This was posted at the Speakeasy on March 4, 2016, and is being reposted
here by request. :D
Hello Wimms,
You obviously have a good understanding of how GLD works from a technical
standpoint. But I can tell from your comment that you do not have a very good
understanding of what I have been explaining.
First of all, in characterizing your perception of what I've been explaining,
you used the following words and phrases: "quite a bit of monkey
business"; "conspiring"; "shady business"; "to
cheat"; "fraudulent"; and "assuming conspiracy". But
nothing in my "coat check view" is any of those things. None of it
is illegal, fraudulent, or in the least bit shady. I meant it, and I still
mean it, what I wrote in one of my comments to Maus69: "No conspiracy. No
plan. Nothing illegal about it. It’s just the correct way to understand GLD
and how it works."
There are plenty of gold bugs (even here at the Speakeasy) who want to
believe that GLD is in some way fraudulent. But I am not one of them. Often
they read what I write about GLD and interpret it through their own
"GLD-is-fraudulent lens", and then post a comment that reveals that
lens. So I want to say it again here, as plainly as possible, that I do not
think there's anything illegal or fraudulent about GLD, even under the
coat-check room view. For anyone who thinks it is "shady business"
that the physical in GLD will ultimately go to someone other than the
shareholders of GLD, all I can say is you didn't read the small print. Or if
you did, then you didn't understand it the correct way, which is what I'm
explaining.
I can tell by your comment, Wimms, that I need to go back and explain
"coat check" from the beginning. And to do so, I will also need to
explain "bullion banking" from the beginning. Understanding bullion
banking is the key to everything, and I'm starting to think that not even one
in a million gold bugs (and even gold and investment industry professionals)
actually understands what bullion banking is. Bullion banking didn't even
exist before 1971. Back then, it was just called banking. And it's no
coincidence that the establishment of the LBMA by the Bank of England in
1987, as an umbrella association for the London Bullion Market, coincided
with the birth of "this new gold market" that Another described.
Such an association was necessary for bullion banking to function in "this
new gold market."
Before I do, however, I want to address a couple of things from your comment.
The first is that you really seem to take issue with my characterizing
transactions in layman terms. I do this not only because it makes it easier
to understand, but also because it helps to get across the correct way to
view what is actually happening.
The main example here is that you didn't like when I wrote that GLD
"buys" gold from HSBC. Here's exactly what I wrote:
"From GLD’s perspective, it “buys” and “sells” its gold outright. But it
always “buys” from HSBC, and it always “sells” to HSBC. So like Maus69 says,
GLD always owns its gold outright, but HSBC holds it for GLD."
Then you wrote:
"Now lets focus on assumptions you presented as facts.
First, GLD trust does not buy or sell anything, not from HSBC, nor any of the
APs."
There's a reason I wrote it the way I did, and I think it will be helpful to
explain why. First of all, notice that I put "buy" and
"sell" in quotation marks. In a previous paragraph, I wrote (more
precisely) that, "HSBC might lease gold from someone else to increase
its reserves, and then it might allocate some of its reserves to
GLD." Allocate is the key word there. "Buy" in quotes meant
allocate, and "sell" in quotes meant "unallocate" or
"deallocate."
So why did I write "buy" and "sell" rather than allocate?
Because it gets us closer to understanding what's really happening. No matter
where the physical gold bars come from initially, they all come from HSBC's
reserves right before they "go into" GLD. Even if an occasional
numbered bar added to the list is physically somewhere other than HSBC's own
vault (and I doubt this is ever the case, but it is possible), it must be
allocated to HSBC and become part of HSBC's pool of physical reserves before
it is placed on the bar list.
Part of HSBC's job as custodian is to identify specific bars by their
numbers. And when they are going "into" or "out of" GLD,
they are doing so "from" or "to" HSBC's pool of physical
reserves (quotes in this sentence are used because the movements are often
just on paper, and the physical metal doesn't actually move). The transaction
is not explained this way or using these words in the prospectus or the
Participant Agreement, but my version actually explains more clearly what is
meant in the official documents.
I highlighted a relevant line from the Participant Agreement you linked:
3. DEPOSITS
3.1 PROCEDURE: You may at any time notify us of your intention to deposit
Precious Metal in your Unallocated Account. A deposit may be made (in the
manner and accompanied by such documentation as we may require) only by
transfer from an account of yours relating to the same kind of Precious Metal
and having the same denomination as that to which this Unallocated Account
relates. We will not accept physical delivery of Precious Metal into this
account.
They are talking about an AP making a deposit into the Trust's account at
HSBC. What do you think it means that they will not accept physical delivery
into that account? It means allocated, or bar numbers. It means, in
essence, that deposits from APs do not include bar numbers. Bar numbers
come only from the custodian.
This will make more sense once I explain bullion banking the way you've
probably never heard it explained before, but in order for HSBC to assign a
bar to the Trust, it must first be or become one of HSBC's own bars, meaning
one of its physical reserves. This bar, as a reserve of HSBC, is an asset of
HSBC which gets transferred to "The Trust" when it gets allocated
to the GLD bar list. It is no longer an HSBC asset once it is on the GLD bar
list. In essence, GLD "bought" that bar from HSBC.
So what did HSBC receive in exchange for surrendering one of its assets to
"The Trust"? It received payment from the Trust's unallocated
account in exchange for one of its reserves. Now, that account is also at
HSBC, so the unallocated credits in the Trust's account are actually HSBC
liabilities. So, in a sense, it is more like a withdrawal by the Trust. But
then again, remember that HSBC continues holding the bars on behalf of the
Trust, so that's why it's called allocation.
I also used "buy" and "sell" to make the point that GLD
owns it outright. This is important because the entity owning it outright has
the exchange rate exposure, which GLD wants and needs. If, hypothetically,
gold bar numbers could be leased by GLD directly (a contention that came up
in the comments which I was indirectly addressing with that paragraph), then
GLD would not have the exchange rate (price) exposure to the gold, because in
a lease, the price at which gold will be returned is agreed in advance as
part of the lease. You have to own it outright (not borrow it) to profit (or
lose) from its price movements. I believe this "outright ownership"
was made a little more clear using "buy" and "sell"
rather than saying HSBC "allocated" some of its unallocated
physical to GLD.
This concept also affects HSBC in the case that it did lease some physical
gold. Forget about the lease having anything to do with GLD share creations,
which was something else that really seemed to bother you. If HSBC leased
some physical gold bars from anyone, it does not have price exposure, meaning
it does not gain if the price of gold rises, and it does not lose if the
price of gold falls. Yet those bars still become the "free and
clear" assets of the bank. It just also has a new liability to provide
gold to the lessor in the future at a set price, which neutralizes any gain
or loss from the price of gold during the lease.
Now let's say that HSBC allocates some bars to GLD, while it still has that
outstanding lease. By doing this, HSBC has taken on price risk, which it now
must hedge, because it still has to return some gold to the lessor at a
predetermined price, but it has reduced its reserves, de-neutralizing that
liability. This is what I was talking about here:
"But I can imagine an AP, today, preferring to pass the buck and make
HSBC source the gold and hedge its subsequent exposure (if the gold is
leased), rather than expanding its own balance sheet and having its own
delta-one desk hedge off the risk."
Wimms, you objected to the idea that HSBC might lease physical to fulfill its
duty as Custodian. You wrote:
"you say that HSBC can create GLD shares with gold it does not own title
to. This is not true."
The way you put it is not what I say. If HSBC leases gold bars from a client,
it can sell them or let them be withdrawn, or allocate them to someone else.
For all intents and purposes, HSBC has perfectly clear title to those bars,
even though they were leased. That's because HSBC is not only a bank, it is a
bullion bank.
An apt analogy, whether you like it or not, is physical cash at your
neighborhood bank. If your bank has borrowed some cash because it was running
low, it can put that borrowed cash into its ATM machine where you may
withdraw it. So yes, HSBC can create GLD shares with gold bars it has leased
from someone else. That someone else holds, as an asset, a liability from
HSBC, and the physical bars are absorbed into the bank's pool of reserves,
becoming assets of the bank, on par with any other assets of the bank, as far
as what the bank can do with them.
So, in essence, HSBC may borrow some bullion banking reserves
(physical gold bars), and then "The Trust" may make a
"withdrawal" from its unallocated account, essentially pulling out
those same reserves that were borrowed and sticking them into GLD. GLD now
owns them outright. It doesn't matter that HSBC leased them a few days prior,
because gold is fungible, and because HSBC is a bank, and because of
something very special that sets banks apart from non-banks, which is the
ability to hold deposits as on-balance sheet assets of the bank.
Bullion Banking 101
Imagine you're the CEO of a small asset management firm. That won't be a
stretch for several of you who I know have your own firms. What is the most
fundamental difference between your firm and a bank? Yes, banks create money
and you can't do that, but there's something even more fundamental than that,
something that enables banks to create new money. Can you think of what it
is?
Remember Jon Corzine and MF Global? MF Global went bankrupt in 2011. And Jon
Corzine, its CEO, faced possible criminal charges in the bankruptcy, but why?
Many companies go bankrupt. Going bankrupt is not against the law, so how did
MF Global break the law?
Here's an excerpt from the MF Global Wikipedia page:
"MF Global mixed customer funds and used them for its own account for at
least several days before the bankruptcy and transferred funds outside the
country.[27]
The liquidation trustee ultimately reported that on October 26, 2011, Edith
O’Brien, an assistant treasurer in Chicago who reported to the firm’s
treasurer in New York approved transfers totaling $615 million from
segregated customer trust accounts at JPMorgan Chase, supposedly for an
intraday loan. The funds weren’t returned by the end of the day, causing
“panic” in Ms. O’Brien’s operation. Ms. O’Brien continued to approve such
“loans” in the ensuing days.
On the morning of October 28, two company officials noted a deficit in
segregated customer accounts of about $300 million. Two members of O’Brien’s
staff improperly determined that a $540 million wire transfer into the
segregated accounts the previous day had somehow gone unrecorded and
double-counted the transfer. The firm reported a surplus of more than $200
million to the commodities commission. The segregation report was revised to
show a surplus without any backup documentation.
That same day, the 28th, CEO Jon Corzine ordered O’Brien to transfer $175
million to JPMorgan to cover a firm overdraft. With no other source for the
cash, O’Brien approved a transfer of $200 million from a customer trust
account at JPMorgan. The trustee’s report concludes there was a substantial
“shortfall” in customer segregated funds every day from Oct. 26, when $615
million in loans from customer accounts were not repaid, until MF Global
filed for bankruptcy on Oct. 31.
[…]
U.S. regulators subpoenaed MF Global’s auditor, PricewaterhouseCoopers LLP,
for information on the segregation of assets belonging to clients trading on
U.S. commodity exchanges.[54]
[…]
Bloomberg reported that "Barry Zubrow, JPMorgan's chief risk officer,
called Corzine to seek assurances that the funds belonged to MF Global and
not customers. JPMorgan drafted a letter to be signed by [Edith] O'Brien to
ensure that MF Global was complying with rules requiring customers’
collateral to be segregated. The letter was not returned to
JPMorgan."[63] Corzine resigned from the firm in early November 2011.
[…]
On April 24, 2012, Jill Sommers, a CFTC commissioner, outlined possible
enforcement actions against MF Global employees and executives. Potential
violations involve rules that require segregation of customer funds from a
brokerage's own operating accounts…"
Here's a quote from the GLD prospectus which I used in the last post. The
only thing I did here was replace "Custodian" and "bullion
dealer" with HSBC, the name of the bank acting as both in some if not
most cases:
Gold held in an unallocated account is not segregated from HSBC's assets. The
account holder therefore has no ownership interest in any specific bars of
gold that HSBC holds or owns. The account holder is an unsecured creditor of
HSBC…
It's not a perfect analogy, the difference of which I'll get to in a moment,
but I am making a point here about HSBC being a bank, while MF Global and
your own small asset management firm are not. In London, it's called the
Client Money Rules:
CASS 7.13 Segregation of client money
Application and purpose
CASS 7.13.1G01/06/2015
The segregation of client money from a firm's own money is an important
safeguard for its protection.
CASS 7.13.2R01/06/2015
Where a firm establishes one or more sub-pools, the provisions of CASS 7.13
(Segregation of client money) shall be read as applying separately to the
firm's general pool and each sub-pool in line with CASS 7.19.3 R and CASS
7.19.12 R.
Depositing client money
CASS 7.13.3R01/06/2015
A firm, on receiving any client money, must promptly place this money into
one or more accounts opened with any of the following:
(1)
a central bank;
(2)
a CRD credit institution;
(3)
a bank authorised in a third country;
(4)
a qualifying money market fund.
(Source)
Banks are exempt from the Client Money Rules:
Depositaries
CASS 1.4.6R01/01/2009
The client money chapter does not apply to a depositary when acting as such.
(Source)
Here's a short excerpt from a paper on this subject:
"It follows then that what enables banks to create credit and hence
money is their exemption from the Client Money Rules. Thanks to this
exemption they are allowed to keep customer deposits on their own balance
sheet. This means that depositors who deposit their money with a bank are no
longer the legal owners of this money. Instead, they are just one of the
general creditors of the bank whom it owes money to.
[…]
What makes banks unique and explains the combination of lending and
deposit-taking under one roof is the more fundamental fact that they do not
have to segregate client accounts, and thus are able to engage in an exercise
of ‘re-labelling’ and mixing different liabilities, specifically by
re-assigning their accounts payable liabilities incurred when entering into
loan agreements, to another category of liability called ‘customer deposits’.
What distinguishes banks from non-banks is their ability to create credit and
money through lending, which is accomplished by booking what actually are
accounts payable liabilities as imaginary customer deposits, and this is in
turn made possible by a particular regulation that renders banks unique:
their exemption from the Client Money Rules."
(Source)
Here's my question again. Can you answer it now? "Imagine you're the
CEO of a small asset management firm. What is the most fundamental difference
between your firm and a bank? Yes, banks create money and you can't do that,
but there's something even more fundamental than that, something that enables
banks to create new money. Can you think of what it is?"
Okay, I said above that this was not a perfect analogy, and what I meant is
that bullion banking is not precisely similar to regular banking where you
need a banking license and have a central bank. It is more similar to
eurodollar banking, or carrying bank-like books in a foreign currency, or
even in something else, like a wealth asset.
Keep imagining you have your own asset management firm, and let's say you're
inside the US. If you wanted to carry bank-like books in dollars, you'd need
to get a banking license to do so. But if you (hypothetically) did so in a
foreign currency or gold, there's no such banking license to even be issued.
You'd be theoretically acting outside of the purview of that currency's
banking authority, and without the safety net of a lender of last resort. The
eurodollar system is a good example. This is from What the World Needs Now:
“And just to be sure we’re on the same page, the eurodollar is not to be in
any way confused with the euro, but rather stands to mean the artificial
supply of “U.S. dollars” that “exist” as accounting units in off-shore banks,
having originally been authentic deposits of New York’s finest export, but
which were then subsequently lent on – fractionalized and derivatized into a
vast amorphous mass as only a network of cooperating banks can do best. ”
[…]
“Think about Eurodollars. Think about European banks outside of the Federal
Reserve System making dollar denominated loans or simply issuing dollar
liabilities to FX traders. Sure they have a few physical dollars in reserve.
But they don’t have direct access to the Fed lending facilities. So if they
find themselves short on reserves, they will have to go into the market to
buy some dollars, just as you say. Which, in aggregate, could drive up the
price of the dollar versus the euro.”
This is what banks do. It is how they "create money". They create
an artificial supply of something by being able to take deposits, lend them
out, and keep it all on their own balance sheet.
Say you want to be a rock bank. So you take a deposit of 10 rocks from your
neighbor Steve, and you lend those 10 rocks to your other neighbor Gary, who
deposits them at your rock bank of course. You now have two deposits of 10
rocks each on the liability side of your balance sheet, and on the asset side
you have a promissory note from Gary as an asset worth 10 rocks, plus your 10
rock reserves. But Gary might choose to withdraw 9 of his rocks from his
account, and then you'll be down to 11 rocks deposited, but only 1 physical
rock in your reserves. So, with that withdrawal, your reserve ratio dropped
from 50% (10 physical rock assets held against 20 rock liabilities) to 9% (1
physical rock asset against 11 rock liabilities). See how it works being a
bank? And notice, also, that your reserve ratio is out of your control.
That's basically what bullion banks do. They create an artificial supply of
gold on their balance sheet. Wimms asked:
"Where does the idea come from that all of London unallocated gold is
fractional reserve? Unallocated account only means that you do not have
specific bars attached. Whether it is fractionally reserved or fully reserved
is completely separate matter and depends on the contract with BB."
The answer is, we know it because they are banks… bullion banks, and
that's what banks do. Jeff Christian, who has been working with bullion banks
since the 80s, says they are fractionally reserved just like banks. The LBMA
is a banking system, not unlike the Federal Reserve System is a
banking system, so you can't really say this part is fractionally reserved
and that part is not. The system itself is fractionally reserved. Their own
survey of daily turnover amounts to more gold changing hands each day (2,700
tonnes) than is mined in an entire year. The LBMA was asked if the numbers in
the survey included FOREX trading of XAU/USD, etc.., and they said yes it
does. And Anthony Fell of LBMA bullion bank and GLD AP, RBC, said, "At Royal Bank of Canada, we trade gold
bullion off our foreign exchange desks rather than our commodity desks,
because that’s what it is – a global currency."
We tend to think of bullion banking like this:
When it's really more like this:
Here are just a few of the LBMA bullion banks that don't even have
LBMA-approved gold vaults, yet still keep books denominated in gold ounces:
BNP Paribas, CIBC, Citibank, Commerzbank SA, Credit Agricole, Credit Suisse,
Goldman Sachs, Morgan Stanley, RBC, Société Générale, Standard Bank and
Standard Chartered Bank, and that's not even half of them. Many of these
banks are actually LBMA market makers, and even GLD APs, and none of them
even touch the metal.
Here's a snip from The View: A Classic Bank Run:
"To clarify the distinction for our readers, let us consider a bullion
bank with a physical ounce asset backing an unallocated ounce liability to
its clients. If that bullion bank then lends that physical to a jewellery
company who use it in their operations, then the bullion bank now has an
ounce claim asset backing its unallocated ounce liability. From your point
they are short “physical” but I would also note that the bullion bank is not
short “financially”, that is they are not exposed to any movement in the
price of gold."
This is what I meant in my last post when I said that the huge stock of paper
gold in existence constitutes a short position by the banks:
"Yes, the LBMA has huge daily turnover. That’s the flow, and it implies
an enormous “stock” of spot unallocated gold credits sitting on the aggregate
LBMA books. Please understand that this “stock” is essentially a gigantic
short position."
It's a short position in the same sense that your neighborhood bank is short
physical dollars. Your bank only has a tiny proportion of physical dollars on
hand relative to the amount of customer deposits it has. In fact, if you want
to make a large withdrawal in cash, you have to give the bank a few days'
notice.
It's a short position that would become a big problem in a bank run situation
if it was still 1930, but today your neighborhood bank has an ace in the
hole. That ace is that the central bank can, in a pinch, print an unlimited
amount of reserves.
Here's another excerpt from The View: A Classic Bank Run. I can tell
you now that the email from "a friend" (the parts in blue) was from
Aristotle:
It is important to start thinking of these gold operators as the banks that
they are, because then you can start to see the significance of the CBs
publicly announcing, through the twice-renewed CBGA, that they are no longer
going to be the lender of last resort to this system. Quote: "The
signatories to this agreement have agreed not to expand their gold
leasings…" You cannot be a backstop without expanding!
Furthermore, you will be able to see how the very act of commercial banking
(which is lending) automatically creates a ginormous synthetic supply of
whatever the system's reserves are. Think credit money versus cash, or even
M3 versus M0 once you throw in a few derivatives. The LBMA today clears
18,000,000 ounces, or 560 tonnes of paper gold liabilities every single day.
That's down from its peak of 1,359 tonnes in December, 1997 when Another
started writing. That's each and every day! It's all right here.
And that's just the part the LBMA clears. A Friend writes:
"A bank can be "populated" with unallocated gold accounts in
two primary ways. It can either be done as a physical deposit by a silly
person or by another corporate entity, or else it can occur completely in the
non-physical realm as a cashflow event whereby a customer with a surplus
account of forex calls up and requests to exchange some or all of it for gold
units, whereupon the bank acts as a broker/dealer to cover the deal –
occurring and residing on the books as an accounting event among
counterparties rather than as any sort of physical purchase. No bread, no
breadcrumbs, only a paper trail and metal of the mind. This is how the LBMA
can report its mere subset of clearing volumes averaging in the neighborhood
of 18 million ounces PER DAY. Just a whole lot of "unallocated
gold" digital activity as an ongoing counterparty-squaring
exercise."
Here is an analogy that my Friend wrote me in an email:
"It is here that I offer the eurodollar market as a very good parallel
to the bullion sector of banking. While not a perfect parallel (for all the
most obvious reasons) it provides a remarkably good bridge to help anyone who
has a good footing on modern commercial banking to successfully cross over to
that seemingly unfamiliar territory of "bullion banking". In fact,
they need do little more to successfully cross over than to simply think of
bullion banking ops as though they were eurodollar banking ops – the
difference being that whereas eurodollar banking makes extra-sovereign use of
the U.S. dollar as its accounting basis in international banking activities
(thus outflanking New York's purview and restrictions), bullion banking
engages in similar "extra-sovereign" use of gold ounces within its
operational/accounting basis (thus outflanking and overrunning Mother Earth's
domain and tangible restrictions)."
That's what I'm trying to do here, to bridge your thought process
from banking to bullion banking. I think everyone (or virtually everyone)
thinks about bullion banking and the LBMA as being similar to the rest of the
non-bank gold industry, when, in reality, it is much more similar to
the commercial banking industry than the physical gold industry.
If you read that GLD Participant Agreement with your gold industry hat on, or
even just your standard thinking hat, it reads just like Wimms portrayed the
procedures. There's "gold this" and "precious metal
that," and "bullion whatnot" all throughout, all of which
reads like it involves physical moving around but doesn't. That's because we
are imagining physical moving around when we read those sentences, but with
our banking hats on, we can see that it's simply like saying "dollars
must be tendered," or "it's a cash account," or "money
was deposited," or "how much currency," none of which
necessarily means physical cash.
The LBMA was created in 1987, in part as a direct result of the collapse of
bullion banking pioneer, Johnson Matthey Bankers, in 1984. From Seventeen:
"It was a mess that had to be cleaned up by the Bank of England itself,
and in the aftermath, the BOE assumed the supervisory role over the London
bullion market and demanded that the participants create a formal body to
represent them as a group. A little more than a year later, in Dec. 1987, the
LBMA was born."
It was around this same time that, as FOA explained, "a new gold market was being
created was when bullion banks were allowed to sell Central Bank gold
"ownership invoices", for cash to the benefit of Barrick."
And later in that same post, "It wasn't long before gold was lent
without any gold at all! No different than "fractional reserve"
banking."
The rest of FOA's post is in this video, for those of you who need a break:
;D
Notice that I haven't even mentioned GLD yet. That's because, so far, I'm
just trying to pound it in that the LBMA is a banking system, an association
of banks. Bullion banking didn't exist before 1971. Back then it was simply
called banking because, back then, gold was monetary reserves in the banking
system. Bullion banking is, by definition, fractional reserve banking, and
keep in mind that the LBMA is a natural carryover from the old gold standard.
And most important to bear in mind, is that physical gold is the
"physical cash" in the LBMA banking system. When we say "gold
this" and "gold that," it's like saying "dollars
this" and "dollars that," and the word "gold" within
the LBMA means physical gold about as much as the word "dollars"
means physical cash.
I said the dollar banks have an ace in the hole, which is that the CB can
create an unlimited amount of cash if necessary. Obviously you can't do that
with physical gold, but the bullion banks have an ace in the hole too. That
ace is cash settlement.
Coat Check 101
First of all, I didn't come up with the idea of GLD being viewed as a central
coat-check room for the bullion banks. I got it from Randy Strauss in 2011,
and the earliest reference I've seen was in 2004, right after GLD was
launched. By the way, the $POG had already risen 70% from 2001 to the launch
of GLD in 2004, and I don't agree with Wimms' theory about GLD pulling the
suppressing demand away from futures and thereby supporting the rising $POG.
It was a commodity bull market, simple as that.
In mid-2010, we can see from the chart below that phase 1 ended. And in early
2011, the GLD inventory started to drop. The big drop (green arrow) was on
January 25th, a big 31 tonne puke, and my Who is Draining GLD? post was four days later. That's
when the coat check room idea first crossed my radar, and when it first
appeared on my blog.
The price of gold was also dropping, from $1,400 at the beginning of 2011, to
$1,324 on the day of the puke. And there were numerous stories in the MSM
about the outflow from GLD being symptomatic of the souring of investor
sentiment toward gold. That's when Randy Strauss wrote two posts about GLD
that really caught my eye. The first one was on Jan. 14th, and the second one
was on the 25th, the day of the puke:
RS View: Silly reporters. Instead of calling these
“outflows” from the ETFs, it should be called what it is — a redemption of a
basket of shares for physical gold by the Authorized Participants (e.g.
bullion banks). Such share redemptions would actually be a bullish sign
because it entails a reduction in the global supply of paper gold while at
the same time signifying a preference by the redeeming party for having the
metal over the ETF shares. That is, of course, unless the drawdown in
physical gold merely represented the routine sales of the gold inventory that
occur to cover the ETF’s administrative expenses.
RS View: I’ve said it before and I’ll say it again now,
the reporters are getting it wrong when they equate outflows of gold from the
ETFs with “sour” investor sentiment. What they need to work harder to
understand is that these are NOT actively managed funds whose gold inventory
is tweaked to ebb and flow based on public sentiment in the shares. Instead,
the ETFs are more like a central coat-check room in which the various bullion
banks have temporarily hung out their own inventories (i.e., meaning, their
unallocated stock which they hold loosely on behalf of their depositors). And
whereas the claim tickets (ETF shares) may freely circulate on the open
market, any significant outflow of physical inventory is simply and primarily
indicative of a bullion bank reclaiming the original inventory based on a
heightened need or desire for physical metal in a tightening market — for example,
to meet the demands emerging from Asia.
I was emailing with Randy at the time, and he explained a lot more about GLD
to me than was in his posts. I also happened to be "IMing" (this
was 2011, back when AOL Instant Messenger was still in use) with one of my
readers at the time, a fellow I dubbed "Small Giant" in the post.
He was an investment industry professional and long-time gold bug, so I was
surprised to learn that he knew nothing about GLD redemptions, baskets,
Authorized Participants, all the stuff I was learning from Randy. All that
stuff, the stuff that everyone seems to know at least something about today
(perhaps because that post got more than 50,000 views) was the focus of the
post. Coat check wasn't even a footnote. In fact, it only appeared in the
post once, and that was in Randy's quote above.
Soon, however, GLD inventory mechanisms became old news, while the
sentiment-related creation/redemption myths continued. They did evolve,
however, from being related to gold sentiment in general, to being related to
investor sentiment toward GLD specifically, relative to gold sentiment in
general. And they still persist to this day. Even Wimms' comment repeats the
myth, more or less. From his comment:
"When there is a spike of GLD share selloff, orders are matched with
buyers or APs as DTC market makers buy the shares themselves. So after a peak
of selloff APs would own lots of GLD shares. They can sit on them as a
buffer, or they can chose to redeem them. There is no requirement by GLD to sell
the phys gold off. GLD the trust does not care. Trust only cares about one
thing - that there is gold pledged for every basket of shares they have
created, and they charge for every basket holding, so there is cost attached
to sitting on the parked GLD shares to APs. That gives incentive to redeem
when too many baskets are redeemable. Whether they sell off that gold on the
market or not is of no interest to GLD trust.
When there is a peak of buying and GLD runs out of "free" (AP
owned) shares, the price of GLD tries to go above market and there lies
profit, so there is incentive for APs to create a basket and have shares to
sell. For that they need to source gold and they are in business. It's not a
physical arb at all. It's just the way GLD trust works. They have the right
to sell shorts into DTC. This allows to handle sudden spikes of GLD buying as
sourcing gold and basket creation is a slow process. Later when they have
created a basket, they can cancel shorts. That may be happening all the time
and we just do not see it due to low reporting frequency.
It is this part of the process that is interpreted as physical arb that is
making the GLD to track spot price. It is not of course. But it can be
presented as phys arb in a loose sense. If, and only if noone else is
buying/selling in the open market, and if, and only if APs always sell/buy
each basket's worth of gold on the open market, then GLD would have some
impact on the spot price. But thats not what GLD is for. Its purpose is
exactly opposite - to NOT have any impact on physical price.
So of course GLD market makers are using paper deals to track spot price.
They run HFT on the DTC shares and set the spread and capture orders that
don't have a counterparty. When there are no share transactions, they do
nothing. They don't need to do anything for GLD to track the spot price. The
price of gold backing the GLD shares is moving by itself together with spot,
and market makers simply adjust their spread reference price along with it.
Market makers are effectively doing the mark to market of the GLD gold
reserves on the continuous basis."
This specific discussion, about why GLD's inventory changes,
gets right to the crux of "coat check". Read it again, paying
attention to why he says pukes and chugs happen. He says that
redemptions (pukes) happen because of "a spike of GLD
share selloff". And creations (chugs, like are happening right now)
happen because of "a peak of buying".
He objects to calling it a "physical arb" which is fine with me.
Let's simply call it "sentiment-driven inventory changes." That's
not saying it's required by the trust, but he says it simply happens because
the APs end up with a lot of shares, and find it cheaper to redeem them than
to sit on them. But why not sell them instead? Why are sitting on them or
redeeming them the primary options? In fact, they aren't. I made the point in
my last post, and even made a conceptual chart illustrating the point, that
there is greater profit in selling shares captured by the arb than in
redeeming:
It may seem like splitting hairs, but this really is the continental divide of
the entire debate, whether gold is being "pulled" into and
"pushed" out of GLD by "investor sentiment", or whether
inventory changes are ultimately, primarily and fundamentally a free choice
of the bullion banks, which essentially makes GLD a "reserve management"
tool of the LBMA. You may bury your head in the sand and tell yourself it's a
bit of both if it makes your brain hurt thinking about it, but logic dictates
that it is primarily and fundamentally one or the other, and the implications
of each are as vast as a drop of rainwater flowing to the Pacific if it lands
on one side of the hair, and to the Atlantic if it lands on the other.
I think it is obviously the latter, that pukes and chugs are fundamentally a
choice of the bullion banks, and GLD is essentially a reserve management tool
of the LBMA, even though it doesn't specify that in the prospectus. I think
this is the correct way to view GLD, and I think that using the correct lens
reveals things that other people can't see. And I think that what we're now
calling "sentiment-driven inventory changes" are simply (and
obviously, to me) a myth, albeit a persistent and widely-accepted one.
For me this is intuitive, but that doesn't mean it's based on faith. After
five years of thinking about, discussing and debating the subject, I have
consciously reasoned that which is also intuitive. And now I will attempt to
enumerate the ways in which the "coat check view" makes sense,
while the "sentiment-driven view" does not.
Let's start with Wimms' description above. If I may summarize it in a single
paragraph, the APs "help" GLD track the price of gold through HFT
(high frequency trading run by computers and algorithms), and when there's a
spike in selling (negative sentiment), the APs' HFT algorithms capture more
shares than normal. At some point, they find it most efficient to redeem
these shares rather than to hold them, because GLD charges a small storage
fee. When there's a spike in buying (positive sentiment), the APs' HFT
algorithm are allowed to essentially sell short (to sell shares that don't
yet exist), racking up a larger short position than normal. And at some
point, they find it most efficient to buy some physical and pledge it to GLD
in order to unwind their short position, because, well, he doesn't really
give us a reason, but I read it as that's something the Trust expects them to
do in exchange for being allowed to sell short during positive sentiment
spikes.
I'm going to break this down as quickly as possible, so try to keep up with
me. ;D
The first issue is whether the APs are obliged to do this (to
"help" GLD track the price of gold), or if they want to do
it because they make a profit doing it. Pretty much everyone on both sides of
the debate agrees it is done voluntarily, for profit. That was an easy one,
but I needed to mention it.
Now, because this arbitrage is being done for profit, we can safely assume
it's not just one AP doing it, it's several, and also that other non-AP HFT
players might be doing it as well. And with competitive arbitrageurs in play,
there will be plenty of liquidity and therefore no reason for any one arb to
accumulate an overly-large position. So I'll ask it again. Why would the HFT
algos not close out their position by selling the shares once the selling pressure
has abated? It's a rhetorical question, because they have every reason, from
more profit to less work and less cost, to sell those shares rather than
redeem them. And if they are redeeming but not selling the redeemed gold as
Wimms proposed (because of GLD's storage fees), then it's a bet not an arb,
because they are not squaring their position, and that makes no sense under
the "sentiment-driven view". Not to mention that most of these APs
would have storage costs on physical reserves anyway, because they aren't
LBMA custodians.
Now let's talk about creations, since that's what's happening right now.
There are two relevant spreadsheets which anyone can download from the GLD
website, the daily spreadsheet of historical data, and the
bar list. The creation procedure takes three days from purchase order to
bar allocation, and the bar list is three days behind the daily spreadsheet.
Today (Thursday, 3/3/16), the bar list is showing 777 tonnes in the Trust's
allocated account, which was the total on Monday, three days ago, and the
daily spreadsheet is showing 793 tonnes which is the current total.
So far this year, we've had 42 trading days, and during that time, 150.96
tonnes have been added to GLD. Out of the 42 days, there were 14 days (a
third of the time) with no change to the inventory. There were 3 days (7% of
the time) with net redemptions. And there were 25 days (60% of the time) with
additions, i.e., net creations. So on average, that's a little over 6 tonnes
on each day some was added, but actually, there were two days with more than
19 tonnes per day added, and three more days with 12, 14 and 15 tonnes added.
It's those five days I want to look at a little more closely. And there's one
more day I'll include, December 18th, the day the rise started, with 18.74
tonnes added that day.
One thing the daily spread sheet reports as well as the inventory is the
daily trading volume in shares. When GLD started in 2004, each share was
worth 0.1 ounces, or 1/10th of an ounce. But the way that the Trust pays
itself its fees is by slowly decreasing the weight of each share, so today,
the shares are each worth 0.09561 ounces. I will use this weight to convert
the daily share volume to tonnes, so we can see what percentage of the
trading would have to be sentiment-related on those days, and then we can
decide if that even passes the sniff test. ;D
So here are the dates in question, the daily volume in tonnes, the
net-creations in tonnes, and finally the percentage of volume used to create
new shares (under the "sentiment-driven view):
In case you're thinking we should also take the previous day's trading volume
into account, in case there's a hangover effect happening, two of the
previous days had lower trading volume, and three had higher (remember that
two of the chug days were consecutive). In fact, the two lower trading days
were so much lower that all of the preceding days were, on average, 12.6%
lower volume than the chug days.
So, for the slow, this little exercise means that, if Wimms is right, then
the spike in buying was almost 50% of the volume on those days, yet volume
didn't jump nearly that much. Volume even declined a little on three of the
days. So it could just be that 50% of the sellers disappeared, so the APs had
to "naked" short 49% of the volume, and then put on some clothes by
buying 98.45 tonnes of physical gold metal (the sum total of those six
chugs). That's 98 pallets, or 7,913 LGD bars, in six days. Does that pass your
sniff test?
On the other hand, I like the way those numbers fit with my current theory of
short term hedge fund bets on the price of gold, as big as up to half the
daily trading volume, so that the only way they made sense was OTC or
off-market, i.e., creating new shares. Two more things in my view make this
theory even more plausible. Normally these bullion banks would simply take
the other side of that bet themselves, but according to my view, LBMA
reserves are tight, most if not all of them are already in GLD and/or HSBC's
vault, so the bullion banks are trying to reduce their bullion books right
now, not increase them. And these banks do not have to find someone to sell
them those 7,913 400-oz. bars. They simply have to transfer the hedge fund's
cash to HSBC or another approved LBMA gold dealer, request an exchange into
gold credits, and transfer the gold credits into the Trust's unallocated
account at HSBC.
If Wimms is right, then I'm totally wrong about that, and so was Ari when he
wrote this:
"A bank can be “populated” with unallocated gold accounts in two primary
ways. It can either be done as a physical deposit by a silly person or by
another corporate entity, or else it can occur completely in the non-physical
realm as a cashflow event whereby a customer with a surplus account of forex
calls up and requests to exchange some or all of it for gold units, whereupon
the bank acts as a broker/dealer to cover the deal – occurring and residing
on the books as an accounting event among counterparties rather than as any
sort of physical purchase. No bread, no breadcrumbs, only a paper trail and
metal of the mind."
Forget about how or where HSBC came up with those bar numbers. Without that
element of the story, and with only the APs creating new shares for the hedge
funds to bet big on gold without moving the market, and then wiring the hedge
funds' money to London, to fund a FOREX account, and then exchange USD
for XAU to transfer to HSBC and fund the creations… does that not pass the
sniff test? And this is just a theory, unlike my c-c view which is fact. ;D
In his new email today (the first one), Wimms paraphrased the "Creation
Process" from the AP Agreement:
3. AP notifies Custodian it will deliver gold to its unallocated account on
day 2 (it could be physical tango, or deallocation)
The highlighted part is not in the document. It is Wimms editorializing, and
he missed one option. It could be physical tango, deallocation, or, as Ari
called it, "a cashflow event… No bread, no breadcrumbs, only a paper
trail and metal of the mind."
8. Trustee creates and issues shares to AP. Note that this happens NOT before
3rd business day after initial AP request is filed.
The actual shares are created and credited to the AP's account at the DTC on
the 3rd day, after allocation, but they show up on the daily spreadsheet on
the first day. We know this because, as I pointed out earlier, the bar list
is three days behind the daily spreadsheet.
Why is this important? Because it shows the order and importance of events.
The actual, real shares being issued and listed at the DTC is basically a mere
technicality that happens after the fact, not before. As far as the market is
concerned, the new shares are out there, in someone's account, and possibly
being traded, at least three days before "real" shares technically
exist (if they came about the way Wimms says, through an AP shorting
operation). Let's call this the "leeway" afforded to APs. Or maybe
that's not the best term. It's essentially a temporal separation, a
disconnect, between the technical aspects of creation/redemption that happen
between the AP, the Trust and the Custodian, and what happens in the market
between the AP and its clients. There is this potential disconnect of
a few days between the two, and it works in the other direction too.
With creations, as Wimms pointed out, the AP may short sell shares and then
put in a Purchase Order with the Trust after the fact. Likewise, it may have
agreed to create shares for an OTC client, like Hedge Fund X, and then put in
the Purchase Order after the fact. The Trust doesn't care about the details
that led up to the Purchase Order, it only cares about how many baskets the
AP wants to create.
So in the other direction, with redemptions, it follows that the Trust
doesn't know or care about the details between the AP and its clients that
led up to the redemption, it only cares about how many baskets are to be
redeemed. Therefore, it follows that an AP can request redemption before
the fact. That is, before buying the shares back "from the
market." And if that AP is HSBC, the bars could theoretically be out the
door and on their way to Switzerland before it buys back the shares. It can,
of course, only redeem as many shares as it owns per the DTC at the time of
redemption, but it can always buy more from another AP if it needs more.
Further on, Wimms says:
"You may also notice that the whole process of creation and redemption
is by design at least 3 days long. This creates incentive for AP to have
sufficient number of baskets on hands to handle 3 days worth of trading
volume. This pretty much makes phys arb impossible, and requires forward
thinking. Thus, if AP is anticipating high volatility, they may preemptively
start creation of baskets."
While technically correct, this is wrong because it makes it seem like the AP
is at the mercy of future volatility, i.e., investor sentiment. It makes it
seem like the AP is essentially forced by the GLD market to create or
redeem shares. This is the wrong view. It is always a choice.
The three-day process makes practical sense, plain and simple, and I never
saw it like Wimms characterizes it, as a means "to counter BB
questionable behaviour when GLD was created." That's pure rubbish as far
as I'm concerned.
HSBC, being an AP and the custodian for the Trust, has a lot of leeway
simply by the fact that a good portion of that three-day process was allotted
for communication between AP and Custodian, and the time needed for bar
identification. I wouldn't even be surprised if HSBC occasionally had bars,
say, already loaded on the forklift, before they had technically been
deallocated from the Trust. And I wouldn't even consider that questionable
behavior. It's within the rules.
Wimms writes:
"After rereading what FOFOA has said I think I better understand now
what bothers me.
The way he presented a Fund could use GLD. That really doesn't click with me.
Why? The basis of this maneuver is that it is cheap and fast for the Fund to
get into GLD through forex purchase of gold credits.
It isn't fast. Now lets think about cheap for a moment. By selling to anyone
XAU at spot, BB is taking the risk of spot movements and risk of buyer
requesting delivery. Thats a large cost risk. Why would they do that? If it
were so cheap to get into gold credits and cash out later, why isn't it used
widely to get exposure to gold price movements? And if it is then 1) why go
any further and into GLD and 2) how does BB hedge itself against speculators
using unallocated gold to buy/hold/sell/profit as BB would be effectively the
creditor of that profit?
If they hedge by buying spot with delivery from someone else on LBMA then
this would move the market. If they buy from themselves, there is no
hedge."
First, I must repeat that this Hedge Fund X explanation is just a theory, and
therefore not critical to my coat-check room view. But yes, it is cheap and
easy to get into gold credits and cash out later, and it is widely used to
get exposure to the gold price. It's precisely what the LBMA does. The LBMA
is the largest OTC gold market in the world, and it also runs XAU currency
trading, which is a cheap, easy and quick way to get exposure to gold.
The GLD share creation process may take three days, but the bank facilitating
the deal can give its client exposure to the $POG immediately, either
directly, or by buying unallocated from another bank like HSBC. It's what
banks do. It's why they have quants and delta-one desks, to hedge risk and
price exposure through fancy derivatives made from correlated commodities and
currencies. It's what I called expanding their bullion books, which I'm guessing
they're trying to do the opposite right now. So, in this scenario, as soon as
the GLD shares are created three days later, they can unwind the hedge and
shrink their books back down to where they were.
"There is a difference between BB clients who deposits their owned
physical LGD bar to BB vault and expect phys to be redeemable, and someone
who uses cash to buy gold credits onto their unallocated account, isn't it?
That difference cannot be totally ignored by BB, they need to cover up their asses."
There is a difference! You see it, I see it, and that's kind of the
whole point of understanding bullion banking, because that's precisely what
they do. They act like there is no difference. Not out of malice or anything
like that, it's just what banks do. Let's go back to the physical cash
analogy.
There is a difference between bank customers who deposit their owned physical
cash and expect to be able to get cash out of the ATM later, and someone who
wires foreign currency-denominated electronic credits, requests a currency
exchange, and then expects to be able to withdraw cash later, isn't there?
That difference cannot be totally ignored by the banking system, can it? They
need to cover their asses, don't they?
No! That's what banks do! And in this case, it's what bullion banks do with
gold!
I wrote about precisely this concept, that bullion banks do not differentiate
their liabilities based on the type of deposit, way back in 2011, in Via
Email:
"The daily LBMA clearing turnover has dropped to 18 million ounces
today. But even at today's lower amount, if the 3 to 5 estimate above holds,
it is still likely to be more than global ANNUAL gold mine production that is
traded (OTC) every single day. And what do you think is actually being traded
as if it were simply another foreign currency?
Bullion Bank liabilities! BBs make money like any other bank, on their
ability to issue "liabilities" as if they were real money, willy-nilly.
How many of these "BB liabilities" are outstanding at any given
point in the 24 hr. cycle? And do you think these liabilities have any LESS
of a claim on the BB physical reserves (unallocated gold) than any other? The
answer is that all BB liabilities have an EQUAL claim. Whether you deposited
2 tonnes of physical yourself 30 years ago after your rich grandfather died,
or if you called in a currency exchange order last night. Equal ability to
demand allocation."
Wimms again:
"I do not see the point of parking gold into GLD when there is no demand
by the GLD buyers. Slack could be used to support GLD, but imo only to the
extent that needs to be done to satisfy market demand for GLD shares. Thus I
don't think that phase 1 was initiated by parking excess gold into GLD in
exchange for dormant shares."
Who said there was no demand? There was plenty of demand, it just wasn't the
driving force. And since there was plenty of demand, they weren't just
"dormant shares."
Okay, I can see that I need to wrap this up and post it today, since Wimms is
now fielding questions and comments from the peanut gallery, and if I don't
wrap it up, I'll quickly drown in comments that need to be addressed. So what
I'm going to do is to use a few "freehand analogies" to try and
help you see how I view LBMA reserves, how the bars in GLD are a part of
those reserves, and how draining GLD provides "cash for
withdrawals". I think if you can simply see GLD the way I see it, all
the other little details will make more sense. So I'll try to describe the
picture rather than to continue enumerating details that are apparently hard
to swallow for some of you.
I don't expect to convince Wimms. I never convinced Bron, and I think part of
the reason is because he's in the non-bank gold industry. But hopefully I can
at least clarify my view, since I think it was mischaracterized in Wimms'
initial post.
I'm going to make a few statements here that will probably seem shocking and
hard to swallow to some of you, but hopefully they'll make more sense in a
few minutes.
Bullion banks do not want physical gold. They will buy it if someone
approaches them to sell some, because they are market makers, but they don't
go looking for it. That's because physical (or allocated) gold is
"reserves" to them, and just like in regular banking, reserves are
a dead asset. Just like a regular bank, they try to minimize the amount of
cash/reserves they are holding. And, like a regular bank, they prefer to hold
live assets with a yield over dead assets with no yield. And, in fact,
physical gold is even worse than cash in that regard, because gold has more
storage costs associated with it, so physical gold reserves actually have a negative
yield.
Not all gold ETFs are equal. Eric Sprott, for example, had to go out and buy
the gold to put in his ETF. I even had a reader who was involved in the
creation of a new gold ETF back in 2011, who told me all about the process.
The launch was canceled after the $POG crashed in September, but the plan was
to create a fund like Sprott's PHYS, only with kilo bars being the minimum
redemption rather than 400 oz. bars.
They didn't have the money to just buy all the gold outright, up front, so
they had to source institutional investors on one side, and source the
physical gold from the mints on the other. The idea was, you get
institutional investors to pledge to buy X amount of shares, you source the
amount of gold required to back X amount of shares, and then you essentially
use the investors' money to buy the gold and launch the fund which will then
trade on a public exchange. The reason behind creating this new ETF was not
that there was all this extra gold that needed to go somewhere, nor was it
all this demand for a new gold ETF. The reason was the money that can be made
from the fees you get for running a gold ETF!
So Sprott and this kilo ETF that never happened, had to go out and buy the
gold to back their shares. But GLD is the gold ETF of a bunch of LBMA bullion
banks (yes, almost all of the APs are also bullion banks), so their gold came
straight out of their reserves. Because even if a bullion bank buys some
physical gold from a customer who wants to sell, it goes right into the
bank's reserves. Bullion banks, practically by definition, have more
outstanding gold liabilities than they have physical gold assets (reserves),
so even if a bullion bank segregated some physical on its balance sheet, it
would still be de facto reserves.
So as these bullion banks were essentially "selling" (there's that
word again) their reserves to the new GLD ETF during phase 1, and receiving
shares as payment which they then sold to customers for dollars, they were
essentially allocating (there's that other word I was earlier using
interchangeably with "selling" in quotes) reserves that were
already offset by other gold liabilities. In other words, to quote Randy
Strauss again, it was "like a central coat-check room in which the
various bullion banks temporarily hung out their own inventories (i.e.,
meaning, their unallocated stock which they hold loosely on behalf of their
depositors). And whereas the claim tickets (ETF shares) freely circulated on
the open market, any significant outflow of physical inventory is simply and
primarily indicative of a bullion bank reclaiming the original inventory
based on a heightened need or desire for physical metal in a tightening
market — for example, to meet the demands emerging from Asia."
For anyone still having trouble with the concept of "inventories held
loosely on behalf of their depositors," let's try a couple analogies.
First, imagine you are going to start your own business, a store. Let's say
it's going to be a small, local hardware store. You're going to carry
everything from nuts and bolts to John Deere riding lawnmowers. You don't
have enough money to buy everything you're going to carry, but that's okay,
because your suppliers will give you credit. They'll gladly place their
particular items in your store, and you just pay them when someone buys their
item.
See? You have all this valuable stuff in your possession, but you're really
just the middleman in the flow of this stuff from its producer to its end
user. In the meantime, it sits in your store. Your store is like a pool or an
eddy in the stream-like flow of these goods from producer to end user. Your
inventory is like the slack in the flow. Of course no one has come up with a
hardware ETF yet, so that's about as far as I can take that analogy.
So now let's picture a different kind of business. Imagine you own a gold
coin and bar fabrication business. You take raw gold bars and loose gold shot
you get from the refineries, and you melt it down and make it into fancy
investment-grade bars and coins, some of which you sell in your own fancy
showroom, some you sell on the internet, and some you sell to other dealers,
wholesalers and distributors.
Again, you don't have enough money to buy outright all the gold that is on
your physical premises at any given moment in time, so you rely on credit
from others. You must essentially finance your inventory, one way or another.
At first you do it similarly to the hardware store owner. You pay the
refineries, essentially, net-30, or net-60, or however long it takes to
fabricate and sell your products. So as the refinery gives you some raw gold,
you also take on a liability, kind of like a bank.
Over time, your business grows, and before you know it, you have 20 tonnes of
gold, in various states of completion, on your premises at any given point in
time. So let's say you decide to start selling "unallocated gold
credits" for a "fully reserved gold pool" which you'll keep
stored in your secure warehouse. For each "credit" you sell, you
pull a piece of gold out of your slack in the flow, and set it aside. And
each "credit" is always fully backed with physical in your
warehouse. To prove it, anyone can come in and redeem their
"credits" for gold coins any time they want. And when they do, they
become just like any of your other end user customers.
Depending on how carefully you manage it, you could theoretically sell
"credits" for up to 20 tonnes, your entire inventory. Think about
it. At $1,260 an ounce, that's $810 million you could invest in Australian
MBS, or something with an equally good yield!
What you've essentially done there is inventory finance. Only you've
essentially double-financed your inventory. It's not a problem, though, as
long as you never let your inventory drop below 20 tonnes, and that might
mean turning down some orders from regular customers. Then again, it's
unlikely that all of your "credit" holders will ever
want to redeem at the same time, and you don't want to be turning down sales,
especially if you have what they want in your warehouse. So you might start
to let it drop below 20 tonnes from time to time, hedging off your price
exposure elsewhere.
Congratulations, you have now become a bullion bank, or something similar,
and this probably won't be a problem as long as there's not a run on your
"cash in the ATM". And as a bullion bank, you will probably run
your reserves down to a small fraction of your liabilities. But you've still
got tonnes of gold just sitting there in your warehouse. Surely that’s a dead
asset you can make a little more live. How about launching an Exchange Traded
Fund, fully backed by the gold in your warehouse?
These shares won't be as redeemable by the public as your unallocated
credits, but there will always be an ounce of gold in your warehouse for
every share outstanding. You'll even publish a list of the pieces allocated
to the ETF. Your "credits" are unallocated, but easily redeemable,
and your ETF shares will be allocated but not as easily redeemable. This
differential will buy you the leeway you need to manage your reserves and
meet all redemption requests. If someone buys a gold coin from your regular
business, or redeems an unallocated "credit" for one, then you will
simply deallocate that coin from the ETF, and buy back one share on the
public exchange.
"Really clear eyes," as FOA might say, could see that any
significant outflow from your ETF was simply you reclaiming the inventory due
to a need for it in other parts of your business, and therefore indicative of
a scarcity of reserves, even as all purchase and redemption requests were
still being met. It reminds me of MF Global and Madoff Investment Securities.
Those closest to the companies were the most convinced of plenitude, because
all redemptions were being met… until the moment they weren't. The main
difference, of course, is that bullion banking is perfectly legal.
This was only a very rough and general analogy to help you visualize GLD and
bullion banking in a different way. All characters, businesses, suppliers,
customers and funds appearing in this analogy were entirely fictitious. Any
resemblance to real characters, businesses, suppliers, customers and funds,
living or dead, was purely coincidental.
I agree that, when put this way, it sure sounds sinister, shady and
fraudulent, especially to a brainwashed gold bug. But I assure you that
everything about GLD is perfecly legal and out in the open. The only reason
it seems so darn invisible, is because nobody really understands bullion
banking, they picture the way the rest of the gold industry operates when
reading the prospectus, etc., and myths built around that view abound. I
mean, I think I'm probably the only one in the world who's trying to explain
this stuff. As I said above, the coat check concept has been around since GLD
was launched, but it's rarely mentioned, and I know why. Even I rarely
mention it.
Wimms says I'm doing a disservice to you, my readers, by writing about
"coat check". He said I have misguided ideas based on the
application of logic to bad assumptions. He said I'm wandering off the path
and into the woods. He thinks I have become attached to this coat check idea,
and that I'm trying to defend it like dogma.
With all due respect to Wimms, who is, of course, paying me to be here,
that's not what I'm doing. I did not write that last post to defend my own
personal dogma. Quite the opposite, as usual, I glossed over explaining it
because it's a monumental pain in the ass to do so (Q.E.D!). I write about
this topic only every two or three years. I wrote about it in early 2011,
following the first big drop in phase 2, again in 2013, when the inventory drained
for an entire year, and now in 2016, because the inventory is inexplicably
rising again. So what I am doing is applying this lens on the rare occasions
it becomes relevant, and sharing with you (which is what I do) what I see.
In his first comment, the long one, Wimms linked to a guest post by Catherine
Austin Fitts on Zero Hedge. In the summary at the end of that post, Fitts
writes this:
"At best, GLD and SLV are simply a bank deposit priced in spot prices
without the benefit of government deposit insurance.
At worst, GLD and SLV are vehicles by which investors provide the banking
community with the resources to control and manipulate the precious metals
market without adequate compensation."
Her "at best" is remarkably close, IMO!
It is true that GLD was not around when Another and FOA were writing, so in
that sense I am out on a limb a little with this topic. But it's really not
so much about GLD as it is about bullion banking. "Coat check" is
about fractional reserve bullion banking, and Another and FOA did
write about that. In fact, it is the key to everything they wrote
about, and that's why, in my opinion, GLD and coat check matter in the
overall scope of my blog.
Again, from Freegold Foundations:
The Free in Freegold
Okay, here it is. What you've been waiting for patiently, I presume. This is
what gold will be freed from: The fractional reserve banking practice, which
is a carryover from the gold standard.
This is the free in Freegold.
Wimms: "Where does the idea come from that all of London unallocated
gold is fractional reserve?"
FOA (1/9/00; 11:22:41MDT - Msg ID:22579)
Comment
This is "gold banking" on a pure fractional reserve basis and very
much reflects the dollar prior to 71.
ANOTHER (Fri Dec 12 1997 21:06 - ID#60253)
THOUGHTS!
The paper gold market controlled by the BIS/LBMA system is, alone equal to
more than all the gold in existence. This market works like a hybrid currency
using approximately twenty to forty percent of all CB gold in leased form as
backing. The paper behind the lease is a form of CB/gold and is used as a
"fractional reserve" that has built this huge market. This system
has worked and does work well. You have but to look at the good value that is
received when dollar debt ( digital currency ) is purchased with oil. The
world works! But this system cannot continue. There is a limit to how far
gold can be inflated in quantity using "fractional reserve leasing"
as backing.
Friend of Another (10/14/98; 21:46:26MDT - Msg ID:585)
Tyler Rose (10/14/98; 20:19:54MDT - Msg ID:580)
Using fractional reserve banking, I wonder how many loans could be made with
the same million ounces of gold?
FOA (5/15/99; 21:38:42MDT - Msg ID:6212)
Comment on earlier discussion!
It wasn't long before gold was lent without any gold at all! No different
than "fractional reserve" banking.
ANOTHER (7/11/99; 17:07:45MDT - Msg ID:8673)
Reply to: USAGOLD (7/10/99; 19:35:16MDT - Msg ID:8634)
Today, the gold sand blows from Central Bank to Central Bank, and is loaned
many times. It has become the "fractional reserve" currency that we
dare not speak of, but have it we must. The BIS and the ECB now hold the
London market in the palm of their hand. And this old British market holds
the fate of the dollar in it's hand.
FOA (7/25/99; 22:30:53MDT - Msg ID:9655)
Reply to old question.
This system did make sense as a contracting mechanism alternative from the
dollar during a time that they could reasonably self liquidate. But a span of
years and commercial speculators through fractional reserve lending has
brought yet another quasi-fiat currency (paper gold) to the end of its useful
life.
FOA (10/20/99; 19:25:56MDT - Msg ID:17025)
Reply
Like fractional reserve currency inflation, stop the presses and banks fail.
Therefore, stop the fractional gold lending and the market
"officially" changes!
FOA (10/23/99; 17:01:18MDT - Msg ID:17268)
One long post.
Once the "timeline" of the dollar is near the end of it's
mathematical ability to expand world trade, destroy this "new fractional
reserve gold market" by adopting "self liquidating rules" into
the official sector lending game.
FOA (10/27/99; 6:15:53MDT - Msg ID:17588)
Comment
If everyone wanted their physical gold at once, there isn't enough to cover
all the accounts. Official sales and lending will no longer back this
"fractional reserve" paper gold market.
Trail Guide (5/25/2000; 14:21:55MT - usagold.com msg#: 31262)
Comment
During this time, the more funds available from investors or fractional
reserve banking, the more gold paper is sold, the lower the lease rate, the
more paper gold is expanded. Why, almost anyone could borrow gold cash in
this fashion.
FOA (09/03/00; 16:27:20MD - usagold.com msg#34)
Of Currency Wars
That's right, this modern world of paper gold very much functions as the same
IOUs that currency is based on,,,,,, not much different from fractional
reserve dollars.
FOA (10/5/01; 10:55:19MT - usagold.com msg#112)
Discussing the World with Michael Kosares
This is where they must install a free market in gold that ends international
confidence in the current gold fractional reserve game.
If anyone would like to read more about the "coat-check room view",
I recommend these posts:
http://fofoa.blogspot.com/2013/04/open-window-forum.html
(There's a whole long section on it in this post!)
http://fofoa.blogspot.com/2013/08/my-candid-view-part-7.html
(There's a shorter summary in this post. Just search for "coat".)
And there are two Speakeasy posts from 2013, with slightly different angles:
http://freegoldspeakeasy.com/2013/09/15/anoth...r-angle-on-gld/
target="_blank" http://freegoldspeakeasy.com/2013/09/19/an...angle-on-gld-2/
The post preceding this one at the Speakeasy target="_blank"was Plausible Explanations (for GLD’s Recent Behavior), the
one following it target="_blank" is Bullion Banking 201, and the current post, from two days
ago, is tit target="_blank"led LBMA
Reserves. If you would like to subscribe, you can do so by click target="_blank"ing here. :D
And don't forget what year it target="_blank"is: Year
of the POP! ;D
Sincerely,
FOFOA
