Friday, May 4, 2018

Comex is a Side Show

A sideshow is a secondary production associated
with a circus, carnival, or other main attraction.

Gold is now caught in a crossfire of world thought.
The traders are viewing it as a commodity and trying to
make money on its moves using various paper trading vehicles.
Their opinion of the market is flawed because the
"real value buyers" would never deal with these people
or let anyone in that circle know they are buying gold as "money"!
The major buying and selling is between CBs, nations,
merchant banks, "the super rich" and the hordes of small buyers
in forgotten places. That is one of the small many reasons
wall street hates gold, they are not part of the real action.
Comex is a side show!
–Another (10/18/97)


One of the great mysteries of the universe is where the price of gold comes from. The standard view is that it comes from Comex (and from Globex, another subsidiary of Comex parent company CME Group, during the hours that Comex is closed). At least that's where Kitco gets its price data from, and lots of people, including me, check Kitco when we want to check the price.

The LBMA, however, is almost ten times larger than Comex in terms of volume. But the LBMA only presents a new price twice a day, at the two fixes. So one of the main differences between Comex and the LBMA is that Comex is more transparent, presenting a constant flow of price changes. Another difference is that Comex is exchange traded futures and options (gold derivatives), while the LBMA is 90% spot transactions which are traded over-the-counter (OTC), not on a transparent exchange.

There are dozens of other gold markets around the world, but all combined, they add up to about 5% of the trading volume, while New York and London together make up the other 95%. Several years back, the LBMA put out a report titled, London or New York: Where Does the Gold Price Come From? In it, they used two different statistical methods to determine which of the two markets had a greater influence on the price (from 1986-2012), and they concluded that it switches back and forth periodically. The two statistical methods agreed with each other 90% of the time, and the periodic reversals were roughly every year or two.

Where the price of gold comes from, however, is not what Another was talking about when he said Comex is a side show. I know you probably thought that's what he meant, but go read it again. "The major buying and selling" he's talking about is between people and entities that don't care about the price, and "would never deal with these people" who drive the price.

How many times have I said that the price of gold has little or nothing to do with the physical side of the market? The "little" part is that the physical side does respond somewhat to the price, it just doesn't drive it, or feed back into it. I know this is hard to comprehend, but maybe this post will help.

Consider how small our little "Freegold" group here at the Speakeasy is, compared to the rest of the world, and consider that (obviously) the rest of the world views gold differently than we do. That doesn't change the reality we discuss here, but it's important to be aware of the difference between our own personal perception of things, and the reality that exists regardless of our perceptions.

Consider that, for 99.99% of the gold owners in the world, and for 99.99% of the gold in the world, the inevitable collapse of the paper gold market and revaluation of physical gold was not a motivating factor in purchasing physical gold. Consider that, for the "real value buyers" Another mentioned, the "CBs, nations, merchant banks, "the super rich" and the hordes of small buyers in forgotten places," a windfall profit from revaluation was not a motivating factor in purchasing physical gold. And consider that, for Another himself, I believe it was not a motivating factor, even for him speaking out about it.

The point is not that our perception is always different from reality, but that we need to be vigilant about differentiating perception from reality. If we can differentiate the two, then we can make them match. Reality doesn't rely on people's perception of it, it exists regardless of perception. When Michael Burry figured out the subprime crisis and started betting on it two years before the rest of the world, he had identified a consequence of reality that was inevitable, regardless of anyone else's perception of real estate prices, MBS, CDOs, CDSs and the rest of it.

When Another explained the collapse of the paper gold market and revaluation of physical gold, it was merely an inevitable consequence of reality. And it was incidental to the main driver which was the inevitable end of the dollar reserve system.

Consider that, prior to 1971, a certain weight of gold was the monetary unit of account, so there wasn't really even a "price of gold" per se. (Gold, in its best Heisenberg impression, says, "I don't have a price. I am the price!")

Comex is a futures market. Comex gold futures began trading in 1975 as a way for Wall Street to capitalize on the gold fever that resulted from A.) President Nixon's closing of the gold window in 1971, and B.) President Ford's repeal of President Roosevelt's ban on gold ownership in the US, which went into effect on December 31, 1974.

Prior to that, and for the previous 300 years, London was the central hub of the global gold market. The LBMA traces it back to 1671, with the arrival of a young merchant named Moses Mocatta. London still is the main show in reality, but perception changed with the arrival of a sideshow called Comex in 1975.

The term "futures" is misleading. People often think futures mean a prediction of future prices, but this is just a misperception based on the name. Futures are essentially forward contracts that have been standardized for trading on an exchange.

Forward contracts were basically buy/sell contracts between producers and users for a sale sometime in the future. The purpose would be to eliminate risk between now and then. The producer knew he had a buyer, and the buyer knew he had a seller, and the price was locked in, so there was no worry about changes in price. The problem was, prices changed. And buyers and sellers would both back out of these contracts if the price at the end of the contract period made backing out profitable.

What emerged to solve that problem were standardized futures exchanges, where gamblers could bet on price changes, absorbing the price and default risk previously carried by the producers and users. These exchanges popped up in big, regional trading hubs, like Chicago, New York and London.

They served two groups of people, the gamblers, and the actual users of the goods being traded. The people running the exchanges made a nice cut as well, so it was profitable to create exchanges that weren't necessarily needed or demanded by the actual users of the goods. Take, for example, Bitcoin futures. Not needed, except as a casino and new revenue stream for the exchange.

It's the same thing with gold. A gold futures market was as unnecessary in 1975 as a Bitcoin futures market is today. Worse than unnecessary, it actually made things worse for the real gold market. Just look at this chart caused by gamblers on Comex:

If you think that was good for gold, just consider that it forced Comex to change its own rules in the middle of the game, and ultimately suspend trading. Gold spent the next two decades slowly declining from $500 to $250. 1980 gave birth to modern bullion banking, CB-backed mine forward sales, the LBMA, and the paper gold market as we know it today.

I can't say what the gold market would have looked like if the sideshow of Comex gold futures hadn't come along in 1975, but the late 70s would have been dominated by a mostly-physical market out of London, where price settled the mismatch between supply and demand. Instead of the manic energy that was diverted into a paper gold gambling arena sideshow, where the rules could be changed or suspended altogether, it would have played out in the main show, the physical market.

Understand that a futures market is unnecessary for gold because gold isn't consumed. It isn't used up. It is just purchased and stored for its resale value. So the "supply" isn't only what's coming from producers (mines and recycling), it's all the gold that was sold previously. Gold that's been in a private vault or at the bottom of the ocean for 300 years is just as good as brand new gold fresh out of the ground. There is no difference. So, unlike commodity markets that are vulnerable to supply and demand shocks, and can therefore benefit from gamblers absorbing that risk, there is no such benefit for the gold market.

There was no benefit, but there was harm. We can't know what the gold market would have looked like without Comex. That's called a counterfactual condition, and there's not much use in pondering it. Perhaps the price of gold would have risen more slowly and sustainably, or perhaps it would have risen faster, and even higher than it did. Perhaps the market would have closed while the price gapped up to Freegold levels. It's impossible to know what would have happened. But what did happen, what isn't counterfactual, is that a bunch of gamblers broke the market, and the real physical gold users got screwed.

The 1980 spike on Comex didn't do anyone any favors. Certainly not gold or gold bugs, unless you consider severely damaging gold's reputation for the next two generations and driving gold bugs crazy with frustration for decades on end a favor. And strangely enough, this is what gold bugs want most, a replay of 1980. Luckily, Another came along and offered a different view, even if most of the gold bug community was too deep into their mining shares and conspiracy theories to see it.

This is all water under the bridge, of course, and I'm not complaining about the past. I'm simply offering up some objective reality for you to use. The exercise here is to differentiate perception from reality, because that's how you ultimately make them match, even if you're only one in a million like Michael Burry.

Comex is not the only sideshow. The gold price itself is a sideshow.

When I look at the gold price action ever since 1980, I see two main phases. The first phase lasted from 1980 until the low in 2001, and the second phase was from 2001 to present. In terms of drivers, neither of the two phases was driven by what was happening in the physical market, but I think it's interesting to contemplate potential differences between the two phases.

From 1980 to 2001, the price of gold dropped from a high of over $800 down to a low of $255. This was a period of formation for the paper gold universe that reached maturity in the late 90s when the LBMA began releasing its stunning volume. As I said above, it was the beginning of CB gold leasing and special CB-backed gold mine forward sale deals, when Barrick's "Munk and Gilmour, with their expert number-cruncher partner, Bill Birchall, would orchestrate the money mining."

It was the period of the oil for gold deal. As Another said: "It truly started with Barrick, in Canada in the 80s. It was a "thin market", but grew big in oil." He said the Saudis were buying 20M oz/year, or 622 tonnes/year, mostly on paper that was guaranteed by the CBs, beginning in 1991, and he said they were buying even more than that per year by 1998. That was enough to cover all of their remaining oil in the ground, according to Another.

Remember, the LBMA was formed in 1987 at the behest of the Bank of England, due to the 1984 collapse of Johnson Matthey Bankers, one of the earliest pioneers of post-Bretton Woods "bullion banking". And after less than ten years of "growing big in oil," the LBMA revealed a clearing volume of 1,157 tonnes per day. For comparison, the clearing volume on the Q1 2011 LBMA survey was 584 tonnes per day, with a trading volume of 5,403 tonnes per day. The implied trading volume for January of 1997 is a whopping 10,705 tonnes per day. Of course the price of gold was so much lower back then that, on a currency basis, the volume was only half. So on a weight basis, the LBMA volume in 1997 was twice as much as in 2011, but on a currency basis, it was half. The price was almost exactly four times higher in Q1 2011 as well, just as you'd expect.

Then, in 1999, there was some kind of a crisis at the LBMA, which I would characterize, perhaps going out on a limb a bit, as they ran out of gold. The evidence is really fourfold. There's the Bank of England gold auctions known as Brown's Bottom, which, again going out on a limb, I would characterize as a gold bailout of the LBMA which ran out of gold. There was the brief bout of backwardation seen here:

The price jumped an astounding 23% over just seven trading days following that backwardation. To put that into perspective, the POG is $1,348 as I write, so a 23% jump would take it up to $1,658 in just over a week. And the fourth piece of evidence that a crisis at the LBMA occurred in 1999 was the statement by the Bank of England Governor at the time, Eddie George, in front of three witnesses at a party, where he said:

"We looked into the abyss if the gold price rose further. A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake.

"Therefore at any price, at any cost, the central banks had to quell the gold price, manage it. It was very difficult to get the gold price under control but we have now succeeded. The US Fed was very active in getting the gold price down. So was the U.K."

There was also the Central Bank Gold Agreement of 1999 (CBGA, aka WAG), which Ari characterized as a warning from the CBs to the LBMA bullion banks to pull back on their volume, because they could no longer count on the CBs as gold lenders of last resort, nor for more gold bailouts and guarantees. They must have gotten the message, because from the CBGA in 1999 until the POG low in 2001, LBMA volume dropped 57% by weight, and 63% in currency terms. And that was the end of phase 1.

So "Phase 1" is all about the birth and growth of this new post-Bretton-Woods paper gold market. And the 20-year price decline can be explained on the LBMA side by the diverting of demand from physical into paper proxies, the expanding of supply through bullion bank "fractional reserve gold credit banking", and the witting or unwitting cooperation of the mining companies, central banks, bullion banks and "Oil" (the biggest singular source of demand during that phase). On the Comex side, shorting the s**t out of gold became a popular sport for Wall Street hedge funds during the latter part of phase 1.

Now, keep in mind that none of this price action in either phase has anything to do with the real gold market, "the major buying and selling" as Another put it, "between CBs, nations, merchant banks, "the super rich" and the hordes of small buyers in forgotten places." Everything in that price chart above is a side show, but like I said, I think it's interesting to contemplate differences between the two phases, even though it's a side show.

"Phase 2", I think, is characterized by a now-mature post-Bretton-Woods paper gold market, in which gold can simply go with the flow, behaving like other commodities or currencies, just following the bull and bear market trends of everything else—whatever market narrative Western gamblers traders are buying into at any given time. Not that it couldn't before, but that with the new market now mature, trader expectations and automated arbitrage could become the dominant driver, chaining the price of gold to commodity and currency market trends that have nothing to do with real gold.

One thing of note is that the LBMA volume returned with a vengeance in phase 2, along with the price. Of course the same occurred in silver, and other correlated commodities as well. Sometime around mid-2013, however, the gold price inexplicably began correlating with the yen. This, of course, has nothing to do with the real gold market. It is, in my opinion, simply another sign of the continuing maturation of the currency trading segment of the paper gold market.

Prior to the 2011 LBMA survey, we didn't know the extent of the turnover volume. We only knew the clearing volume from the clearing members. The LBMA itself didn't know the turnover volume. The only way to know it is to survey all of the members, and 2011 is the first time they did. They didn't even get a full response. Only 64% of the members responded to the survey. That volume above is from only 64% of the members.

The turnover volume was $240B per day, which in weight terms would be 5,403 tonnes per day. Obviously that much physical wasn't changing hands. Global mining supply for the entire year was only 2,700 tonnes, so they were trading twice that amount (in currency terms) every single day. Note also that after aggregating the numbers they received, they divided by two in order to avoid double counting.

That volume of turnover was so astonishing, so large, that it sparked years (plural) of debate on my blog as to what could account for it, and how the LBMA members could possibly be offsetting the price exposure it implied (because the real physical gold market is so tiny by comparison). We finally emailed the LBMA, two years after the survey came out, asking if the volume included currency trading—gold trading on the FOREX market—to account for the astonishing volume, to settle it once and for all. They said they'd have to check with someone who knows and get back to us, and it only took five months to get the answer. Sure enough, the survey included gold trading as a currency on the FOREX!

Now, as large as that trading volume was (it was 504 times larger than the flow from mining), it was wholesale volume, which means it was net of retail volume. Like I said, it was a survey, and the members reported a total plus the number of transactions that made up that total. If we divide the total by the number of transactions, we get the average size of the transactions that made up the entire survey. And the average transaction was for $39 million. That's not retail, that's wholesale.

Understand that the LBMA (London) is the central hub of the global gold market. And this means that virtually everyone involved in the gold trade anywhere (paper or physical, there's no difference here) is either hedged at the LBMA, or is hedged with someone who is hedged in London, or is hedged with someone who hedges with someone who hedges with an LBMA member, and so on. In other words, it all traces back to London.

Comex is not the only sideshow. The gold price itself is a sideshow. And now, to ensure heads explode and comments are lively, I'll take it one step further. Even China's SGE is a sideshow!

Could opening a true physical-only gold market create a dynamic that breaks the paper gold market?

The answer is no. To understand why, you need to understand how global markets are interconnected. Markets are run by market-makers, which are big companies that are not in it for the gamble. They are like bookies. Bookies don't gamble. They are in it for the spread or the vig, their take of the action (or transactions).

The idea behind a physical-only gold market breaking the paper gold market is based on a widespread misperception, not on reality. The reality is: when the paper gold market finally breaks, a physical-only market will emerge and take its place. The misperception is: therefore, if someone launches a physical-only market, then the paper gold market will finally break. See the reversal of causation?

FOA actually predicted a physical gold market would open in Shanghai (among other places), but not as a mechanism to break the paper market. Instead, as part of a decentralized physical bullion exchange system that will emerge as a result of the closing of the centralized LBMA system:

"There will be no squeeze in these markets now, as they will be allowed to kill themselves by trying to save themselves. Inflating the supply is that process. The loss of such credibility will eventually come as trading just stops, virtually closing the dollar contract markets as we know them. Opening the door to an ECB sponsored physical market. If I had to guess, we will see Shanghai, Johannesburg and Dubai all joining with major internal Euroland financial centers to form the EBES (Euro Bullion Exchange System)." –FOA (2/15/01)

Someone created a website called It might even be someone here. I don't know. Obviously it's not entirely serious, but the idea behind it is quite common—that a physical market will eventually have a higher price than the paper markets, which will collapse the system, so the site tracks the price difference between Shanghai and London:

If you click on the WHAT IS GOING ON? link at the top right of the page, it tells you this:

"On April 19th 2016, China locked in the dollar's death by launching their own gold price fix. For the first time in modern history there are now two prices of gold, one in the Chinese yuan and the other in the dying dollar…

If the East were to raise the price of gold, it would drain the West's gold reserves due to arbitrage. This would expose the West's fake gold market and kill the dollar…

The eventual endgame is that the price of gold skyrockets and the dollar permanently collapses along with the global banking system and modern society as we know it. Black Friday will be everyday as the masses murder each other for a peach pit. This is sure to happen anytime between now and the end of 2018."

Look, at the moment when the physical stops flowing in London—perhaps even before we know that the LBMA has shut down, but not long before—during that relatively short period of time, we should see a massive spike in the premium on physical over the known (paper/spot) price. This is what FOA was talking about:

"…the demand for real gold will eventually spike physical premiums thousands past the paper dollar gold markets."

That's quite a different pot from the one the website is watching. A premium is what you pay over spot (the "paper" price) when you buy physical directly. The price at the SGE is a spot price. There will be no predictive value in following the difference between the spot price at the SGE and the spot price in London or New York. Any price difference is due mainly to the difference in time and location, not because one is more physical than the other. Traders and arbitrage aren't going to break the global gold market. Remember, traders are part of the sideshow.

What the website is anticipating is "information leakage" via the SGE. It won't happen. When the LBMA shuts down, the SGE will have to shut down for a short while too. Just like I explained here, there will be no information leakage:

"We are all looking for "information leakage" as to the criticality of the systemic pressure we just know must be building. We look to the contango, the curve, the spread, stock and flow to leak us a hint about what kind of scramble might be happening on the other side of the curtain. But when I look back on other big Ponzi-like collapses, there never was much if any "leakage" before the event.

I think there are a couple of reasons why this is the case. In the last days before a Ponzi-like collapse, redemptions, conversions and exchanges are usually settled in an outwardly normal fashion. In fact, it is often those closest to the collapsing structure, like clients and counterparties, who are most in denial in the final days because they are directly privy to the superficial normalcy of transactions taking place.

It is at the precise point that the immediacy of collapse becomes unequivocally apparent to the inside operator that the plug is pulled and the music stopped. Operators pull the plug on redemptions all at once in order to either make off with the remaining assets, distribute them to favored associates, or in some cases, to preserve as large a pool of assets as possible."

In the future, when the LBMA is no longer functioning as a fractional reserve bullion banking system at the central core of the global gold market, the SGE will truly be an important distribution hub in the new, decentralized, global Bullion Exchange System, as FOA called it. But for now, it is little more than an arm of the global gold market centered in London.

When I talk about redemptions, conversions and exchanges being settled in an outwardly normal fashion right up until the plug is pulled, you can think of physical settlement at the SGE in the same way. When the plug is finally pulled in London, physical settlement will have to be halted, at least temporarily, at the SGE as well. You see, for now, the SGE is just another side show.

The LBMA is up to 150 members now, and at least 22 of them are also key members of the SGE. Here's the list:

China Minsheng Bank
Ping An Bank Co., Ltd.
Shanghai Pudong Development Bank
Industrial and Commercial Bank of China
Bank of China
Bank of Communications Co., Ltd.
China Construction Banking Corporation
HSBC Bank Company Limited
JP Morgan Chase Bank, N.A. London Branch
Standard Chartered Bank
BNP Paribas China Limited
The Bank of Nova Scotia-Hong Kong Sub-Branch
ICBC Standard Bank Plc
Heraeus Metals Hong Kong Ltd.
Australia and New Zealand Banking Group
Metalor Technologies SA
MKS (Switzerland) SA
Public Joint Stock Company Bank "Otkritie Financial Corporation"
Sberbank AG
VTB Bank

Those companies are all members of both the SGE and the LBMA. Here's the full list of current LBMA members:

ABC Bullion
Al Bahrain Jewellers LL
Alex Stewart International
Allgemeine Gold- und Silberscheideanstalt AG
Almalyk Mining - Metallurgical Complex
ALS Inspection
Amalgamated Metal Trading Ltd
A-Mark Precious Metals, Inc.
Ames Goldsmith UK Limited
AngloGold Ashanti Limited
Argor-Heraeus SA
Asahi Holdings, Inc.
Aster Commodities DMCC
Australia & New Zealand Banking Group Ltd
Baird & Co Limited
Bank Julius Baer
Bank of America N.A
Bank of China
Bank of Communications Co., Ltd.
Bank of Montreal
BASF Metal Limited
Bayerische Landesbank
BNP Paribas
Borsa İstanbul A.Ş.
Brink's Limited
Bullion Management Group Inc
China Construction Banking Corporation
China Minsheng Bank
Citibank N A
CJSC "Sberbank" CIB
CME Group
Coeur Mining, Inc.
CoinInvest GmbH
Coins N' Things (CNT, Inc)
Commerzbank AG
Commonwealth Bank of Australia
Cookson Precious Metals Limited
Credit Agricole CIB London
Credit Suisse
Credit Suisse AG Zurich
CRI Criterion Catalyst Co Ltd
Degussa Sonne/MondGoldhandel Gmbh
Derek Pobjoy International Limited
Dillon Gage Inc.
Doduco GmbH
EBS Dealing ResourcesInternational Ltd
Emirates Gold DMCC
ETF Securities (UK) Ltd
FideliTrade Incorporated
G4S Cash Solutions UK Ltd
G4S International
Gerrards (Precious Metals) Ltd
GFI Brokers Limited
Glencore International AG
Gold Standard DMCC
Goldman Sachs International
GT Commodities LLC
Heraeus Deutschland GmbH & Co. KG
Hindustan Platinum Pvt. Ltd
HSBC Bank Plc
ICAP Energy Limited
ICBC Standard Bank Plc
ICE Clear US Inc
Industrial and Commercial Bank of China
Inspectorate International Limited
International Depository Services of Canada Inc.
International Depository Services of Delaware
INTL FCStone Ltd
Italpreziosi SpA
Jane Street Global Trading LLC
JBR Recovery Limited
Jewellers Trade Services Partners
Jindal Dyechem Industries Pvt. Ltd
Johnson Matthey PLC
JP Morgan Chase Bank
JP Morgan Securities Plc
JSW Metals Ltd
Kazzinc Ltd
KGHM Polska Miedz S.A
Koch Metals Trading Limited
Koch Supply & Trading LP
Kuveyt Türk Katılım Bankası A.Ş
Landesbank Baden-Wurttemberg
Limpid Markets Ltd
Loomis International (UK) Ltd
M.D. Overseas Ltd
Macquarie Bank Limited
Malca-Amit Commodities Ltd
Marex Financial Ltd
Mastermelt Ltd
Merrill Lynch International
Metalor Technologies SA
Metals Focus Limited
Met-Mex Peñoles S.A. de C.V.
Mitsubishi Corporation International (Europe) Plc
Mitsubishi Materials Corporation
Mitsui & Co., Ltd.
MKS Finance SA
Morgan Stanley & Co International Ltd
National Australia Bank Limited
Natixis London Branch
Navoi Mining & Metallurgical Combinat
Peekay Intermark Limited
Perth Mint
Pictet & Cie
Ping An Bank Co., Ltd.
PJSC "Bank Otkritie Financial Corporation"
Prebon Premex London
Rand Merchant Bank a division of First Rand Bank Ltd
Rand Refinery Limited
RC Inspection (Hong Kong) Limited
Republic Metals Corporation
Royal Bank of Canada Limited
Royal Canadian Mint
Sberbank (Switzerland) AG
Schöne Edelmetaal B.V
Shanghai Pudong Development Bank
Sharps Pixley Ltd
Société Générale
Solar Applied Materials Technology Corp.
Standard Chartered Bank
Sucden Financial Limited
Sumitomo Corporation Global Commodities Limited
Sumitomo Metal Mining Co Ltd
Sunshine Minting Inc
T.C.A S.p.A
Tanaka Kikinzoku Kogyo K.K.
The Bank of Nova Scotia - ScotiaMocatta
The Great Wall Precious Metals Co., LTD. of CBPM
The Royal Mint
Thomson Reuters GFMS
Toronto-Dominion Bank
Triland Metals Ltd
UBS Switzerland AG
Umicore SA/NV
United Precious Metal Refining Inc
Valcambi SA
Vintage Bullion DMCC
VTB Bank
Westpac Banking Corporation
World Gold Trust Services LLC
Zaveri & Co Pvt Ltd
Zürcher Kantonalbank

Let me repeat something from above. The LBMA is ten times larger than Comex in terms of turnover, and combined, they make up 95% of the global gold market trading volume. The other gold markets around the world all combined, including the SGE, make up the other 5%. I know we like to theoretically differentiate between the paper and physical markets, but in reality they're all integrated. In reality, there's the global gold market, and within that exists the physical market.

Remember recently, there was a story about EFPs (Exchange for Physical) between Comex and the LBMA? Themagicbusguy brought it up here. Apparently this was the first Harvey Organ had heard of EFPs, and he had calculated that some "560 tons" worth of obligations had shifted to London within a month.

Now, I don't know if that's true, if it's common or uncommon, or why it happened. I'm not offering an explanation here, and it's not even a mystery worth trying to solve in my opinion. But I just want to point out that the biggest market makers in these markets operate in both places. Look at JP Morgan. It's at Comex, the LBMA and the SGE. So are several others. Think of them as giant see-saws. Being international giants, their actions in one market may simply be to balance exposure created on the other side of the world.

We don't know if those EFPs were between clients or subsidiaries of the big bullion banks operating in both markets. They are private, off-market, paper exchanges. Physical is not really involved. It's a swap of futures and cash for unleveraged spot unallocated, not physical. The point being, it's all integrated. Comex is a sideshow. SGE is a sideshow. Even the price itself is a sideshow. The real show, the main show, "the major buying and selling" of real physical gold, "is between CBs, nations, merchant banks, "the super rich" and the hordes of small buyers in forgotten places."

Here's how I like to picture it. The "global gold market" consists of "turnover" or "trading volume", it's really a concept of flow, not stock. And somewhere inside that massive "global gold market" flow, real physical gold courses like blood through its veins. But even though it's a concept of flow, there does exist a certain stock at any given point in time. We just have no way to know what it is. Even the LBMA itself doesn't know what it is.

No matter, we don't need to know precisely what it is. We already know that it’s a massive amount of gold liabilities, balanced by a massive amount of derivatives plus a tiny amount of physical reserves. The amount of physical flowing through is also tiny in comparison to the amount of paper, but that's because most of the gold in the world is just lying still right now.

Real physical gold is not so tiny by comparison, even at today's paper price. If we view it as a whole, all of the gold in the world right now, even at current prices, is worth more than $8 trillion. And at least $3.2 trillion of that (at current prices) found its way into private ownership over only the last 30 years since the LBMA was formed. That’s 75,000 tonnes that came out of the ground since 1987, and most of it, one way or another, passed through the LBMA. Not physically through London necessarily, but through the books of LBMA "merchant banks" acting as middlemen, on its way from the mines to its new owners.

That's a lot of gold, but remember that the LBMA turnover volume is 504 times larger than the flow from mining. It takes only 14 trading days, less than three weeks, for 75,000 tonnes (in currency terms) to change hands in the LBMA, just to put some perspective on it.

The reason this is unsustainable is not because someone started a new gold market somewhere else that will drain the physical gold away from the paper markets (they are all interconnected), but because there is no feedback mechanism for supply and demand mismatches to "feed back" into the price. In most markets, whenever there is a mismatch between supply and demand, the price moves until they match again. That's how markets work. But the global gold market is different.

The global gold market is underpinned by a banking system. Bullion banking, to be precise, but a banking system no less. This bullion banking system literally underpins every aspect, arm and sideshow of the global gold market, physical market flow included.

In this bullion banking system, gold is like a currency. In fact, thinking of it this way will help you understand why it is unsustainable, and how the Comex, SGE and even the price are all side shows to the main event.

Gold is like a currency in the bullion banks. They can issue it like regular banks issue dollars or euros when you take out a loan. It has a currency code: XAU. In FOREX circles, it trades in currency pairs, like XAU/USD, or XAU/AUD, or XAU/EUR, XAU/CAD, etc. But don't get too hung up on the FOREX trading aspect; Gold is like a currency in all aspects—its "price" is actually more like a currency exchange rate.

Think about what I said above regarding how I view the price action since 1980 in two phases. In the first phase, I said, admittedly going out on a limb a bit, that the price declined by 50% even as the bullion banks ran out of gold and had to be bailed out by the central banks in 1999. How can the price decline even as you run out of a good in a normal market where price makes supply and demand always match? The answer is it can't. But that's just what happened in the gold market in 1999.

The reason it happened is because there was no feedback mechanism for supply and demand mismatches to "feed back" into the price. The reason the price was able to keep declining in the late 90s even as demand was overwhelming was because the bullion banks were treating it like a currency, and issuing more than enough bullion bank liabilities to meet demand. Remember when Another said this?

"Some say, "gold fall because noone was buying it". I say, "gold fall because many were buying it"! They buy as the "trading market" was made "much fat" with added paper! … If the price did not fall, this paper market "could not function" as "it would not be profitable to the writer"!" –Another (5/26/98)

When a currency is in high demand, it is profitable for a bank to keep issuing more and more of it. To let a currency rise without issuing more of it is to leave "money on the table". This currency we're talking about is the bullion banks' liabilities. It's like the effective money supply as I have defined it. The effective money supply is bank credit money plus all cash that is outside of the banking system. Cash inside the banking system is reserves, and it is not part of the effective money supply.

Likewise, this "XAU" currency we're talking about is bullion bank liabilities (gold credit money) plus physical gold (gold cash) outside of the bullion banking system. Physical gold inside the banking system is reserves, like cash in the cashier's drawer or in an ATM machine at a regular bank.

To understand how the bullion banks could have run out of gold in 1999, just think about the bank runs and bank failures in 1933. The dollar was in high demand (deflation), and the banks ran out of reserves. FDR's first act as President was to declare a national "bank holiday". 4,000 banks failed that year.

During the second phase, there's circumstantial evidence that the opposite situation occurred between 2004 and 2010, that there may have been a surplus of physical reserves in the bullion banks even as the price of gold traded up in lockstep with the commodity "bull run". The point being that the common thread is a disconnect between price and the physical supply and demand dynamic. This disconnect is the reason why the global gold market as it exists today is unsustainable and will inevitably end, and why all these things are mere side shows.

That same circumstantial evidence points to a flow reversal around 2010, and an extreme lack of reserves beginning in 2013. The LBMA will never run out of reserves completely, as long as there is still some flow coming from mining and recycling, but it will pull the plug on redemptions, withdrawals and conversions in the end. That's when it's game over.

There is evidence that the lack of reserves continued, even after the extreme draining of GLD ended. GLD's inventory is still down 37% from 2013, lower than it was even on Nov. 22nd of 2013. It didn't recover. I'm not sure what's going on with GLD since 2013, but I suspect they viewed it as "information leakage" and somehow managed to plug the leak. Still, there are signs that all is not quite right with GLD.

Inventory has been remarkably and uncharacteristically stable for more than a year now, meaning we haven't seen much activity at all in terms of creation and redemption of shares. There was that odd instance in 2016 when we found out that the BoE had provided some gold to GLD, which I viewed as more "information leakage", and then that leak was plugged. And finally, GLD is the WGC's golden goose, so to speak, paying its bills and providing for a rather lavish lifestyle for what is essentially a trade organization that has been abandoned by its trade. So my brow furled a bit last month when the WGC filed papers to start a new physical gold ETF… wait for it… sans HSBC.

I'm not going to speculate here about what this might imply, just throwing it out there. But suffice it to say that I suspect the LBMA's reserves are as tight right now as they've ever been. They could potentially pull the plug at any minute, but they have also plugged the information leakage. So there's no forewarning to be had, or anything even worth watching. The price of gold is a side show, and so now too is the GLD inventory.

I used to think that we'd see the gold market break first. And we still may, but since all thermostats and smoke alarms have been disabled, there's nothing to back that up. The $IMFS, on the other hand, is primed for implosion like never before, in plain view, and thus I have changed my thinking on this.

Now, since I'm already a little bit out on a speculative limb, here's a hypothetical situation just for consideration.

Suppose there actually is a person or group of people who would be the ones to make the ultimate decision that it's finally time to pull the plug on the LBMA. I have no difficulty imagining what institutions they would be associated with. Just picture the apex leadership of physical gold custody in London, and imagine that pulling the plug means no more allocations, simple as that. It's pretty easy to imagine the mechanics of powering down the central hub of the global gold market, and the players who would need to be involved to pull it off. No conspiracy, just a practical matter. Good business as Another would say.

Suppose they also understand what we understand, that the LBMA and the $IMFS are inextricably linked, that when one goes, the other will follow. It's a simple concept that was explained to me by an insider (Another), so I have no difficulty imagining that such a person or group of people would understand it.

They would also be seeing the same things we are seeing, that the $IMFS is primed for implosion like never before, in plain view. So even if it were time to pull the plug, it might be worth expending some resources to keep the wheels on the bus just a little while longer, or at least keep appearance up, until $IMFS pops and takes all the (well-deserved) blame.

There's a lot of stuff happening right now, a lot of news. It's almost too much to keep up with, but I'm trying. And if I squint my eyes just right, I can almost see how it's all connected. Forget bitcoin. In the end, gold will be remembered as the greatest show ever, and you're here at the right time, at the greatest place on earth to watch it all unfold. ;D


"Comex is a Side Show" was posted at the Speakeasy on 1/26/18, and has 223 comments under it.