Sunday, December 31, 2023

Happy New Year!

Year of the Conflagration

Know this now, the world will again, in your time,
feel value in gold as never before. And that value will be as the
"productive use of holding wealth thru the fire of change".
-Another (2/7/98)

Conflagration has a couple of different meanings. The first is a very intense and uncontrolled fire, which burns over a large area and destroys everything. It's the fire of change. And the second is a state of armed violent struggle between states, nations, or groups, involving a lot of people. And in this case, I'm afraid that both meanings may apply.

Solitary Monk suggested conflagration back in late 2015, for 2016. If you remember, I named 2015 the Year of the Fire, so his suggestion implied an expansion and intensification, which was a very good suggestion. But in the end, I went with 2016 - Year of the Fire Sale, writing:

Last year, I began with “The dollar is on fire right now… 90.28 at the close!” The dollar has indeed been on fire all year, and is now at 98.69. Gold was just under $1,300 last January, and today it’s on sale for only $1,062. So my title for this year, in a way, is already a fait accompli.

I picked a different name for 2024 about six months ago, but I decided to push that one to 2025 after receiving an update from my crystal ball. So, for the first time ever, I have not only already named the next year a year in advance, but I’m not even going to keep it a secret. I’m going to share it with you right now:

Year of the Denouement

In case you don't know what denouement means, here's a paragraph from my 2011 post, Deflation or Hyperinflation?:

The whole point of the deflation versus hyperinflation debate is about the denouement, the final outcome of this 100-year dollar experiment. It is about the ultimate end, and the debate has been going on ever since the 70s when the dollar was separated from gold and it became clear that there would be an end. The debate is about determining the best stance someone should take who has plenty of net worth. And I do mean PLENTY. People of modest net worth, like me, can of course participate in the debate. But then it can become confusing at times when we think about shortages or supply disruptions of necessities like food. Of course you need to look out for life's necessities first and foremost. But beyond that, there is real value to be gained by truly understanding this debate.

Normally, I can only see out into the future about a year. The difference this year that makes it so I can see out 2 years into the future is the election scheduled for November 5th, 10 months and 6 days from today. I don't know how it's going to end, just that it's going to be messy.

"Nothing is yet known as to how this will ultimately unfold; but what is known is that something will change."

"The only thing that is certain is 'uncertainty'."

"All I know for a fact is that this can’t be resolved in an orderly way, and it won’t be, period."

Conflagration and denouement are basically death and rebirth. They imply the death and rebirth of the US political and monetary systems, because the two are inseparable. And, because the US monetary system is the global monetary system, the impact will be global.

Looking back about 24 years, I can see an emergent pattern, centered around presidential election years, that began with Bush v. Gore and this guy:
The 5-4 Supreme Court decision in favor of Bush after a month of recounting paper ballots was simply unacceptable to the Democrats. That's when they started working on secure election tactics. Not more secure elections, but tactics that could secure election results.

You can read the rest of the post at the Speakeasy. (See the side bar to subscribe.)

Here I'm giving you a portion of Think Like a Giant 4 that pertains to GLD, from back in November. And then I'm giving you a short update regarding GLD from my New Year's post. So enjoy, and have a Happy New Year!


One year ago, in November of 2022, GLD inventory hit 906 tonnes and stuck. For the preceding 6 months, from 4/20/22 until 11/4/22, GLD was drained from 1,106 tonnes down to 906 tonnes, a drain of 200 tonnes in just over 6 months. Then it hit 906 tonnes on 11/4/22, and stayed there, or at least within a relatively-tight range of 43 tonnes, between 901 and 944, for the next 9 months. That’s a range of plus or minus about 2.3% from its average during those 9 months, and that followed an 18% decline over the previous 6 months. Here’s what it looks like on a chart:
It was not only precisely 906 tonnes on 11/4/22, but also on 11/16, 11/17, 11/21, 11/22, 11/23, 12/1 (the day GLD announced that it was adding JPM as a 2nd custodian), and again on 12/6 (the very day that JPM began as a new GLD custodian). Nine months later, it was again at precisely 906 tonnes on 8/3/23 and 8/4/23. That’s when the drain resumed. As of this writing, GLD is down 38 tonnes in the last 3 months. Here’s how it looks on a chart:
During that same timeframe, actually the past 11 months, from 12/6/22 to 11/11/23 as I write, 53%, more than half, of GLD’s inventory was systematically moved from HSBC’s custody to JPMorgan’s. JPMorgan currently holds 459.83 tonnes of physical gold bars allocated to GLD, 437 tonnes in its London vault and 22.83 tonnes in its New York vault, and HSBC has 407.49 tonnes. Here’s a visual aid I made for this:
And for future reference, here are the HSBC bar list and the JPMorgan bar list that were current at the time I was writing. And here are the live links that get updated every business day:

One more note of interest is that this popped up on my XTL (Twitter/X timeline) just yesterday:
It says:

HSBC shifts part of US precious metal trades to UK
US subsidiary transfers all related market risk to headquarters

HSBC moved to consolidate precious metal trading under one roof in the third quarter, transferring all associated market risk, and part of its physical assets, from its US subsidiary to the non-ringfenced UK unit. HSBC USA Inc sold around $900 million worth of physical inventory to HSBC Bank Plc during the quarter, part of a decision to refer all stateside precious metal financing and trading clients to the London desk going forward. // The US subsidiary’s precious metal assets halved.

Doing the math, $900M works out to about 14 tonnes at the average price for the quarter. [Remember that number, 14 tonnes.]

So, what does any of this mean?

Well, first of all, HSBC is a bullion bank, so "physical inventory" simply means reserves, the physical gold equivalent of physical cash in ATM machines. HSBC transferred half of its gold reserves from its US subsidiary to its LBMA headquarters in London according to that report. This fits nicely with my long-held suspicion that the LBMA has been operating without reserves for several years now.

To recap, banks need reserves for basically three reasons: 1. to meet reserve requirements, 2. for interbank clearing, and 3. for withdrawals. Bullion banks don't have physical bullion reserve requirements on the bullion side of their business, so they don't need physical reserves for #1. As for clearing, the LBMA has created the LPMCL (London Precious Metals Clearing Limited), a separate corporation consisting of HSBC, JPMorgan, UBS and ICBC Standard, for clearing.

ICBC, while it is both a clearing member of the LPMCL and a vaulting custodian for the LBMA, has recently stopped participating in LBMA gold price auctions, raising the obvious question of whether or not it's even still involved in the LPMCL:

It's also the bank that got hacked last week:

And UBS, while it's a clearing member of the LPMCL, is not a vaulting custodian of the LBMA. So it's really just JPMorgan and HSBC doing the physical clearing if there is such a thing, which there isn't by the way. The rest of the LBMA's reserves are unallocated liabilities of the clearing banks, and clearing is all done on ledgers. So they don't need physical reserves for #2.

That leaves us with #3, withdrawals, or allocation and delivery as it's called in bullion banking. That's the only reason the LBMA needs physical reserves, and in most cases, they simply don't offer allocation or delivery, and that's how they've been operating without reserves for at least several years.

I know I've explained it many times before, but reserves are the slack in the flow of gold flowing through the LBMA system of gold industry financing, from mining and recycling to refining, minting, fabricating and wholesaling. And GLD is where that slack now sits. It wasn't designed that way, but GLD, which began in 2004, turned out to be a convenient "coat-check room" for any slack in the flow.

Physical gold is worse than a dead asset to bullion banks, because there's a "carrying cost" (storage and security) associated with it. And GLD gave the bullion banks a place to park that slack in the flow, and let unwitting GLD shareholders pay the carrying cost of the gold. It was a win-win for the banks, because they could put it in when it wasn't needed, and pull it out when it was needed for delivery or allocation.

It's easy to think that there's something nefarious going on with the bullion banks using GLD in this way, but there's not. It's just the way things worked out, and it only applies to GLD, not any other gold ETFs, silver ETFs, SLV, or any other ETFs, period. Most ETFs are managed to some extent in order to track the price of the underlying asset. That means the inventory of underlying assets generally correlates with the price, and sometimes we see this with GLD, but not always.

No one debates me on this coat-check analogy anymore, but I know that many of you simply dismiss it out of hand. You shouldn't, though, because it's true. It's the right way to view GLD, which is different from all other ETF products simply because it's the LBMA's gold ETF, and because gold is different than anything else, even silver.

The clearest statistical proof that coat-check is right (because logical reasoning alone is not enough proof for some people, especially technical analysts) is in this post. If coat-check were wrong, which as I said is the case with SLV, you'd expect GLD and SLV to behave similarly during a given timeframe of any length. In that post, we look at the timeframe just preceding the big drop in April of 2013, specifically the first quarter of the year, from January 1 until April 13th, 2013, the day before the price collapsed.

During that timeframe, the gold price dropped from $1,693 to $1,535, a mild 9% decline compared to what followed. The silver price also dropped, from $30.87 to $27.40, also a 9% drop. But the GLD and SLV inventories moved in opposite directions during that time. SLV added 366 tonnes, while GLD lost 205 tonnes.

Now, you might be thinking that GLD did what you'd expect it to do during a price decline, it lost inventory, and SLV did the unexpected by gaining inventory during a price decline. But that's not all. There's an even more convincing period we looked at in that post:

As shown in Chart 2, from February 1st through September 6, 2011 (151 trading days) the price of the GLD increased from $129.92 to $184.49 or by 42%, while there was essentially no net creation of ETF shares to purchase the underlying physical gold. There were 404 million shares outstanding on February 1st and on September 6th, there were 406.8 million shares outstanding; an increase of less than 1% (virtually no net change in the amount of gold in the pot).

This was the big run-up in gold, to its all-time high. You remember. It went from around $1,330 on February 1st up to $1,895 on September 6.

Yup, that's a 42% rise in the price of "gold" as well, so GLD did a fantastic job of tracking it. And the fact that there was virtually no change in inventory during this remarkable run should put to bed once and for all the idea that the arb is physical. A net total of 5 tonnes was added, actually less than half a percent.

There are various schools of thought on how the mythical physical arb might function, but this period alone should sufficiently debunk all of them. And the only alternative left is that creations and redemptions are a choice made by the banks, not forced upon them by investor sentiment or inflows. And if they're a choice (which they are), then "coat check" is the only view that makes sense.


For those who still don't quite get it, the argument is basically this: The consensus, the settled science, almost anyone you ask, even GLD itself, says that GLD tracks the POG through a physical arbitrage carried out by the APs, the Authorized Participants or bullion banks that act as market makers for the ETF. If net-interest in GLD is higher than in physical, the APs buy physical and put it in GLD, creating new shares. If net-interest in GLD is lower than in the underlying asset, the APs redeem baskets of shares and sell the physical, profiting the difference.

Under this view, whether gold is put into or taken out of the ETF is driven by the public's demand for GLD shares relative to gold, its underlying asset. Coat-check, on the other hand, shows that the arbitrage is all paper, unallocated gold, not physical, and therefore GLD tracks the POG not because the APs run the arb, but simply because the market keeps it tracking. The arb that keeps GLD tracking the POG is open to anybody, and that's why it tracks it so well.

The corollary is that the creation and redemption of shares (putting physical gold into or taking it out of GLD) is purely a matter of choice by the bullion banks running the show. GLD is going to track the POG no matter how much gold is in there, and no matter what the price action is doing, because the arb is between unallocated XAU/USD and GLD shares, and is therefore open to anyone with a computer.

Taking it one step further, the creation and redemption of shares (putting physical gold into or taking it out of GLD) is purely a matter of choice, not by just any LBMA bullion bank, but ultimately by only the custodian, which from 2004 until 11 months ago, was one sole bank, HSBC. Today it is two banks (more on this line of thought later).

The reason the custodian(s) has all the power, is because it's his responsibility to source the actual bar numbers that get allocated to the ETF. Say, for example, Goldman Sachs, an AP and LBMA member but not a London vault or custodian, is expecting a London delivery of some (unwanted) physical. It is unwanted because GS is going to have to pay to store it at HSBC or JPM. In any case, the physical gets delivered to HSBC's vault and credited to GS as unallocated in its interbank account with HSBC.

GS may owe some of that unallocated to someone else to clear some trades, or it can choose to exchange it for either dollar cash or GLD shares, either through another bank, with the public, or with HSBC itself. HSBC doesn't care what GS chooses, but GS's choice does not affect HSBC's choice of what to do with the physical. GS is not going to pay storage costs either way, so HSBC will place the bars wherever someone else is paying for the storage, either in GLD if they're not needed elsewhere, or allocated or delivered elsewhere if needed.

The reverse is true as well. HSBC can pull gold out of GLD at will when it's needed elsewhere, for delivery or allocation. This is how and why the slack in the flow ebbs and flows over time. When the flow is tight, we see GLD draining. And when there's gold coming in (or not flowing out), we see GLD expanding. The last time it expanded to any significant degree was in 2020, during COVID. That was most-likely due to physical outflows being blocked by global lockdowns (it was not flowing out).

This is important to understand when looking at the larger trend which I outlined above. Remember, the bullion banks do not need (or want) physical bars for anything other than deliveries and allocation. So, when we see the big drain of 200 tonnes from 4/20/22 to 11/4/22, we can suppose that someone or multiple someones of some clout was/were requesting (I guess the clout makes it more of a demand than a request) either delivery or allocation.

Then we see it stop at 906 tonnes, and sit there for a month until they bring in a 2nd custodian, and the outflow is cut off until the two custodians have basically split the physical 50/50, and then the drain resumes. The drain not only resumes on August 4th, barely three months ago, but HSBC also transfers half of its reserves held in the US over to London. So, just in the last quarter, we see another 38 tonnes gone from GLD, and another 14 tonnes brought over from the US by HSBC, presumably for delivery or allocation, for a total of about 52 tonnes, halfway back to the drain-rate of 2022. Looks like someone, or several someones of some import, have been demanding (and taking) delivery.

Over the last few years, the gold market developed with a two tier nature. Entities that had massive oil to supply a needing world would most certainly receive their gold in "allocated" form if they asked for it. Whether it be from private investors who exchanged their physical for holding paper derivatives or from the vaults of Major CBs, this gold would come from somewhere, "come hell or high water".
-FOA (10/6/99)

The important thing to note in that paragraph is that he's talking about the two tier nature of the 1999 gold market not in terms of two prices, but in terms of the top tier being those entities who would receive physical allocation (or delivery) if and when they asked for it, and that it would be sourced one way or another, "come hell or high water." One way the gold would be sourced would be to "borrow" it from someone who had allocated physical. FOA goes on to talk about the lending of gold via the gold carry trade, which was popular at that time:

The modern financing tool we call the "gold carry trade" is now becoming the poison that will kill this market. The demands of gold lenders to return their "at risk" positions are creating an atmosphere where no amount of physical gold exists that can supply the outstanding paper claims. Great blocks of gold are now lent into the markets at 4% or greater, where once 1% was considered a good return. As each new group of lenders enter the market they are followed close behind by former lenders demanding their gold return. Fear begins to grip those who were once bullion owners as they now became paper pawns. Each new demand for "full allocation" creates yet further demands to borrow. The supply of new lenders grows smaller and smaller as the possibility of default increases. -FOA (10/6/99)

For those who don't understand the "gold carry trade," here's a brief explanation from

Gold Carry Trade
A carry trade where you borrow and pay interest in order to buy something else that has higher interest. The gold carry trade works as follows. A central bank loans a bank (sometimes called a bullion bank) some gold. The gold lease rate is usually very low. The bullion bank immediately sells the gold and invests in securities with a higher rate of return, such as government long-term bonds. The carry return is the return on the bonds minus the gold lease rate. However, this trade is risky on two dimensions. First, if the bullion bank invested in long-term bonds and the interest rate goes up, the trade could be unprofitable. More seriously, the bullion bank has effectively sold the gold short. If the loan is called by the central bank and if gold has risen in value, the bullion bank will have to go into the market and purchase higher priced gold. Indeed, if many banks are short, the unwinding of the gold carry trade could drive the gold price even higher.

An important thing to remember here is that the CBs did not lend actual physical gold. They only lent it on paper, and the physical gold, if necessary, came from someone else, either borrowed or purchased from some other entity, or from the mines.

[Central] Banks do lend gold with a reason to control price. If gold rises above its commodity price it loses value in discount trade. They admit now to lending much where they would admit nothing before! They do this now because of the trouble ahead. Does a CB have collateral to lend its gold? Understand, they only lend their good name on paper, not the gold itself. The gold that is put on the market in these deals belongs to someone else!
-ANOTHER (11/16/97)

The world private stockpiles that could be sold have been. The CBs are heavy into their own stuff now and are over their heads if they had to make good on all the private deals.
-ANOTHER (10/19/97)

How DO they do it?

It's more complicated than this but here is a close explanation. In the beginning the CBs didn't sell their own gold. They ( thru third party ) found someone else who had bullion. That "party" sold to a broker who sold forward for a mine or speculator or government ) . In the end the 3rd party had the backing from the broker that he had backing from the CB to supply physical if needed to put out a fire. The CB held a very private note from the broker as insurance and was paid a small fee. This process mobilized free standing bullion outside the government stockpiles. The world currency gold price was kept down as large existing physical stockpiles were replaced by notes of future delivery from the merchant banks ( and anyone else who wanted to play ) .

This whole game was not lost on some very large buyers WHO WANTED GOLD BUT DIDN'T WANT ITS MOVEMENT TO BE SEEN! Why not move a little closer to the action by offering cash directly to the broker/bank ( to be lent out ) in return for a future gold note that was indirectly backed by the CBs. That "paper gold" was just like gold in the bank. The CBs liked it because no one had to move gold and it took BIG buying power off the market that would have gunned the price! It also worked well as a vehicle to cycle oil wealth for gold as a complete paper deal.

Are you with me?

Well a funny thing happened right after the Gulf war ended. What looked like big money before turned out to be little money as some HK people, I'll call them "Big Trader" for short, moved in and started buying all the notes and physical the market offered. The rub was that they only bought low, and lower and cheaper. They never ran the price and they never ran out of money. Seeing this, some people ( middle east ) started to exchange their existing paper gold for the real stuff. -ANOTHER (10/12/97)

I know this one is a little confusing. But don't worry, I'll simplify it for you.

When he says brokers, he's talking about the bullion banks of the LBMA. Remember, there's no shortage of gold. All the gold ever mined is still out there, owned by somebody. You just don't know who those owners are. So, the idea here in the mid-90s was to "mobilize" some of those large, non-government, non-CB stockpiles of physical to supply physical demand to those top-tier entities who would receive physical allocation (or delivery) if and when they asked for it, which would be sourced one way or another, "come hell or high water."

When he says third party, or just party, he's talking about the person or entity that has a large stockpile of physical. And when he says that party "sold" the gold to the broker (the bullion bank), he really means lent, in a repurchase kind of way. It was "sold" with, essentially, a repurchase agreement, because he then says that the 3rd party (the original owner of the gold) had assurances from the broker (the bullion bank) that it had assurances from the CB that CB physical would be made available in extremis (ie., to put out a fire).

In essence, the CB was lending its gold to the bullion bank on paper (the "very private note" he mentions was that promissory note from the bullion bank to the CB, for which the bullion bank paid a small rate of interest, 1% or lower, for the guarantee that CB gold would be made available if necessary). A sale with a repurchase agreement is essentially a loan. The interest is worked into the repurchase price, so the seller of the gold is assured that he will be able to buy it back, whenever he wants, at the market price minus a discount representing the interest. Either that, or he's paid a premium up front representing the interest.

In any case, this was 1997, and the price of gold had been declining for more than a decade. So, if you had a very large private stockpile of gold, and you had a guarantee from a CB that CB gold would be used to keep the price from rising (ie., to put out a fire), then it made sense to sell your gold for cash to buy Treasuries that paid interest, and then buy the gold back later when the price started rising. So, there may or may not have been a formal repurchase agreement, but these are the people that FOA was talking about in 1999 when he wrote:

The demands of gold lenders to return their "at risk" positions are creating an atmosphere where no amount of physical gold exists that can supply the outstanding paper claims. Great blocks of gold are now lent into the markets at 4% or greater, where once 1% was considered a good return. As each new group of lenders enter the market they are followed close behind by former lenders demanding their gold return. -FOA (10/6/99)

The "parties" whose "free standing bullion outside the government stockpiles" was mobilized and "replaced by notes of future delivery from the merchant banks (ie., the LBMA bullion banks)" that Another was talking about in October of 1997, were the "former gold lenders" involved in the "gold carry trade," "demanding their gold return," that FOA was talking about two years later, in October of 1999.

The rest of the quote from Another above is about how it then evolved into a purely paper market, where gold traders would buy those same CB-guaranteed "notes of future delivery from the merchant banks (ie., the LBMA bullion banks)" with cash rather than "free standing bullion stockpiles," and the CBs were fine with it because "it took BIG buying power off the [physical] market," and it "also worked well as a vehicle to cycle oil wealth for gold as a complete paper deal."

The problems started in the mid-90s, when "Big Trader" from Hong Kong "started buying all the notes and physical the market offered." "He" was buying the CB-guaranteed notes AND the physical. Seeing this, others who had been sitting on CB-guaranteed notes (ie., the Saudis), started demanding allocation and delivery, and they were the "entities who would receive physical allocation (or delivery) if and when they asked for it, which would be sourced one way or another, 'come hell or high water.'"

We have seen the last of cheap oil in US$ as the oil states are no longer taking paper gold! I think a large purchase of bullion was just made by them. It should have been paper. The BIS must soon take a stand! -ANOTHER (11/30/97)

That was the basic situation when Another showed up on the scene, warning of the possible collapse of the gold market. The CBs that came up with this deal thought that the "notes of future delivery" they were guaranteeing with their own gold would be fulfilled by new gold coming from the mines:

It was never the intent of the CBs to sell their countries gold in massive amounts. The "understanding" that was worked out years ago was good for the economies and the world. In return for the US$ remaining the "oil reserve" currency, ( oil would be not just supplied but supplied in dollars ) large amounts of gold would be supplied far into the future. The gold, while indirectly backed by the CBs would actually come from the mines of the future. With the oil money making a ready market for gold priced at a premium ( contangoed out many years ) , the mines could make a fair profit even with spot gold priced below production. All would win! And for some time, we did! I am able to know some CBs, they are not evil, their minds are for the best that can occur. But, I THINK the world ran away from them. -ANOTHER (11/13/97)

The Asians are the problem, by buying up bullion worldwide and thru South Africa they created a default situation on all the paper for the oil / gold trade! Now the CBs are selling in the open to calm nerves but it's known that they will never sell enough. It was never their intent to provide the gold, only the backing until new mining technology could increase production. Over time the forward sales, such as ABX's should have worked. But LBMA went nuts with the game and the whole mess has now accelerated. -ANOTHER (10/19/97)

The commodity value of gold was forced so low in paper currency terms that all of the new mined gold, going out some 10 years is spoken for. Between the third world buying physical gold and the jewelry industry ( same people buying ) there is none left for the oil states! -ANOTHER (10/9/97)

The BIS and other various governments that developed this trade ( notice I didn't use conspiracy as it was good business, as the world gained a lot ) , thought that the paper gold forward market would have allowed the gold industry to expand production some five times over! Don't ask where they got this, as they are the same people that bring us government finance and such. But, without a major increase in gold supply, the paper created by this "gold control operation" will either be paid by, 1. new supply. 2. the central banks. 3. rollover existing. 4. cash? 5. or total default! As the Asians started buying up everything last year ( 97 ) , number 5 and 5 started looking like the answer! When the CBs started selling into this black hole of demand, the discussion of #5 started in their rooms also.
-ANOTHER (2/16/98)

Trading of gold, on and off official markets dwarfs not only new mine supply but is even larger than all existing stocks. LBMA, trades a million ounces a day! And that is only what is seen. -FOA (9/29/98)

The problem back then, the amount of physical needed at the time, was about 14,000 tonnes according to Another. Since then, some 70,000 tonnes have been added to the above-ground supply, Barrick (ABX) retired its forward sales hedge book, and the pressing issues of the time (1997-1999) were overcome.

My point of walking you through all of this is because I think that what we see happening today with GLD draining, and HSBC moving reserves from New York to London, is that some top tier entities, who are not necessarily the same ones as 25 years ago, are demanding (and receiving) allocation and/or delivery.

It is my suspicion that the LBMA does not have any slack in the flow other than what's in GLD, and it uses GLD as its reserve pool. I have also deduced that most if not all of what's in GLD must already be spoken for, or at least its ultimate distribution is under the control of some group of central bankers (I'm not using the term BIS here because it triggers some of you, and all you can think of is the woke fat guy πŸ˜‰).

South Africa is now part of the BRICS, who have essentially splintered off from the half of the world that contains the LBMA. China, also part of the BRICS, is buying gold directly from Africa, which was part of the problem in the 90s as it diverted LBMA inflow. So, there's not only no slack in the flow of gold passing through the LBMA's gold industry financing network, but the outflow is significantly higher than the inflow, as can be seen in the above-mentioned draining and movements.

The initial 200 tonne drain began in April of 2022, less than two months after the entire West sanctioned Russia and anyone who did business with Russia (essentially sanctioning the BRICS), and froze Russian assets. The timing could be related.
I initially speculated that the 906 tonne number was the amount in GLD that was already spoken for, and that's why the drain was stopped at that number. In hindsight, now, I think it was probably stopped in order to bring JPMorgan on as a 2nd custodian.

There was absolutely no obvious need for a 2nd custodian. It wasn't like they needed more vault space; GLD was getting smaller, not bigger. And HSBC had apparently done a fine job as the sole custodian for 18 years.

I later speculated that perhaps JPMorgan was added to location-swap GLD inventory with its vaults in Switzerland and New York, but that hasn't happened. There is no GLD gold in Switzerland, and the amount in JPMorgan's New York vault is the same as it was back in May, 22.8 tonnes, which is only 2.6% of GLD.

What happened was that the drain resumed right around the time that JPMorgan and HSBC hit 50/50 parity in terms of GLD holdings, which happened around July 12, 2023, about a month before the BRICS summit in South Africa. Perhaps the timing is related.
Remember above, I said "more on this line of thought later"? That was regarding HSBC being the sole custodian, and therefore being the sole entity that could decide whether to create or redeem shares, whether to allocate or deallocate physical bars to or from GLD.

All interbank GLD share creation and redemption transactions between HSBC and all of the other APs, including JPMorgan before it became a custodian, were transacted in unallocated gold, meaning gold credits, or "gold of the mind." If GS, for example, wanted to redeem some GLD shares, whether on behalf of itself or a client doesn't matter, then it would receive unallocated credits from HSBC. There is nothing that says that HSBC has to deallocate bars. HSBC could simply take the shares and issue credits to Goldman Sachs. This probably happened many times, when one bank would be redeeming while another was creating, HSBC would simply manage the flow.

Goldman Sachs, if it wanted physical gold, whether for itself or its client doesn't matter, could then request allocation or delivery. But again, HSBC would be under no GLD-related obligation to grant the request. There's nothing wrong with this, it's just the way GLD and the LBMA operate, and understanding the way they operate in extremis, helps us understand the actions they might take when facing extremis.

During normal times, I'm sure this all worked just fine. It was HSBC's job as custodian of GLD to source physical when needed, and to provide physical when requested. As GLD gradually became the entirety of the LBMA's physical gold reserves, as everyone eventually learned that parking any slack in the flow in GLD was the most efficient way to store reserves, HSBC ended up with a tremendous amount of power with regard to controlling the slack in the flow.

In extremis, having a single entity in charge of managing the LBMA's reserves, that entity can unilaterally decide where those bars go. But once you add a second entity, neither one can make unilateral decisions. So, I now think that JPMorgan was brought in to eliminate the risk of a single entity unilaterally giving away the rest of the gold.

I don't think anyone at either bank even knows this stuff. They're just doing their jobs. As I've said many times, the banks don't even own this gold, and banks aren't individuals. And most people who work at banks don't even like gold, haven't even heard of Freegold, and, if I'm being honest, aren't very creative or curious. Perhaps they're smart, greedy, and willing to break a rule here or there for a buck, but they aren't thinking like us about how unallocated differs from physical, and its inevitable revaluation.

Now, as I've said, not anyone can just go buy physical gold from a bullion bank. It's just not what they do. They'll tell you to go to a gold broker or a coin shop, depending on how much you want to buy. But if you happen to have $65M, you could probably buy a pallet of gold bars, and you might even be able to take delivery from HSBC's vault, although it's pretty unlikely.

That said, there are individuals and entities that have much more than $65M which they want to protect with the timeless wealth asset known for revaluing whenever monetary and financial systems collapse, and new ones rise from the ashes. And I have no problem imagining that, following the seizure of state and private Russian assets in March of 2022, that the LBMA was hit up for whatever gold it could cough up to individuals and entities with that kind of money, and I'm talking billions, not millions.

All such requests, if not outright turned down due to Russian-sounding surnames, would eventually make their way to HSBC, the sole LBMA member capable of unilaterally deciding whether or not to honor a physical delivery request. And having never had to actually turn one down before (even though they could have), because that's just the way it worked, I can easily see them unwittingly draining 200 tonnes from GLD before someone stepped in and stopped them.

Again, the drain lasted from April 20, 2022 until November 4, 2022, a little more than 6 months, with GLD draining at an average rate of about 30 tonnes a month, or 1 tonne per day. Then it stopped, held steady for a month and a weekend, and voila, GLD suddenly had a 2nd custodian.

Then, no more drain until the two custodians held equal amounts, and now the drain is on again, only this time a little bit slower, as if it's being managed by a third party.

And that's why I now think that JPMorgan was added as a GLD custodian. There were other theories, but after 11 months, none of them panned out. And with 11 months of hindsight, now, I think this explanation makes perfect sense.

Whether the gold was already spoken for, previously purchased, or is being sold now to top tier parties at 2nd tier prices is beyond the purview of this speculation, at this time. But it appears that distribution is ongoing, rather than just waiting for the inevitable termination event.

[There is much more to this post at the Speakeasy, as well as 525 comments under it. But this was the part about GLD.]

And here's the New Year's Eve update:


GLD is currently at 879 tonnes. There's not much to be gleaned from that number alone, but it is still consistent with what I wrote back in November, in Think Like a Giant 4, and there's an interesting new trend emerging. It's up about 11 tonnes overall since 11/11/23. But if I look at HSBC and JPM individually, HSBC is up 28 tonnes, while JPM is down 14 tonnes since 11/11, for a net increase in GLD of 14 tonnes. So, why don't the HSBC and JPM bar lists match the GLD spreadsheet (14t vs. 11t)?

Remember, the bar lists that the custodians put out are two or three days behind the daily spreadsheet that GLD puts out. When shares are created or redeemed, it happens on paper, using unallocated or paper gold, and GLD reports it that day. Then, the custodians have three days to either source the new bars, or decide which bars to deliver. So what they report each day actually matches what GLD reported two or three days earlier.

So, if we go back two days, we see that GLD had 882 tonnes on Wednesday, which matches the custodian bar lists, with an increase of 14 tonnes since 11/11/23. This is kind of interesting since we know that HSBC transferred about 14 tonnes from its US subsidiary to its London vault.

So, 14 tonnes (net) were added to GLD, and it appears that it was HSBC's turn to source that gold. Remember, back on 11/11, even though they were pretty balanced, HSBC had about 53 tonnes less than JPMorgan.
So HSBC gets a 14 tonne addition, and takes 14 tonnes that are already in GLD from JPMorgan, and also sources 14 tonnes from its US subsidiary. Now they are only 10 tonnes apart. On 11/11, they were 53 tonnes apart, and today they are only 10 tonnes apart! HSBC has 436 tonnes of GLD gold, and JPMorgan has 446 tonnes, as of Wednesday.
2.6 tonnes came out between Thursday and Friday. It'll be interesting to see if they came out of JPM's vault, because that would put them even closer to even. We should be able to check on Tuesday and Wednesday.

So, for convenience, here are the HSBC bar list and the JPMorgan bar list from 12/29/23. And here are the live links that get updated every business day:

We'll check again on Tuesday and Wednesday, and if both withdrawals came out of JPMorgan's vault, then it looks like someone is trying to make them even-steven.

I'll also note that the amount of GLD inventory in JPMorgan's New York vault remains the same as it has been for the past 7 months, 22.83 tonnes. This raises the question, in my mind at least, whether HSBC actually physically moved 14 tonnes from New York to London, or if it was only on paper. And if it was only on paper, the question remains, are those 14 tonnes in New York or London? Because even though HSBC USA Inc. "owned" that gold, and sold it to HSBC Bank Plc. London last fall, it could have been in London all along. Or it could still be in New York.

We don't know what any of this means, yet, but it's interesting to watch, since it doesn't quite seem random that HSBC now holds 49.4% of GLD's inventory, and JPM has 50.6%. And if the next 2.6 tonnes come out of JPM, it'll be 49.6% and 50.4%. So if there's a third party managing GLD now (and it would be the BIS acting through the BOE), which I speculated in Think Like a Giant 4, then it seems to want equal amounts in the two banks for some unknown reason.

Happy New Year, everyone!!!


Wednesday, August 23, 2023


Today this blog turns 15!
At the Speakeasy, there's a new post up called Credibility Deflation, because this is also the 13th anniversary of the original post, Credibility Inflation! If you would like to subscribe to the Speakeasy, there's a link in the side bar, or just shoot me an email at fofoamail at gmail dot com.

Here, I'm giving you a short post from a couple of weeks ago, titled How 'bout a Brick, because today is also the 15th annual BRICS summit, which ends tomorrow. I don't know what's going to come out of the summit, but here's something I wrote about it recently:

How 'bout a Brick
“In these fertile grounds
people escaped reality with the New Idea
of long term debt, (Deep bond market?!?)
being held as a money asset. Yes, here was born
the American Experience that comes to maturity today.”
-Another via Zinpa

Earlier today, someone wrote:

"Anop – good article.

At the end the author concludes:

“What the BRICS don’t have – at least not yet – is a viable bond market with which to challenge the US bond market. However, according to Rickards, the means by which states financed warfare in the twentieth century might provide a greatly expanded BRICS bloc with a means of quickly developing a viable bond market:”

Many people have made a similar claim that the BRICS monetary system requires a deep bond market. I’ve been thinking that using internationally recognized debt (US treasuries) as central bank’s primary reserves is an artifact of Bretton Woods post 1971 rather than a prerequisite of a monetary system. If they hold gold as a primary reserve, use an anchored BRICS trade currency for trade, and are able to settle accrued imbalances in gold there is no need to have a deep bond market.

Any thoughts on this from the SE or FOFOA?"

Here's another quote from the article:

Given the choice between putting your savings in a BRICS bond or in Zimbabwe Dollars, Sudanese Pounds, Venezuelan Bolivar or even Russian Roubles, the BRICS might well emerge with an instant market of several billion people. After which, even western traders are going to get involved. At which point, would you rather invest in a BRICS Bond or a British Gilt?

Okay, let's think about this. According to Jim Rickards, they will define the new BRICS international trade clearing currency as a weight of physical gold. He said it could be an ounce, but whatever they say it is doesn’t really matter. It’s just how the exchange rate will be calculated in each country, between that country’s local currency and the new BRICS clearing currency. The exchange rate will be the price of gold in that currency.

They're not creating a new physical currency like the dollar (which was defined as a weight of gold once, but also belonged to a single country, and therefore the definition had to be defended by that country's gold reserves). They're also not creating a new country-less ("supranational") reserve currency like the SDR (which is defined as a basket of certain countries' currencies, and redeemable in those currencies). According to Rickards, they are creating something more like the idea of the Bancor, which was sort of a hybrid, somewhere between the SDR (being country-less) and the pre-71 dollar (being defined as a weight of gold).

Let's call it a brick (like a brick of gold). And, rather than an ounce, let's imagine that they define it as 1 brick = 1 gram of gold. Right now, 1 gram of gold costs about $62, so that's a reasonable definition. (According to Rickards, they considered using a basket of commodities, including oil and gold, but went back to just gold.)

They'll work out the details of how it will work. I don't need to speculate on the range of possibilities, but it's quite large. And let's be clear, this is not Freegold they are creating. And it's not going to end the $IMFS, which is ending regardless. But let's go back to the question in the quote: "Given the choice between putting your savings in a BRICS bond or…"

A brick is going to be kind of like an SDR. You can't hold an SDR. There are no physical SDRs. There's no SDR bond market. An SDR is a unit of account, and it was originally defined as 1 USD, which in turn was defined as 1/35th of an ounce of gold (which is pretty close to a gram, btw).

In the 70s, the definition of an SDR was split into a basket of currencies. Today, the definition of an SDR is 0.57813 USD + 0.37379 EUR + 1.0993 RMB + 13.452 JPY + 0.080870 STG = 1 SDR. So, you can't hold an SDR, but you could hold those currencies in those exact amounts, and you'd be holding the very definition of an SDR, i.e., an SDR. But just beware, they change the definition of an SDR every five years or so.

Now, if a brick is defined as a gram of gold, then if you want to hold a brick (which you can't), you'd just go buy a gram of gold. See?

If everyone is doing that with their savings at the individual level, then there will be little need for central banks to settle trade imbalances at the national level. This is the essence of Freegold.

Each country's currency will have an exchange rate against a brick, which will basically be the price of a gram of gold in that currency. And if you're an importer or exporter, doing international business within the BRICS zone, you'll invoice, pay and be paid in bricks, which you'll get from, and sell back to, the local banking system, which will get them from your local central bank. They'll be digital central bank tokens, issued by the BRICS secretariat.

Let's say, and this is just a guess, but let's say they decide to issue to each participating central bank an amount of BRICS equal to double their central bank gold reserves. That's a reasonable amount, and it would be well above (maybe 40% greater than) expected intra-BRICS annual trade volume. They could call it "50% backing" which, in gold standard terms, would sound good (even though they're not actually backing it with their central bank gold).

The original five BRICS countries have a combined total of 5,296.8 tonnes of gold, which is 170M ounces, or 5.3B grams. If they issued double that, it would be a total issuance of 10.6B bricks, with a current dollar value of $657B. As you add more countries to the BRICS, you issue more bricks, and right now, 40 more countries want in, including Saudi Arabia.

Since bricks are digital, they could easily be divisible down to the penny.

If you, a Chinese exporter, receive a surplus of bricks, you will exchange what you need in currency for yuan (at the bank), and you'll buy gold with the rest (perhaps also at the bank). The banking system could easily offer exchange of yuan, bricks and gold, but you can't hold bricks in your account for more than, say, a week (perhaps a little longer depending on your particular business needs).

All bricks exist on a central ledger at the BRICS secretariat, and are credited to the accounts of the member central banks. The central banks exchange them with commercial bank customers on demand, at the going exchange rate, and commercial banks are merely the facilitators of these transactions between individuals/businesses and the central bank.

When bricks get sent to an exporter in another country, they are debited from the sending central bank's account, and credited to the receiving central bank's account. The receiving customer then has a week to either send them as payment to someone in another country, or exchange them for local currency or gold. If he does nothing, then they get automatically exchanged for local currency in his account.

Now, this might seem like a gold standard since you can redeem them for gold at the bank, but that's no different than buying gold with cash. In fact, it could work the same if, instead of buying gold from the bank, there was an independent gold dealer right next to each bank, and you simply exchanged all of your bricks for local currency, then walked through the glass doors to the gold shop to buy whatever portion you wanted to save in gold.

This is the essence of Freegold, that currency is redeemable in gold, at a floating rate. It's redeemable from the marketplace, not from the central bank gold reserves.

So, the brick is essentially a CBDC used for intra-BRICS international trading, but it can't be used locally, and it can't be used for savings. If you need to borrow some bricks for a transaction, the loan will be denominated in local currency, not in bricks.

Bricks will flow back and forth, and most trades will net out, but if bricks start accumulating in certain central bank accounts, it will represent a trade imbalance, and it can be dealt with at the central bank level. Yes, it could be settled in gold, but it doesn't need to be a transfer from the deficit country's official gold reserves.

In Freegold, currency exchange rates will naturally adjust to trade balance differentials. A trade deficit will indicate that one of the currencies is overvalued, so its exchange rate will naturally decline. In this brick system, the country with the trade deficit/brick deficit will need to buy back bricks with gold from the country that's running the trade surplus. But if you just take gold out of one central bank and put it in the other, that doesn't do anything to fix the overvalued currency. That's basically an exchange rate manipulation, not unlike the Bretton Woods system.

So, if I were designing and running this new brick system, I would instruct the deficit country to go buy enough gold on the open market with newly-printed local currency to buy back the bricks from the surplus country. This would draw more gold into the BRICS system, stressing the gold markets of the West.

It may seem complicated, but think about it from a central bank's perspective. If the supply of physical gold runs out in your country, it means the price of physical gold is too low in your currency. So, what do you do? Under the old form of gold standard, or gold-backed currency of yesteryear, you'd have to supply the market with your gold reserves to defend the exchange rate of your local currency and the brick. But under this system, you can just bid up the price of gold in the currency you print by printing, until more physical gold shows up in your country.

You don't need to go into the $IMFS FOREX market and buy foreign currency to buy gold elsewhere. Let the open market take care of that. You just keep raising your bid for physical gold until it shows up.

In this new system, the brick has replaced the dollar, and physical gold has replaced dollar settlement options, like buying Treasuries or other US-based financial assets. And when you look at the flow of capital that has been coming into the US through the $IMFS for the last 50+ years, if only a portion of it starts settling in physical gold in places like Dubai and Shanghai, that'll really test the limits of the link between the LBMA's XAU price and the global physical market price of gold.

Think about this dynamic happening, not just in one country, but BRICS-wide. And imagine Western currency traders seeing this dynamic play out in real-time, with Eastern gold bourses running low on physical, and their central banks putting out bids that are higher than XAU is trading on the FOREX. What will be their most-profitable move?

It might be something like "sell XAU and buy physical" as long as they're the same price. Can you see how this would test the link between the price of paper and physical gold?

And what would be the bullion bank's best move in that case? The essence of the FOREX trader's best move is a demand for physical allocation or delivery from the bullion bank. But the bullion bank doesn't have the physical reserves to meet such demands, so it's going to say cash only, here's your cash, go buy your physical from someone who has some.

But anyone who has some at that point will either be sitting on it, or sending it to the BRICS to cash in on the arbitrage opportunity. They won't be selling it for the same price as a unit of XAU.

The difference between the price of physical and the price of an LBMA XAU liability will be called "the premium." And very quickly, the premium will soar. FOA said this many times:

The day of big premiums on gold coins and bullion is coming… -FOA (10/15/01)

look for the premiums on cash bullion and cash coins to begin rising well above contract and futures prices. […] because we are moving into full cash settlement of gold, without physical delivery, you can take this wholesale price and add whatever premium is necessary to buy your physical gold. -FOA (10/25/01)

the real bullion markets will get extremely thin and build up a huge premium to contract settlement.
-FOA (10/26/01)

The coming premium price, paid for physical delivery, will develop for all to see. -FOA (11/2/01)

"Buy what has value at the greatest discount and wait for the politics of money to price your new savings correctly"!

The politics of wealth today is centered around gold bullion and only gold bullion: that is where the wealth and power will be manifest: this is where the gains will be! …

Place as much of your wealth in physical gold as your understanding allows, and save this "virtual wealth" of the ages today: waiting for it to become real wealth, priced correctly in the market place, tomorrow.

Make no mistake, the wealth is there "but only there in bullion"! Because a free bullion market cannot be denied or controlled when it stands between the opposite goals of [opposing] political powers!

In this: it will separate from the politically-crushing reality the current dollar based paper gold market represents. The premium on bullion will soar!

The “Political will” [of the old world] is about to help make our investment real. For myself, a large percentage of my wealth is being saved by going with the evolution of paper money: not against!

This trend is visible now and based on the forward flow of human affairs, not the backward rules of money theory!
-FOA (11/3/01)

You see, it's not that complicated. It really is a simple concept. It's the ultimate fiat currency. Half of the world declares its international trade clearing CBDC currency, the brick, to be defined as the price of a gram of gold, and then lets the other half of the world supply the gold that backs it.

You might now be thinking, what will happen when the LBMA collapses and gold revalues by 40x or whatever? It's simple. A brick will be automatically redefined as 1/40th of a gram.

It's like when the dollar devalued because it was running out of gold, only in this case, nobody gets screwed. The BRICS central banks have not lost any gold. If anything, they've accumulated more through this process. No one is holding bricks as savings. No one has loans in bricks. In fact, if bricks are backed by anything, it's the $IMFS's physical gold market.

A brick is a country-less token defined as a weight of gold, and backed by the open physical gold market. When that open market runs out of physical (at LBMA XAU prices), the brick will devalue in gold terms to accommodate the necessary revaluation. (That may even end up being the primary modus of revaluation.)

Where will these billionaires and oligarchs park their billions without a deep bond market like the $IMFS, you ask? They will have the same options they have right now. They are more or less cut off from the $IMFS anyway, and if not, it doesn't hold much upside at this point. So, they can keep it in buildings, businesses, banks, yachts and local currency. They just can't keep it in bricks, unless you're talking gold bricks. πŸ˜‰


Thursday, May 18, 2023

How to Blow and then Pop an Everything Bubble for Dummies

This post was published at the Speakeasy on 3/31/23, a little over a month and a half ago. Some of the rates mentioned in the post are higher now. $IRX, or the 3-month T-Bill, was yielding 4.57%, and is now up to 5.1%. The IORB, which was 4.9%, is now 5.15%. The ON-RRP was 4.8%, and is now 5.05%. And the ECB's DFR was 3%, and is now 3.25%. Also, don't miss the bonus comments at the bottom, about how the gold market actually works. πŸ˜‰

In my New Year's post, I wrote:

Basically, the Fed controls interest rates by controlling the supply and demand of bank reserves (i.e., Fed liabilities). Before 2008, there was a naturally-low demand for reserves, and the Fed adjusted that low demand in two ways, by capping the rate banks paid for extra reserves when needed, and by adjusting reserve requirements. It controlled the supply of reserves in the system through open market operations, where it could increase supply by buying securities, or decrease supply by selling securities (buying back its own liabilities). But it was limited in how much it could increase supply by the naturally-low demand. If it raised supply above demand, it would lose control of monetary policy. Demand would turn negative. Interest rates would turn negative. Banks would shun depositors and start charging them interest on their deposits. Cash withdrawals would skyrocket, the dollar would plummet, and the dollar system would collapse.

The point is, the scarce reserves system before 2008 naturally constrained the Fed’s ability to print.

After 2008, it switched to an “ample reserves” system, where it controls interest rates by the rate of interest it pays on reserves parked at the Fed. This created a new demand for reserves.

You might remember this graph from Hyperinflation Update Update:
It shows that up until 2008, most of the money in the commercial banking system was backed by (and created by) loans. Since then, loans have held steady while total deposits kept rising.

What happened was, by creating a new demand for bank reserves, the Fed eliminated the constraint, was suddenly able to create an unlimited supply of bank reserves, buy an unlimited amount of securities, and indirectly finance the United States government, the housing market, and virtually any market it desired. In other words, QE became possible.

Anyone remember OBA/Topaz and his theory that the $IRX zero boundary was the Fiat System's Rubicon? Basically, he predicted that when the $IRX (3-month T-bill yield) turned definitively negative, it would be game over for the $IMFS. Here are a handful of his comments I picked at random to refresh your memory. You can find all of his 625 comments from 2009 to 2015 here and here. I don't know what happened to him, I haven't heard from him, and he never joined the Speakeasy:

Of course, it never happened. We never breached the zero bound, even as we bounced off it for almost nine years (2008-2015 and 2020-2021). Here's the $IRX chart:
And here's the FFR chart:
And now we know why rates didn't go negative. It's because at the height of the GFC in 2008, the Fed switched from a scarce reserves regime to an ample reserves regime, and ran what is called a "floor system" monetary policy. From Just Another Hyperinflation Update #4:

The Floor with High Balances approach is essentially how the Fed ended up conducting monetary policy starting in October 2008… The Fed continued to conduct policy using a floor system as successive rounds of QE increased the quantity of reserve balances further. It then officially adopted the floor system implementation approach in January 2019 (see “Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization”).

When the staff evaluated a floor system in 2008, they envisioned a much more modest floor system than what transpired. The approach was expected to require about $35 billion in reserve balances, and the interest rate on reserve balances was expected to be 10 to 15 basis points below the fed funds rate. The Fed currently estimates that $2.3 trillion in reserve balances are necessary to implement a floor system. […]

The Fed’s estimate of the quantity of reserve balances required to implement a floor system has increased dramatically over time. In March 2016, the New York Fed raised its assumption about the level of reserve balances needed in equilibrium to $100 billion.[4] In 2017, it raised it to $500 billion.[5] The FOMC did not specify the quantity of reserves it thought would be necessary when it made its decision to use a floor system in January 2019, but in March 2018, the New York Fed put its estimate of that level at $600 billion; by September 2019, it had more than doubled its estimate to $1.3 trillion.[6]


In September 2019, a mismatch in the supply of and demand for repo financing led to a sharp spike in repo rates and unsettled repo markets for a week. In “Reserves were not so Ample After All,” Copeland, Duffie, and Yang (2021) attribute the dislocation in part to an insufficient supply of reserve balances, then $1.45 trillion.[8] The New York Fed has estimated that a buffer of at least $350 billion above the structural demand for reserves is needed to account for variation in reserve balances, which would put the amount needed to conduct a floor system at $1.8 trillion.[9]

That estimate has not been tested. In response to the September 2019 turmoil the Federal Reserve expanded the supply of reserve balances, and the Fed’s massive purchases of government securities in response to the COVID-19 pandemic increased the supply further. […]

Reserves balances a year ago were $3.96T. Today they are $3T, down $960B year over year (YoY), but still well above the Fed's current estimate of $2.3T needed to implement a floor system. That means that reserves (aka base money, or Fed liabilities) make up about 12.7% of the total assets held by the US banking system right now, down from 17.4% a year ago, a 27% decrease.

Today, the Fed controls the amount of reserves in the system through QE and QT. QE adds reserves, and QT removes them or extinguishes them. QE also tends to lower interest rates because the Fed is buying debt securities, which adds demand to the market for debt securities, which tends to raise the price of those securities, and a higher price equates to a lower interest rate (this is an important point to keep in mind, that price and interest rate have an inverse correlation). But the main way the Fed controls interest rates is the floor system. It sets a floor under interest rates by paying interest on the reserves it added through QE.

The Fed created a new kind of demand for reserves in 2008 with IOER, Interest on Excess Reserves (now, as of July 2021, changed to IORB, or Interest on [all] Reserve Balances). The amount of reserves demanded by the banking system has been growing ever since, and the Fed has been miscalculating that demand ever since.

So, QE pushes prices up, rates down and adds reserves, and the interest rate the Fed pays banks on those reserves sets the interest rate floor. Here is IOER from 10/9/08 through 2021 (discontinued on 7/28/21):
And here's IORB from 7/29/21 through present:
In Europe, the ECB didn't adopt the floor system until mid-2014, the same time it started QE. But with rates already at the zero bound in 2013, EuroQE pushed them definitively negative, and the ECB set a negative floor. Here's the ECB’s deposit facility rate, or DFR. It's basically like the Fed's IORB, and it was negative from June of 2014 until 7/30/22, when the ECB raised it back to zero, and then hiked it from there. It currently sits at 3% while the Fed's IORB is at a whopping 4.9%:
Again, that's the same timeframe as the ECB's own QE program, called the "Expanded Asset Purchase Programme" which ran from mid-2014 until March of 2022, when it began tapering its purchases through June before raising rates in July.
Click twice to view a readable image:(Source - dated Sept. 2021)

Did you notice in that ECB excerpt from 2021 that even short-term government bond yields went negative? It seems to defy logic, doesn't it? Who would ever buy a bond with a negative yield? Why didn't we cross OBA's Rubicon? And why wasn't it the end of fiat currency?

The answer is simple. It was a bubble. And in a bubble, yields don't matter, only rising asset prices matter.

Think about rental properties. Why would anyone buy a rental property at a price where they could never make a profit, or even break even, renting it? It's the same as a negative-yielding bond. They buy it to flip it, not to hold an income-producing asset.

Think of all these tech companies with billion dollar valuations that do nothing but lose money. It's all a bubble. Everything is a bubble, and the Fed just popped it.

It's been this way since at least 2015, when I wrote:

What the world needs now is a grand liquidation of overinvested, overvalued, unprofitable economic assets. It needs a grand reboot! But that's not going to happen through the nominal deflation the deflationists hope for. That would be like unwinding a Ponzi scheme. Sure, markets will collapse, and that's what I'm waiting for, but the Fed will respond. Do you think the Fed will raise rates next week? I really hope they do, but they probably won't. Eventually, however, they will be printing and buying everything in sight, because, in the real world, in extremis, that is their only mandate.

FOA: Many of you have read countless opinions as to why our credit markets would implode into deflation as a "Mises" style economic theory surfaced to control the controllers. Truly, these people confuse theory with human action as much as they do not understand real physics! Indeed, strings that cannot be pushed are either thrown or cast aside in the real world.

What the world needs now is a good, old-fashioned hyperinflation! That'll fix shit. And you better get ready, because it's coming! πŸ˜€

Ever since 2008, the Fed has been stuffing the banking system with reserves, and the money supply with deposits. I'm going to go over the mechanism one more time, because I know there are still some out there claiming that QE never left the banking system due to our two-tiered money, at least not until the Fed started purchasing securities directly from non-banks.

It is true that our money system is based on two tiers of money, one for banks which we'll call reserves for the purpose of this post, and one for you, me, non-banks and everyone else, which we'll call deposits for the purpose of this post. It is also true that when the Fed buys securities directly from non-banks, deposits and reserves rise simultaneously. But the same happens when the Fed buys securities from banks, whether it be Treasuries or MBS or some other kind of debt security. It just doesn't happen simultaneously. Reserves go up at the point that the Fed buys the security from a bank, and deposits go up at the point that the debtor who the security funded either spends or deposits the borrowed funds.

As I have said before, this chart alone proves that deposits increased in line with QE in the early years:
But this one from John Hussman is even better, as it overlays Fed balance sheet growth and commercial bank deposits:
The increase is not exactly 1 for 1 from 2008 to 2019, but it is almost exactly 1 for 1 from 2019 to the peak in 2022. Of course, 2020 was the big $3T pandemic emergency liquidity injection, but it is noteworthy that from the REPO crisis in 2019 until the peak of both the Fed's balance sheet and commercial deposits in April of last year, almost exactly a year ago, both increased by almost exactly the same amount ($5.1T on the Fed's BS, and $5.2T in deposits).

This is noteworthy because it means that there's likely a 1 to 1 correlation as the Fed is now shrinking its balance sheet, and indeed there is. For every reserve dollar that the Fed retires, a deposit dollar disappears as well.

The point of all this is that the Fed's response to the GFC was to flood the system with money, both reserves and deposits, essentially cash which is normally a non-interest-bearing asset. And indeed, it drove interest rates to zero for most of a decade. Also, remember that as interest rates fall, the prices of debt securities rise, so as the Fed put a floor under interest rates (at zero), it was also essentially putting a ceiling on the price of the securities.

This is relevant because it forced all that money to go in search of a yield elsewhere, which inflated the everything bubble. As debt was capped at no yield, the great asset inflation was underway.

Another important concept you need to understand is that all those deposit dollars, those normally-non-interest-bearing assets, don't flow into other assets. You know this, but it needs to be said. They flow through assets, and end up as deposits in the sellers' accounts. There are only a few ways deposits can actually leave the banking system, and that’s when they are borrowed by someone with a reserve account at the Fed, like the US Treasury or the FHLB, when they are withdrawn as physical cash like you would do at an ATM, when loans are repaid and the banks shrink their balance sheets, or when the Fed sells an asset or lets one mature without reinvesting the proceeds. Theoretically, deposits can also disappear if a bank fails and the government decides not to make large depositors whole, but that's probably not going to happen.

Other than that, all that money is basically trapped in the system. It circulates, but someone, somewhere, is always holding it.

Here's how Hussman puts it:

By early-2022, the Fed was forcing the public to choke down a breathtaking 36% of GDP in zero-interest money, passing like stale, re-gifted fruit cakes from one holder to another (how’s that one Dave?), fueling yield-seeking speculation in every security that might offer the hope of something more than “zero.”


Given that the Fed has created $8 trillion in liabilities, someone has to hold them either: 1) indirectly as bank deposits, where your bank earns 4.65% interest from the Fed on the reserves that back your deposit, and thanks you for being part of its profitable “zero-interest deposit franchise”; 2) indirectly in a money market fund, where the money market fund receives “interest” on ON-RRP transactions with the Fed, or; 3) directly as currency you just pulled out of the ATM.

That’s it. The Fed created a mountain of liabilities, and someone has to hold them. Whenever someone waxes rhapsodic about all the “cash on the sidelines” waiting to “go into” some other market, they’re basically telling you they haven’t learned how equilibrium works. Every security that’s issued, even base money, must be held by someone until it is retired.

And The Economist:

But money does not actually flow into these [money-market] funds, for they are unable to take deposits. Instead, cash leaving a bank for a money-market fund is credited to the fund’s bank account, from which it is used to purchase the commercial paper or short-term debt in which the fund wants to invest. When the fund uses the cash in this way, it then flows into the bank account of whichever institution sells the asset. Inflows to money-market funds should thus shuffle deposits around the banking system, not force them out.

The point is, when you hear that total deposits are shrinking, which they are, it's not as simple as them running to Treasuries, or MMFs, or stocks or bonds or real estate, or any asset for that matter. For the most part, that money is captive in the system, so for deposits to be shrinking, something systemic is happening, and it's probably being driven by the Fed.

Now, let's look back to 2008 – 2022 and the great (asset) inflation. During that time, deposits grew by more than $11T. Total deposits reached $18T in 2022, up from less than $7T in 2008. That's a lot of new money, but it's really not that much when compared to the great asset inflation, which encompasses stocks, bonds, real estate, private equity, VC, art, you-name-it. All that went up by a lot more than $11T total, and that’s because money doesn't go into assets, it circulates. It flows through them.

Think of all those zero-interest reserves and zero-interest deposits as hot potatoes, or re-gifted fruit cakes. They circulated with a certain velocity driven by zero interest rates as depositors became buyers of assets, and sellers of assets became buyers of different assets, and so on and so forth, in both tiers of our money system, the banks and the rest of us. This is what drove the great asset inflation from 2008 until 2022: Lots of new zero-interest hot potato money printed by the Fed.

The “excess deposits” are there because the Fed put them there. According to the most recent FDIC quarterly banking profile, the U.S. banking system had $17.9 trillion of deposits as of the third quarter of 2022, with estimated insured deposits of $9.9 trillion, leaving $8 trillion of deposits that exceed the FDIC insurance limit. It is not a coincidence that the U.S. banking system also has nearly $8 trillion of bank deposits in excess of bank loans. They are there because more than a decade of “quantitative easing” took bonds out of the hands of the public and replaced those bonds with zero-interest bank deposits.

Meanwhile, overvalued long-term securities dominate portfolios because yield-starved investors and banks couldn’t tolerate the perpetual zero-interest rate world created by the Fed, and felt forced to reach for yield. All of those holders – investors, banks, pension funds, everybody – reached for yield, driving the equity market to valuations beyond their 1929 and 2000 extremes; driving interest rates to historic lows; driving the risk-premiums on low-grade debt to levels that still provide little margin of safety; encouraging speculative new issues of stock and covenant-lite debt; encouraging Silicon Valley Bank and others to invest their excess deposits in securities that might offer them something more than zero. (Hussman)

Then, about a year ago, the Fed started paying real interest on reserves, and everything changed.

That new demand for reserves which the Fed created through the floor system was sent into overdrive. But even before that, the Fed raised the overnight reverse repo rate (ON-RRP, or just RRP, same thing). ON-RRP is like IORB, only for non-banks, mostly money market funds (MMFs). MMFs used to invest mostly in commercial paper and Treasuries, but now about 40% is in ON-RRPs.

Here's the timeline:

2015-2017: The Fed slowly begins raising rates.
2018: The Fed slowly begins contracting its balance sheet, which removes reserves from the system.
9/17/19: REPO market crisis. REPO rate spikes to 10%, so the Fed pivots and starts cutting rates and adding reserves.
March 2020: Pandemic financial crisis. Stock market crashes. ON-RRP jumps from $1B to $285B in about 2 weeks. The Fed quickly takes FFR and ON-RRP back to zero and floods the system with $3T in newly-printed reserves and deposits over the next 3 months. ON-RRP drops back down to about $1B and the stock market recovers all March losses by August.
June 2021: The Fed raises the ON-RRP rate from zero to 0.05% (5bp), and total RRPs jump from $450B to $1T. The Dow plateaus at 35K (it's currently under 33K).
3/17/22: The Fed starts raising rates and slowly contracting its balance sheet. It raises the FFR from 25bp to 50bp, and the RRP from 5bp to 30bp. RRPs jump from $1.5T to $2.3T in 3 months. The Fed continues hiking rates for the entire year. FFR went from 0.25% (25bp) on 3/16/22 to 5% today (500bp). And the RRP rate went from 0.05% (5bp) on 3/16/22 to 4.8% (480bp) today.

Let's talk about ON-RRPs. Fed liabilities come in three forms: Federal Reserve notes, aka FRNs or physical cash (26%), Reserves (44%), and RRPs (30%). This is all base money. The Fed doesn't count RRPs as base money, but I do, because they make up almost a third of the Fed's current total liabilities. RRPs currently sit at $2.6T on the Fed's balance sheet:
The Fed created its ON-RRP facility in 2013, in preparation for eventually raising rates off the zero floor. It's a way to pay non-bank depositories like money market funds an interest rate similar to, but slightly less than, the IORB rate it pays banks. Use of the facility went from $0 on 3/17/21 to $2.4T on 3/31/23:
Let's go back to The Economist:

Inflows to money-market funds should thus shuffle deposits around the banking system, not force them out.

And that is what used to happen. Yet there is one new way in which money-market funds may suck deposits from the banking system: the Federal Reserve’s reverse-repo facility, which was introduced in 2013. The scheme was a seemingly innocuous change to the financial system’s plumbing that may, just under a decade later, be having a profoundly destabilising impact on banks.

In a usual repo transaction a bank borrows from competitors or the central bank and deposits collateral in exchange. A reverse repo does the opposite. A shadow bank, such as a money-market fund, instructs its custodian bank to deposit reserves at the Fed in return for securities. The scheme was meant to aid the Fed’s exit from ultra-low rates by putting a floor on the cost of borrowing in the interbank market. After all, why would a bank or shadow bank ever lend to its peers at a lower rate than is available from the Fed?

But use of the facility has jumped in recent years, owing to vast quantitative easing (qe) during covid-19 and regulatory tweaks which left banks laden with cash. qe creates deposits: when the Fed buys a bond from an investment fund, a bank must intermediate the transaction. The fund’s bank account swells; so does the bank’s reserve account at the Fed. From the start of qe in 2020 to its end two years later, deposits in commercial banks rose by $4.5trn, roughly equal to the growth in the Fed’s own balance-sheet.

For a while the banks could cope with the inflows because the Fed eased a rule known as the “Supplementary Leverage Ratio” (slr) at the start of covid. This stopped the growth in commercial banks’ balance-sheets from forcing them to raise more capital, allowing them to safely use the inflow of deposits to increase holdings of Treasury bonds and cash. Banks duly did so, buying $1.5trn of Treasury and agency bonds. Then in March 2021 the Fed let the exemption from the slr lapse. Banks found themselves swimming in unwanted cash. They shrank by cutting their borrowing from money-market funds, which instead parked cash at the Fed. By 2022 the funds had $1.7trn deposited overnight in the Fed’s reverse-repo facility, compared with a few billion a year earlier.

After SVB’s fall, America’s smaller banks fear deposit losses. Monetary tightening has made them even more likely. Use of money-market funds rises along with rates, as Gara Afonso and colleagues at the Federal Reserve Bank of New York find, since returns adjust faster than bank deposits. Indeed, the Fed has raised the rate on overnight-reverse-repo transactions from 0.05% in February 2022 to 4.55%, making it far more alluring than the going rate on bank deposits of 0.4%. The amount money-market funds parked at the Fed in the reverse-repo facility—and thus outside the banks—jumped by half a trillion dollars in the same period.

For those lacking a banking licence, leaving money at the repo facility is a better bet than leaving it in a bank. Not only is the yield higher, but there is no reason to worry about the Fed going bust. Money-market funds could in effect become “narrow banks”: institutions that back consumer deposits with central-bank reserves, rather than higher-return but riskier assets. A narrow bank cannot make loans to firms or write mortgages. Nor can it go bust.

As I said earlier, deposits and the Fed's balance sheet are down almost exactly the same amount from a year ago (down $620B on the Fed's BS prior to SVB, and down $602B in deposits). That's more than $600B disappeared from both tiers of our money system, reserves and deposits, in just the past year.

RRPs have a similar effect. As the total amount of RRPs rises, it doesn't show up as disappearing deposits, but it has the same effect, at least temporarily. It also converts liquid bank reserves, one form of Fed liability, into illiquid (to banks) RRPs, another form of Fed liability. So, as RRPs rise, they pull deposits out of the great asset inflation circulation game, and they change bank reserves into RRPs, which can't be used for clearing or redemptions, and which don't earn the bank any interest. So we can add the $2.4T that went into RRPs over the past two years, to the $600B in reserves and deposits that disappeared over the past year, and that's $3T gone from the $11T in deposits and $8T in reserves that the Fed created since 2008, and which has been inflating the everything bubble.

So, the Fed created a new kind of demand for reserves in 2008, and then sent it into overdrive this past year by cranking the IORB up from 0.15% to 4.9%:
This while more than a third of all reserves either disappeared or were converted to illiquid, interest-free (for the banks) RRPs.

Meanwhile, we saw a spike in "advances" (reserves being borrowed) from the FHLB. The FHLB annual report for last year came out a week ago, on 3/24, and Andrewe1 noted this:

"Sorry, one more comment on the FHLB report. The increase in advances of $470 billion from 2021 occurred mostly in the last three quarters of 2022 (I took a quick look at the 2022 quarterly reports), $146B in Q2, $140B in Q3 and $164B in Q4. So the $470B net increase of mostly less than 1-year terms could just be a ramping up to higher level of activity before reaching steady state or not. Will need more information. But it’s interesting that the activity really began after the Fed launched its rate hiking."

In a report dated 2/23/23, Bill Nelson of the Bank Policy Institute writes:

In a 2013 New York Fed blog post “Who is Lending in the Fed Funds Market?”, Afonso and colleagues report that fed funds lending (and therefore borrowing) fell after the GFC to one-fourth of its pre-GFC level. They attribute the decline to the expansion of the Federal Reserve’s balance sheet and to the payment of interest by the Fed on reserve balances. Banks now hold such large amounts of extra reserves that there is no need to redistribute liquidity at the end of the day. Currently, the federal funds market consists almost entirely of loans from FHLBs (which have extra funds to invest and have accounts at the Fed but do not earn interest) to the U.S. branches of foreign banking organizations, who borrow the funds and deposit them at the Fed, earning the spread. FBOs are the main participants in these transactions, because it is slightly cheaper for them to do so than domestic commercial banks, owing to how deposit insurance premiums are calculated.

This may be another drain on deposits, because if banks are borrowing reserves from the FHLB simply to park them at the Fed and earn the IORB spread, rather than lending them to borrowers which creates deposits, then the FHLB may be facilitating a net drain on deposits in the banking system. The FHLB gets those reserves by borrowing from the bond market. This drains deposits from the banking system until the funds are relent to someone else. But if they're simply being hoarded for free money from the Fed, then it's the same effect as net-borrowing by the FHLB, which I mentioned in my last post:

"That’s a $300B to $400B increase in FHLB net-borrowing over the past year, which could possibly account for the $361B YoY decline in deposits."

This may all sound deflationary, and it is. It's how you pop an everything bubble that you spent the last 13 years inflating. You remove a good portion of the money that was circulating through any and all assets to inflate it, and you suck the rest into interest-bearing "facilities".

Investment losses have emerged since early 2022, both because inflation pressures forced the Fed to normalize rates after 13 years of zero-rate financial repression, and because extreme valuations are never sustained indefinitely. Sudden banking strains in the U.S. and Europe, the British pension crisis last year, all of these are just symptoms of an unwinding bubble. The same process is underway in the equity market, and the downside risk remains absurdly high. (Hussman)

In the area where I now live, housing prices are even higher than they were last year, and last year they were higher than the year before, which was when I bought. But nothing is selling, because the monthly cost of a mortgage has gone up 60%, which should equate to about a 38% drop in prices.

Debt markets are quick to respond to a liquidity contraction like this. Real estate, not so quick. Stock market, also not so quick, but it's coming.
By now we all know how these rate hikes have impaired debt securities on bank balance sheets. But there's so much more damage that's already baked into the cake that we haven't even seen yet. I think what we're going to see over the coming weeks and months are a series of seemingly-unconnected crises, as various sectors of the everything bubble are forced to acknowledge what has already happened.

I don't want to get into any specific predictions, because this encompasses everything. But just to give you an idea, I think that a lot of projects that were started a year ago or more are no longer viable, for a whole list of reasons, so I think we could see a great abandoning of projects, accompanied by some unexpected and surprising unemployment it will create. I think that credit which was plentiful is about to become scarce, which will cramp a lot of lifestyles. And as these things start to cascade, watch what happens to the big funds. You know, the ones that manage all the pension funds. If you thought the banking system's balance sheet was impaired, wait until the non-banks are forced to acknowledge what has already happened.

Oh, and guess who was just given the Paul A. Volcker award yesterday, by the National Association for Business Economics… yup, good ol' Janet "There will never be another financial crisis in our lifetime" Yellen:

You can't make this stuff up.

Things are getting spicy, so you need to stay frosty, and keep an eye out for this guy:
My current window for DEFCON 3 is between now and Juneteenth, with a special focus on May, just FYI. πŸ˜‰

Happy April Fools Eve, and watch out for fools this weekend! 🀑


A Banking System Running a Currency of its Own

The following is a series of comments from the Speakeasy back in January. The POG had just spiked up hard, and MDV asked:

FOFOA What do you suppose is going through the minds of the bullion bankers and those who control the ETFs?

I responded:

Due to what? The POG? or am I missing something that happened?

And he said:

Yes…I’d think if they were quitin the biz that 1650 was a better place.

Here was my reply:

Hello MdV,

OK, yeah, the POG hit a high of $1,923 today. That may seem unexpectedly high to someone who understands my reasoning that the price will collapse in the end, and that the end is near. If the end is so near, why isn't it collapsing? Why is it going up? Why is it so high?

First, here are some first principles to keep in mind when thinking about this:

1. The LBMA bullion banks dominate the paper gold (spot unallocated) market.

More than a quarter of a trillion dollars-worth of spot unallocated transactions occur daily with LBMA members on one or both sides of the transaction. There's no double counting in that number, and it's probably way low, but it dwarfs any other segment of the "gold" market, and therefore drives the POG.

2. The largest LBMA bullion banks can control the POG by expanding or contracting their bullion-denominated books.

This is not unlike how FTX and Alameda Research pumped the price of FTT to make themselves look like billionaires, or with BTC and Tether, how a few whales can control the price of BTC, holding it above $16K, but not letting it rise so fast that the bag hodlers decide to cash out. It's all about controlling the supply. And in the case of the POG, we're talking about the supply of LBMA bullion bank bullion-denominated liabilities.

Now, with these principles in mind, let's think about Bitcoin first. It dropped to around $16K and then just stuck there, as if someone was propping it up. If bag hodlers were still selling at $16K, then the whales had to buy BTC to prop it up. That costs real dollars. So the whales were expanding their BTC hodlings in the face of low demand to control the price, to keep it from falling below $16K.

Over time, demand would come back as people got used to the $16K price, and it would fluctuate between the whales buying or selling BTC to hold it steady. Right now, it's up to $20K. If my hypothesis is correct, then something spiked demand, and it's not necessarily millions of little people rushing into BTC. But whatever it is, the whales who've been controlling the price are probably not the ones pumping it up. Rather, I would think they are selling some of their supply into the spiking demand, to keep it from rising too fast, and perhaps to also bring their BTC hodlings back down to where they were a year ago.

Now think about the bullion banks managing the supply of their own bullion-denominated liabilities. And don't think about physical gold. This is only a matter of supply and demand in paper gold. The supply and demand dynamics in physical gold are disconnected from the POG due to the banking nature of the dominant "gold" market, and in extremis will have the opposite of the expected effect (the price of paper gold will collapse when physical supply can't be found).

When I see the price at $1,923, I'm thinking that the bullion banks are seeing a high demand for their bullion-denominated liabilities right now, and they are probably taking advantage of that to expand the size of their balance sheets, which brings in precious dollars, similar to how the BTC whales reducing their hodlings during high demand brings in dollars. That would, in turn, keep the price from rising so fast as to draw a lot of unwanted attention to gold.

So, what's driving that demand for paper gold? I don't think it's gold bugs, and I don't think it's central banks or sovereigns. I don't know what it is, but there are some things happening right now in the "gold" space.

JPMorgan, who just last month became a GLD custodian with talk about expanding GLD custodianship to Zurich, and possibly even New York, now wants to move into precious metals clearing in Zurich:

The Saudis suddenly want "to invest in mining assets globally," and have "inked another partnership agreement with Barrick Gold Limited, a subsidiary of Barrick Gold Corp."

On the physical side, London vault holdings are down 116.5 tonnes in December:

And the GLD inventory has hardly budged. It currently sits at 912 tonnes. It was at 906 tonnes at the beginning of December, and 918 tonnes when I wrote my New Year's post on 12/29. So it's up 6 tonnes from the beginning of December, and down 6 tonnes from about a week ago. And just for the record, JPMorgan's share hasn't changed since my post, so the 6 tonnes came out of HSBC.

As for the 116.5 tonnes that left London in December, I don't think any of that was LBMA reserves. I think it was all allocated, and, for whatever reason, the owners moved it out of London. My reasoning is based in part on the fact that I don't think the LBMA has any reserves other than GLD. Also, the LBMA vault holdings data includes the BOE vault which is all allocated, the data doesn't differentiate between allocated and LBMA reserves (or even mention reserves), and if it had been an allocation and delivery request (which would come out of reserves), I think we would have seen a drop in GLD. Instead, we saw GLD inventory go up in December while someone (could have been CBs, sovereigns or individuals) moved 116 tonnes out of London.

So, we have this apparent movement away from physical centrality (in London), and at the same time we are seeing a spike in demand for LBMA bullion-denominated liabilities (spot unallocated). Simultaneously, we have the Saudis and Barrick talking about a joint mining venture, and JPMorgan expanding its gold-supply-chain-financing business into Switzerland.

Here's another principle to keep in mind:

3. Whenever I hear about ventures or developments in gold mining, paper gold, bullion banking, GLD, or any other pseudo-gold-type stuff, my first thought is that it's more about finance and making dollars than about anything to do with the real stuff.

So, perhaps these various stories have some connection to the spike in demand for paper gold. It trades as a currency, so a spike in demand might come from hedging related to a flurry of pseudo-gold-type stuff happening all at once. I don't think it has anything to do with a spike in demand for physical. Not saying there is or isn't a spiking demand for physical, just that it doesn't affect the price, so it's not driving this POG spike we saw this week.

The apparent diversification out of London is consistent with a "quitin the biz" mindset. The high POG is merely a high currency price (exchange rate) on their own BB liabilities, which can be brought down to near zero on a moment's notice with a simple announcement. They could announce that there are no more reserves, or that they are quitting the biz, halting trading and redemptions, and cashing everyone out. Anything that destroys the perception of a connection between XAU and physical would work.

So I'm gonna just go with Mobgrazer's answer. I doubt they even noticed that the POG is back up to where it was a few years ago. In fact, I didn't notice until you commented on in! πŸ˜‰


Then, Jman hit me with this:

Can you elaborate a little more on the bullion banks ability to cap paper gold price rises? Is their balance sheet expansion capability big enough to offset a significant, fear driven, worldwide move away from the equity and bond markets? I have it in my head that the daily notional values traded in the world bond and equity markets would dwarf the $250 billion a day in paper gold, but am I off base here? I mean, if the BBs have unlimited balance sheet expansion, why would paper gold ever go up at all? Not questioning the end game when paper eventually fails, but just want to better understand the odds of what can happen in the meantime, prior to the demise of paper gold. Thanks man, always appreciate the BB education.

And here was my reply:

Hello Jman,

It's a simple matter of supply and demand. The bullion banks can increase supply, or decrease supply, because the supply we're talking about are their own liabilities.

If your mythical shift from stocks and bonds into gold that overwhelms the trading volume of the LBMA ever happens, then the LBMA will probably be halting trading at that time. Not because it is overwhelmed with demand, but because the $IMFS is collapsing. But, to be clear, I don't see that shift happening during the collapse. Freegold is a revaluation after the collapse, not a run up in the price during the collapse.

It is not my position that the bullion banks are actively capping the price of gold. The price of gold is naturally suppressed because of the nature of its dominant market, which is run by a structured system of banks, and exists as mere notations on their balance sheets.

They are not actively capping it, but they may be passively damping it. Volatility attracts unwanted attention to gold. Plus, passive damping may yield a marginal profit for the banks.

These banks are market makers in almost all of the various "gold" markets, futures, ETFs, and even other exchanges. So they have feelers in more than just the dominant, price-setting market, which is spot unallocated (their own liabilities). This means that they can sense demand differentials between markets.

If I see the POG is rising, I assume that there is strong demand for LBMA "currency gold," because that's the price-setter due to its overwhelming mass (think bowling ball vs. billiard ball). Let's say XAU (currency gold) demand is outstripping demand for futures, ETFs, or even correlated assets. That creates an arbitrage opportunity that the BB can sense before anyone else.

So, rather than match buyers with sellers and just let the price rise and let someone else take the arb, they simply expand their balance sheet, print new XAU, take the dollars, and then go buy the assets to back those new liabilities with the dollars. The demand differential will quickly disappear because the banks are adding supply to the market segment where demand is spiking, and adding to demand to other segments.

Thus, the price rise is relatively suppressed by the banks simply taking the marginal profit from the arb. That doesn't mean the price doesn't rise, just that it doesn't rise as much or as quickly as it would in a real market.

The gold market is different from any other markets because of the LBMA. There are other segments to the market, but they take the price that spot unallocated gives them, and if there's any price differential between market segments, someone arbs it away almost seamlessly.

As a gold bug, you have been trained to think of the gold market in a certain way, similar to other markets. You have been conditioned to think that physical demand feeds back into price through the futures market, and that when the price goes down it's because banks and CBs pounded it down. But there's a better way to understand the gold market that helps make the price movements make more sense.

Let's think about it very generally going back to the 1960s. The gold market in the 60s was basically the dollar, because the dollar was pegged to gold. So there was no gold market per se, other than the CBs managing the peg. That of course failed in 1971, and for the next decade the gold market was more or less a physical market trying to come to terms with the failure of the dollar peg.

The price was set by large London dealers who dealt in large wholesale quantities, and the US even auctioned off some of its gold in an effort to slow the rise which was making the dollar look bad. But volatility attracts the trader mindset, and ultimately, those who were most excited about gold were really just in it to get dollars. And that's when bullion banking came into its own.

The late 70s and early 80s were the beginning of bullion banking, which was a way of making dollars by putting gold back into that fractional reserve cage it escaped in 1971. They could print "currency gold" out of thin air, and they used it to finance Barrick, which turned out to be more of a dollar mining operation than anything else.

Of course, you know the story; one of the bullion banks collapsed in 1984 and had to be bailed out by the Bank of England, who subsequently formed the LBMA in 1987. And as you know, under this new fractional reserve system, the POG declined for the next 20½ years, from 1980 to 2001. Another warned that the physical reserves would run out if the price got below the cost of mining, which it did, and that's when we got Brown's bottom, where the BoE sold half of its gold to the bullion banks.

After that, they let the price rise. But, again, this is a market unlike anything else, because it's a banking system running a currency of its own. LBMA volume was huge from 1997-1999, but not quite as large in the early 2000s. But it was still big enough to dominate, and to therefore be the price-setter.

So, the price rise from 2001-2011 represents a rise in demand for paper gold. GLD is one of the outcomes of that demand. Paper gold was so popular that the bullion banks were able to create a new kind of paper gold that let gold bugs carry the cost of their physical inventory. I don't necessarily think this was how it was discussed in the beginning, but that's essentially what it is, and was, from the beginning.

Note that when the price drops in 2013, GLD is drained. When the price drops, that means a lower demand for paper gold. It doesn't mean anything for physical gold demand, because physical demand doesn't affect the price. In fact, Another told us that Asian buyers like to buy physical when the price goes down. So low demand for paper gold drops the price, and then the relative demand for physical from the East rises, thus we see physical leaving the paper gold vehicle of GLD during low paper gold demand.

This is key to adjusting your thinking: Changes in the POG give us information about the supply and demand dynamics of paper gold only. And since the BBs can control the supply, I'd just say that changes in the POG give us information about the demand for paper gold. Not physical, just paper.

As I showed above with the Asian preference for physical when the price drops, per Another, there may be an inverse correlation between the POG and physical demand. I'm not making that case, just pointing out the possibility. But here's a possible example:

Someone created a chart not too long ago that showed an apparent correlation between the POG and the net gold flow in and out of London, as seen in import/export data. It seemed to show that physical gold flowed into London when the POG was high or rising, and out of London when the POG was low or falling.

His explanation for this correlation was that high physical demand was not only driving up the POG, but drawing physical gold into London. And then when the price was falling, he said there was low demand for physical, so the gold was being sold to someone else, somewhere else. In other words, he says that physical supply and demand dynamics drive the price, and the chart he made proves it.

But the LBMA is not like other markets. The LBMA is a banking system that finances a large part of the global gold supply chain flow, and the LBMA’s physical reserves are the slack in that flow. Think of it as a rope. If it’s tight, i.e., there’s no slack, or any slack is being taken up, that would present as gold flowing OUT of London when physical demand was high (or higher than supply). Likewise, gold would be flowing INTO London when physical demand was low, or supply was higher than demand. London is like the reservoir in a river of physical gold flow.

That’s the opposite of what he was saying.

He was saying: high price = high physical demand = gold flowing into London.

But perhaps it should be: high price = high paper gold demand = low physical gold demand = gold flowing into London.

Take my coat-check analogy and pair it with the slack in the flow rope analogy, and think about GLD as the reservoir, or coat-check. Same idea.

In that case, you’d expect to see GLD inventory rising when gold is flowing into London, and declining when gold is flowing out of London. And that’s exactly what we see!

Again, I'm not trying to make a case for an inverse correlation between physical and paper gold demand. They can both be high, but it's the paper gold demand that drives the price. The apparent inversion may just be from one being marginally higher than the other at a given time.

The bottom line of this whole discussion is that the POG is pretty meaningless, unless you're buying or selling right now. In my opinion, it could potentially double before the LBMA goes kaput, but that's probably unlikely. I don't really give it that much thought. And for people who like to throw around prices like $10K or $20K because they think they're more reasonable than Freegold, they just don't get it.

When the LBMA is gone, it's going to be a whole different gold market. Perceptions of gold will be completely reset. Gold will be used differently. It will regain an ancient value it hasn't had in thousands of years, and things are so different today that you can't really draw a comparison between the two, at least not one that most people will understand.

Nor can you draw a connection between the current POG and one without the LBMA, because they are pricing two different things. You can't come up with a reasonable multiple, because they are two different things. When the LBMA goes away, gold will be set free from fractional reserve banking. It will be set free from use as a currency. It will be restored to pure wealth.

I'll leave it at that for now. πŸ˜€


I wanted to add a note about the LBMA trading volume mentioned in my comments. Back in 2015, the LBMA said it would start releasing volume or turnover data on a regular basis, just like it releases clearing data, which it has been doing since 1997. It essentially said, what we did with the 2011 liquidity survey, we’ll start doing on a regular basis “in the name of transparency.”

Clearing data is released monthly, and the data goes back to 1996, which they first released in 1997. What they publish is the average daily clearing volume for each month, and you can find it here. Daily trading volume is roughly ten times the clearing volume.

The 10:1 multiple comes from the 2011 gold liquidity survey, which revealed a 9.2:1 ratio of turnover to clearing volume. But that included data from only 36 of the 56 full members, or 64% of the LBMA members who might have turnover to report, versus 100% of the clearing members. So, it's probably at least 10:1, and maybe higher. Even the LBMA itself has said that turnover is ten times clearing.

But if you search for LBMA trade volume, you'll find something called LBMA Trade Data, which from what I can tell is garbage data that, beginning in 2020, the LBMA outsourced to NASDAQ, who publishes the data through Bloomberg Terminals and Refinitiv Eikon, both expensive subscriptions. If you have an expensive Bloomberg Terminal (which costs about $25K per year), you have access to the weekly volume, but if you want to see the daily volume, you have to pay an additional subscription fee. Not so transparent, huh?

And not only that, but from what I can tell, the data is complete garbage. For example, the LBMA page quotes average weekly turnover for the 12 weeks from October through December, 2022, at $228.82B, which would be $45.8B per day. The source of this quote is data that is "reported electronically (to NASDAQ) by LBMA members," which "makes it possible for market participants to gauge the size and shape of the London OTC precious metals market, the oldest and biggest financial market for gold in the world."

The problem is that the daily clearing volume for that same period was $31.2B, which would mean that the average daily turnover ($45.8B) was only a multiple of about 1.5x to clearing volume. That makes no sense, and we can have confidence in the clearing data, because it comes directly from the LPMCL, and includes data from 100% of the clearers.

Furthermore, the NASDAQ page boasts $174.33B as the "Record Single Days Volume". But how can the record single-day volume be $174.33B, when the 2011 survey said that the average daily volume for an entire quarter was $240.8B? Note also that clearing volume today is 20% higher than it was during the 2011 survey period.
The daily clearing volumes for the past two years have ranged from $25B to $38B. Applying the 10:1 ratio, we get a daily trading volume range of $250B to $380B, and the average is $324B. Compare that to the NASDAQ data which says the daily average trading volume is only $45.8B, and the all-time high was only $174.33B.

I should note that the WGC is using this LBMA garbage data too. But even so, it created this nice chart which answer's Jman's question: "I have it in my head that the daily notional values traded in the world bond and equity markets would dwarf the $250 billion a day in paper gold, but am I off base here?" This chart would say yes, if it could talk:
I don't know why the LBMA is putting out junk data, laundering it through NASDAQ, Bloomberg and Refinitiv, and then charging an arm and a leg to see it, but I can guess. No one ever said that the LBMA would operate in a fishbowl for all to see. ANOTHER said the opposite:

If you are searching for facts you will find them, but the items you find will not be true! Did you think that the high powered world of the LBMA would operate in a fishbowl for all to see? We cannot take what is on the outside as evidence for what is on the inside. To find the answer work with inside assumptions and extrapolate them to the outside!

Yup, that's what I do! πŸ˜‰

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