Germany has announced that it
plans to take home all 374 tonnes of its gold stored at the Banque de France,
and 300 out of 1,500 tonnes held at the Federal Reserve Bank of New York (http://www.ft.com/intl/cms/s/0/97970542-5fd2-...l#axzz2I9UZ7iGA).
Bill Gross of PIMCO tweeted:
"Report claims Germany
moving gold from NY/Paris back to Frankfurt. Central banks don't trust each
other?"
In this article, I consider
some popular reactions to the news and then present my own analysis and some
ideas about what I think could happen.
Declining trust is a global
megatrend. It is impossible to ignore. I proposed trying to measure it as one
indicator for financial Armageddon in my dissertation target="_blank"(http://keithweiner.posterous.com/a-free-ma...vices-and-money).
I am sure distrust for the US
government, or more likely, responding to the German voter's distrust is
among their concerns. But, I doubt that this is the primary motivation. The
Bundesbank is not acting as if they are in any hurry, planning to have the
gold moved over a period of 8 years (yes, I know, it all "fits",
the delay is because the Fed hasn't got the gold, etc.) A lot can and will
happen in 8 years (including the end of the current monetary system). The
distrust theory has to answer: why would Germany leave 1,200 tonnes of gold
in New York and 447 tonnes in London?
As a side note, if distrust
grows to the point where a major government cannot trust another major
government with $2.4B worth of gold, then there are some negative
consequences. The gold market will not be the greatest of them, as the world
experiences a collapse in trade, borders are closed to the movement of
(peaceful) people, goods, and money, and the world in general moves towards
world war and the possibility of a new dark age.
Some have declared that
German's gold withdrawal is a "game changer". The game will change
sooner or later, and gold will be used again as money. In this sense,
German's move is not a game-changer at all. They are just moving metal
from one central bank vault to another. They are doing nothing to change the
paper game into a gold game. They are not helping gold to circulate.
In any case, I don't think
this is what most pundits mean when they say, "game changer". I
think they mean the price will rise sharply. This follows from the belief
that the Federal Reserve has already sold this gold, perhaps multiple times
over. If this were true, then it would be obvious why Germany would want its
gold back, while it is still possible to get it back. This would force the
Fed to buy it back. This would cause the price to rise.
The data does not fit this
theory.
At the time I prepared the
chart for my appearance on Capital Accou target="_blank"nt (http://monetary-metals.com/summary-of-k...short-position/),
there were less than 400,000 gold futures contracts open. Even if there were
a conspiracy to manipulate the market by naked shorting futures, a big
fraction of them would certainly be legitimate. There aren't enough contracts
to support the theory that Germany's 1500 tonnes of gold, which would be
about 480,000 COMEX contracts, was sold in the futures market (let alone that
it was sold multiple times over!)
Alternatively, the Fed could
have sold the gold in the physical market (albeit only once). This gives us
an easily testable hypothesis. If the Fed had sold Germany's gold and now it
must buy about 1.2M ounces a year, this should show up in the gold basis. The
Fed would become the marginal buyer of physical gold. This should cause the
basis to fall sharply, or perhaps even go negative.
This is a graph of the gold
basis (for the December contract). There has been a gently falling trend
since the start of the data series in July, from about 0.7% annualized to
around 0.55%.
It is hard to guess how much
impact would occur as a result of a new 1.2M ounces of annual demand at the
margin. This would be about 5000 ounces a day, every business day
relentlessly for 8 years (assuming it is disbursed evenly, which is doubtful).
I think there would be an impact in the basis. We shall have to wait, and
watch the basis to see.
I think the Fed does have the
gold, or at least title to gold leases. If the gold is out on lease, then the
Fed would have to wait for the leases to mature. The leased gold might even
be in the Fed's vaults. It has to be stored somewhere, and to a financial
institution the Fed's vault is as good as anywhere.
I plan to write more about
gold lending and leasing. In short, no one today borrows gold to directly
finance anything. The world runs on dollars. A gold lease today is basically
a swap. One party provides gold. The other party provides dollars. And at the
end, the gold and dollars are returned to their original owners; plus one
party has to pay dollars to the other. Typically the party who owns the gold
pays net interest (it's like a dollar loan to the gold owner, secured by the
latter's gold as collateral).
Of course the Fed has no need
to borrow dollars, so if it leases gold it must be for another reason. I can
think of two. First, the Fed might want to remove liquidity from the banking
system (though not in the post-2008 world!). Second, the Fed might
accommodate the case of a bank with a profitable gold arbitrage opportunity.
There are several potential candidates, but one that comes to mind is
temporary gold backward target="_blank"ation (http://keithweiner.posterous.com/tem...th-forward-from).
In this case, the Fed leases gold to a bank. The bank sells the gold in the
spot market, and simultaneously buys a future. The bank ends with the same
gold bar and pockets a spread. It returns the gold to the Fed and even gets a
little interest on the dollars it lent against the Fed's gold collateral.
While this might have been
occurring intermittently since December 2008, there is not much of a
backwardation today in the February contract (around 0.1% annualized). And in
any case, a lease for this purpose would be a short-term lease as there has
not been any backwardation in long-dated futures, only the expiring month
(less than 60 days).
Moving 300 tonnes of gold from
New York to Frankfurt will be a non-event in the gold market in itself.
However, there could be a large and unpredictable change if the gold-buying
public sees this as a reason to increase their distrust of the system and
runs to their nearest coin shop to load up.
Let's not forget that the
Bundesbank is also a central bank, invested in the regime of irredeemable
currency. Like the Fed, it is built on faith in Keynesianism, along with some
Monetarism and Mercantilism. Is there any reason to assume that they would
not do the same things that the Fed is doing, when they feel the same
pressures? The gold is going out of the frying pan and ... into another
frying pan.
What if the Fed is currently
leasing out all 300 tonnes and the Bundesbank plans not to lease? This would
remove some gold currently circulating in the market. Will this cause the
price to rise? Certainly.
More importantly, it is a move
away from the gold standard, away from the use of gold as money. It is a step
towards target="_blank" the end (http://keithweiner.posterous.com/...comes-permanent).
I suspect the reason for
repatriating the gold has more to do with a shift in German politics than any
sudden concern about the intentions of the Fed, any sudden questions about
the faith and credit of a central bank, or any desire to re-monetize gold in
Germany. Readers from Germany are encouraged to write me if they disagree.
