Open (Window?) Forum

Hello, and sorry I've been gone so long. I've been taking a little time away from the blog to get a few things done around the house. You know, Spring cleaning and stuff like that! ;D

So let's see what's been going on… ah, yes… Cyprus! I consumed a lot of popcorn watching that blockbuster! It sure seems like something big changed in the Eurozone; almost like they're now willing to let the chips fall where they may. And, of course, we had another Snapshot day and MTM Party. Here's the result, and here are the last five snapshots to put it into context:

3/29/13 - €1,251.464
1/4/13 - €1,261.179
9/28/12 - €1,377.417
6/29/12 - €1,246.624
3/30/12 - €1,243.449

That's right, we're back where we were a year ago! In fact, we're currently at €1,213, well below a year ago, and we even dipped below €1,200 for a few hours on MTM Party day.

Meanwhile, GLD has been spilling its guts. Down to just 1,200.37 tonnes from its peak of 1,353.35 exactly four months ago. I wonder where those 153 tonnes went. Remember: for every seller there is also a buyer. And for every sale, there must be a purchase. So when you hear someone saying "sale", think "purchase", and if they're trying to say that the sale of physical from GLD explains (or is explained by) the price decline, just remember that there's much more paper being sold than physical. ;D

This is an open forum, but I'm going to give you a couple of recent discussions that I had in private to set the mood. These are topics that came up in the last thread of comments, which is why I decided to publish them here. The first one is my personal view of GLD, and the second one is about the GOR or the gold:oil ratio.

Do you remember this lead-in from FOA on 10/10/01?

"(pulling a cloth from my pocket and cleaning my glasses while talking)

On most parts of this Trail, I could walk with my eyes closed; while in other areas I would need six maps and two GPSs units just to know north! Right now, I can tell ya what's most likely out there, but in those strange areas; not really sure?"

That's kind of what this post is. While the two topics below will seem like they could each be their own post, there's a good reason why I dumped them here in an open forum. My blog is a tribute to the thoughts of Another and FOA, and these discussions fall a little bit outside the scope of the archives they left behind. So they are a little more speculative, more like my view, as opposed to theirs, but still my view as it has developed with a constant focus on their view. So take it for what it is, and that means with a grain of salt. ;D

In this first discussion, I attempted to explain my view of GLD to a friend. I am well aware of the consensus view or standard explanation of how GLD operates. I am also aware that it is considered indisputable and even fact by most industry professionals. The consensus view is basically that GLD buys and sells bullion based on an arb that the Authorized Participants (APs) take advantage of. If sellers beat GLD so hard that it trades below spot (i.e., below its Net Asset Value or NAV), the APs will buy GLD shares and redeem them for metal which they then sell and make the spread between the GLD price and the spot price. The same works in reverse when GLD trades above spot and the AP buys physical, puts it in GLD and sells the shares earning the spread. This is how GLD "tracks" the metal over time, or at least that's the consensus view assumed by most everyone to be indisputable fact.

My view is a little different. It is not a conspiracy theory, simply a different view. If you can entertain it, even without accepting it, then perhaps you can judge for yourself which of the two views does a better job explaining what we see happening in reality, what actually is indisputable fact.

GLD – The Coat-Check Room View

Hello Michael,

Re: "I currently have a gap in my understanding of how the BBs would acquire the shares of GLD necessary to drain the fund's inventory when they are in need of physical gold."

It looks like the pukes all fit comfortably inside their day's trading volume. So if the BBs need some physical fast, they should be able to just buy the shares as long as they are OK paying above the NAV to get it. But perhaps they don't even need to. Here's a paragraph taken right out of the GLD prospectus. Read it carefully and then tell me what you think. Seems to me that any AP can withdraw any amount of physical up to that which its own clients are holding in GLD shares:

BOOK ENTRY FORM

Individual certificates will not be issued for the Shares. Instead, global certificates are deposited by the Trustee with DTC and registered in the name of Cede & Co., as nominee for DTC. The global certificates evidence all of the Shares outstanding at any time. Under the Trust Indenture, Shareholders are limited to: (1) DTC Participants; (2) those who maintain, either directly or indirectly, a custodial relationship with a DTC Participant, or Indirect Participants; and (3) those banks, brokers, dealers, trust companies and others who hold interests in the Shares through DTC Participants or Indirect Participants. The Shares are only transferable through the book-entry system of DTC. Shareholders who are not DTC Participants may transfer their Shares through DTC by instructing the DTC Participant holding their Shares (or by instructing the Indirect Participant or other entity through which their Shares are held) to transfer the Shares. Transfers are made in accordance with standard securities industry practice.

As far as the Trustee is concerned, all of the GLD shares are registered "in street name" which means "Cede & Co.", the nominee for DTC. And as far as DTC is concerned, the shares are shuffled around electronically on the DTC "books" between the banks and broker dealers, many of whom are also Authorized Participants in GLD.

Now please just think about this for a while. And then think about it in light of what Randy Strauss wrote, which I quoted in Who is Draining GLD:

"These are NOT actively managed funds whose gold inventory is tweaked to ebb and flow based on public sentiment in the shares. Instead, the ETFs are more like a central coat-check room in which the various bullion banks have temporarily hung out their own inventories (i.e., meaning, their unallocated stock which they hold loosely on behalf of their depositors). And whereas the claim tickets (ETF shares) may freely circulate on the open market, any significant outflow of physical inventory is simply and primarily indicative of a bullion bank reclaiming the original inventory based on a heightened need or desire for physical metal in a tightening market — for example, to meet the demands emerging from Asia."

That post was a popular one, but even to this day, more than two years later, I don't think that 99% of the people that read it understood my main point. It requires a slight shift in perspective, and I think that with this shift, a lot of what we've been discussing recently will come into focus. And after you've given this "coat check room perspective" some thought, consider these emails from Ari which I used in The View: A Classic Bank Run. I think they will help tie it all together in a comprehensive view of the BBs and their unique position at the center of the universe for all things forex, XAU, "gold", Gold and even GLD:

"A bank can be "populated" with unallocated gold accounts in two primary ways. It can either be done as a physical deposit by a silly person or by another corporate entity, or else it can occur completely in the non-physical realm as a cashflow event whereby a customer with a surplus account of forex calls up and requests to exchange some or all of it for gold units, whereupon the bank acts as a broker/dealer to cover the deal – occurring and residing on the books as an accounting event among counterparties rather than as any sort of physical purchase. No bread, no breadcrumbs, only a paper trail and metal of the mind. This is how the LBMA can report its mere subset of clearing volumes averaging in the neighborhood of 18 million ounces PER DAY. Just a whole lot of "unallocated gold" digital activity as an ongoing counterparty-squaring exercise.

It is here that I offer the eurodollar market as a very good parallel to the bullion sector of banking. While not a perfect parallel (for all the most obvious reasons) it provides a remarkably good bridge to help anyone who has a good footing on modern commercial banking to successfully cross over to that seemingly unfamiliar territory of "bullion banking". In fact, they need do little more to successfully cross over than to simply think of bullion banking ops as though they were eurodollar banking ops – the difference being that whereas eurodollar banking makes extra-sovereign use of the U.S. dollar as its accounting basis in international banking activities (thus outflanking New York's purview and restrictions), bullion banking engages in similar "extra-sovereign" use of gold ounces within its operational/accounting basis (thus outflanking and overrunning Mother Earth's domain and tangible restrictions).

And just to be sure we're on the same page, the eurodollar is not to be in any way confused with the euro, but rather stands to mean the artificial supply of "U.S. dollars" that "exist" as accounting units in off-shore banks, having originally been authentic deposits of New York's finest export, but which were then subsequently lent on – fractionalized and derivatized into a vast amorphous mass as only a network of cooperating banks can do best."

I'd like to draw your attention to two phrases Ari used in those emails I posted:

"…an ongoing counterparty-squaring exercise…

…a vast amorphous mass as only a network of cooperating banks can do best."

I think it's best to think of the banks' primary job as being that of a middleman, bringing buyers and sellers together, more so than to think of the banks as the direct counterparty their customers. And like banks do maturity transformation in traditional banking, these banks can also do "other kinds of" transformation in their "ongoing counterparty-squaring exercise" which, if you could see it all laid bare, would look like "a vast amorphous mass as only a network of cooperating banks can do best."

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The APs are market makers. Your "ownership" of a GLD share is recorded in their books (or your broker's books and then your broker is listed in the AP's book). It is your credit and their liability. As far as the GLD Trust is concerned, the APs own the baskets which means they own the gold. Kind of like saying a bank "owns" its reserves. It's not a scam. It's not a conspiracy. It's just the way it is. If you can adjust your view, this will all start to make sense. I'll send you more as time allows, because this is one of those things that has been bugging me for two years… that no one seemed to understand the implication of that post.

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Re: "They do need the shares to redeem the basket right?"

They already have the shares. The shares are already in their name at the DTC. So they can put in physical or take it out as needed. It is a choice they make. And it is not a choice based on the gold price, the discount or premium to the NAV or the popularity of GLD as is the common explanation for pukes and additions.

"These are NOT actively managed funds whose gold inventory is tweaked to ebb and flow based on public sentiment in the shares. Instead, the ETFs are more like a central coat-check room in which the various bullion banks have temporarily hung out their own inventories…"

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Underneath this "amorphous mass" the BBs have a second job—managing the flow of physical gold. This flow has incoming and outgoing. Incoming includes supply from refineries, mints, mines and scrap supply as well as any physical gold deposits. Physical deposits are what Ari referred to as "a physical deposit by a silly person or by another corporate entity." ANOTHER put it like this: "In the beginning the CBs didn't sell their own gold. They ( thru third party ) found someone else who had bullion." So physical deposits are essentially someone giving up their allocated in exchange for unallocated (tradable) credits. That's the incoming.

The outgoing is the allocation and shipments of real physical gold. Here's how I clumsily explained it two years ago in The View: A Classic Bank Run:

"So, imagine two "gold windows" at the Bullion Bank. One is marked "incoming" and the other is marked "outgoing." At the "incoming window" you have "the West" lined up to turn in their physical gold for exchange-tradable paper liabilities. And right around the corner you have "oil" lined up taking delivery or allocation. It is this flow that allowed the oil for gold deal to go on as long as it did. But then something happened.

The thing was, the incoming flow from the mines was not exploding as hoped and expected. And the overall flow from the mines combined with the Western gold bugs puking up their private stashes was nothing compared to the sheer volume of the "oil" wealth in line around the corner. At the current price there was literally unlimited demand at the "outgoing" window and a limited supply coming in. This is what Another meant when he wrote that the oil states had already (almost inadvertently) cornered the gold market by 1997."

The BB's "second job" of managing this flow is not unlike a regular commercial bank in 1933 managing its gold coin reserves. If the reserves get too low, it needs to find more. Normally it does this by borrowing them from its central bank. But in a general bank run, even the central bank doesn't have enough reserves, which is when the people get a "bank holiday". At least that was the case before 1934.

The idea of central banking grew out of the need to pool excess reserves to avoid the unnecessary hassle of having to shop around for reserves when they are needed. A central bank is a kind of a gentleman's club or trade union in which the member banks are actually the owners and users. And in this way, GLD is very much like the central bank of the BBs in a pre-1934 sort of environment.

Unlike the physical gold that I like to buy which has a subjective value, GLD shares have a decidedly objective value. That objective value is the NAV (net asset value) ÷ the number of shares outstanding as reported (and revised) by the Trustee. The NAV is simple. It is the dollar price of an ounce of paper gold times the number of ounces held in the Trust. So if I, as a bullion bank, remove some physical from the Trust, this reduces both the number of ounces in there and the number of shares outstanding as reported by the Trustee. The market price or value of a share doesn't change. But the real value of a share changes because I have some inside information that the shareholders don't have.

Do I need to report any new short sales of these shares? Nope. No one has short sold any shares. And yet I now know that there are more shared on my books than I have in reserve. So the price isn't too high, just the number of shares believed to be held by my clients is too high. And those "shares" are actually my liabilities of GLD shares to my clients. In other words, my GLD share liabilities to my clients now exceed my GLD share reserves.

What I have to do now is buy back those excess liabilities and, as a market maker supplying a bid and offer spread to my clients, I might just be able to accomplish my goal entirely in-house simply by accommodating more sales than buys over a few days. In the meantime, I can offset my price exposure by incorporating it into my hedging operations for my much larger OTC (FOREX/XAU) side of the business.

Here's how I clumsily explained the objective value of GLD two years ago in Who is Draining GLD:

"GLD is designed to track the price of gold. It is not actively managed to track the price of gold. Instead, it does so through opportunities that arise whenever it doesn't. Imagine GLD as a big lump of gold just sitting there in Town Square. The price of gold is "discovered" elsewhere and shares in this big lump just trade based on that elsewhere-discovered price. If the share price is too high, then an opportunity exists to sell your share and buy "gold" elsewhere. Likewise, if it is too low, there is an opportunity to sell elsewhere and buy into this lump on display."

I find it useful to think of the flow of physical gold (i.e., the physical portion of the overall gold market) as separate from the paper gold market. Not that it's a separate market with a separate price—parity must be maintained—but that it's simply a flow that must be maintained and it is not an integral part of the price discovery mechanism that we call the overall gold market.

The reason price parity must be maintained is because without it the paper gold market won't function for its majority users, the "FDIC sticker" crowd. Here's where that reference comes from:

FOA: "What doesn't seem to be obvious is the "why for" the paper market grew so large. It grew to dominate because worldwide dollar expansion reached its "non-hedged" peak. In other words, the dollar's timeline was ending as its ability to produce non price inflationary economic gains came into sight.

In order to push dollar holdings further, international players needed and purchased "paper financial hedges" to balance their risk. Within their total mix of derivative hedges were found "paper gold price hedges"; modern gold derivatives. The important thing to remember is that these positions are not and never will be used to demand physical gold. They are held to buffer financial and currency risk associated with holding any form of dollar based asset. To work these items don't need to really perform "dollar price movements" in the holders favor as much as they are present in the portfolio to act as insurance stickers.

In that truth, these paper gold positions act like FDIC insurance at our banks. It can and will manage only a small determined portion of bank runs,,,,, not a full scale failure of the banking system. In a real full banking failure we would all get, perhaps, 80% of our covered $100,000 and 10% of the rest.

The same is true for these gold position's performance; real gold delivery along with true price performance, matching real bullion trading, would be only for the very few. For that matter, an actual functioning paper gold marketplace would be for the very few, too! But, in the same way a bank account owner understands the credibility of FDIC insurance when times are good; the international dollar asset owner will not grasp that modern paper gold hedges cannot be allowed to work until after a real serious price inflationary run begins."

The reason I view the physical portion of the gold market as something separate from the overall gold market is because demand for physical exerts the opposite effect on the overall market as demand for paper gold. Demand for paper gold supports the cohesion of the overall gold market and demand for physical stresses it, IMO.

What I picture in my mind is like a subterranean stream. This stream is the flow of physical gold from the mines and refiners (and all other physical gold inputs combined) into the BBs and then on to the East, "oil" and the old world Giants. With the BBs in the middle, there is always some flow coming in and some going out. And during whatever time the gold spends (or "eddies") in the possession of the BBs on its journey, it could be considered the BB's reserves (the slack in their rope). The rest of us trading paper gold look at that swirling "eddy" of BB gold and believe we have a valid bid ticket for our portion of it, even though 20 others believe the same thing. We think, "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!" (FOA)

Over time (say, through the 80s and 90s), the size of the BBs' eddy of gold will stabilize, and then it will appear to just sit there. Everyone can look at it and say, "wow, look at all the gold those BBs have!" In fact, the very same pieces (bars) may lie very still in the same place for years and decades even, creating the illusion that they are no longer part of the subterranean flow. Once stabilized, the incoming gold is simply matched up with the outgoing and the eddy appears almost separate from the stream. But it is not.

Now picture this eddy bubbling up to a surface pool, visible to all. From the paper gold surface it appears to be a pool of still water (a hoard of physical gold lying still), but what is unseen is that the pool is actually connected to a subterranean stream deep below the surface. From time to time the level of the pool rises and falls, revealing that there's something going on under the surface, though few understand what is actually happening down there.

To most eyes, this is simply a large hoard of gold just sitting there. And there is a time value to such a hoard. Gold bars don't generate offspring, but dollars do. Enter the "coat check room idea" c.2004.

That gold "hoard" wasn't "sold to the public" as it wasn't actually owned by the BBs in the first place. It was simply their reserves, the slack in the flow, that portion of the flow of physical from one owner to its next owner that is in the temporary possession of the BBs at any given time. If enough of the global flow passes through the BBs, and if that flow is big enough, and if the portion in their possession can be stabilized, then it can appear to lie still and be "owned" by GLD investors even as it is really only an illusion of the management of the slack in the flow. This is the "coat check room" view.

I think the utility of a view or a perspective is in how it explains or clarifies what we see, and how it helps us understand events as they unfold. It is like a lens that we can look through, and it is possible to have multiple lenses in order to check the focus and field of view of one versus the other. Yet most people simply pick one lens, usually one that was handed to them or the one that everyone else seems to be using, and stick with it and it alone. It's like buying an SLR camera with an interchangeable lens and only ever using the lens that came in the box, never trying a wide angle or a really long lens.

FOA: "I (we) expect none of you to consider anything said here as credible. Everything is given as I understand it. If you came with a notion that I am someone who sees the future, grab the children and run far away. For these Thoughts, and my ongoing commentary, are meant to impact exactly as the "gentleman" said they would. People hear them, and whether believed or not, the words leave a mark. A mental mark on the trail, if you will. And later, after the world turns, our little "stacks of rocks" will be easier to understand next time you are passing this way. In fact, your ability to find your own way will forever be enhanced for having seen this path in a different light."

I just love that quote because it explains this concept of the lens in a way that disarms the critics. It's like, "here's a lens, stick it in your bag, and then maybe someday when you can't make sense of what you are seeing you'll try it on again and everything will suddenly come into focus." He's not saying, "here's the right lens for all situations, so you might as well throw away yours and superglue this one onto your camera." But like I said, it's tough to get some people to even understand that the lens that came with the camera is even removable/interchangeable.

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So back to our "coat check room" lens. When I put this lens on my camera, some funny-looking things come into focus. For example, if this view is correct, then one implication is that these pukes or redemptions could actually be happening in the exact opposite direction or chain of events than the standard explanation implies (e.g., physical delivery or allocation in excess of the incoming flow is promised to someone, then it is "removed" from the Trust through a technical basket redemption, then the BB's GLD share liabilities are bought back from the public). You see this. I can tell from your replies. And yet you are still looking for some arb mechanism or some link that maintains the parity between paper and physical. What I see is that none is necessary. What I see is all that is necessary to maintain parity on the surface is that the subterranean stream doesn't run dry.

Now there are two separate things here. There is what the view reveals, the picture I see, and then there are the unseen things going on behind the scene that I can only speculate about. For those things unseen, I try to come up with a plausible explanation that fits. That doesn't necessarily mean the unseen is happening exactly that way, but it lends its plausibility to the picture and to the lens. Above, I said that redemptions could be happening in the opposite direction. But that doesn't mean that ALL redemptions MUST be happening that way for the view to be correct. Some could be happening in the standard explanation direction as well. So with this view we could say that the lens that came with your camera is not necessarily lying to you, it just isn't showing you the whole picture [if the "coat check room" view is correct].

My blog is a tribute to A/FOA, so they are my primary lens for all things within their field of view. Unfortunately GLD didn't even exist when they were writing, so I can't claim that this "coat check room" lens is precisely the same lens. In fact, it would be a mistake to assume that I give the "coat check room" view equal weighting to the A/FOA view. I certainly try to avoid giving that impression. So if I seem a little hesitant to write more extensively about the GLD pukes, or if I seem to hold back a bit of my view when I do, that is why.

Ari is my closest proxy to A/FOA, and I know through email exchanges that he shares this view of GLD which gives me additional confidence in it. Plus, of all the competing GLD lenses (I can think of two or three others if I count the ones that say there's no actual physical in the ETF), I think this one fits best with the A/FOA view, and I think it explains what we are seeing better than the others.

Anyway, the point I'm trying to get to is that fitting this view with the A/FOA view and the big picture of what we see happening today leaves me with two primary mysteries. The first is why and how a trend developed such that Lance Lewis picked up on it and even gave it a name. And the second mystery is how and why the subterranean stream hasn't frozen up yet, seeing as it was essentially cornered by the East back in 1997.

The best, simplest and most fitting explanations that I have found for these two mysteries come from Ari and Another respectively. When I add them to the big picture, I have a full view (perspective) on what is happening today that suddenly makes more sense than anything else I've seen. Whether it is exactly what is happening today is uncertain, but I have yet to see another view that even comes close to explaining everything we see.

The first mystery is why and how the price of gold tends to rise for a period after large GLD redemptions. Lance labeled it as an indication of a "significant bottom" in gold. But I'm not sure that is correct. As you pointed out, we had some large redemptions (pukes) in August 2011 near the peak. So if it's not a bottom symptom, what is it? Could it be a stress symptom? Could it simply be the visible symptom that the outgoing flow of physical suddenly overwhelmed the incoming supply?

Now it generally happens after a drop in the price of gold, even though that's not what happened in 2011. So, with my view, that would indicate a lack of demand for paper gold. In Aug. 2011 there was plenty of demand for paper gold, and then it suddenly dropped off a cliff. One explanation for that could be that the tremendous build-up of XAU paper we saw in Q1 of 2011 on the survey had to be unwound when the demand suddenly fell. Perhaps too much paper was created in Q1, preventing the price from exploding during that quarter, then when paper demand suddenly fell, the price rise seen in July and August couldn't (and didn't need to be) maintained (levitated) artificially.

But, perhaps, when the price drops in the absence of a prior large paper expansion and a subsequent (almost parabolic) price run-up, a drop in XAU paper demand (like we saw in May 2012) is more threatening to the physical flow and some sort of official support is needed at that point to prevent it from spiraling out of control. I'm talking about the combination of overwhelming physical demand which stresses the cohesion of the overall gold market combined with low paper demand giving it no support. See my posts The Two-Legged Dog and Legs for more of my thoughts about "official support" for paper gold.

As I mentioned earlier, I think that the BBs can manage "too much paper demand" on their own. They can normally keep the price from rising too fast in the face of more buy orders than sell orders by simply expanding the paper supply and delta hedging their exposure in another part of the gold market or even in correlated markets. But I think they have less control when the bottom drops out of the demand for their paper (more sell orders and very few or no buy orders). When that happens, if "artificial support" is required (for whatever reason), I think it must come from an external source with a motivation other than profit from the trade, like a CB.

And this is where Ari's "Snapshot day" theory comes into play. If that view is correct, then why not on pukes too? Perhaps (and this is just a guess), ever since late 2008 there have been two main times when the CBs step in and buy up some paper XAU on the exchanges to fill in the lack of public demand: for Snapshot days (but only when needed) and for GLD Pukes (when needed). We could call this the "official support" explanation. And, if you can accept it as plausible, I think it explains the trend better, more simply and more completely than the other explanations.

Now back to that subterranean stream. Even with the pukes, there must be some explanation as to how and why it's still flowing. If the demand was as high as Another says it was in the late 90s, and now the mine supply is roughly the same while the mines are no longer hedging 10 years out and the CBs are no longer "primary suppliers" then where is all the gold coming from to keep it flowing? This is the second mystery, and I believe that Another gave us the answer. It may be just as hard to swallow as "official support", "coat check room" and "snapshot day" for mainstream analysts who can't afford to utilize these lens, but if you accept it as plausible then it becomes the final missing piece of the puzzle. And that answer is gold *IN SIZE* being traded at a huge premium to spot and a discount to the expected revaluation price.

When Another said that the flow of physical gold was cornered, the attribution of the corner went to the Giants, both Asian (Big Trader) and Middle Eastern oil (the Saudis). If you can just satisfy these two players then the flow from the mines must be enough, as evidenced by the fact that the LBMA continues functioning today.

Earlier I mentioned that I like to think of the banks as middlemen, pairing buyers with sellers (buyers and sellers who may never meet each other), rather than the banks being the direct counterparty to each of their clients. And this view extends to the BIS brokering these *IN SIZE* deals as far as I'm concerned.

So imagine that the CBs (aka the BIS), working through a "third party" who would be the broker, finds people with gold *IN SIZE* who would be willing to part with it at a HUGE premium to the LBMA price, and they match these sellers with the Giant buyers on the other side. Both sides are getting a deal in the present, but the Giant buy side would have to be given some assurance of an inevitable revaluation. That's the catch that I can see. There must be a credible promise given. The alternative is that the Eastern Giant simply buys paper gold, as much as he wants, but for a Giant that wants physical, there must be an assurance of some kind.

Or maybe they didn't need to find Giant sellers. Maybe the ~2,100 tonnes sold by the European CBs (including the BOE) since 1999 was enough at the right price. I don't know and I don't even pretend to know. But that only takes care of the supply side. The demand side, if Another was right about gold being cornered, must have received a credible promise of some kind. And this implies a plan which implies a target date for "assertively rolling forth the freegold paradigm" as Ari wrote in 2010.

When I put all of these pieces together, they fit together like a puzzle and present a clear picture even in the absence of A/FOA's guidance for the last 11 years. The fact that it all fits together while remaining logically consistent, as well as consistent with A/FOA and what we see happening, is the best evidence I have that it is the correct view. That, and also the fact that I have yet to see another lens that explains everything plausibly and comprehensively.

Everything fits, especially Ari's read of the central bank discussions around 2005 that seemed to be pointing to 2010 as the next window. And then pushing it back after the financial crisis in 2008. And assuming that no one wants to intentionally crash the current system, which I do assume, then they must be confident that the removal of support is all it will take. And they would know this because they would also know the level of support they had been providing. The more support necessary to prop something up, the more confidence you'd have that the mere removal of support would bring it down, enough confidence, perhaps, to make assurances that would be credible enough that they would actually work to prolong the system until your targeted window. Which brings us to today.

In addition to Ari's intuition and the January 4th snapshot day, we now also have a significant string of GLD redemptions without the timely (mysterious) levitation we've grown used to seeing in the past. As Victor has been pointing out, if this time was to follow the pattern of last time (March 2012), then we should have seen a $100 increase in the $PoG by March 4. That would have been at least $1,675, instead it went nowhere. I'm not making a prediction here, just pointing out the obvious signs.

Michael, you wrote:

"My gut feeling is that 60 tonnes/week is stressful but not at the limit, and that the limit would be more like 150 tonnes in a week, and that would about hold whether it occurs in a day or evenly distributed through 5 days. But another sign of stress would be if GLD gets drained at a slow but steady and continuous rate such that its inventory drops below the 1200-1300 range. Below 1070 would be my first level to watch, and below 700 would be trouble."

I view the pukes as a visible symptom of stress under the surface. I doubt that we can accurately judge the level of stress by what we see. I think we can only know that there is stress.

Unlike a well-made, good quality glass lens, a crystal ball provides only a highly distorted, bubbly-looking image. When I look through my crystal ball right now, what I see is that we won't get to see GLD whittled down even to those ranges you mentioned. As I said above, these redemptions could be happening in a chain of events that is the reverse of what you'd normally expect. First the gold is promised to someone, then it is taken out. And if this is the case, then I'd expect at some point it all gets "promised" at once and then the music stops, the "price" is frozen and the shareholders cashed out. From my old post, The Waterfall Effect:

"The Waterfall Effect describes the "overnight" collapse of a complex system, without even the forewarning of a run up (like gold in 1980 or the dot com run up). The following two graphs demonstrate this effect as seen in the collapse of Roman money in the 3rd century AD…"

"…Entropy is the amount of chaos, disorder or unknowable elements in any system. A system has low entropy when it is highly organized, ordered, controlled, contained, and all the elements are known. A system has high entropy when it is disordered, chaotic, out of control, and many elements cannot be known. Science teaches us that everything in the universe ultimately ends in absolute entropy (chaos) through the passage of time. In other words, ashes to ashes and dust to dust.

One thing that can affect the natural progression of entropy along the way is adding energy into a system. In certain closed systems with a high degree of order and control, adding energy can actually reduce entropy, increasing organization and order. This can be seen in the wonders of life and reproduction. In the closed system of a baby, we add energy (food) and watch it grow. Ultimately, though, entropy wins out and we return to dust.

But adding energy to a system usually has the opposite effect. It speeds up the journey to absolute entropy. This can be seen in an explosion. A bomb can take an entire building from low entropy to high entropy in a fraction of a second…"

The point of mentioning this concept from an old post is that I imagine the graph of GLD inventory will ultimately look more like a waterfall than a gently-sloping stream.

You also wrote:

"FOFOA, if I understand you correctly, you are saying that GLD will always track the XAU price, and only the XAU price. Thus, GLD would be entirely drained of gold before the gold-XAU parity is broken."

A few things here… First, why is there any discussion about GLD tracking the price of gold? It tracks the price of gold because it has an objective value that includes the price of gold in its calculation formula. It tracks the price of gold because an arbitrage opportunity arises when it doesn't. An arbitrage opportunity arises because arbitrageurs believe an arbitrage opportunity arises, simple as that. It is either an actively managed fund or it is not. I think it is not. And I think the arb that keeps it close to the Comex POG is an all-paper arb simply because people (arbitrageurs) believe the opportunity is real and therefore make it real.

Second, yes, I think GLD would be de facto drained and trading stopped before parity is broken. And I expect that would all happen while you are asleep. From Unambiguous Wealth 2:

"And this is a key difference between the average guy and the big money. Big money isn't used to being kept waiting. Big money owns the "bus company". They know the buses aren't going to run before the little guy. They panic early. There was an electronic bank run around the time of the Lehman collapse. That was one of the reasons why governments around the world stepped in with fresh deposit guarantees. But there were no lines outside the banks to alert the average guy to what the Giants were up to…

There's only one way to beat the Giants to the gold, and that is to run in front of them."

Lastly, keep in mind that the price you see is a derivative (the product) of sales that already happened in the past. To us shrimps it appears to be the price of the immediate future, that is, it is the price we'll pay right now if we choose to execute our purchase. But this is only a shrimp illusion. In reality the quoted price (bid and offer—it's actually a spread and not one price) is the result of sales that already transpired.

Imagine you are a hypothetical Giant with a few billion in your briefcase and you want a lot of gold. So you fly to London and somehow get yourself in to observe the daily fix. You are waiting, calculator in hand, to hear them quote you the price you will pay for your gold, since the fix is supposedly the cash price of physical. So they call out the AM fix and you immediately step up with your cash to take advantage of this awesome deal. What do you think happens next?

Or let's say you don't care to fly to London, so you just phone up the bullion desk at JP Morgan where you've got $5B cash sitting in your account after you just liquidated your APPL shares and BTC. Let's assume you get the bullion desk on the phone just based on your name without the guy actually looking at what's in your cash account. You ask him to quote you a price for gold. He asks, "are you buying or selling." You're a clever guy so you ask, "what does it matter?" He says, "OK" and proceeds to quote you two prices, one for buying and one for selling. You immediately say, "I'll take 100 tonnes, allocated." What do you think happens next?

Let's say you're really clever and figure out how to get a lot of physical all at a good price, rather than buying over time as most Giants do. You're a little late to the big game and you need to play catch-up! Let's say you read FOFOA, you understand Freegold, and you believe my bellwether who says the technicals suggest the $PoG is heading to somewhere between $1,050 and $1,250 by the end of 2013 (he actually predicted that). Just to be safe, you figure that a price of $1,450 for all of it will make you happy!! So how would you do it?

Well, the way to do it is to lock in your price on the FOREX. If you can buy paper gold at $1,450, then you can take your time buying physical wherever you can get it, at any price, and then sell off your XAUUSD position in bits and pieces concurrent with your physical acquisitions. Even if the price skyrockets to $2K you'll still be getting it for $1,450 because the paper you'll sell will be $2K at the time you sell it. You've locked in your price!

The first problem you will encounter is that your "footprint" is too large, even for the FOREX. Your limit order of 100 tonnes at $1,450 will only be partially filled and then the price will skyrocket. You see, as the price hits $1,450 it is only a reflection of past sales. Sure, it is an offer price, but all you will get is whatever has already been offered by sellers on that exchange at $1,450. And that's just paper!

Anyway, enough hypotheticals. But I will note that it seems paper gold is used in this way to accumulate some physical. Once you own paper gold, even XAUUSD, you can either ask to have it allocated by the bullion bank and find out what they say, or you can simply use it as a locked-in price and sell it off as you buy your physical closer to home, on a slower timeline, without worrying about price changes.

I guess my point is that the price we see is always the price of the past, it is never the price of the future. And also that there are many ways the physical flow can be stressed even if the BIS has the biggest Giants in check. If enough "clever" small giants were doing this, I could imagine it would tug on the LBMA through the dealers' network. Then again, I'm sure that none of these "small giants" read FOFOA or understand Freegold, so it's probably just something else that's stressing the subterranean flow right now. Perhaps official support has been withdrawn.

Alright, I think that's enough of "my view" for today. ;D

Sincerely,
FOFOA

_____________________________________

GOR – The Gold Oil Ratio



Two years ago I started thinking about the GOR (gold oil ratio) and how it has been relatively constant ever since an American oil company first struck oil in Saudi Arabia. (Read more here. See also US Mints ‘Gold Disks’ for Oil Payments to Saudi Arabia.) Then about a year ago, while I was working on Peak Exorbitant Privilege, I noticed a correlation between the GOR and "the privilege". (Important: Always keep in mind that correlation does not necessarily imply causation.)

I don't pretend to know if the USG "wants" oil prices higher or lower. There's an argument that high oil prices support the strong dollar and the perpetual US(G) deficit, but it's a double-edged sword. What I do know is that the dollar reserve system needs oil and gold to remain correlated commodities as they have been for the last 67 years. So I think the $PoG is kind of stuck where it is right now. If gold rises, oil needs to rise in tandem or else it's curtains for the dollar reserve system. But if oil rises too much, then it's probably curtains for the dollar anyway. And if paper gold falls, well, you know what I think about that. It's what I call a Catch-22. A no-win situation for the dollar at present. It can't afford a big movement of either in either direction, IMO.

The GOR ranged from 9 up to 29 for the last 67 years. What I noticed while writing Peak Exorbitant Privilege was that the extremes of that GOR range correlated with times when the US exorbitant privilege apparently retreated quite a bit. It seems that somewhere around 15 in the GOR is the sweet spot for the $IMFS, and dropping below 9 or up to almost 30 was somehow stressful on the $IMFS (or at least indicative of stress) and something had to give. Of course, if you understand ANOTHER (which I think I do), the GOR will gap up or phase shift from this range to around 1,000 when gold is revalued in real terms. But maybe we should call that the FGOR since comparing it to the GOR is like comparing apples to oranges. Anyway, I guess I am expecting the GOR to plunge from 16 down to around 9 in the final moments before revaluation. That could either be the paper gold price falling below $900 or the oil price rising to $200. Either way, I think it will portend imminent transition to the new Freegold paradigm.

Here's the GOR data going back to 1946, the very time the world's largest oil refinery first went into production as a joint operation between the Saudis and the American oil companies (Saudi Aramco):

Annual Average Gold and Crude Price 1946-Present			# of bbl Oil 1 OZ Gold will buy
Year	Average $/bbl	Average $/oz	Ave bbl / oz
1946	$1.63	$34.71	21.294
1947	$2.16	$34.71	16.069
1948	$2.77	$34.71	12.531
1949	$2.77	$31.69	11.440
1950	$2.77	$34.72	12.534
1951	$2.77	$34.72	12.534
1952	$2.77	$34.60	12.491
1953	$2.92	$34.84	11.932
1954	$2.99	$35.04	11.719
1955	$2.93	$35.03	11.956
1956	$2.94	$34.99	11.901
1957	$3.00	$34.95	11.650
1958	$3.01	$35.10	11.661
1959	$3.00	$35.10	11.700
1960	$2.91	$35.27	12.120
1961	$2.85	$35.25	12.368
1962	$2.85	$35.23	12.361
1963	$3.00	$35.09	11.697
1964	$2.88	$35.10	12.188
1965	$3.01	$35.12	11.668
1966	$3.10	$35.13	11.332
1967	$3.12	$34.95	11.202
1968	$3.18	$39.31	12.362
1969	$3.32	$41.28	12.434
1970	$3.39	$36.02	10.625
1971	$3.60	$40.62	11.283
1972	$3.60	$58.42	16.228
1973	$4.75	$97.39	20.503
1974	$9.35	$154.00	16.471
1975	$7.67	$160.86	20.973
1976	$13.10	$124.74	9.522
1977	$14.40	$147.84	10.267
1978	$14.95	$193.40	12.936
1979	$25.10	$306.00	12.191
1980	$37.42	$615.00	16.435
1981	$35.75	$460.00	12.867
1982	$31.83	$376.00	11.813
1983	$29.08	$424.00	14.580
1984	$28.75	$361.00	12.557
1985	$26.92	$317.00	11.776
1986	$14.64	$368.00	25.137
1987	$17.50	$447.00	25.543
1988	$14.87	$437.00	29.388
1989	$18.33	$381.00	20.786
1990	$23.19	$383.51	16.538
1991	$20.19	$362.11	17.935
1992	$19.25	$343.82	17.861
1993	$16.74	$359.77	21.492
1994	$15.66	$384.00	24.521
1995	$16.75	$383.79	22.913
1996	$20.46	$387.81	18.955
1997	$18.97	$331.02	17.450
1998	$11.91	$294.24	24.705
1999	$16.55	$278.98	16.857
2000	$27.40	$279.11	10.186
2001	$23.00	$271.04	11.784
2002	$22.81	$309.73	13.579
2003	$27.69	$363.38	13.123
2004	$37.41	$409.72	10.952
2005	$50.04	$444.74	8.888
2006	$58.30	$603.46	10.351
2007	$64.20	$695.39	10.832
2008	$91.48	$871.96	9.532
2009	$53.48	$972.35	18.180
2010	$71.21	$1,224.53	17.196
2011	$87.04	$1,571.52	18.055
		Average	14.771

Consider that the GOR peaked at 29.388 in 1988. That peak correlates with a dramatic drop-off in the US trade deficit from more than 30% of total trade in 1987 down to only 5% by 1991:

Here's the data from that exorbitant privilege chart which was explained in Peak Exorbitant Privilege as the percentage of US imports paid for with paper promises rather than actual exports:

	1970 -4.14% 1971 2.14% 1972 7.49% 1973 -2.13% 1974 3.43% 1975 -10.32% 1976 4.09% 1977 15.17% 1978 14.30% 1979 9.88% 1980 6.66% 1981 5.21% 1982 8.07% 1983 17.84%		1984 27.26% 1985 29.66% 1986 30.88% 1987 30.31% 1988 20.99% 1989 16.05% 1990 13.13% 1991 5.11% 1992 5.98% 1993 9.86% 1994 12.28% 1995 10.82% 1996 10.89% 1997 10.38%		1998 15.11% 1999 21.39% 2000 25.99% 2001 26.42% 2002 29.85% 2003 32.42% 2004 34.23% 2005 35.50% 2006 34.04% 2007 29.63% 2008 27.48% 2009 19.49% 2010 21.39% 2011 20.97%

What drew this correlation to my attention was that there is also a dramatic drop-off in the US trade deficit that corresponds with the two times the GOR hit the bottom of its range as well. So I’m considering whether both extremes might be somehow tough on the $IMFS (or at least indicative of stress—an effect or a cause of the stress?). In 1976 the GOR hit 9.522, its lowest point in 30 years, and the US trade deficit subsequently fell from 15% in 1977 down to 5% in 1981. And then in 2005 the GOR hit its lowest point ever at 8.888 which preceded a drop in the trade deficit from 35% in 2005 to 19% in 2009:

Is it possible that the correlation may have something to do with the ability of our trading partners to save their surplus production revenue? If you think about the oil price as, in general, a representation of or proxy for the general price level of goods flowing to the West, and the (paper) gold price as the determinant of the eastward flow of physical relative to the westward flow of gold, it starts to make a little sense.

With a low GOR, general prices are relatively high providing a high income to the producers, but with a low paper price for gold, the underlying physical flow might be relatively tight. So while the net-producer can get more gold by weight with his relatively higher surpluses, the Superproducer finds it difficult to get the larger quantities of physical his currency profits are telling him that he should be able to get. Notice I'm not talking just about oil Superproducers. With a low GOR everyone will have higher profits in real (gold) terms.

Look at the prices of oil and gold in 1976 and 2005 above. Oil was very high relative to gold, so oil currency profits should have brought in massive amounts of gold (by weight). But if that massive tonnage of physical gold was not readily available, this would stress the system and something might have to give, like, say, the US exorbitant privilege.

With a high GOR, on the other hand, the general price level is relatively low and, presumably, paper profits are also relatively smaller (at least relative to gold by weight). So while the Superproducers face no problem getting all the physical their paper profits say they should be able to get, they are also concerned that they are getting relatively less gold (by weight) and that, *once the (paper) GOR reverts back down to its mean*, their foregone purchasing power during that high GOR period will have been cut in half. So, perhaps, they spend more of those overseas dollars in the present which then make their way back to the US, raising the general price level and decreasing the US trade deficit.

The bottom line is that our international monetary system has needed a revaluation in the real price of gold (not just the nominal price) ever since WWI (see Once Upon a Time for more on what happened in the 1920s). That’s a monetary revaluation of gold and a monetary devaluation of the dollar (as opposed to devaluing the dollar against everything else). In 1971 they opted instead to raise the price of oil and everything else for reasons we now know (thanks to ANOTHER). But today the problem is a bit more complicated. Today they really need a gold revaluation (only physical gold revalues and nothing else).

As I have said in the past, every ounce of physical gold in the world is owned by somebody. Even the gold in the ground is ultimately owned by the sovereign of that land (in extremis). So, in essence, every last bit of physical gold in the world represents a counterpartyless asset. What this means is that a revaluation of physical does not increase anyone's liabilities. Paper gold is another story.

If paper gold were to be revalued along with physical, the increase in the nominal (meaning in terms of dollars) liabilities of the bullion banks would break the system. But what about a gradual rise in paper gold to, say, $3,500 per ounce? At a GOR of 15 that means an oil price of $233 per barrel. At a GOR of 30, oil would still be almost $20 higher than it is today and then something would have to give.

This view fits with everything else that I expect to ultimately unfold. So it seems like today's (quote-unquote) "gold" can't go much higher or lower without ushering in the new financial architecture. Sometimes I wonder if that's why we've been stuck here at $1,600 for a year and a half now. If I was supporting the current system, that's where I'd want it to stay, since any big move in either direction will be very stressful.

FOA (08/09/01; 10:27:19MT - usagold.com msg#93)
"everything to do with a gold bull market"

This not only has "everything to do with a gold bull market", it has everything to do with a changing world financial architecture. And I have to admit: if you hated our last one, you will no doubt hate this new one, too. However, everyone that is positioned in physical gold will carry this storm in fantastic shape. This is because the ECB has no intentions of backing their currency with gold and every intention of using gold as a "free trading" financial reserve. None of the other metals will play a part in this.

Sincerely,
FOFOA

The first time I used this song was more than three years ago, and I still feel it, more now than ever! ;)