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What is a piece of physical gold in the hand (of a banker) really worth
today?
The following is a nice little video about the history and evolution of
debt-based money. It is about 50 minutes long, but I am only referencing 5
minutes. I have set this video to start at the 4:14 mark automatically so
just watch it to the end of this section to set the stage for this post...
http://www.youtube.com/watch?v=D0IJCGuNtqk
As sentient beings, we humans exist in a certain, specific frame of
reference. For example, a small golden sun disc appears to circle our giant
green planet each day. This is our frame of reference. But in another frame
of reference, say, sitting in a space ship in outer space, the sun would
appear stationary and the Earth would be seen spinning. And in yet another
frame of reference, an astronomical time and scale frame, the Earth would be
seen circling the sun while they both circle the galaxy together.
The point is that it is not difficult to picture other frames of reference in
your mind once you learn how, but getting to that point of ease requires
either centuries of thought or a little help.
Gold
One of the unique characteristics of gold that sets it apart from commodities
is that its primary use - store of value - has no weight or mass
requirements. In commodities, where industry is the primary user, weight is
critical. If you are a builder who needs a ton of copper, then your need for this
specific weight is more important than, and independent from, the price of
copper. If copper rises in price, then darn-it, you must pay more. If copper
falls in price, hurray, you just saved yourself some money.
But if your need is to store $100,000 worth of present value in gold, it
doesn’t matter how much gold you get. All that matters is that whatever
weight you get reliably and efficiently stores your value. One ounce could do
just as good of a job as 100 ounces. In fact, one ounce would do a BETTER job
than 100 ounces! The less gold it takes to store your value, the better it
does its job. This particular “gold dynamic” sets it apart from
all commodities.
One ounce would store your value more efficiently and stably than 100 ounces
because A) your storage and security costs would be lower (efficiency), and
B) if one ounce is worth $100,000 then that infers gold is being valued by
many more people relative to when it was $1,000 per ounce. This wider
distribution brings with it a more stable base of valuation and less relative
volatility in price (stability).
Comparing this “gold dynamic” to any industrial or food commodity
we can see a stark difference. What commodity could perform its job BETTER at
a price 100x higher than today? Can you name one?
Gold as a Store of Value
Almost the entire human race today shares a common frame of reference when it
comes to physical gold investing. That frame of reference is that when you
invest in gold (you store value in gold) you are doing so in a specific weight
of gold. “I bought ten ounces today,” you might say. Notice that
you didn’t say, “I transferred $12,000 of value into gold
today,” or, “I exchanged $12,000 for gold today.” It is
true that you might have mentioned the price, but you ALWAYS mention the weight.
Even if it’s just to yourself.
Of course there is nothing wrong with this perspective, this frame of
reference, as long as you actually did take possession of the gold. But what
if you didn’t take possession?
Notice the subtle difference in ETF investing, like GLD. If you bought some
GLD today you might say, “I bought $12,000 in GLD shares today,”
or, “I put $12,000 into GLD today.” Can you see the difference?
Feel free to substitute anything besides actual physical in for GLD.
The next question is, Are there some gold investment vehicles in the world
today that are less clearly either paper (GLD) or physical (e.g. Coins) in
which the common frame of reference is denominated in weight? In other words,
is there a way you could say, “I bought ten ounces today” and
mean it, without ever touching the gold?
Of course! There are many. Are they all equal? Of course not. Is there an
ounce of gold somewhere out there in the world set aside for everyone that
thinks they own one? Unfortunately there is not.
So what we end up with today is a wide spectrum of “gold
investment” options of relatively different qualitative values. On one
end of the spectrum we have physical gold coins stuffed in the “gold
toe” of your black socks in the back of your sock drawer. ;) And on the
other end we have investments like GLD from which you cannot take delivery,
and in fact, you are quite unclear on the legal definition of its
“physical backing” and who actually owns that
“physical” gold.
And in between these two there are many other options where your investment
is actually someone else’s liability to you. Sometimes it is a
weight-denominated liability. Sometimes it is a dollar-denominated liability
fixed at par to the published trading price of gold. Sometimes it is a weight-denominated
liability with the contractual option to settle in currency at the published
price of that weight of gold left to the depository’s discretion. And
other times it is strictly weight-denominated because the depository knows
full well that, in a pinch, the legal system can and does only enforce
currency settlements.
Think about this last one for a minute. Imagine you paid in advance for a new
tractor from a tractor company. But before it finished building your tractor,
the factory went out of business. When you later sue the factory owners in
court, do you think the judge will award you a tractor? Can a judge force a
defunct company to cough up a tractor it doesn’t have? Of course not.
This is why the legal system can and does only enforce legal tender
settlements.
Hopefully it is clear now that this wide spectrum of “gold
investment” options casts a rather hazy cloud over the aggregate amount
of “wealth” stored in gold from a weight-based frame of
reference.
In other words, it would be quite incorrect to say Johnny has 25 ounces in
gold, Davey has 75 ounces, Phil has 100 ounces and James has 200 ounces if
only 20 ounces exist in the whole world. Instead it would be a little more
correct to say, “Johnny, Davey, Phil and James combined have $480,000
total invested in gold.”
And if the four of them had all invested in perfectly equal “gold
investment options”, with only 20 ounces existing in the world, we
could deduce that gold was worth $24,000 per ounce! They each bought the same
investment over and over that claimed gold was worth $1,200 per ounce until,
combined, they owned 400 ounces. But since all the investments were equal,
the 20 ounces of real physical gold would each be worth $24,000… to the
banker.
But now let’s say that out of Johnny’s "25 ounces", 20
are in the same “investment option” as everyone else, and the
other 5 are coins in his sock drawer. Let’s do a little math.
20 ounces exist in the whole world. 5 are in Johnny’s sock drawer and
15 are in the banker’s vault. Johnny paid $1,200 each for the 5 coins
in his drawer and also for his other “20 coin receipts”. So we
have $6,000 invested in gold in Johnny’s sock drawer and $474,000 total
invested in gold through the banker, who has 15 ounces in the vault.
$474,000 divided by 15 equals $31,600 per ounce.
In this frame of reference, Johnny’s sock drawer is really worth
$158,000 alone (5 x $31,600)! Johnny’s total investment is actually
worth $182,000 even though his initial investment was only $30,000. And Phil,
who initially invested four times as much as Johnny has, in reality,
35% LESS than Johnny. How? Why? Simply because of the total number of claims
against gold in the banker’s vault! And so far, only the banker knows
this true value!
Each coin in the banker’s vault is worth $31,600 to the banker because
he is able to sell many extra claims at $1,200. (Remember the video above?)
The key to this statement is these words: "is able to". How
is the banker "able to?" Not because he tricked the people, but
because the people chose the amount of value they wanted to store in stable
and efficient gold.
The banker is simply managing his fractional reserves in an attempt to keep
the price steady and show the efficiency and stability of his business model.
But that doesn't mean the actual gold is only worth $1,200. And again, only
the banker knows this true value.
If Johnny were to sell the banker one of his “sock drawer coins”
(deposit in an unallocated bank account) for $1,200, the banker would put it
in his vault, give Johnny a claim check for that ounce, and then sell 25 more
“one ounce” claim checks to Davey, Phil and James.
Can you see how this works? I apologize for making this point embarrassingly
simple, but hopefully this will enhance the likelihood that all of you will
get it. If necessary, please give this simple shift in your frame of
reference some time to sink in before you read on.
Another
Quoted from here:
5/3/98 Friend of
ANOTHER
Merrill Lynch, et al, don't grasp the gold valuations by the BIS. Gold is
valued by the number of outstanding claims against it. Kind of like a house
for sale with ten bidders. Each bidder thinks the house is in the bag because
they have a valid bid ticket. Each one thinks he can have the house at any
time, even though nine others want it too, because all I have to do is bid a
little higher and take it! Insane, but that's what is going on! Somehow,
the BIS and the major private gold holders know the total claims, as does
Another. The Euro group is going to force those claims into real bids
instead of just claims!
A Little Background
"...Then, in October of 1997 at the internet's only gold discussion
forum of the day, a series of remarkable postings began appearing under the
pseudonym "ANOTHER", offering plausible answers to those
questions…
"Knowledge as is conveyed in his series of "THOUGHTS!" is
rarely to be found outside the highest levels of international
finance...”
Date: Sat Apr 18 1998 19:18
ANOTHER (THOUGHTS!)
ID#60253:
"What Is The Real Price Of Gold IN The Central Bank World?"
The one that posts using SDRer, has shown many times how "Gold
Value" is used in international trade. What cannot be seen is the value
of gold in the "INTERBANK" world. Here is the realm of "true
valuations" in paper currency terms. It is a real shocker for lesser
eyes.
In this modern world, the current value of every asset is formed by a
relationship of gold/currencies/oil. This cross relationship is the
"very basis of our modern world banking system"!
Through this basis, all currencies are given value as the local government
treasuries hold US$ as reserves. The US$ is given backing as its government
is guaranteed that all crude oil, worldwide, will be settled in dollars. An
oil reserve backing, if you will. And the "value" that the
"future supply of" currency traded "oil" imparts to the
world economy, is guaranteed by an "INTERBANK paper gold MARKET"
that values "physical bullion" in the Thousands!...
But, how can this be, you ask? It is done, "right before your eyes"
and we see it not! I ask you, if you have one ounce of gold, and sell it on
the market for $300, it is worth $300, yes? Now, what if a CB holds one ounce
of gold, and sells it twenty times, that one ounce is now worth $6,000, no?
The difference between you and CB? The persons that hold
"interbank" IOUs for gold, value them at the multiple of
leases/sales made against reserves. This leverage, it is held for performance
on bank part. The BIS, it forces performance, on any economy! You ask Korea
about gold, yes?
This is why oil can take a small amount of physical gold out of world supply,
at current "freely traded", "managed prices", and hold it
at a many times valuation. That is what gives this "new world gold
market" much value in trade at high levels. Look even at your
"Comex", and divide the daily volume by the "eligible stocks
for delivery". That number (perhaps three million ounces divided by
150,000 stocks), deliverable, times the spot close gives close, real world
price of physical, $6,000. It follows close to paper trade on LBMA.
You see,
"physical gold is of much greater value than public traders can move it
for"! In your world, this cannot be, but it is, and will show
for all to see in your time.
Date: Sat Feb 14 1998 19:10
ANOTHER (THOUGHTS!)
ID#60253:
Look to LBMA, for currency looking for gold! Compare the Comex average open
interest with its average daily trading volume. Now use average daily trading
volume at LBMA and convert to open interest in London, using comex ratio. Here you will find "real
currency" in "paid for" gold derivatives ( not futures ) !
This money is now looking to convert to physical! It is
caught in this paper with no way out!
Date: Sat Apr 25 1998 22:55
ANOTHER (THOUGHTS!)
ID#60253:
It is true, that in times past when a currency is inflated (over printed) to
a point of only 10% real gold backing, the government could revalue gold
upward and the currency was 100% backed again! A terrible blow to the holders
of this paper, but at least the money system survived! Today, the world's
currency, the US$, by default, would require a gold price of many, many
thousands to back it without using its citizens as collateral! The only
problem with this is the US gold stock is so small, that even at $10,000/oz,
a large deflation would be necessary to decrease the outstanding US currency
to this gold backing level!
Now, consider the Euro. It will have much real gold backing from the
beginning. Even at 10% to 30%, the Euro will be the equivalent of a 100% gold
backed dollar, when the world comes off the dollar standard! The selling of
old dollar reserves alone will reprice gold in US$ terms of at least
$6,000/oz! Its present interbank reserve value.
5/5/98 ANOTHER
(THOUGHTS!)
The BIS is the gold broker for all
interbank sales/purchases. Bullion Banks are for sales to
other entities.
6/14/98 ANOTHER
(THOUGHTS!)
Sir, The history of "Hot" paper money does show it to "burn
easily" from " much heat"! If you read my Thoughts in today's
replies, we see much "fuel" in dollar derivatives trading in
foreign markets. Much of this trading represents a "claim" on
physical gold that may become "a transaction for physical gold" as
dollar reserves are displaced. The $6,000 valuation of gold can only be
true if currency deflation destroys enough dollars to bring it down to that
range. Without deflation, the dollar will be devalued much lower than
this (higher gold price)!
I will note that gold was around $300 per ounce at the time the above was
written. Has the paper gold market leveraged up or down since 1998?
Once Again
5/3/98 Friend of
ANOTHER
Merrill Lynch, et al, don't grasp the gold valuations by the BIS. Gold is
valued by the number of outstanding claims against it. Kind of like a house
for sale with ten bidders. Each bidder thinks the house is in the bag because
they have a valid bid ticket. Each one thinks he can have the house at any
time, even though nine others want it too, because all I have to do is bid a
little higher and take it! Insane, but that's what is going on! Somehow,
the BIS and the major private gold holders know the total claims, as does
Another. The Euro group is going to force those claims into real bids instead
of just claims!
A Fresh Look
With this new frame of reference in mind, let’s take a fresh look at this FT article from
last week. I cut out some of what I consider to be “spin”:
“Three big
banks – HSBC, Société Générale and BNP
Paribas – were among more than 10 based in Europe that swapped gold
with the Bank for International Settlements in a series of unusual deals that
caused confusion in the gold market and left traders scratching their heads.
“…The Financial Times has learnt that the swaps… were
initiated by the BIS…
“The client approached us with the idea of buying some gold with the
option to sell it back,” said one European banker, referring to the
BIS.
“…two central bank officials said some of the commercial banks
also needed the US dollar funding and were keen to act as a counterparty with
the BIS…
“Jaime Caruana, head of the BIS, told the FT the swaps were
“regular commercial activities” for the bank.
“In a short note in its annual report, published at the end of June,
the BIS said it had taken 346 tonnes of gold in exchange for foreign currency
in “swap operations” in the financial year to March 31.
“…In a gold swap, one counterparty, in this case a bank, sells
its gold to the other, in this case the BIS, with an agreement to buy it back
at a later date.
“The gold swaps were, in effect, a form of collateral… Gold is
widely regarded as one of the safest assets, but has not been widely used as
collateral in the past. Mr Caruana described the transactions as “loans
with a guarantee”.
“Investors have bought physical gold in record amounts during the past
two years and deposited it in commercial banks. European financial
institutions are awash with bullion and some are trying to pledge gold as a
guarantee.
“George Milling-Stanley, managing director for government affairs at
the industry-backed World Gold Council, said: “The gold swaps
commercial banks carried out with the BIS demonstrate the effectiveness of
gold as an asset class, because even in the depths of the worst liquidity
crisis in living memory, institutions with access to gold were able to make
use of it to generate dollar liquidity.
“The issue also feeds right into the current debate among Asian central
banks about the lack of assets suitable for use as cross-border
collateral.”
“Last year, CME Group, the world’s largest derivatives exchange,
allowed investors to use gold futures as collateral for some operations.
Other institutions, such as central banks, had begun using and requesting
gold as collateral in the past two years as perceptions of counterparty risk
have risen, bankers and officials said.
“The gold used in the swaps came mainly from investors’ deposit
accounts at the European commercial banks. Some investors prefer to deposit
their gold in so-called “allocated accounts”, which restrict the
custodian banks’ ability to use the gold in their market operations by
assigning them specific bullion bars. But other investors prefer cheaper
“unallocated accounts”, which give banks access to their bullion
for their day-to-day operations.
“Officials said other commercial banks obtained the gold from the
lending market, borrowing bullion from emerging countries’ central
banks.”
A Final Word
The dollar/gold bid dynamic is a relativistic Thought experiment, not unlike
Einstein’s Special Relativity. It can be viewed differently from many
reference frames.
Dollars bidding for gold.
Gold bidding for dollars.
Dollars bidding for paper gold.
Paper gold bidding for dollars.
Dollars bidding for physical gold.
Physical gold bidding for dollars.
Smart dollars bidding for physical gold.
Paper gold
bidding for “idiot dollars”?
And with this, I leave you to finish the puzzle on your own. Hopefully a new
frame of reference helps.
Sincerely,
FOFOA
FOFOA is A Tribute to the Thoughts of Another and his
Friend
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