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On April 21, 2010
Paul Tustain, CEO of BullionVault, posted an article at gooldseek.com
entitled “Cash Futures, Physical Forwards, and London Gold's 100-to-1
Leverage" in which he characterizes my comments and analysis of the LBMA
as a “misunderstanding”.
http://www.24hgold.com/english/contributor.as...or=Paul+Tustain
The following
commentary is written as a rebuttal to Mr. Tustain’s article.
Mr. Tustain
argues that the characterization of the London LBMA OTC market as a
“paper” market where the ratio of paper to actual bullion sold is
100:1 is incorrect because much of the “paper” trades are
“forwards” which will at some future date be delivered against with
actual bullion by the seller of those forwards. I will show that cannot
possibly be the case.
The Bank for
International Settlements (BIS) in its Q2 2009 OTC Derivatives report gives
the notional value of gold forwards and swaps as $179 billion and for silver
as $101 billion. In weight terms this is 193 million ozs of gold and 7,481
million ozs of silver. Over the last 50 years all large above ground
inventories of silver have been drawn down so the only legitimate sellers of
silver forwards on a consistent basis have to be mining companies. The US
Geological Survey tells us that in 2009 the total silver reserves on planet
earth were 8,400 million ozs. If the LBMA is not a paper market we would have
to believe that mining companies have already sold forward 89% of the silver
reserves of the world! Yet if we look at the major silver mining companies
their production is largely unhedged. So who could possibly have sold forward
89% of the economically mineable silver on the planet if it was not the
entities who actually own it? It must be entities who don’t own it. The
inevitable conclusion is that the LBMA forward market is a paper market and
is not backed by future production.
Mr. Tustain spoke
about the spot market and the forward market but conveniently sidestepped the
issue of unallocated bullion that is meant to be held by the LBMA.
What I argued was
that there is a large amount of gold that is neither a spot market operation
which is for immediate delivery nor a forward purchase that is for delivery
in the future. That category is “unallocated gold” which has been
bought by investors and should be held by the LBMA on their behalf. The fact
that such investors are considered “unsecured creditors” means
that the gold is not vault gold but an IOU gold. The LBMA is selling much
more bullion than it actually has by employing a fractional reserve system.
Mr. Tustain says “exchangeability
is the source of their [futures contracts] liquidity. Forwards, on the other
hand, are hopelessly illiquid. Each was custom built 'over the counter' for a
specific settlement day. But forwards really are deals in physical gold
– which will settle as Good Delivery bars, on almost every day of the
year”
He claims that
“forwards” are hopelessly illiquid. But the LBMA reports that on
average 20 million ozs of gold are transferred each day and 90 million ozs of
silver on a net basis. That is $6.5 Trillion of net trade on an
annual basis in gold alone. That is one heck of a lot of liquidity! If the
forwards are hopelessly illiquid then this trading must be almost entirely
due to trading of unallocated gold. I have addressed this before in previous
articles and shown that this level of trading cannot be backed 100%. In fact
I estimated that approximately 50,000 tonnes of gold has been sold that does
not exist in the vaults. Interestingly enough 50,000 tonnes is approximately
equal to all the gold reserves left to be mined on the planet.
Finally Mr.
Tustain addresses futures market manipulation. He concludes that small
investors will lose money in the futures markets because they don’t
have the monetary or bullion resources to play against “the
professionals” (aka the Gold Cartel). This is exactly what regulations
are meant to guard against. Big players are not supposed to make money just
because they are big. Is it the small investor’s fault that just two
bullion banks are allowed to control anywhere from 40-100% of the net short
position or to hold 95% of all OTC precious metals derivatives? Is it the
small investor’s fault that two bullion banks in July 2008 sold short
the equivalent of 25% of the global annual silver production and 10% of the
world gold production in 4 weeks? This was not some professionals doing
some arbitrage between the futures market and the forward curve. This was
blatant manipulation because the financial crisis was causing a “run on
the bank” of the LBMA due to investors wanting so much bullion that it
risked exposing their inability to deliver. This was not
“novices” as Mr. Tustain characterized them; this was intelligent
and rational investors wanting to protect themselves in a credit crisis. The
“run on the bank” for physical had to be stopped at any cost
before it exposed the bullion bank short position. So the bullion banks went
massively short on the Comex to crater the price to squash the notion that
precious metals could be a safe haven. This process was accurately described
by Jeffrey Christian in his testimony before the CFTC except he described the
shorting on the Comex as “hedging” of the physical sales being
made in London.
When questioned by Chairman Gensler about this bizarre concept of going short
to hedge something that has already been sold he claimed he had misspoken.
But the facts speak for themselves; there were physical shortages which even
obliged the mints around the world to ration supply, and yet the Comex prices
of gold and silver plummeted.
In characterizing
the shenanigans on the Comex as perfectly logical arbitrage trades against
the forward curve, Mr. Tustain disregards the information given to the CFTC
by Andrew Maguire about manipulation of the silver market by JPMorganChase in
advance of the manipulative events actually occurring; he also disregards the
fact that the CFTC has been investigating alleged manipulation in the silver
market for over 19 months. There is a preponderance of evidence that the
counterintuitive price behavior of the Comex gold and silver futures market
are anything but just innocent arbitrage.
I would like to
commend Mr. Tustain for taking the time to publish his comments because it is
by way of following a healthy debate that market participants can be better
informed. However, his arguments to dismiss my concerns that the LBMA has
sold many times more gold and silver than it can deliver do not stand up to
close examination.
Of course, the
debate could easily be settled by the LBMA making a statement that all the
unallocated bullion they have sold is 100% backed by inventory which is
unencumbered in any way and publishing a third party to audit to verify it.
They could further change their account agreements to make unallocated
account holders “secured creditors” instead of “unsecured
creditors”. They could further aid investors by publishing data on
their forward contracts and details on their trading volumes and making it
clear how annual net trades of $6.5 trillion can be achieved with bullion
that is not hypothecated and confirming that the Comex futures are hedging
real physical bullion and not paper promises of bullion.
I will not hold
my breath waiting.
Adrian Douglas
Marketforceanalys.com
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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