Friday, May 28, 2021

FOFOA in the New IGWT Report

I have a new post in the new 'In Gold We Trust Report' which was just released yesterday. It's called 'My View of the Nixon Shock', because this year is the 50th anniversary of the day that Nixon closed the gold window.

The full post is 28 pages long, but there is a much shorter 8-page version in the main report. They could only fit so much in the report, so they asked for an edited version, but they also published the full post separately. Of course I recommend the full, unedited post. :D

Here's the website for the IGWT Report:

https://ingoldwetrust.report/igwt/?lang=en

You can download the report directly by clicking here. The download will begin automatically (the short version of my post begins on page 215):

https://ingoldwetrust.report/download/12773/?lang=en

Here's the url for my full post:

https://ingoldwetrust.report/igwt/exclusive-interview-with-fofoa/?lang=en

And here's the direct link to the pdf of the post itself. It will open in a browser if you click on it, or you can download the pdf by right-clicking on the link:

https://ingoldwetrust.report/wp-content/uploads/2021/05/My-View-of-the-Nixon-Shock-%E2%80%93-Exclusive-Interview-with-FOFOA-In-Gold-We-Trust-report-2021.pdf <-- This is the one I recommend!

For those of you who are new to this blog, I changed it in 2015 to a private, subscription-required blog to escape the trolls and bad energy of the open internet. I have hundreds of subscribers right now, the highest number since it began in 2015, there are more than 200 posts, and more than 55,000 comments. We're averaging around 35 comments a day right now, on topics like COVID, the vaccines, hyperinflation, Bitcoin, crypto, food, health, and of course money, economics, Basel III, gold and Freegold. In other words, we talk about a wide range of topics at the Speakeasy. That's what it's called: The Freegold Speakeasy.

The subscription price is $110 for 6 months, which works out to 60 cents a day. You'll find a link to subscribe at the top right of this blog, in the sidebar. It's through Paypal, but you don't need a Paypal account to subscribe.

To give you an idea of what to expect, here is a list of some of the recent posts from this year:

Will Basel III End the LBMA?
194 comments
Published
2021/05/23 at 5:12 pm

Hyperinflation Update Update
616 comments
Published
2021/05/06 at 8:34 pm

Hyperinflation Update
487 comments
Published
2021/04/25 at 5:58 pm

October 2008
554 comments
Published
2021/04/07 at 8:16 pm

Bitcoins and Wind Turbines
804 comments
Published
2021/02/19 at 7:52 pm

GameStop v. Silver
410 comments
Published
2021/02/01 at 9:50 pm

The Original Singularity
453 comments
Published
2021/01/22 at 7:09 pm

Happy New Year! 2021 Year of TEOTWAWKI
1,710 comments
Published
2020/12/31 at 8:30 pm

I hope to see you there! :D

Sincerely,
FOFOA

PS. If you subscribe, please be patient, because I have to give you access manually. It's not automatic. This is a feature, not a bug, but it does mean that I have to be at my computer, so you may have to wait a few hours in some cases.

Friday, January 1, 2021

Happy New Year!

2021
Year of ________?


You'll have to go to the Speakeasy to read the New Year's post, but here I'm giving you a post from back in June, titled The Achilles’ Heel of the Paper Gold Market...



The Achilles’ Heel of the Paper Gold Market

On 5/30, Organm999, one of the newer Speakeasy members, asked the following:

"I’m really confused by this. If physical is supposedly so tight, how on earth was 550 tons secured at the cheap spot rates so that it could be sent to the Comex?

This is one aspect of Freegold theory that I’ve not been able to grok. Why is so much physical available at below FG prices?"

Article referenced for above comment https://www.zerohedge.com/commodities/largest-ever-physical-transfer-gold

Hello Organm999,

That's a lot of gold, huh? 550 tonnes moved physically into the Comex in just two months! It should be noted that this was unusual, i.e., not normal.

Now, I don't have any inside information beyond what I can read in the article you linked and its source articles, but I may have a different take on what I read there—a different lens as it were. For example, I don't automatically assume that the unusual physical movement of so much gold implies plenitude rather than scarcity. Nor do I assume that physical movement necessarily implies a change in ownership.

One thing I know for sure is that there is no shortage of gold. All the gold still exists and is owned by someone. And that's a lot of gold! Also, there is a flow of new gold, from mines to refineries to mints to wholesalers to retailers to end users. And a good deal of that gold passes through the bullion banks of the LBMA, on paper at least. It is always owned by someone, every step of the way, but on paper at least, some of it is owned by the bullion banks for some (short) period of time.

So there's an inflow and an outflow of new gold that passes through the books of the LBMA bullion banks. And during that period of time when it is "owned" by the bullion banks (when it's on their books), any slack in the flow constitutes their reserves. They don't "buy" this gold, per se, any more than your bank "buys" cash from you when you deposit some cash. You give the bank your cash and the bank credits your account. Same with the gold flow. Someone (perhaps a mine) "deposits" gold at the bullion bank (not physically, but on paper), and the bank credits their account with "paper gold" (which they can "sell" (exchange) for cash at the current POG). Meanwhile, the gold is refined at the refinery and then sent to the mint. From there it is probably sent to a wholesaler, then to a retailer, and ultimately it is sold to the end user.

Ownership is not necessarily transferred from the mine to the refiner to the mint to the wholesaler to the retailer to the end user. That just wouldn't make sense. Imagine the amount of capital that would be required for a refinery or mint, or even a wholesaler, to own all of the inventory under its roof at any given time. No, these are businesses like any other, and they finance their inventory through banks. That's what banks do. They finance businesses. And what bullion banks do is they finance bullion businesses. But that's not all they do. (They are also market makers for the trading of their own gold-ounce-denominated liabilities, called spot unallocated, against all currencies on the FOREX, which is where the price of gold is actually derived. More on this in a moment.)

You see, gold is different from everything else. There are no meat banks that carry books denominated in meat. Nor are there milk banks that carry books denominated in milk. If you're in the meat or milk business, you just go to a regular bank and borrow dollars to finance your operation. The reason there are bullion banks is because it's a carryover from the gold standard, when gold was the base of a fractionally reserved monetary system. Here's something I wrote back in 2011:

When Nixon abruptly took the dollar off the gold standard in 1971, the billions of ounces in private ownership didn't just disappear. They weren't cast into the streets in disgust. And these giants with 100,000 ounces or more didn't take those tonnes home to the basement. No, they stayed right there in the bank vaults and literally JUMPED in value.

In fact, the banking system never really stopped "banking" with all that gold, even though Nixon demonetized it. While gold was currency, deposits of gold generally went into unallocated accounts, just like your deposits of physical dollars do today. Putting gold in an allocated account in the past would be akin to putting cash in a safety deposit box today. Sure, it happens, but it is not common because it has a cost associated with it.

And what is it that banks do with unallocated accounts? They make loans to generate income for the bank, and they use fractional reserve accounting to juggle the deposits and (hopefully) keep everyone happy. And in the rare situation where they come up short on reserves, the Central Bank stands ready to backstop their fractional reserves with a loan of extra reserves.

Even today, a few of the biggest banks still have bullion departments where they can take deposits in physical gold. These banks are what we now call the Bullion Banks. This bullion banking practice seems very foreign to us shrimps with a little gold in the family safe. But yes, just like the billions of ounces that existed during the gold standard era, this practice of bullion banking still exists.

And today the bullion banks still operate with fractionally reserved unallocated gold…

This is what gold will be freed from: The fractional reserve banking practice, which is a carryover from the gold standard.

This is the free in Freegold.


You wrote: "If physical is supposedly so tight…"

The only tightness that matters is in the LBMA bullion bank reserves. The slack in the flow is their reserves. If the inflow is greater than the outflow, then their reserves are expanding, and if the outflow is greater than the inflow, then their reserves are shrinking. It's like a rope, and when there is no slack, the rope is tight. It is my contention that their reserves are all but gone, and at this point the rope is stretched so tight it's barely a thread, which (I think) may be why we see some banks exiting the bullion banking business.

Here's part of a comment I wrote on March 31st. It was a few days after you joined the Speakeasy, when comments were piling up so fast that it was hard to keep up:

At this point, physical gold premiums [due to supply tightness] are [localized and] unique to each dealer. Think of the global gold market as similar to a cardiovascular system. You have a heart with an inflow and outflow, and interconnected veins and arteries that branch out into smaller and smaller vessels called capillaries. These capillaries provide shrimp-sized gold to the tissue (that's you) all over the body, even in the farthest reaches of [insert your locality].

At some point, we expect the heart (LBMA) so seize up, like in a cardiac arrest or heart attack. We can see the early signs of tightness in the flow, but even after the heart stops pumping, we may still experience bleeding for a while at the extremities, from pressure or gravity or whatever.

[…]

So what the "coronavirus shutdowns" did was stop the venous inflow to an already diseased heart. Imagine someone who got shot in the heart, but isn't actually dead yet. He's twitching and gurgling, and we're just ants on the ground drinking the blood as it drips down his neck, watching his body convulse, debating whether he's alive or dead, because he's still moving and there's plenty of blood available at a low premium in our "neck" of the woods.


The ZeroHedge article you linked, titled "The Largest Ever Physical Transfer Of Gold", was based on a May 29 Bloomberg article titled "Virus Sparks Round-the-Clock Rush to Fill U.S. Gold Vaults". (Here's a link that will get you around the Bloomberg paywall: http://archive.is/KQAtV)

The gist of the ZH article, dated 5/31, is that during the two months from late March to late May, "no less than 550 tons of gold [were] added to Comex warehouse stockpiles," and that "hundreds of tons of that [but not all of it] was imported [111.7 tons came from Switzerland in April]." It says the cause was "traders rushing to take advantage of this arbitrage opportunity [gold futures decoupling and trading far above spot prices beginning on 3/24] by shipping bullion to New York," which it says "came to a head on Thursday [5/28], when traders declared their intent to deliver a record 2.8 million ounces of gold against the June Comex contract, the largest daily delivery notice in exchange data going back to 1994."

Here's where they got the 550 tonne number


The article goes on to say (via a quote) that the gold-shortage-on-Comex story, which drove gold futures far above spot, "was ill-informed… and was made on assumptions rather than fact." Further, ZeroHedge, remarkably, is using this to push silver, which it says is about to have a "violent reversal" vis-a-vis gold (Silver Shines As Gold Glut Weighs On Barbarous Relic). But that's a whole 'nother story. ;D

Now, to be clear, just because ZeroHedge says something, doesn't mean it's true. And again, the ZH post was based on a Bloomberg article, and the same goes for Bloomberg. Just because they write something, doesn't mean it's true. So now that we know the gist, let's look at some of the details.

On the surface, it sounds like traders bought 550 tonnes of physical gold somewhere, at the low spot price, and then shipped it to Comex to deliver it against the June contract (at the high futures price). But, again, just to be clear, 2.8 million ounces is not 550 tonnes. This is not an argument, just pointing out that 2.8 million ounces is 87 tonnes. And 87 tonnes is not being delivered in June, it's just that "traders declared their intent to deliver." In fact, according to Bloomberg on 5/27, "Now, contract holders are trying to avoid taking delivery from the massive inventory." (New York Gold Traders Drown in a Glut They Helped Create)

Now, I don't know what's going on here, but someone named Tai Wong, the head of metals derivatives trading at BMO Capital Markets, is quoted in that Bloomberg article as saying, “It’s a little bit of a game of chicken.” And in a funny way, that makes sense to me. Something (pandemic speculators?) spiked the futures price on Comex, "which left banks such as HSBC suffering hundreds of millions ($200M) in losses," then some gold showed up, and now "contract holders are trying to avoid taking delivery from the massive inventory."

A game of chicken is any contest with two players where neither one wants to "back down" or let the other win, even though not backing down can be very dangerous.


I remember when this first started happening. On 3/23, futures were $20 higher than spot, and Torgny of BullionStar asked me about it. My initial response was that Comex is a Side Show. That was the same day the Dow hit its low of 18,591, and spot gold was hovering around $1,500. The next day the divergence widened to $96 at one point, spot had jumped to $1,600, and Torgny's take was that the futures were rising faster than spot because "no one wants to buy unallocated spot because it’s impossible to get delivery whereas it is, in theory, still somewhat possible to get delivery via COMEX."

Not a terrible take, but now 2 1/2 months later, gold is hovering around $1,700, a hundred bucks higher, someone put some gold into Comex warehouses, declared their intent to deliver, and now the Comex contract holders are trying to avoid taking delivery.

According to Bloomberg:

Since the end of March, just over 17 million ounces have flowed into Comex. That’s more than the total increase in ETF holdings last year, and almost equivalent to India’s annual jewelery demand. Inventories stand at a record 26.3 million ounces as of Wednesday, dwarfing the 6.1 million ounces worth of June contracts still open.


That sure sounds like a lot of gold! 17 million ounces is 529 tonnes, so I guess ZH was rounding up. And as of today, total inventories including registered, eligible and pledged, stands at 28.8 million ounces, or 897 tonnes! The thing is, Comex "inventories" include gold that simply conforms to Comex bar size standards and remains in a Comex approved warehouse or vault. It's all owned by someone, and it's not all for sale. It's the same thing as the LBMA stating that it had 8,326 tonnes of gold back in April (on April Fool's Day no less), when it is entirely plausible that their reserves are virtually gone:

LBMA reports record gold stocks

Gold stocks in London remain healthy with the latest published numbers showing record stocks of 8,326 tonnes of gold, which is equivalent to 666,045 standard 400-ounce gold bars. Visit the LBMA website for more information.


The point is, as I said above, there is no shortage of gold. All the gold still exists and is owned by someone. And just because it gets physically moved around (which, remember, is unusual), doesn't mean it changed ownership.

I don't know who the 550 tonnes came from (oops, I mean 529 tonnes). At least some of it was apparently flown over from Switzerland by Malca Amit, Loomis and Brinks, the three secure transporters of both the LBMA and Comex. Incidentally, according to Bloomberg:

Since late March, some 550 tons of gold -- worth $30 billion at today’s price and roughly equal to global mine output in the period -- have been added to Comex warehouse stockpiles.


Hmm. So the amount added to Comex inventories was roughly equal to the amount that would have been "in the [LBMA] flow" during that timeframe. That doesn't mean it was slack in the flow. Remember, everything was locked down, so the flow wasn't moving. Again, I don't know who it came from. It could have been borrowed, leased, swapped, whatever. Or it could have been bought at spot by a bunch of traders arbing the divergence by flying hundreds of tonnes into New York, like Bloomberg and ZeroHedge assume.

Like I said, I don't have any inside information beyond what I can read in the articles, but the unusual movement of that much gold does not scream plenitude to me. I don't assume that physical movement means someone bought it to move it, in fact, I would lean the other way. What if the "arbing traders" are actually the banks playing chicken with the "pandemic speculators", punishing them for the losses they incurred back in March?

Here's another question Organm999 asked on 6/2:

"Another piece of head-scratching data – weak gold demand from China. If the paper price of gold isn’t the “real” price, why are traditionally gold-loving Chinese selling their gold for a significant discount to the current paper spot price? https://finance.yahoo.com/news/china-reduces-paperwork-gold-exporters-152357741.html

This is the part of Freegold theory that I’m just not able to get my head around. I understand the manipulation and suppression of gold and how it works. I don’t understand though why there is so much physical gold available at this price."

China is a controlled economy, especially when it comes to gold. Gold can get into China a lot easier than it can get out. Normally that's not a problem for gold businesses in China, because as the article says, "China… typically consumes much more gold than it produces." But not in April. In April, the article says, "China's exports of gold via Hong Kong exceeded its gold imports via the territory for the first time since at least 2011."

My guess is the reason the Chinese people were buying less gold had something to do with the pandemic and the lockdown. But the Chinese people don't buy paper gold like Westerners, they buy physical gold at brick and mortar gold shops. One of the main principles of my "Freegold theory" as you call it is that the supply and demand dynamics on the physical side of the market have no effect on the official price of gold, which is derived as I said above on the bullion bank-sponsored spot unallocated trade in the international foreign exchange markets (see How Gold is Different and Gold as a FOREX Currency if you haven't read them yet).

So this is actually a neat little demonstration of how that principle works. But first, here's the full article you linked, because it's short and kind of interesting:

China reduces paperwork for gold exporters
June 2, 2020

(Reuters) - China's central bank and customs authority said on Tuesday they would simplify procedures for companies exporting gold, following a slump in domestic demand for the metal.

The economic fallout from the coronavirus pandemic led dealers to sell gold in China, the world's largest bullion consumer, at massive discounts versus the international spot prices.

Companies applying to export gold no longer need to submit physical gold inventory certificates approved by the State Council, China's cabinet, or gold production capacity certificates, the central bank said.

The People's Bank of China and the General Administration of Customs said in a statement the changes were aimed at reducing paperwork to make the process more convenient. Analysts said they were unlikely to have a significant impact on gold flows.

China has strict controls on exporting gold, and typically consumes much more gold than it produces.

But prices in the country in April fell as much as $70 an ounce below international prices - the biggest discount since Reuters records going back to at least 2014 - and are now around $20 below international rates.

In April, China's exports of gold via Hong Kong exceeded its gold imports via the territory for the first time since at least 2011, and Switzerland, which usually sends tens of tonnes of gold to China every month, shipped no metal to the country at all.


During April, the "international price" of gold actually rose from $1,576 to $1,741, an increase of $165. So if gold sold in China for $70 below the international price, that doesn't necessarily mean that the price in China declined at all. It could have simply not increased as much.

Now, the physical market price is normally subservient to the official "international price" (paper price) of gold, meaning physical trades at the paper price. This is important to understand because it means that the price doesn't respond to surpluses or shortages on the physical side, nor to increases or decreases in demand for physical. From my post, What drives the price of “gold”?:

The price of gold is driven up and down and wherever it goes with absolute disregard for the supply and demand dynamics of the physical side of the market. What this means is that the physical flow can dry up (i.e., run out) without running up the price, which, in other commodities, stops them from running out. In fact, it’s probably more likely to run out while the price is low. It’s also likely to simply stop trading in the event of a major financial market dislocation, even if it has nothing directly to do with the gold market. So the potential for the LBMA to fail and for paper gold and all that other stuff to no longer track the price of real gold is not only real, it’s probably way overdue.


In the case of China in April, there was a disconnection between the paper and physical price because of the one-way flow valve for gold set up by the Chinese government. Normally, as the article says, physical gold is flowing into China, which means demand is higher than supply. If you were to hypothetically isolate China from the rest of the world with demand higher than supply, then the price would rise in China until supply and demand reached equilibrium. But because gold is allowed to flow into China, the price doesn't need to rise because the flow adds supply until supply and demand reach equilibrium. But the flow is only allowed to respond freely in one direction.

What happened in April was that, because of the Wuhan pandemic and lockdown, demand was temporarily lower than supply in China. And because the outflow was restricted, the price had to change for supply and demand to reach equilibrium.

So, for a brief time in China, under unusual circumstances, the supply and demand dynamics of the physical side of the market (which is really the only side in China) were able to influence the price of gold. And yes, it was temporarily lower than the price of Western paper gold traded on the FOREX, where Western paper traders were driving it up.

Curiously, and for different reasons, the price of Comex gold futures also disconnected from the official (LBMA) price of gold around the same time. (Comex is a side show. Comex is not the official price of gold, it is also subservient to the LBMA spot unallocated trade, which eclipses it in daily turnover ten times over.)

Getting back to China, under normal circumstances, with gold flowing in, the LBMA paper price is dominant because external supply meets internal demand. But under this unusual circumstance, because external demand couldn't meet internal supply, the LBMA paper price became disconnected from the internal physical market.

You wrote in your comment/question: "If the paper price of gold isn’t the “real” price…"

The paper price of gold is the "real" price of paper gold. It automatically responds to feedback from the supply and demand dynamics of the paper side of the market (which includes aggregate balance sheet expansion and contraction by the bullion banks, the way they can manipulate supply if they want to), but not from the supply and demand dynamics of the physical side of the market.

This is the Achilles' heel of the paper gold market: There is no automatic feedback mechanism for the supply and demand dynamics of the physical gold market to affect the price of gold.

We got a glimpse of it in late March and April, when Comex and China, both under pressure from the supply and demand dynamics of the physical side of the gold market, disconnected from spot. It's not something that can be fixed within the existing market. It's part of how physical gold is different from everything else, and how paper gold is different from paper-anything-else.

Some might argue that the futures market did its job by drawing physical out of hiding during a demand spike and supply shortage, but that's not what happened, and what happened is not how a futures market is supposed to work. There is no need for a futures market in gold.

Yes, there was a demand spike and supply shortage as perceived by the speculators on Comex, due to the pandemic, the shut-down, and the stock market crash, but the futures didn't pull spot higher, they simply disconnected.

Futures markets exist so that speculators can relieve businesses of price risk from supply and demand shocks. Businesses hedge their physical side (spot) price risk by buying or selling futures on the paper side. If they buy on the physical side, they sell futures, and vice versa. Then when they sell the physical they bought (remember these are businesses, not investors/end users), they unwind the hedge by reversing the futures trade. So you can see how the disconnection of futures from spot might have caused some businesses to lose money.

Here's a short excerpt about futures markets from my post, Comex is a Side Show:

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 change. 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.


LBMA bullion banks are still the heart of the global physical gold market flow, but the spot price, which is and should be the price of physical, has been taken over by the massive $5-trillion-a-day currency market where gold is traded like just another electronic currency. And like other currencies, where each unit traded is a liability on some bank's balance sheet, each ounce-unit of gold that trades with other currencies is a liability on a bullion bank's balance sheet. And with a daily trading volume of around 173 million ounces (5,381 tonnes), that's a lot of liabilities.

Clearing volume today is higher than when this survey was taken, so turnover is likely higher as well, which means 173 million ounces is probably low as an estimate.

And because the currency trade is so much larger than the futures market (remember, one is about ten times larger than the other), the bullion banks hedge their gold currency exposure with complex derivatives based on currencies and commodities with a known historical correlation to the price of gold. (See The Great LBMA Survey Debate for background on this.)

The point is, the paper price of gold (the spot price) is not connected to the supply and demand dynamics of the physical gold market. Its only connection is the tenuous ability of the LBMA to manage a tight flow of physical (no slack=no reserves other than GLD shares held in street name only used for clearing, not redemptions or allocation requests) with redemption and allocation requests against a massive book of gold-ounce-denominated liabilities.

There are three basic purposes for which bullion banks need reserves. They are 1.) interbank clearing, the same as regular commercial banks need reserves for clearing, 2.) redemption requests, the same as regular commercial banks need cash for withdrawals, and 3.) allocation requests, which are like redemption requests in that the bank has to allocate actual bar numbers to the client, but more flexible because the physical bars stay in the bank's custody, making multiple claims on the same bars at least possible through some sort of fraudulent hypothecation. (It is irrelevant whether that is happening or not, I'm only making note that it may be possible with allocation, but not with physical withdrawal.)

Where bullion banks differ is that they don't have reserve requirements like regular banks do. (Do regular banks have those anymore? Hard to keep track these days.) So they don't need reserves for regulatory purposes.

Now, there is always a flow of new gold which passes through the bullion banks on paper, as I said above, from mines to refineries to mints to wholesalers to retailers, and on to end users. But if that flow is tight, meaning gold in = gold out, then it doesn't count as reserves, and can't be used for those purposes. Can you see how that works? If the gold outflow is as big as the inflow, then it's not going to end up as 400 ounce bars in London, unless that's where the end user wants it.

So, just because there's a flow, doesn't mean there are reserves. During the lockdown, the flow stopped. It was essentially frozen in place, which may have made it available to be placed in the Comex showroom window for a while. I'm not saying that's what happened, just pointing out that it's possible. There are many possibilities, some are more probable than others, and that's how my lens works.

Assuming the flow is tight and the LBMA is out of reserves, clearing would still not be a problem. Interbank clearing for the LBMA is like moving poker chips around a table. One day JP Morgan might have 10 chips while HSBC only has 8, and the next day HSBC might have 11 while JP Morgan has 7. And it's all on paper, just bookkeeping really. No gold is physically moved. And that's why I've long said that they could use GLD shares for clearing purposes if they ever got low on actual reserves.

GLD shares, the actual shares, can only be officially registered to (owned by) the banks, which means GLD shareholders are really just holding bank liabilities denominated in GLD shares. So, because the banks technically own the shares, and because it's not only possible it's provable that the outstanding number of shares never equals the number held by shareholders and therefore it's essentially a slightly-fractionally reserved bullion bank scheme, it is possible that, in the absence of sufficient actual reserves, GLD shares could be used for interbank clearing purposes. I'm not saying that's what they're doing now, just pointing out that it's possible. And if you understand how and why it's possible, you would also understand that, while there's nothing illegal or fraudulent about it, they'd still never admit it's what they're doing because it would be admitting that they are out of reserves.

Incidentally, the highest the LBMA daily clearing average has been this year is 908 tonnes per day, and that was in March. That's how many poker chips they shuffled around each day. Coincidentally, GLD had more than that all throughout March, and the lowest point the GLD inventory hit that month, which was on March 20th, was 908.18 tonnes, almost exactly the daily clearing average for the month. I'm certainly not suggesting that's anything more than a curious coincidence, but I thought I'd mention it since I looked it up. ;D

So how might we know if they're out of reserves? What signs might we look for? Well, if they had reserves, they wouldn't need to borrow CB gold from the Bank of England's vault to add to GLD, which actually happened in April!

If you don't know how GLD works, I recommend Just Another GLD Coat Check Room Post and Coat Check 101. The gist of those posts is that they never have to add gold to GLD. There's no mechanism that forces them to, it's always a choice of the bullion banks to add or remove inventory from GLD. So you might be wondering why they would add 46 tonnes of borrowed central bank gold to GLD in April.

Well, something similar happened once before, back in 2016, and I wrote several posts about it. If you're interested, I recommend Plausible Explanations (for GLD’s Recent Behavior), GLD Recap, GLD and the BOE, GLD and the WGC, and the summary I wrote in Eight!. The gist is that it looks like some big hedge fund money (through BlackRock) wanted to place a bet on the then-rising price of gold by creating new GLD shares, which is a way to get a large foot in the door without leaving a footprint in the market, basically like placing an off-market bet so as to maximize profit. And the World Gold Council, the sponsor of GLD, is happy to facilitate any increase in the GLD inventory because they make their fee based on the size, even if it's borrowed central bank gold.

I'm not saying that's what happened in April, but it's at least possible since it looks like that's what happened the last time they used BOE gold, and the gold price was rising substantially in April, so it does make sense. But here's the thing. There's no reason to use BOE gold if the LBMA has any reserves, at any of its banks, in any of its vaults. And, in fact, the 46 tonnes from the BOE weren't the only addition that month.

From March 23rd through the end of April (we don't know if any gold added after April came from the BOE or not), 133 tonnes were added, 46 of which came from the BOE on or around the end of April (between 4/15 and 4/27). What this looks like through my lens is that the LBMA put the last 87 tonnes of its reserves in GLD between March 23rd and April 15th, at which point it ran out of reserves. I'm not saying that's precisely what happened. There are many possible explanations, but that's one which my lens reveals.

How long could this go on, assuming zero reserves? Well, they've disabled all the smoke detectors, the inflow feeds the outflow, and clearing isn't an issue as I said, so all they'd have to do is to deny allocation and redemption requests, and there's no rule or regulation that forces them to provide physical in exchange for spot unallocated on demand. Quite the opposite actually.

So it could go on for quite a while. But that doesn't mean it's sustainable, or resilient under the condition of low to no reserves. I think the dislocation of futures from spot in March and April gave us a glimpse of its fragility. It cannot withstand shocks with no reserves, and we are now in a season of shocks, for the first time in more than a decade, and probably the first time with low reserves in more than two decades.

It's frustrating that the paper gold market seems to keep chugging along, and it's tempting to think that maybe it always will, that maybe we're missing something. But we're not. The longer I watch this thing, the more clear the big picture becomes, and the big picture is that we're near the end of the line.

With hindsight, we can see certain times when the LBMA was vulnerable, probably low on reserves, struggling to paint a façade of plenitude on a crumbling structure of scarcity and tight flow: In 1999 and 2008 when GOFO went negative, in 2013 with the rapid draining of GLD, in 2015 when they stopped publishing GOFO data, in 2016 when they borrowed 29 tonnes of central bank gold for GLD, and this year when they did it again, borrowing 46 tonnes this time.

Here's something I wrote back in 2018, and I think it is even more apt in 2020:

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 furrowed 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 appearances 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.


That should give you a better feel for "Freegold theory", at least my take on it. And sticking with the theme of the year, both articles were good fodder for the application of my Freegold lens. So thank you for your comments. In my New Year's post, I predicted that something big would happen this year, and already so much has happened. But I can say with confidence that the biggest is yet to come. I don't know if the election and its aftermath will be the biggest thing that happens this year, but it will be bigger than what we've seen so far. So stick around, because there'll be plenty more crazy to discuss this year!

Sincerely,
FOFOA