Think like a Giant 2

In Legs there was a quote from Another that mentioned the "discount trade" in gold: "If gold rises above its commodity price it loses value in discount trade." In the comments under the post, Woland asked about it:

Woland said…

I have a question about the specific meaning of a phrase quoted in a paragraph by Another;

"[Central] banks do lend gold with a reason to control price. If gold rises above its commodity price, (me: cost of production) it loses value in discount trade".

My reading of this is that "discount trade" refers to oil sold BELOW the currency price OIL would otherwise demand, in return for gold being made available to OIL at a price far lower than would otherwise be possible, without the CB leasing/intervention. Is this the correct interpretation of the phrase?

(I am reminded of the old example by Another of $30 oil plus X amount of gold, then later the same $30 plus XX amount.)

January 18, 2013 at 11:08 AM

I responded to Woland with this comment:

Hello Woland,

My reading is that "discount trade" refers to the the BIS deals in physical gold at a "discount" to the "future reset price", deals that kept the really big money wanting real gold from blowing up the paper markets and the "plan" to make it to the euro's birthday party. In the 90s, the "discount price" ranged (according to ANOTHER) from $1,000 per ounce up to $6,000 per ounce. This was a big discount on the "future reset price" of $10,000 and the real future dollar price of $30,000.

Of course he may have simply meant the low commodity price of gold when he wrote "discount trade." But I put the emphasis on the word value: "…it loses value in the discount trade." The value was the control it gave the CBs in managing the Giants. The wider the gap between gold's "price" and its obvious "value" the more room the BIS had to negotiate deals that would keep the Giants happy. Here, I'll try to make my case using ANOTHER's own words! ;D

First, let's look at the deal the Saudi's cut for themselves in the early 90s which you mentioned above. Here's how ANOTHER explained it:

Date: Sat Oct 18 1997 21:04
ANOTHER (THOUGHTS!) ID#60253:

The Deal:

We ( an oil state ) now value gold in trade far higher than currencies. We are willing to use gold as a partial payment for the future use of "all oil" and value it at $1,000 US. ( only a small amount of oil is in this deal ) And take a very small amount of gold out of circulation each month using its present commodity price.

If the world price can be maintained in the $300s it would be a small price for the west to pay for cheap oil and monetary stability.

The battle is now between CBs trying to keep gold in the $300s and the "others" buying it up. In effect the governments are selling gold in any form to "KEEP IT" being used as 'REAL MONEY" in oil deals! Some people know this, that is why they aren't trading it,, they are buying it.

Not all oil producers can take advantage of this deal as it is done "where noone can see". And, they know not what has happened for gold does not change in price! But I tell you, gold has been moved and its price has changed in terms of oil! For the monthly amount to be taken off the market has changed from $10 in gold ( valued at $1,000 ) /per barrel to the current $30 in gold /per barrel still valued at $1,000! Much of this gold was in the form of deals in London to launder its movement. Because of some Asians, these deals are no longer being rolled over as paper!

First of all, they said they valued gold at $1,000/oz. in this deal and took $10 worth of physical off the market per barrel for a "small amount of oil." This was in the early days of the deal (c.1991). $10 is 1/100th of $1,000 so they were taking 1/100th of an ounce per barrel. In the early 90s the Saudis were producing about 9 million barrels per day. ANOTHER said that starting in 1991 they were taking about 20 million ounces of gold per year off the market through this deal. 20M ounces X 100 = 2 billion barrels of oil per year. Divide that by 365 days and it looks like the "small amount of oil in this deal" was 5.5M barrels per day, or about 61% of their production.

20 million ounces at $360/ounce would have cost $7.2B. At $1,000/ounce it would have cost $20B. 3.3B bbls of oil sold at $30/bbl would have brought in $100B per year. So let's say that they came to the negotiating table in 1991 saying that 20% of their production was "net-production" or surplus for which they needed a real wealth reserve (gold) in return.

There were two options on the table. To use ANOTHER's first example, they could lower the dollar price of oil from $30 to $25, but also price oil in gold at 1/400th of an ounce per barrel. Here's how ANOTHER put it:

What if the oil states offered to buy gold with oil, OUTRIGHT? No currencies involved. " We will produce flat out, all the oil you want. And, we offer this oil as payment, per barrel, to buy ( say? ) 25US dollars or gold priced by us, at ( say? ) $10,000oz.!"

The answer is very simple, the world would sell them gold for oil. I tell you now, this almost happened!

If that had happened, as ANOTHER said, anyone with gold would have gotten oil really cheap. And the gold arb would have immediately taken gold to $10,000 per ounce. The Saudis could easily exchange gold to cover their overhead costs and save their 20% excess without a problem. The problem for the CBs would be that the world would be off a fiat standard and back on a gold standard a decade before the euro's birthday party.

The other option on the table was, let's not rock the boat just yet. At $30/bbl, you want to save about $20B in gold each year. At current prices that would be 50 million ounces or 1,555 tonnes per year. But you saw what happened in the late 70s. Obviously you can't just go to the market and get that much—in other words, obviously the price of gold today is bullshit. Obviously it's going to have to reset at a much higher level someday, we'd just prefer that day not be today.

So let's see if we can figure out a way for you to take, say, 20M ounces, or 622 tonnes per year off the market as long as we can keep the price of gold low so as not to rock the fiat currency boat. We'll even underwrite (guarantee) this deal with our own gold (and we have lots of it!). From what you, the Saudis, obviously understand, this is an excellent deal for both of us, especially if the gold you get comes from someone else and not from our vaults. But either way you're covered. Deal done!

I guess we will never know the exact deal, but ANOTHER sure spilled a lot of details in his early posts if you look closely!

Now let's see what ANOTHER said about the discount trade in gold:

"As long as there is an open market for gold, it will not be allowed to trade above its commodity price! It has far too much value for that to happen. You see, in much the same way that a zero coupon bond trades at a discount to face, gold is traded for its discount of "money value to commodity price! Think that I a fool, because I trade gold for thousands US an oz.? You will think much on this in the future.

[…]

With gold discounted to its production cost and below, those that have it can trade it for its monetary value. Make no mistake, the BIS knows gold in the many thousands. The future "reset value" of gold is the key. "support the dollar with oil and the currency system works" "fail the currencies and the dollar will come off the oil standard and the BIS will reset gold to $10,000+ with many conditions. That is why they continue to accept the dollar as a reserve. If Japan or any other COUNTRY sells US treasury debt it's all over!"

[…]

The selling of old dollar reserves, alone will reprice gold in US$ terms of at least $6,000/oz! Its present interbank reserve value.

[…]

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)! Once the Euro is created and begins to effect world trade (late 1999 perhaps), the gold market will begin a transition as never before! I think it will be interesting to follow the politics of this change, yes?

[…]

When the battle to keep gold from devaluing oil ( in direct gold for oil terms ) is lost, the dollar will find "no problem" with $30,000 gold, as it will be seen as a "benefit for all" and "why did noone see this sooner"?

[…]

The true value of gold, as a monetary currency, in today's current US$ values, is over $30,000. If all currencies were destroyed, and gold only was used, this value would be higher. However, currencies will be used in the future, as today, only their value in trade will change. They will no longer be held as reserves, without gold at their side!

Okay, so if you've got really big money and you want to protect a large portion of it in physical gold, you've got to pay what to us shrimps would be a big premium. But to the true Giant it is actually a discount.

Imagine, Woland, that you woke up one day and discovered that you owned an oil field that would produce millions of barrels a day for the rest of your life. Would you consider that a windfall? In fact, that's exactly what it is. And with that windfall you will be able to raise your standard of living up to the greatest standard available to mankind in 2013. You will even be able to accumulate wealth on top of your unlimited "maximum consumption" binge. What a rare treat!

But what you won't be able to do is get the full windfall profit from moving your excess into physical gold that we shrimps can get. You already got your windfall. You simply have too much money to do what we're doing. If you tried to go "all in", you alone would drive the price so high that you'd never get the windfall you were after. Go ahead, try. Approach your local Bullion Bank and see how far you get. I bet you'll eventually find yourself in a private room somewhere in London receiving an education and an offer. What seemed like a huge premium when you walked in will feel like a big discount by the time you leave.

When ANOTHER used terms like discount (and even premium) in this context, I think he was usually referring to gold, and I don't think he was talking about the 10% and 20% premiums and discounts we shrimps are used to. I think he was talking about Freegold-sized premiums and discounts. Remember this fellow from the post?

"A proposal was offered to borrow in broken lots, 3.5 and 5.5 million ozs for resale. It was turned down. The owner offered to sell only, no lease. What turned heads was that someone else stepped in and took it all, at a premium!"

I wonder what premium he got. That's the same 9,000,000 ounces I mentioned later in the post converting it to 280 tonnes. Remember ANOTHER saying:

"Think that I a fool, because I trade gold for thousands US an oz.? You will think much on this in the future."

Think now! I wonder if this guy got "thousands US an oz." when he was expecting $310/ounce. Let's see, that was a $2.8B sale offer at $310. At $1,000 it would have been $9B. Yeah, I guess that would turn some heads.

Woland, have you noticed that in ANOTHER (THOUGHTS!) there are many times when ANOTHER gives brief replies to various people yet we don't always know the question that was asked or the context in which it was asked? Well, I added the link to the old Kitco archives to my list of links in the sidebar. It's called Early Kitco Forum Archive.

It's pretty easy to click over and find the comments associated with ANOTHER's answers, and I think it adds a new dimension to (THOUGHTS!). For example, here's a discussion about that 9 million ounce deal, but you wouldn't have known that's what it was about from reading only ANOTHER's side of the conversation. I included a little more of the discussion for additional context (and also just because it was interesting), so enjoy!

Date: Fri Dec 12 1997 22:18
sweat (To Anybody) ID#23782:

Is there any way to find out if the 9,000,000 oz. deal really happened?

Where might the trade have taken place?

Is this whole gold trading business really that much "cloak and dagger"?

Date: Fri Dec 12 1997 22:31
ANOTHER (THOUGHTS!) ID#60253:

SW,
What is "cloak and dagger"?

Date: Fri Dec 12 1997 22:54
sweat (ANOTHER) ID#23782:

"Cloak and dagger" is an expression I would use for an action ( or trade ) done in great secracy.

My experience as a trader has taught me to value such things as
a ) time and sales - as reported on various exchanges
b ) open interest - as reported on various exchanges

The market always moves to size, you spoke of "making the turn". I would love to see documentation of a trade that size.

No offence intended, of course.

Date: Fri Dec 12 1997 23:08
ANOTHER (THOUGHTS!) ID#60253:

SWEAT:
You will not see 80% or more of gold deals. If it was done with all to see the discount value would be lost as the world price would explode. This is not the relm of any public “wall street”. At one time it belonged mostly to the Barron. Now it is large with the BIS and super rich. Wars will be fought over the lack of “visibility” of these dealings.

Date: Sat Jan 10 1998 21:50
sweat (ANOTHER) ID#23782:

What quantity of GOLD, paper or physical, has OIL traditionally purchased on an annual basis? How much paper GOLD is out there ready to be squeezed? Do you think OIL will be able to collect what is owed to them?

Why would OIL not want some ownership of GOLD EQUITIES?

Date: Sat Jan 10 1998 23:13
Cmax (COMEX is only but a refernence to the value of paper gold, NOT physical.) ID#344205:

It is interesting to watch all these various reasons for gold’s fall…..but most are missing the REAL issue.

The fact is, that when we talk about the purchase of gold, we are really talking about two divergent things:
a. that of the physical metal……… ( money )
b. that of a paper derivative, an I.O.U., kind of like a dollar bill…… ( currency )

What ( and who ) determines the price every day of the gold market?

Obviously, everyone looks first to COMEX as a reference before adjusting their prices.

What does COMEX use?

Supply and demand determined by it’s participants, who trade in gold contracts ( er ah, derivatives? ) , gold leases, and options and futures ( er ah, derivatives of derivatives ) .

One point must be plainly put forward:
Gold contracts, no matter what they are printed on or HOW they are worded, they are merely DEBTS, nothing more than a simple I.O.U. There is nowhere near enough gold on the planet to satisfy all these I.O.U.’s ( debts ) that are outstanding…….. and they are the very antithesis of what acumulators ( hoarders ) of wealth find in the spirit of holding real gold ( money ) .

I find it so wildly insane that holders of physical gold, ( money ) , would allow their wealth to be sold ( or valued ) at a price that is established by the supply of FIAT gold. If this scenario was written into a novel, no one would believe it……. or one would read it only as a comedy.

ANOTHER said it quite well, in his comment that “there is no end to the amount of paper gold that can be created.” All of this FIAT supply has overwhelmed the REAL demand for physical, and most people believe that they REALLY have purchased gold, when they buy these contracts. As long as the majority of gold purchasers believe that their paper is as “real” as physical, the COMEX paper gold value reference will continue to drop.

I for one, no longer accept established paper gold values for the real value of gold. Just try and buy a substantial quantity of the yellow……and what do you see? 6 months ago, you could buy at spot. Today, one ounce coins have a premium of $14 over spot….and rising every day. Oh, and don’t forget that even when paying the “premiums”, one has to really work at finding the coins for delivery. Easier said, there is now a phenominal demand, but very little supply of physical. And yet we allow paper to determine gold prices. Gold has never had the brute demand as what we have today……yet we are told that prices are down due to lack of interest.

COMEX should now be looked upon as the animal that it really is……
A REFERENCE TO THE VALUE OF PAPER GOLD. It has nothing to do with the price of physical beyond suckering in the few ignorant to sell there physical for the price of paper.

ANOTHER (THOUGHTS!) ID#60253:

CMAX: You are exactly correct! Follow your thoughts. good luck

SWEAT: What quantity of GOLD, paper or physical, has OIL traditionally purchased on an annual basis?
From 1991, appx. 20m/oz./yr., now it is more.

How much paper GOLD is out there ready to be squeezed?
Over 14,000 tons.

Do you think OIL will be able to collect what is owed to them?
It will come outright or thru the increase in value of metal owned after an oil for gold bid.

Date: Wed Feb 04 1998 20:09
kuston (followups) ID#273227:

Another - Did I misunderstand you posts last year? When you were promoting your gold theory last year - you stated silver and platinum would crash along with paper. I remember specifically asking this question just before I made a large physical purchase. Today, you are promoting world wealth will go into all physicals. I ask only for personal reasons. My physical collection has been going on for a long time, that's how I found Kitco many many months ago.

Date: Wed Feb 04 1998 20:04
sweat (ANOTHER) ID#23782:

Is it still possible that OIL will make a bid outside the BIS? If so, where might one look to follow this drama? How has the collection of physical progressed? Kitcoites have surmised RBA's 167 tonnes went to China or South Korea. ( Korean collection of 161 tonnes looks suspicious ) Any comments?

Date: Wed Feb 04 1998 23:23
ANOTHER (THOUGHTS!) ID#60254:

REPLYS:

Mr. Sweat,
If oil or the BIS bid for gold, you will know it ! In your terms,

" up front and personal"??

RBA's 167 tonnes ? No comment.

Mr. Kuston,
Please understand, that wealth will move into all forms of real assets as the destruction of our debt/ digitial currency system continues. When the currencies move to a final resolution, it will be the "marketplace for precious metals" that will die first! It is well known that gold will hold it's value above everything. All other metals could lose much of the value they gained prior to this meltdown! Remember, "when the currencies go to nuclear war, all paper and paper markets will burn"! Many hard assets will lose in the public mind as confusion will rule. In the thoughts of many, gold will perform!

The discussion above sparked an email exchange with a reader, the conclusion of which I wanted to share with you:


Hello XXXX,

Okay, now I think I see where you were going with this "top level approach". Here's what I think. At the highest level of wealth, I think the giants that understand gold have a lot less than 50% of their wealth in gold at today's price. At a Freegold price it may be closer to 50%, but I doubt they would book their gold at Freegold prices now, or even at the much higher off-market price they paid.

At that level, gold is merely insurance of sorts, even if they understand Freegold, and especially if they understand Freegold. The reason it is transacted at a higher-than-market price is so that the seller of the gold gets the future Freegold windfall now at the time of the sale, and the buyer simply preserves his current purchasing power through the transition. I'm only speaking very roughly, of course, since the higher prices mentioned by Another were not the full revaluation figure, but some number in between. So essentially the "Freegold windfall profit" is being split between the buyer and seller at the highest levels.

If you have, say, $20B that you want to put into gold, you can only do so in paper unallocated through the BBs. When the revaluation happens, as Another said, you will get your $20B in real gold at the new Freegold price. In other words, you buy $20B in unallocated paper gold today and then after Freegold you will have about 11 tonnes of real physical. Alternatively, if you want to take possession of your physical now, or have it allocated now, you are taken into a private room and given a very private education on the realities and constraints of today's gold market.

Here's my guess. Perhaps you are given two choices. $20B in paper gold as above and you suffer the same fate as everyone else in paper gold but you're at least guaranteed that physical at the revaluation price (11t), or you can take 22t now for your $20B. Let's see, that 22t option would be at a present price of $28K per ounce. So you're still likely to double your wealth if you take the latter deal and believe the story. But there's no way you are going to get the 370 tonnes that today's price says you should be able to buy.

But more likely than that is they simply say, look, you can't get more than 5 tonnes if you want physical. If you want paper gold, we'll take your $20B and give you the paper gold credits, but you can't have it allocated because there's simply not enough physical to go around. So let's say this guy gives them his $20B and also gets the 5t allocated. Come Freegold his paper gold will bring him 9.9t plus he'll have his 5t allocated for a total of 14.9 tonnes. See how that outcome is right in between the two choices above? And the best part is that this way they didn't have to explain Freegold to him, they simply had to explain the realities and constraints of today's gold market.

So now let's look at this guy's net worth. Let's say in Freegold his gold is roughly half of his net worth. 14.9 tonnes in Freegold would be about $26B, so let's say this guy is worth around $50B in Freegold. Maybe he's worth $40B today (pre-Freegold) because he's going to make a little bit of a gain (~25% gain overall) through the transition because of his choice to go after some physical gold. Today he only has 5 tonnes in actual physical, but in reality he has the equivalent of 14.9t because he put half of his net worth into a combination of paper and physical gold.

So, at $1,680, 14.9 tonnes is $805M, which represents only 2% of his current net worth. This is what I mean by insurance. The really big money cannot go deep enough into physical to get a windfall anywhere near what we shrimps can. It can only use gold as insurance to preserve what it already has, and with a little foresight, make a relatively modest gain.

Now, if we apply this across the board to those elites with $35T in net worth, 2% in real physical would be $700B or about 13,000 tonnes of physical, which sounds reasonable. But perhaps some of them have much more, like, for example, the Saudis. They could easily have 6,000+ tonnes alone (according to Another's figures), but even that is small potatoes compared to what they could have bought at market prices over the years.

Here is what the USG worried about back in 1973. It's from Foreign Relations of the United States, 1969-1976, V. XXXVI, The Energy Crisis, 1969-1974:

Saudi Arabia, Abu Dhabi, and Kuwait, limited by small populations, inadequate numbers of technically capable people and a dearth of non-oil resources, will not be able to increase spending on imports as fast as oil revenues mount. Nor could their gifts to other Middle Eastern nations even on a generous scale, greatly reduce this surplus of receipts over current expenditures.

Thus the foreign assets of the Middle East countries could amount to between $50–$80 billion by 1980 in constant 1973 dollars. At the upper limit these assets would be equal to about 60% of the world’s gold and foreign exchange reserves in 1972. The trends already in motion, if continued through 1985, would result in the Middle East oil producing states accumulating foreign assets that would be truly astronomical. Their assets would range from a low of $100 billion to as much as $180 billion by 1985, comparable to total gross U.S. foreign assets and to more than double net U.S. foreign assets.

Foreign assets of such enormous magnitude would inevitably be held in relatively liquid forms, such as securities and short-term instruments. The Middle East countries lack the industries and managers to make direct investments abroad on a really massive scale. Moreover, their buying up existing foreign companies would cause strong policy reactions.

In any case the Middle East oil producers would have unprecedented financial power. Discretionary use of such vast assets obviously has enormous potential for disruption of financial markets. Attempts to neutralize these assets through capital controls in producing countries might induce the producers to curtail output.

Footnote:
In an April 17 briefing memorandum, Saunders and Quandt reminded Kissinger of Yamani’s proposal for a special relationship with the United States (see Document 140), the “real purpose” of which was to develop closer strategic ties by binding the United States to Saudi oil, offsetting a short-term U.S. balance-of-payments problem by investing in the United States, and thus guaranteeing that the Saudis would not cut off the flow of oil.

The point here is that they knew, even back in 1974, that the Saudis essentially had gold cornered. The Saudis could, theoretically, have had 60% of the world's gold by the early 80s and probably all of it by the late 80s (and it's a good thing for them that didn't happen). But instead, someone worked out a deal and, by 1999, let's say the Saudis had 6,000 tonnes of physical amounting to maybe 4% or 5% of the world's gold at that time, rather than all of it or even 60% of it.

You see, the Saudi's windfall came in the 1940s when they woke up and found themselves sitting on top of the world's richest resource. Freegold will not be their windfall, they already got that long ago. Freegold will simply preserve it for them long into the future, perhaps even well past the end of fossil fuels. And that's kind of the way it is for any Giant at that level. If you're worth $40B today, you already got your "windfall" and Freegold is simply a way to lock it in and preserve it far into the future, it is not a way to multiply it many times over. The realities and constraints of today's gold market make that impossible.

There's plenty more that wealth at that level can do other than just hoard gold:









The point is that they don't hoard gold for profit. They do it to lock in the profit that they already made above and beyond their ability to spend it in their lifetime. And that's the way the gold market has been managed at this level. Sure, they will get some gain, some profit from the Freegold revaluation, because not everyone at that level is in gold.

So, yes, those higher prices are already here for the super-wealthy Giants, and always have been. That's what Another was trying to tell us. And this is my version of a "top level approach"! ;D

Sincerely,
FOFOA

Hello Fofoa:

Wow! Thanks for a really comprehensive answer. The "back room" explanation was vaguely familiar, so I'm sure you're dealing with questions already asked and answered. Your email read like a personal post, and I'm going to go back and re-read it several times until I get it all. This bit...

"freegold windfall profit" is being split between the buyer and seller at the highest levels...

is a great explanation, of a more scrambled thought I had, but this...

they don't hold gold for profit

is a Goliath idea: nothin' like that ever entered my head before! Both concepts would be very bloggable, by the way. Thanks again, and all the best!

XXXX