLD long position. So while you may earn the contango, you won't make any money on the increase in the gold price because if the gold price increases, then you are losing on your short futures contract.<br /><br />She has confused trading the <a href="http://www.bullionbasis.com/index.php?p=1_8">basis</a> (gap between spot and futures) with trading the price. You are either doing one or the other, but can't do both at the same time with the same capital.</div>

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

Debtors v. Savers III - Back to "honest" gold money? Or forward on to Freegold?

My fustration with GATA

<div align="justify">Regular readers of my blog know my main objective is to educate. Unfortunately, this often finds me having to take objection to something GATA has written.<br /><br />In Adrian Douglas’ <a href="http://www.gata.org/node/8820">latest dispatch</a> he says that <em>"the process by which only a portion of an investment is used to purchase bullion -- what is politely called "fractional reserve bullion banking" -- is fraudulent because it acts against the investor's interests. ... because the consequence of fractional-reserve bullion banking is undeniably price suppression."</em><br /><br />This is a dramatic, but exaggerated and somewhat misleading statement typical of GATA. I understand their motivation to generate passion in their readers, but I don't think it excuses imprecision with the truth.<br /><br />Fractional reserve bullion banking is not necessarily or inherently against an investor's interest and means price suppression. For example, an investor buys 100oz from a bullion bank, who then buys 100oz of physical. If the bullion bank then lends 50oz of that physical to jeweller, it has engaged in fractional banking as there is now only 50% of the investor's claim on the bank backed by physical. However, the other 50% of physical is with the jeweller and, most importantly, it has not been sold.<br /><br />Yes, the investor is exposed in that the bank's lending has "locked out" 50oz of physical to the jeweller for the term of the loan as well as the possibility that the jeweller may go bankrupt (assuming the bank has no form of security). However, this sort of fractional banking does not result in a sale and therefore there is no price suppression.<br /><br />My point is that it is the use (or to whom) the bank puts the metal backing its unallocated liabilities to that determines whether fractional banking = price suppression. Of itself, fractional banking does not necessarily mean price suppression as Adrian would have you believe.<br /><br />Having said that, I should note that the majority of lending of metal (and I do not know the exact percentage) ultimately involves the sale of that physical to back some sort of short instrument (eg a miner selling forward). On this basis Adrian probably feels his black and white statement that fractional = price suppression is justified. I don't think it is. You may consider I'm being picky but I have a problem with this sort of rhetoric for two reasons:<br /><br />1. GATA is a “tax-exempt educational and civil rights organization”. It is supposed to be about educating people. I think this is important, because a lack of understanding about how the market operates can lead people to exposing themselves to risks they may not be aware of. However by making these types of black and white statements, GATA is furthering misunderstanding. How difficult would it have been to say “because the majority of fractional lending is for short selling, it is a form of price suppression that acts against the interests of the (long) investor”? These sorts of qualifiers do not detract from the point being made, but give notice that the issues are more complex.<br /><br />2. Adrian laments that “attempting to convince industry insiders … meets a lot of resistance”.  Have GATA considered that simplistic statements and conclusions are interpreted by industry insiders not as rhetorical devices but read as ignorance of how the market really works. GATA therefore appears to insiders as lacking credibility, making it easy for them to ignore GATA and label what they say as “rants”.<br /><br />This is the crux of my frustration with GATA and I don’t think it does them, or investors, any good.<br /><br />As an aside, I note the dispatch refers to an <a href="http://www.gata.org/node/8627">earlier dispatch</a> where Adrian Douglas says <em>"a document published by the CPM Group in the year 2000 came to my attention recently"</em>. The document is "Bullion Banking Explained" and I made reference to this document in my <a href="http://goldchat.blogspot.com/2010/04/london-unallocated-fractional-fubar-or.html">London unallocated: Fractional Fubar or Benevolent Banking?</a> post of 11 April. I considered it an obscure document, buried in CPM Group's website and had not seen it referenced to before. If you search google for "Bullion Banking Explained" with a date prior to 11 April there are only two other references to it in 2001 and 2004.<br /><br />Coincidence that it comes to Adrian Douglas' attention in his 10 May dispatch one month after I reference it? By the way, this <a href="http://fofoa.blogspot.com/2010/04/21st-century-bank-run.html">FOFOA blog</a> attributes my post in a discussion of fractional gold banking in a discussion about whether the backing of fractional unallocated is actually physical or just further paper.<br /><br />Another claim I was particularly intrigued by was when Adrian Douglas says that "as a consequence of my article it appears that Christian has realized how damning his paper was, and while it was posted at the CPM Group Internet site for 10 years, it recently was removed mysteriously." I was disappointed to find that it was just a website reorganisation. The document still exists at <a href="http://www.cpmgroup.com/free_library1/HEDGING_AND_DERIVATIVES/Bullion_Banking_Explained_February_2000.pdf">this link</a>.<br /><br />It would have been most amusing if CPM Group had been prompted to remove the paper as a result of GATA. Possibly Mr Christian no longer reads GATA – he did vow recently to never engage with them again after the debate on Financial Sense. Personally I think the paper CPM Group should remove is the two I reference at the end of my post on <a href="http://goldchat.blogspot.com/2010/04/london-unallocated-fractional-fubar-or.html">fractional banking</a> where they say that bullion banks <em>"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."</em> Mr Christian is the expert on the gold market, who are we to argue?</div>

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

Debtors v. Savers II - FOA Retro House Mix

Gold holds its value

<div align="justify">On a recent trip to Sydney I visited the Reserve Bank of Australia's <a href="http://www.rba.gov.au/Museum/index_static.html">Museum of Australian Currency Notes</a>. From the displays comes the following interesting information about prices in "the 1900's":<br /><br />6 shillings a week for meat<br />16 shillings a week for groceries<br />25 shillings a week for rent<br />£250 for a Model T Ford<br />House equal to 10 times annual earnings<br />During war years average weekly earnings were £3<br /><br />Given that there are 20 shillings in a pound and a pound is equal to a sovereign, which is equal to 0.2354 ounces, we can convert those prices at say AUD 1400 ounce into today's money:<br /><br />$99 a week for meat<br />$264 a week for groceries<br />$412 a week for rent<br />$82,500 for a Model T Ford<br />$514,800 for a house<br /><br />Of course this is a bit imprecise given the prices are as at "1900's" and wages are as at "war years", but it is a reasonable holding of value and certainly more than if one had just held on to paper money for a hundred years. See also <a href="http://goldchat.blogspot.com/2009/03/1966-50c-piece.html">this post</a> on the same theme regarding the 1966 50c coin.</div>

On a recent trip to Sydney I visited the Reserve Bank of Australia's Museum of Australian Currency Notes . From the displays comes the f...

Debtors vs Creditors

<div align="justify">Those interested in this issue, which I have covered in <a href="http://goldchat.blogspot.com/2010/06/gold-and-clash-of-civilisations-by-andy.html">this</a> and <a href="http://goldchat.blogspot.com/2009/09/protecting-yourself-from-world-war-iii.html">this</a> post, will find FOFOA's <a href="http://fofoa.blogspot.com/2010/07/debtors-and-savers.html">latest post</a> useful.<br /><br />FOFOA agrees with Marx that "the history of all hitherto existing society is the history of class struggle" but says that he got the classes wrong:<br /><br /><em>The two classes are not the Labour and the Capital, the rich and the poor, the proletariat and the bourgeoisie, or the workers and the elite. The two classes are the Debtors and the Savers. "The soft money camp" and "the hard money camp". History reveals the story of these two groups, over and over and over again. Always one is in power, and always the other one desires the power.</em><br /><br />What is the relevance of this to gold? FOFOA argues that:<br /><br /><em>... when the soft money guys are in power the transfer of wealth happens slowly and gradually, and wealth flows from the Savers to the Debtors. But when "soft money" collapses - and it ALWAYS collapses - there is a very RAPID transfer of wealth in the other direction, from the Debtors back to the Savers.<br /><br />... By selling your debt-financed paper savings and buying physical gold today you are making the conscious CHOICE to join the camp of the true Savers.</em></div>

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

The Debtors and the Savers

Unfair coin ban for SMSFs

<div style="text-align: justify;">The <a href="http://www.supersystemreview.gov.au/content/downloads/self_managed_solutions/self_managed_super_solutions.pdf">Cooper Super System Review</a> has been looking at the issue of collectables held in SMSFs and has a preliminary recommendation that:</div><div style="text-align: justify;"><br /></div><i><div style="text-align: justify;"><span class="Apple-style-span" style="font-style: normal; "><i>a) the acquisition of collectables and personal use assets by SMSF trustees be prohibited;</i></span></div><div style="text-align: justify;"><span class="Apple-style-span" style="font-style: normal; "><i>b) SMSFs that own collectables or personal use assets be provided a transitional period,</i></span></div><div style="text-align: justify;"><span class="Apple-style-span" style="font-style: normal; "><i>up to 30 June 2020, in which to dispose of those assets; and</i></span></div><div style="text-align: justify;"><span class="Apple-style-span" style="font-style: normal; "><i>c) APRA‐regulated funds be exempted from these changes.</i></span></div></i><div style="text-align: justify;"><br /></div><div style="text-align: justify;">Their examples include paintings, jewellery, antiques, stamp collections, wine, exotic cars, golf club memberships, race horses and boats. The list is based on and makes reference to the <a href="http://www.ato.gov.au/individuals/content.asp?doc=/content/36555.htm&page=1#P10_750">ATO's definition</a> of ‘collectables’ and ‘personal use assets’ and this definition includes “coins or medallions”.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">The inclusion of coins, stamps and medallions and the requirement they be sold within 10 years has caused great concern within the numismatic community. It is the view of coin dealers that the market cannot absorb disposal of the volume of numismatic product held in SMSF over 10 years, resulting in a negative impact on market prices.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">Now it is possible for a SMSF to “sell” their collection to the individual(s) who benefit from the SMSF, thereby avoiding any impact in the market. However this assumes that such individuals have the cash to pay their SMSF. In addition, the book sale would result in tax consequences for the SMSF.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">I would note at this point that those who hold bullion coins through their SMSF should not have anything to worry about. The super review's reliance on the ATO's definitions for tax purposes means that bullion should be excluded due to the very clear difference the ATO makes between bullion and collectables for GST purposes in <a href="http://law.ato.gov.au/atolaw/view.htm?docid=GST/GSTR200310/NAT/ATO/00001">this ruling</a>. I cannot see the super review going against this because it would result in the super treatment conflicting and disagreeing with the ATO's arguments around bullion/collectables, opening up all sorts of issues for the ATO. The primary problem would be that individual bullion items under $500 would not attract capital gains tax! I can't see the ATO letting that happen.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">So on what basis has the super review determined that collectables are not a suitable investment? Initially they say that they believe “that there are certain types of assets that should not be regarded as investments that build retirement savings”.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">Now this is contradicted by the fact that their recommendation excludes APRA regulated funds. If collectables were not good enough for SMSF to “build retirement savings” then logically they should also not be good enough for APRA regulated funds. The fact that they make this illogical statement indicates to me they are clutching at justifications for their position.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">Later in their document they give the real reason: “The principal concern is that the cumulative regulatory and compliance complexities outweigh the potential benefits of allowing such a liberal investment menu to a sector that is not directly prudentially regulated.”</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">Now what this is really saying is that they suspect people are abusing the system but it is too much trouble to enforce compliance with the rules so lets just punish everyone and ban it all outright. But what really gets to me is that they are making this ban retrospective. They could have recommended disallowing <i>further</i> investment in collectables rather than forcing the liquidation of existing collections. There is no justice in retrospective law.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">The fact is that it is bureaucrats who drafted the detailed legislation that allowed the loophole but instead of admitting their mistake and living with it, they want to perform a <a href="http://en.wikipedia.org/wiki/Nineteen_Eighty-Four">1984 Orwellian</a> expunging of collectable from SMSFs so they can pretend the whole thing never happened.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">And the result? Forced sales that will depress prices and thus the value of those SMSFs. So much for helping people “build retirement savings”, Mr Cooper.</div>

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

Timing Is Everything

AIG Precious Metal Manipulator?

<div align="justify">Further to this <a href="http://www.zerohedge.com/article/was-aig-addition-being-riskiest-company-world-also-precious-metals-manipulator">Zero Hedge post</a> note the following from CPM Group's Mr Christian:<br /><br /><a href="http://www.cpmgroup.com/free_library1/HEDGING/Bullion_Banking_Explained_February_2000.pdf">Bullion Banking Explained</a> (dated Feb 2000):<br /><br /><em>Many banks use factor loadings of 5 to 10 for their gold and silver, meaning that they will loan or sell 5 to 10 times as much metal as they have either purchased or committed to buy. One dealer we know uses a leverage factor of 40. (Long Term Capital Management had a leverage factor of 100 when it nearly collapsed in 1998.)</em><br /><br />So CPM Group knew of a 40:1 precious metals leveraged firm in 2000, who were they? Mr Christian tells us in his <a href="http://www.netcastdaily.com/broadcast/fsn2010-0410-1.mp3">April 10 2010 interview</a> with Jim Puplava of Financial Sense at the 44 minute mark:<br /><br /><em>AIG was not a bank, was not a commercial bank, and under the US laws non-commercial banks don't come under the law, the guidance of the office of the controller of the currency. AIG used a leverage factor of 40, so if people gave them a million ounces of gold to hold for them, they could lend out 40. I mean, I have friends who are metals traders who were looking for job years ago and, you know, they went to AIG and AIG said “we use a leverage factor of 40” and the trader is a seasoned guy and he's worked at major banks and investment banks, he said “I can't operate at that level of leverage its just too risky more me” and AIG trading said “well this is what we do”, right, so there is a loophole in our regulatory system, its doesn't really have anything to do with gold and silver per se but it allows non-banks to participate in banking activities in a way that skirts banking regulations that are designed to promote stability in the banking system.</em><br /><br />Interesting that in 2000 CPM Group could publicly talk about “one dealer we know” having 40:1 leverage and it was not considered an issue (although he didn’t publicly mention is was via a "loophole") – sign of those times I suppose. Question is, has anything changed?</div>

Further to this Zero Hedge post note the following from CPM Group's Mr Christian: Bullion Banking Explained (dated Feb 2000): Many ban...