My Candid View – Part 7

Actual GLD Vault

Hi FOFOA,

Another question that I think has a decent chance of getting asked is something related to the repatriation of German gold.

We are, of course, standing in a different place from the tidal wave whose narrative is "They don't have the gold and so they crashed da Market" to get their hands on cheap physical to replace that which they didn't have.

My line in response to the conspiracy perspective would be that while a seven year delay for a return of one's gold does seem rather strange, there was no diplomatic furor from The Germans as a result. And if it was the intent of "the manipulators to sidestep some sort of catastrophic market event, driving the price of gold down below the cost of production amounted to swimming through croc infested waters in order to get out of the heat. Could "they" be that stupid? Possibly, but to paraphrase Victor, I don't like any theory that rests on such a premise.

Cheers,
Edwardo

Hello Edwardo,

What a mess these kinds of stories are to deal with. First of all, the price decline has nothing whatsoever to do with German gold repatriation, obviously.

As you know, I don't think anyone is actively trying to suppress paper gold. Short term price manipulation can happen in anything, and in any direction, but that's done for short term profits and not for ideology. And as you point out, the current price decline is probably not producing any extra physical because it is stifling the mines and probably increasing the flow to the East in weight terms. The suppression of gold was systemic and due to the expansion of the supply of paper gold backed by central bank guarantees from ~1983-1999. The suppression was for the purpose of buying time, and not for some CB anti-gold ideology. (For more on this, please see 'The View of the Rocket Man' video at the bottom of Part 3.)

In terms of "active suppression," I do think the BBs have control of how quickly paper gold rises given overwhelming demand. In other words, they have no problem handling high demand for paper gold. They can simply create more of it. They can expand the supply. So the rate of rise can be easily managed as long as there's strong market demand for their product, paper gold. It gets quite a bit more difficult to control the price, however, when there is low market demand for their product, especially with so much of it already out there. Kind of like dollars. ;D

I think this may be partly why "the top" in 2011 looked the way it did. The LBMA survey was coincidentally released right before the top! The survey was released in August of 2011 and gold topped at $1,896 on Sept. 5, 2011, just days later. I wonder if they would have even released the survey if they had known that demand for their product was about to reverse trend.

The survey was conducted in Q1 of 2011 and it appears to show an expansion in paper gold during that quarter. This would be newly-issued paper gold amounting to more than 7,600 tonnes during a quarter in which the price of gold barely rose $35. Since this was near the top of the decade-long bull run, I can imagine demand being high and that some of it was met with new supply rather than old supply. Perhaps in Q3 demand was instead met entirely with old supply which is why we saw the price spike from $1,492 to $1,896 in one quarter. Then demand dropped out from under the massive supply and the BBs lost control.

It's kind of like the printer who has control of the rope as long as demand is pulling. Remember the tug-of-war analogy in 'Big Gap'?

"The printer controls supply and the marketplace controls demand. A tug-of-war is actually an apt analogy. When demand for a currency spikes its price, the printer just eases his grip on the rope, releases more rope and the whole demand side just falls on its butt. […] But in the same way that the marketplace has no control over the supply side, the printer is powerless on the demand side."

Anyway, the point is that any kind of "active manipulation" talk is a non-starter for me unless the talker can demonstrate an understanding of what's actually possible and not simply parrot the conspiracy theories. When you understand what went down and what went up over the last year and a half, that was not manipulation. It was some kind of a massive shift in trader sentiment that has nothing to do with physical gold.

Sorry, enough about manipulation/suppression. Let's talk about German repatriation.

Only simple minds imagine that CBs share the same transitions concerns as we shrimps. I, on the other hand, understand that while "gold in your physical possession" is the best transition policy for shrimps, that is not the case even for private Giants, let alone CBs. At the Giant level, properly allocated physical is the best way to store the bulk of your hoard. I have a hard time imagining anyone with 20+ tonnes stored in a home safe.

For CBs, there are many reasons why their gold is where it is. During WWII Germany stole a lot of gold. A good deal of the European gold that wasn't stolen by Germany was moved to New York for safekeeping, so that it wouldn't be stolen by Germany. Then, after losing WWII, most of that stolen gold was taken away from Germany.

Since WWII, Germany has been a net-producer accumulating a lot of gold. And most of that accumulated gold was accumulated in New York City through Bretton Woods. That's why it's there. Nations generally keep at least some of their gold in the financial centers because that's where it is most useful. And under the auspices of the BIS, that's normally the safest place for it, especially for small countries.

If the gold is all kept at home, then it can disappear whenever there is a violent transfer of power. The gold obviously doesn't belong to the ruling party, it belongs to the people of the country, but that doesn't mean it cannot be physically stolen. However, if it is kept in London or NYC, it is much more difficult for the deposed party to make off with the loot.

There are, however, good reasons for Germany to want to repatriate some of its gold. First of all, it has a lot of it. And it certainly has more than necessary stored externally. But transporting gold is risky and dangerous. So it is always done in secret. Germany is probably doing more business with countries other than the US these days, more business in Europe and the East, so it doesn't make sense to keep so much of its gold on the North American continent. It is potentially more useful if it is physically in Europe.

But more than any of these reasons, the repatriation talk was simply a response to the gold bugs demanding to know where Germany's gold was being kept. So BUBA released a complete list of where it is, and since an inordinate amount was shown on that list to be in NYC, they accompanied the release with the repatriation talk.

We don't know if they really want their gold moved. And if they do, we don't really know if the US refused immediate delivery or if they asked for the 7-year plan. And even if they wanted and were to receive the gold within one year, it would make sense to say it was happening over 7 years. It's safer to transport a pre-announced shipment if you distract potential pirates with a bogus timeline. In any case, we really don't know all of the facts. We only know the theories of conspiracist gold bugs for whom this release was made in the first place. So, whatever.

I care about this story about as much as I imagine the Bundesbank does. It's more of an annoyance to be quelled than anything else.

Sorry if that doesn't help you much for the interview, but I had to get it off my chest since you asked. ;D

Sincerely,
FOFOA

This article approximates quite well the "other" view:

What If? by Grant Williams

Edwardo,

FWIW, I wrote that last reply before I even saw this email, let alone read the 'What If' article in it.

So the GLD drain is to get back the gold for German repatriation, and the price suppression is so the Fed doesn't have to pay too much for that gold? Something like that? ;D

How about this? Something else happened right around the middle point between those two lines. And that is the marginal paper gold bug, as represented by my bellwether, turned his back on the gold market and declared the end of the bull run and the beginning of a secular bull market for the dollar (aka deflation).

As each marginal gold bug throws in the towel, a new marginal gold bug is created, and then it's only a matter of time before he throws in the towel creating another new marginal gold bug. And so on and so forth. And the marginal gold bugs that don't throw in the towel simply get squashed because there are just too many commodities heading lower and dragging paper gold down with them.

These guys really must think that gold moves in isolation. Well, at least he admits he's inclusive when he adds the gratuitous "and silver" while quoting analysis by Maguire and Silver Doctors. ;D

There are a few redeeming ideas and charts in that article, so let's play with his scenario a bit and see if it makes any sense in the big picture without enlisting any conspiracy theories.

The main premise that he relies on is this CB leasing of physical gold that the CBs now want back. In order to have leased gold, you must also have a borrower of that gold. That is, someone who carries the short-side price exposure. In the 90s that borrower was the mines and the hedge funds. And they both took it in the keister when gold started rising in 2001. So from 2001-2011 there was not really a market for leased gold other than the small bit for fabrication, unless the CBs were acting as the lender of last resort for the BBs in providing actual physical reserves needed for the subterranean flow. This would imply a tight flow during that whole period. This would also have left the BBs with the short-side price exposure which they would have hedged going long futures or other correlated asset derivatives. This BB long hedging could have possibly been partial support for the decade-long commodity bull.

If this situation is in the process of unwinding right now, as the article proposes, then as the BBs return the physical to the CBs (taken out of GLD, Comex or wherever), they are relieving themselves of that price exposure and must consequently sell the off-setting long-side hedges, which would have been Comex futures and other correlated commodities/currencies, adding downward pressure to any otherwise organically-emergent bear market.

Let me just pause here to say that, even if this was the case, I would still say categorically that it has absolutely nothing to do with BUBA's repatriation request. At least it's not a response to BUBA. BUBA's announcement may, however, have been BUBA's way of telegraphing the ongoing unwind to anyone who might be paying attention.

One problem with this view is that somehow there was a surplus in the subterranean flow that amounted to at least 1,300 tonnes—the gold that went into GLD. Did the BBs borrow that gold from the CBs in order to corral some of the demand coming from the West? Perhaps, but it seems to me that that particular Western paper gold demand could have been met with fractional paper rather than fully-reserved paper. So this logic tells me that, somehow, the 1,300 tonnes that was accumulated between 2004 and 2010 (when GLD inventory plateaued) actually was surplus to the required physical flow. And if so, then it doesn't make sense to me that the BBs would be borrowing physical from the CBs between those years.

I can't explain the existence of that surplus during those years, except to say that it existed and therefore there must be an explanation. So I am left with imagining plausible explanations to show that it was possible. One such plausible explanation is that the BIS successfully kept the biggest interests out of the flow through some sort of deal-making like Another wrote about. But that kind of deal-making must have had a finite timeline which I wrote about in Think like a Giant 2. This coincides with Ari's 2010 "target" which then got pushed to 2013 after the GFC in 2008. This correlates with GLD inventory plateauing in 2010 and then declining in 2013.

Again, it's merely a plausible explanation to show that the surplus reserves required to build up GLD were possible even though the physical gold flow was technically "cornered" as far back as 1997. The alternative is the view in the 'What If' article that the CBs were leasing out more than just their good name all that time. I suppose it is also possible that, rather than leasing the physical to the BBs, the CBs could have actually ponied up the 1,300 tonnes for GLD directly. That way no one is carrying the short-side price exposure implicit in a lease during an obvious bull market. The CBs could have done that to "corral" the Western demand, but I think it is too much of a stretch to believe the source of that gold being the CBs could have been kept quiet. So I think it is more likely that it was BB gold that was checked into the coat-check room rather than CB gold. And if the BBs had that much gold to spare (that much slack in the flow rope), then why would they have been borrowing physical from the CBs?

The consensus view is that the gold in GLD was "purchased at market" to meet the demand from investors. Well, the BBs are the market in LGD bars so even if they "bought" the gold to put in GLD, they bought it from themselves. Ergo, coat-check room. No matter what, GLD represents a place to put gold that would otherwise be part of the BBs' physical reserves if it were not in GLD. And that's why the coat-check room view is the correct view.

The main difference in the conclusions drawn from the consensus view is that there is no shortage of physical and never was. There's plenty of it to always meet demand. But even in that view of plenitude, it would still be correct to view it as a coat-check room. Just that the checked coats (in that view) would represent only a small fraction of the total coats (physical reserves). And in order to maintain that view of plenitude even in light of the present drain on GLD, redemptions must be a necessary or obligatory part of the arbitrage that keeps GLD in line with "gold", which, of course, makes no sense.

Sorry to meander here, but I thought it would be worthwhile to think through a few ideas out loud, and, yep, turns out I'm still happy with my view. ;D

Sincerely,
FOFOA

How is it the case that in order to have that view (of plenitude) redemptions must be obligatory?

Because in my view the massive redemptions reveal the opposite of plenitude. Redemptions are a choice made by someone, not a necessary part of the arbitrage "mechanism" as it were. "Obligatory" might be the wrong word as it implies that the APs must actively manage GLD so that it tracks "gold". The consensus view would argue that they are simply "arbing" to make a profit off of the stupid GLD investors who don't watch the NAV (the price of GLD relative to "gold"). So (they would say) it's not so much obligatory as it's simply a way to make money.

My answer would be that I used the term "obligatory" (or compulsory) to cover both "the AP actively managing scenario" as well as "the arb requires redemption scenario" which is the crux of the consensus view. That's really what the difference boils down to. Would GLD track "gold" if it weren't for the arbs creating and redeeming shares to skim a profit off of the stupid GLD investors? The answer is of course it would. I does!!! Kind of like silver tracks gold. GLD is not an actively managed fund. Instead, it is an exchange traded fund. That means participants in the exchange arb the correlation between GLD and everything else.

Arbitrage is natural. It mostly happens automatically. A dedicated arbitrageur probably wouldn't even mess with GLD because it tracks everything else so well. He's looking for ratios that are technically exploding past fundamental differences so that he can make a profit. If hundreds of thousands of people are trading GLD and "gold", then the ratio between the two should be self-correcting over a reasonable amount of time… AND IT IS!!! This graph of the intraday premiums and discounts shows it self-correcting repeatedly during the day, every day!

We have evidence in the data that creations and redemptions of shares are not necessarily a part of this mechanism. Logically they are not, because GLD could theoretically trade at $500/oz. gold or $5,000/oz. gold with the same amount of inventory. It has an objective or indicated value, and to the BBs the shares are literally "as good as gold." Think about that.

So if there's plenty of gold reserves in the LBMA, then why are the BBs draining GLD? The consensus view says "because they need to redeem the shares to book the profit on the arb that maintains the correlation between GLD and "gold"." Nonsense!

Sincerely,
FOFOA

"So from 2001-2011 there was not really a market for leased gold other than the small bit for fabrication, unless the CBs were acting as the lender of last resort for the BBs in providing actual physical reserves needed for the subterranean flow. This would imply a tight flow during that whole period."

Well, we have a pretty good idea that there was a tight flow then. I remember discussing this with JR on the forum and him saying the constantly rising price was evidence of gold not flowing well, ergo the ever rising price being required to keep the flow going.

Well, the prices of silver and other commodities went up too. But we know that physical gold is in a league of its own, so I think it might have been a mistake to think that the "gold bull market" was a symptom of the shortage of physical gold (or silver or anything else). It probably helped the physical gold shortage, but it might not have been because of it.

I'm not saying there wasn't a shortage of physical. I think that, because the flow of physical has been "cornered" for at least 16 years, obviously there is a shortage until there is a revaluation. But I'm also saying that something other than the price rise must have delayed the inevitable because obviously there was a "surplus" in the flow of at least 1,300 tonnes from 2004-2010—enough to populate GLD with physical gold.

That's not a huge "surplus" in the big scheme of things. If we think about a roughly 4,000 tonne-per-year flow from mining and scrap during those six years, 1,300 tonnes total amounts to only about 5% of that "new" flow. That's a marginal percentage, so whatever took care of the threatening physical demand could have easily overshot enough to fill GLD with or without intention.

BTW, I hope you realize that I am discussing speculative issues at the "cutting edge" of Freegold that are not fundamental nor foundational to Freegold. I am simply using my "view" or "lens" to tease out the best explanation, or at least a non-contradictory one. That's why I use the term "plausible" instead of the occasional "certainty" I show toward Freegold. Certainty doesn't extend beyond the gold revaluation or dollar hyperinflation. Beyond those two topics I'm venturing into analytically speculative topics trying to apply that in which I have high degree of confidence to those things which are obviously unknown, in the attempt to discover a plausible and non-contradictory explanation.

Some people mistakenly apply my "certainty" toward Freegold to anything I comment on. And then they think that if they can disprove me on any small detail then my macro view must be wrong as well. This reveals poor understanding of what I'm discussing, but it is rampant in my arena, which is why I don't spend much time speculating publicly about things other than what is covered in the A/FOA archives.

Yes, I understand. The naysayers are always on the lookout to catch anyone else who has the temerity to do what you are doing.

Funny, I read this article that someone called "straight out of Freegold" and, to me at least, his choice of words and phrases revealed just how far away from Freegold he really is!

http://dailyreckoning.com/your-personal-gold-standard/

He's clearly not expecting a gold revaluation:

"And gold at the levels I’m talking about would mean that you’ve now verged into hyperinflation, or something close to it, because nothing happens in isolation."

He's clearly talking about an inflationary spike that will occur in all commodities and not exclude paper gold:

"It will have a kind of a slow grind upward… and then a spike… and then another spike… and then a super-spike. The whole thing could happen in a matter of 90 days — six months at the most."

I find it a little funny that people want so badly for someone like him to be a secret Freegolder that they are blind to how different his analysis actually is.

It reminds me of XXXXXX. He, like Rickards, expects the dollar to devalue and gold to fill the hole. But neither one seems to have thought it through far enough to realize that nothing fills the hole without at least one thing being revalued in isolation.

Rickards: nothing happens in isolation.

I'll have to remember that one! ;D

I completely agree. Good catch with the isolation language. He was wrong before the words ever escaped his mouth since we've already had a revaluation (isolated move higher) (1933) albeit a vastly less spectacular and meaningful one than what lies ahead.

_____________________

Open (Window?) Forum

From Open (Window?) Forum, which has more discussion about "GLD – The Coat-Check Room View", here's Phil Collins with a familiar sentiment:



The Debtors and the Savers 2012

"…Thinking for yourself pays. Seeking reassurance feels good, but it doesn't pay. Waiting for official confirmation is also rewarding, but the reward isn't money."

"Change isn't easy. More often, it's wrenching and difficult. But maybe that's a good thing. Because it's change that makes us strong, keeps us resilient, and teaches us to evolve..."