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On October 10 I
published an article that postulated that the gold market is a Ponzi scheme
because it sells gold that doesn't exist by implementation of the principles
of fractional reserve banking. (See http://www.gata.org/node/7887.) Since writing that
article further information has come to light that supports this claim and
allows an estimate of how much gold has been sold that doesn't exist if the
owners of the gold ask for it.
In other words, there
are several owners for each ounce of physical gold.
By complete
coincidence Paul Mylchreest of The Thunder Road Report has just written an
in-depth study into the daily trading volumes of gold on the London over-the-counter market, which can be found here:
http://www.gata.org/files/ThunderRoadReport-10-15-2009.pdf
The London OTC market
is where most physical gold is traded. This market is a wholesale market
where trades are conducted only between the bullion trading houses on behalf
of their clients. About 95 percent of the trading is by way of gold that is
held in unallocated bullion accounts.
The unique
characteristic of gold is that about 50 percent (80,000 tonnes) of the
above-ground stocks are held as a store of wealth (investment). The other 50
percent exists as jewelry. When gold is bought as a store of wealth it can
perform that function for you wherever it is in the world. Given this unique
characteristic many large investors in bullion prefer to leave their gold
with the bullion dealer from whom they bought it so that it can be stored in
their vault and easily resold. This is identical to the situation with
stocks, where most stock certificates are held by brokerage houses, not by
individuals.
That people are
buying and selling gold without ever taking delivery means that there is the
opportunity for bullion houses to sell gold that doesn't exist.
Now the bullion
houses probably don't view this as illegal or dishonest because they will
operate a fractional reserve type of system, just as the banks do with fiat
currency, and will make sure they have enough gold on hand for what would be
the maximum estimated volume of gold that could be called for delivery. After
all, trading is done with unallocated gold, so how much more unallocated can
it get if it doesn't exist at all?
This is what caused
bank runs in the days of the gold standard. People would deposit gold in a
bank and receive bank notes (dollar bills) in exchange. At any time the
depositor could return and hand over his bank notes and receive from the bank
the same quantity of gold he deposited. The banks realized that under normal
circumstances a maximum of about 10 percent of the gold deposited could be
requested. So the banks saw an opportunity. They could issue up to 10 times
as many bank notes in loans as there was gold in the bank and they could earn
interest on the bank notes. The system worked until there was difficulty
meeting withdrawals. Then word spread quickly that the bank was insolvent,
and as holders of the banknotes rushed to the bank to redeem them for gold,
the bank would admit it had insufficient gold and would declare bankruptcy.
The origin of the
word "bankruptcy" is from the Latin words "bancus" and
"ruptus," which means literally that the bank is broken. Banks have
gone bust frequently enough to have earned themselves the ownership of the
word to describe the phenomenon. Isn't that ironic when banks are meant to be
a safe store for money?
This basic scam is at
the center of modern gold market manipulation. Instead of real gold, paper
substitutes for gold are sold through derivatives, futures, pooled accounts,
exchange-traded funds, gold certificates, etc. I estimate that each actual
physical ounce of gold has multiple ownership claims to it.
For the scam to be
sustained there must always be plentiful physical gold for those who want it.
The market is, in effect, a giant inverted pyramid with a huge paper gold
market being supported by a small amount of physical gold at the tip of the
inverted pyramid. The scam can continue until there are indications of a
shortage of physical gold. If all the claimants of each ounce of real gold
demand their gold, then there is the potential for a squeeze such as has
never been seen before.
To lend support to
the idea that all the gold in the world has been sold several times over I
cite the case of Morgan Stanley, which was sued in 2005 for selling
non-existent precious metals. Morgan Stanley even had the audacity to charge
storage fees. The firm settled the class-action lawsuit out of court but no
criminal charges were ever filed. If Morgan Stanley was doing this, you can
bet that it is the tip of the iceberg.
Paul Mylchreest has
done fabulously detailed research into data on the daily trading of gold on
the London OTC market. He concludes that 2,134 tonnes of gold are traded each
and every day. That is a shocking number because this is 346 times larger
than all the gold that is mined in the world each day.
But this on its own
is not sufficient evidence to indicate that the market is fraudulent. For
example, if I have a 1-ounce gold coin and I have a hundred friends I could
sell the coin to a friend and then he could immediately sell it back to me or
sell it to one of my other friends, who could sell it back to me. If I were
to transact with all my friends in the same day in this way, I could have
turned over a volume of 100 ounces in trading transactions but no fraud would
have occurred because the last friend I traded with owns the 1-ounce coin,
even though it went through a hundred sets of hands before it got to him. There
are no multiple ownership claims to the coin because the trades were
sequential, not simultaneous.
But if I were to sell
1 ounce of gold to all my friends and promise I would keep the gold for them,
the trading for the day would be 100 ounces but now fraud has been committed
because I have a liability of 100 ounces while I have possession of only 1
ounce. If they never ask for the gold and I can pay them cash when they want
to sell their gold, then there is a good chance my friends would be none the
wiser ... until the day when at least two friends insist on receiving the
1-ounce coins they each supposedly own.
The daily gold trading
in London is simply humongous. We talk of the gold market being a tiny
market. It is anything but. It has a daily turnover of $70 billion. To put
this in perspective, the world consumes 86 million barrels of oil each day. The
total cost of the global daily oil consumption is a mere $6 billion!
But as discussed
above, the daily volume traded does not in and of itself prove that a
fraudulent fractional reserve operation is being conducted. Mylchreest did
some more work using statistics from the GFMS metals consultancy to determine
the maximum quantity of gold stock the OTC market could be holding with which
it can back the huge daily trade volume. The gold that is traded has to be in
the form of London Good Delivery (LGD) bars, which are 400-ounce bars. Mylchreest
estimates that there can be only about 15,000 tonnes of such bars in the
world. Let us assume that the London OTC market holds them all. We will show
that by comparison with the trading of other unallocated gold products that
15,000 tonnes is nowhere near enough gold stock for the gold not to have more
than one ownership claim to each ounce.
The purpose of buying
investment gold is for it to store wealth. This necessarily implies that it
is held for a long time. If gold is bought and traded quickly it would
destroy wealth, not store it, because there would be a large loss due to
transactional fees. The figures we have so far suggest that the entire stock
of gold of the London gold market could be turned over every seven days
(15,000 / 2,134 = 7). That would hardly be characteristic of a market that is
supposed to be selling a "buy and hold" product. For the purposes
of illustration, in a town of 15,000 houses would you expect 2,134 houses to
be sold each day? Or that each house on average would have 52 owners during
the year?
Let's compare how
much of the inventory of the precious metal exchange-traded funds are traded
each day to get a good idea about how frequently investors trade something
they have bought as a store of wealth. The most liquid and highly traded ETF
is GLD. It has 325 million shares outstanding and the fund trades on average
11.9 million shares each day. This means it trades one share each day for
each 30 shares outstanding. Central Fund of Canada trades one share for each
140 shares outstanding, while the Gold Trust Unit trades one share for each
300 shares outstanding.
The GLD ETF is a way
of buying, holding, or selling unallocated gold. One would expect the
investors' behavior in this ETF would be similar to those trading the unallocated
accounts on the OTC. If the investor trading mentality on the London OTC is
similar, then 2,134 tonnes should be 1/30th of the gold stock held by the
OTC. This equates to 64,000 tonnes of gold. But Mylchreest estimates that the
OTC can hold no more than 15,000 tonnes because that is the entire global
stock of LGD bars. If we use the CEF example, the stock would have to be
298,000 tonnes, or by the GTU example it would have to be 640,000 tonnes.
Probably the GLD
comparison is the most relevant, as that exchange-traded fund claims to hold
1,100 tonnes gold, which is comparable to the maximum 15,000 tonnes that
could be held by the OTC participants. However, the OTC is restricted to
wholesale traders and has a minimum trade limit of 1,000 ounces. In GLD the
minimum trade is a tenth of an ounce and trading is open to everyone. Considering
these limitations it is likely that OTC participants would turn over a lot
less than 1/30th of the inventory in a day. But even taking the GLD estimate,
the OTC participants should be holding 64,000 tonnes when according to what
can be deduced from GFMS statistics they can be holding only 15,000 tonnes.
This means that each
ounce has at least four owners. I think this is probably very conservative
because the GLD vehicle is set up to be easily traded and in units as small
as a tenth of an ounce. I would guess that it is more likely to be as high as
10 or even 20 owners to every ounce, particularly when the banking world has
used a 5-10 percent reserve ratio with fiat money for a long time and bankers
are creatures of habit.
This would imply that
the liability for unallocated gold that has been sold is probably closer to
150,000 tonnes (taking the more conservative 10 percent figure), but the
liability is backed by a totally inadequate maximum of only 15,000 tonnes of
physical gold. So it's likely that between 45,000 and 135,000 tonnes of
unallocated gold has been sold that does not exist.
This is between 50
and 170 percent of the entire existing investment gold stock that has taken
6,000 years to mine and accumulate.
We are hearing of
more and more cases of gold investors wanting to take physical delivery or
have allocated gold.
In my recent article
I said:
"A couple of
months ago Greenlight Capital, the large hedge fund, switched $500 million of
investment in GLD to physical gold bullion. ... Apparently Germany has requested that its sovereign gold held by the New York Federal Reserve Bank be returned
to Germany. Hong Kong has requested the same of the Bank of England, which
stores its sovereign gold. Robert Fisk, a respected journalist for the UK's Independent newspaper, reported this week that the Arab oil-producing states, Japan, Russia, and China have been holding secret talks to replace the dollar as the international
reserve currency and as an accounting unit for trade. He reports that the
basket of currencies they propose instead of the dollar would include gold. If
gold is going to regain its monetary role, then you can understand why those
in the know want actual physical bullion. There are some very real and
significant signs that a run on the Bank of the Gold Cartel for physical gold
is commencing."
Talking of runs on
the bank, Rob Kirby of Kirby Analytics in Toronto, a GATA consultant, did
some brilliant sleuthing work. His sources have told him that there was panic
in the London gold market around September 30 as participants in the market
wanted to take delivery of their purchased gold and refused generous cash
settlements that were offered instead. Central banks had to come to the
rescue to provide the gold via leasing. Apparently even the central banks
could not provide bars that met LGD standards, which indicates that an acute
shortage of physical gold is developing and that perhaps already many OTC
clients have drained a large proportion of the 15,000 tonnes of gold stock
from the London OTC market.
This supports what I
have been discussing above.
Paul Walker, CEO of
GFMS, recently said that gold was going up because of some "large lumpy
transactions in a market with a degree of illiquidity."
If the OTC was
selling only gold that the participants own, there could never be a lack of
liquidity. The panic that occurred at the end of September confirms that there
is a chronic lack of liquidity. This necessarily implies that there is
multiple ownership of the same ounce of gold and it is, therefore,
fraudulent. Leasing of gold from central banks provides only temporary
liquidity, because the central banks want their gold returned at some later
date, and it looks as if the bullion bankers may have dipped into that well
one too many times already.
The gold market is in
a precarious position. Just as in the days of the gold standard it requires
only one customer not having his deposit returned to bring down the bank,
because a domino effect results in all depositors asking for their deposits
to be returned. If my estimates are correct, that somewhere between 64,000
and 150,000 tonnes of gold have been sold against a reserve of only 15,000
tonnes.
But how much of even
this 15,000 tonnes remains?
The panic at the end
of September suggests that liquidity is very tight, in which case only a
small percentage of investors asking for their gold to be delivered or placed
in an allocated account will blow up the gold market and expose the scam -- a
scam that has been repeated time and time again throughout history. Why
should this time be any different?
If you think you own
gold, you should take a few precautions.
If you have
unallocated gold in some sort of pool account that does not have a
satisfactory audit or you own shares in an ETF that does not have a reliable
audit, take action. Take delivery of gold or move your investment to reliable
and audited allocated storage.
If you do nothing
about it and when the music stops you are left with just a piece of paper
that says you own gold but no one is able to give it to you, then perhaps you
will be able to take comfort in your having dismissed the German government,
the Hong Kong government, Greenlight Capital, and many others as a bunch of
nuts who don't know as much as you do about counterparty risk in the gold
market. But the "nuts" who are realizing that there are multiple
claims to each ounce of gold will at least have their gold if they ask for it
first.
Adrian Douglas
Marketforceanalys.com
Also
by Adrian Douglas
Adrian Douglas is
proprietor of the Market Force Analysis newsletter (www.marketforceanalysis.com) and a
member of GATA's Board of Directors.
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