By Trace Mayer, on June 19th, 2009
FUTURES AND FORWARD CONTRACTS
Many commodities trade via forward or futures contracts. A forward contract is is an agreement between two parties to buy or sell an asset at a specified point of time in the future. A futures contract is a standardized contract to buy or sell a specified commodity of standardized quality at a certain date in the future, at a market determined price (the futures price).
REGULATION AND COUNTER-PARTY RISK
Both futures and forward contracts introduce counter-party risk which depends on the financial ability of the counter-party to perform and may result in a failure to deliver. The calculated counter-party risk of futures contracts are assumed to be lower than forward contracts because they are traded on commodity exchanges. This is because generally governments must provide a common insurance or regulatory standard, such as the Commodity Futures Trading Commission (CFTC), and some release of liability, or at least a backing of the insurers, before a commodity market can begin trading.
COMMODITY MARKET SIZE
As a result of this increased confidence the size of futures contracts has grown tremendously. The major commodities exchanges in the United States were the COMEX and NYMEX which merged under the New York Mercantile Exchange and Commodity Exchange, Inc. (NYMEX) name on 3 August 1994.
The notional value outstanding of OTC commodity derivatives contracts increased 27% in 2007 to $9.0 trillion. OTC trading accounts for the majority of trading in gold and silver. Overall, precious metals accounted for 8% of OTC commodities derivatives trading in 2007, down from their 55% share a decade earlier as trading in energy derivatives rose.
BACKWARDATION
Because of the large aboveground stockpiles of the monetary metals threfore gold and silver should never enter backwardation. Backwardation would be evidence of the market’s increased apprehension of counter-party risk and the increased probability of a failure to deliver. The brief gold backwardation or the recent black swan of nine weeks of silver backwardation in the London Bullion Market Association (LBMA) forward markets revealed the extreme fragility of the worldwide financial and monetary system.
Mr. Avery Goodman, a securities attorney and a member of the roster of neutral arbitrators of the National Futures Association (NFA) and the Financial Industry Regulatory Authority (FINRA), has also written extensively about whether the COMEX will default on gold and silver, how the NYSE ran out of gold bars, the evidence that the ECB bailed out Deutsche Bank preventing a failure to deliver of gold on the COMEX and a follow up article on the ECB’s saving of the COMEX from a gold default.
Then there are other commentators like Jason Hommel, the creator of the satirical silver CFTC appreciation medallion above, who alleges regulatory culpability. Still others like the Gold Anti-Trust Action Committee (GATA) who has met with CFTC officials bring considerable intellectual firepower to the allegation of a central bank gold price suppression scheme where Mr. Robert Landis, a Harvard trained attorney, asserts “Any rational person who continues to dispute the existence of the rig after exposure to the evidence is either in denial or is complicit.”
TOOLS OF SPECULATION
Due to the size of the derivative contracts traded on the commodity exchanges and the counter-party risk the contracts are impregnated with therefore a bankruptcy of either the counter-party, the exchange or both could happen. Due to the increased liquidity of these exchanges many of those buying or selling the contracts for speculative purposes neither want possession of the underlying commodity nor possess the underlying commodity and have the ability to physically deliver.
While there are some some legitimate measures such as oil or gold companies that sell forward their production, and the number of gold companies has increasingly withered, in many cases when you buy these gold derivatives you are buying from a speculator who is shorting gold and that gold speculator does not actually own any physical gold.
MECHANICS OF AN EXCHANGE BANKRUPTCY
Let us assume for the sake of argument that gold prices go ballistic and you decide you want your gold by taking delivery on the contract. What if gold prices go up dramatically in one day such as a thousand dollars an ounce. Is it possible? Of course. Is it probable? Not really.
But that means the person who shorted gold is in a very precarious position and could have possibly lost everything or more. Perhaps they had a stop but the market is fast and gaps and as a result they cannot get out of their position. What would happen?
Let us assume this speculator had ten thousand dollars in their commodities account and they were short a gold contract. Suddenly, perhaps overnight, the Chinese press the issue because the International Monetary Fund failed to deliver on their gold sales and needed a line of credit, gold prices rapidly jumped and this speculator lost a hundred thousand dollars overnight. Now the brokerage firm has to attempt to collect on this ninety thousand dollar margin call in the form of an unsecured debt. What if they cannot collect and what if there are hundreds or thousands of speculators in similar situations?
With this failure to deliver and violation of margin requirements what if the exchange, because they do not have adequate capital or liquidity, cannot get the currency to settle the contracts? Then the exchange goes broke unless there is a government bail out but what good would that fiat currency do in purchasing the physical gold or silver bullion?
COUNTER-PARTY RISK MATERIALIZING
This is what happened with the American Insurance Group. The reason AIG went bankrupt is because they were the other side of many speculative contracts. When the flock of black swans they had insured against descended AIG could not perform because they did not have the cash. The government bailed them out at the cost of hundreds of billions if not trillions of dollars.
This means if you buy silver or gold on the COMEX via futures contracts, there is a huge move up, the COMEX goes bankrupt and the government does not bail them out then you are not going to be able to cash out your epic gains from the casino. Like the auto maker’s bond holders you will not realize and enjoy the profits you thought you would.
This is precisely what happened with people who were short a bunch of oranges and other interesting things via hedges with Lehman Brothers and even though they ‘made’ millions of dollars on their positions they lost everything. Why? Because Lehman Brothers went under and did not perform on the contracts. This is counter-party risk.
CONCLUSION
At all time and in all circumstances gold and silver remain money. For the conservative investor the reason to own them is as insurance for when everything else fails. These issues of counter-party risk are important when considering how to buy gold or silver through third parties. There are third-parties, like GoldMoney, that not subject to counter-party risk because of the way ownership is titled and the ability to demand physical delivery at any time.
 As I explain in my book The Great Credit Contraction capital is burrowing down the pyramid into safer and more liquid assets. The safest and most liquid of them all are gold and silver. Why? Because the world reserve currency the FRN$ is merely an illusion that can become worthless while gold and silver are money and will always buy something.
Consequently, the conservative investor will determine what their gold standard is considering there are 140 ounces of paper gold for every ounce of physical gold. Then they will take appropriate actions, such as buying gold in a vending machine, to remove the layers of risk between them and their purchasing power in an effort to preserve and safeguard their capital.
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By Bron Suchecki, on June 18th, 2009
From Prosperity and Depression: A Theoretical Analysis of Cyclical Movements, G Von Haberler, rev ed., 1939, published by League of Nations:
Prosperity comes to an end when credit expansion is discontinued. Since the process of expansion, after it has been allowed to gain a certain speed, can be stopped only by a jolt, theere is always the danger that expansion will be not merely stopped but reversed, and will be followed by a process of contraction which is itself cumulative.
If the restriction of credit did not occur, the active phase of the trade cycle could be indefinitely prolonged, at the cost, no doubt, of an indefinite rise of prices and an abandonment of the gold standard.
Well, we abandoned the gold standard, had unrestricted credit, so now we wait for an indefinite rise of prices?
Bookkeeping is more or less based on the assumption of a constant value of money. Periods of major inflations have shown that this tradition is very deeply rooted and that long and disagreeable experiences are necessary to change the habit. One of the consequences is that durable means of production – such as machines and factory buildings – figure in cost accounts at the actual cost of acquisition, and are written off on that basis. If prices rise, this procedure is illegitimate. The enhanced replacement cost should be substituted for the original cost of acquisition. This, however, is not done, or is done only to an insufficient extent and only after prices have risen considerably. The consequence is that too little is written off, paper profits appear, and the entrepreneur is temptted to increase his consumption. Capital in such case is treated as income.
The paper profits are also likely to add to the cumulative force of the upswing, because they stimulate borrowers and lenders to borrow and lend more. The foster the optimistic spirit prevailing during the upswing, and so the credit expansion is likely to be accelerated. This phenomenon has its exact counterpart during the downswing of the cycle.
Those interested in the above may also find Professor Fekete’s paper Is Our Accounting System Flawed? of interest.
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By Eldon Mast, on June 18th, 2009
U.S. home builders started construction on many more residencies than expected in May. The Commerce Department reported that housing starts increased by 17%. Building permits also rose 4% — significantly more than expected. The increase in starts was punctuated by a 29% surge in the West.
As this recovery begins we’ve continued to look to strength in the housing sector as an indication of how strong this recovery will be. Sales of new and existing homes increased in April and buyers signing contracts to buy previously owned homes has now risen for three straight months.
Home prices are now at record affordability levels across the country. First time home buyers are also rushing to take advantage of the $8,000 tax credit included in Obama’s stimulus plan.
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By David Barr, on June 18th, 2009
Sometime in the next couple of months The Federal Government is going to give the state of California a lot of money. After lavishing more than a trillion dollars on Banks, Insurers and Auto Companies, there is a 0% probability that the government will sit idly while the largest state collapses.
There real question is how do we go about propping up California. Whether we like it or not, California will set a precedent for the rest of the country. Believe it or not California is not the only State struggling to keep its head above water. Congress and the administration need to have a strategy ready before Arnold comes crawling cap in hand to Washington.
Rather than putting together an ad-hoc plan for California, we should develop a national strategy for dealing with insolvent states. The plan that I am proposing is simple, non-intrusive and will ensure that Federal Government gets back every penny that it spends bailing out the states.
Federal loans should be made available to any state that chooses to accept them. In exchange, the state will be required to levy a 1% sales tax, whose revenue would be directed to the Federal government until the loan is repaid.
While, no one would enjoy paying the extra tax, it wouldn’t be nearly as devastating as the massive budget cuts currently facing states across the country. By securing a dedicated revenue stream the loan would be virtually risk free for the Federal Government. Furthermore, enacting a national policy would assure investors that state bonds were a safe investment, reducing borrowing costs for every state.
The greatest advantage of this plan would be in avoiding the political circus of negotiating a special bailout for every state in need. My plan would not solve the underlying problems facing California, but that is intentional. It is up to voters and politicians in California to find a long term solution to the state’s budget crises. Allowing Washington to interfere in the fine details of the State budget would be far worse.
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By Cheryl Grey, on June 17th, 2009
President Obama has made the advancement of renewable energy sources (RES-e in greenspeak) an integral part of both his environmental and economic policies, and Texas billionaire T. Boone Pickens has enough belief in its potential to invest heavily in wind power. But as thirty plus years of research spending and ineffective regulations have proven, that’s not going to be enough to move this horse into the mainstream of residential usage, which has been the driving force in European wind and solar power generation. At least three drivers must come together to accomplish that feat in the United States.
Adopt feed-in tariffs to create demand. It’s not enough for people to want alternative energy; it must be economically viable, as well. No matter an individual’s level of belief in clean energy, global warming, or carbon footprint reduction, as long as entry costs remain prohibitive, most small investors such as homeowners will stay out of the market. Only by offering financial incentives to surmount those entry costs will governments, local or federal, entice homeowners into investing in their own solar panels or rooftop wind turbines, which will create long-term demand, increase production over time, and lower the entry costs naturally.
Accomplishing this goal in Europe, particularly Germany and Spain, has been the feed-in tariff, which mandates payments for homeowners who generate sufficient electricity from their RES-e systems to sell it back to the power companies. Using this system, in Germany between 2000 and 2007, the installed capacity of RES-e more than doubled, including within residential areas, meeting the 2010 goal (12.5% of electricity derived from alternative sources) three years ahead of schedule. At the same time, the entry cost of such systems fell 20% and 10,000 manufacturing and maintenance jobs were created, giving the RES-e industry viability and sustainability.
Aesthetics must be recognized as a luxury item. With homeowners associations (HOAs) wielding the power to refuse urban and suburban residents the ability to utilize solar panels, solar water heaters, or light-colored roofing materials for aesthetic reasons, RES-e production won’t extend into the most heavily populated parts of the nation, which is where the energy is most needed. The same holds true for local governments, which often block adoption of RES-e by refusing to issue building permits for such projects or by charging such high fees to issue permits that again the entry cost is raised beyond the small investor’s reach.
If RES-e production is going to survive and thrive, this trend must be reversed, and state laws and subsequently state courts are increasingly becoming battlegrounds between aesthetics and science. Currently eight states have enacted laws giving homeowners teeth against HOAs and local governments, while four more are considering them. Perhaps most well known is California’s “solar rights” law, which bars restrictions against solar panels and water-heating systems by HOAs and other public entities on the basis of appearances.
Additionally, similar bills have been introduced in both houses of Congress to move homeowners’ RES-e rights to the federal level. Although these bills received little support to date, the new administration’s drive toward green power could change that rapidly.
Not a luxury is the electrical transmission grid. Already aging, subject to brownouts and blackouts in some regions, and in desperate need of upgrades, the grid that stretches across the U.S. and Canada will control the rate of advance for RES-e systems.
Many transmission nodes within the grid require additional depth to handle the increased workload from the exponentially rising numbers of electrical devices—computers, entertainment systems, kitchen appliances, heating and cooling systems, even plug-in cars—in high population areas. In addition, the electrical inputs into the grid must be balanced against the demand load, with additional power needed during peak hours. Under the current system of generating electricity via a few hydrocarbon-based generation plants, grid managers can balance their loads relatively easily; but when a cityful of solar panels or rooftop turbines kick in, this task becomes much more difficult.
Without strengthening this necessary infrastructure, and without finding a means of balancing these inputs against demand loads, RES-e could cause more problems than it solves. The cost of grid upgrades, meanwhile, could eat a significant share of the new administration’s recently proposed economic stimulus plan.
There’s no easy solution to driving such a fundamental change within the world’s largest economy, particularly through established political fiefdoms and vested interests. Nobody should expect the process to be smooth or error-free; but then, neither is economics.
By Bron Suchecki, on June 16th, 2009
This article discusses the issues associated with keeping track of precious metals. I call it metal accounting because the point is to ensure that ounce debits (ie assets) always equals ounce credits (ie liabilities). This should be of interest to anyone holding unallocated metal because the extent that your “custodian” doesn’t have control over their metal activities is the extent that your holding is not backed and thus the custodian is exposed to precious metal prices. If this exposure is excessive, and the price rises, they go bankrupt.
I put custodian in inverted commas because unallocated metal, even if backed 100% by physical, is not the same as a true custodial service, commonly referred to as allocated metal. With allocated, you hold title to the physical metal and the storer is just a safekeeper of your metal. It is off the balance sheet of the storer and control of it is a very simple process: run listing of how many bars your are holding for a client, do a count of the bars in the vault, the two should equal.
Unallocated metal, on the other hand, is on the balance sheet of the storer. This is why it is so important that debits equal credits, from an ounce point of view. At first you may think that the controls around keeping track of allocated should apply to unallocated – if you owe 100oz to clients, then you should have 100oz of physical gold on site. What this article hopefully reveals is that it is not necessarily that simple and an appreciation of the need for stronger controls.
The Golden Table
Let me start with an imperfect analogy for the manufacture of precious metal products: making a wood table. Looking at your plans, you go down to the hardware store and buy some wood and nails, say it costs $100 all up. It is not likely that you will get the exact lengths you need, so some sawing is involved. Whack a few nails in and you have your table.
If I asked you what the table cost, you look at me strangely and say $100 and wonder why I was so stupid. Your answer, however, has made one assumption: that your “by-products” of the table making process are worthless. What are these by-products? They are the wood offcuts and sawdust and your assumption is most likely correct.
Now consider that you are making the same table out of gold. Lets assume the same $100 purchasing cost for the raw gold (it would have to be a really small table) and same process – you have to cut up the gold planks. When I asked what the cost was, would you still say $100? Of course not, you aren’t going to sweep up the golddust and throw it and the gold offcuts in the bin like you would with the wood. You would melt them down and sell them to a refinery and the money you would get back would reduce the initial cost of $100. It is like the hardware store giving you a refund for the wood offcuts and sawdust.
This is what makes precious metal manufacture different from normal manufacture and is a function of the high value of precious metals and the fact that you can melt the by-products and reuse them without any or much loss of “utility”. My first exposure to this was when I looked at a stocktake count summary and saw a line called “sweeps”. It was literally the amount of gold after refining from the sweepings from the factory floor. That plus the fact that the counts were done down to 1/1000th of an ounce that was my first indication that this minting business was just a little bit different.
The existence of by-products introduces our first complication in precious metal control – estimations. To help illustrate the issue, let us first complicate our gold table process. As your local hardware store doesn’t sell gold planks, you have to buy standard size gold bars from your local refinery. You therefore have to melt them and pour them into a mould for the legs of your table.
To melt and pour gold, you have to heat it to above its melting point. The reason for this is that gold cools very quickly and if it is just at its melting point it will go solid before you can finishing pouring it. However, this creates a problem because when something is above its melting point (but not yet at its boiling point), some of the liquid is evaporating. Now you might think how much gold would really evaporate and I don’t know the technical answer to that. But what I do know is that it must be enough because above any gold furnace I’ve seen there is a hood that sucks in the fumes, taking it to a “scrubber” that collects the gold particles. However much gold is evaporated, it must be worth enough to go to all that trouble. Consider also that the crucibles in which the gold bars are melted also, over time, absorb amounts of gold.
Estimations
So how do you do a precious metals stocktake? First step is working out your “theoretical” or book inventory. Say you received 100oz of raw gold and recorded shipments of 90oz of coins. 100 minus 90 equals 10oz. Second step seems simple enough, go around and count all the physical gold and it should add up to 10oz. Easy.
OK, lets say there are 5 x 1oz finished coins on the shelves and 3 ounces of “offcuts”. But what about the gold in the sweeps, embedded in the crucibles, in the scrubbers? This is where one has to estimate the gold that is onsite, but not measurable – for example you don’t want to crush up and refine your perfectly good crucibles just because it happens to be a stocktake date. Introducing estimations, however, introduces room for human error. This is minimised by keeping historical records of the usual gold recovery from spent crucibles, scrubbers etc, so that there is a reasonable basis or justification for the estimated “onsite but not measurable” gold. Lets say this is worked out to be 1 ounce.
We are still missing 1 ounce. At this point consider that not all “recovery” controls are 100% effective. Scrubbers still let some gold evaporated gold out, for example. I’ve only described a few of the many recovery type controls in a precious metal factory, there are many more and over high volumes of manufacture bits of gold can be lost. The use of the word “loss” is often interpreted as “theft” but it is more accurately described as a “production” loss. It is a sort of known unknown. But this is not really fair, because production managers, again from historical stocktakes, know that there is a certain ratio of production losses to volume manufactured, which enables them to calculate and expected production loss.
Lets say in our example that the production loss ratio is 1% (our production manager would get fired if that was an actual loss). The estimate loss is therefore 0.950oz (1% of 95 coins made). This leaves us with a stocktake result of 5+3+1+0.95 = 9.950oz against theoretical or book inventory of 10oz. What happened to the 0.050oz? In a precious metals stocktake this is the key question.
First thing that is looked at is the accuracy of the count of measurable/countable physical gold. Second the production manager reviews the by-product estimations. If these two look OK, then third is to consider the effectiveness of the recovery controls. For example, maybe there was a hole in the ducting to the scrubbers and thus more gold was lost to evaporation. If controls are OK then it only leaves two possibilities:
1. Your production loss ratio is not correct. Maybe for every 95 coins made you lose 1oz?
2. Maybe your production loss ratio is correct. Therefore, someone in the factory has managed to secrete 0.001oz out every week over the past year.
The problem is that it is not easy to answer the question, because the stocktake result relies on estimations. This is why mints have one other “recovery” control – physical metal detection of staff as they leave the factory!
The above discussion is simplified, of course. There are many more processes involved in a refinery or mint and many more opportunities for production losses, necessitating many more controls. This is where accurate historical records and experienced staff come in to keep account of precious metal.
There is one thing we have missed. In our example, we only have 9oz in physical metal. Whether the 1oz is 0.95oz of production losses and 0.05oz of theft, or 1oz of production loss, doesn’t change the fact that we have lost 1oz. If the 10oz book inventory was funded/acquired from clients holding unallocated with us, then we only have 9oz of physical against 10oz of liabilities.
This is why this article was titled Metal Accounting I. In Metal Accounting II, we will discuss how the 1oz loss is dealt with and introduce yet more opportunities for gold to get lost.
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By Eldon Mast, on June 15th, 2009
As this recovery begins, all eyes will be on the housing markets as a gauge for just how strong this return to growth will be.
Of particular note is the jumbo mortgage market which is now springing back to life.
A jumbo mortgage is a home loan with a lending amount above the industry-standard definition of conventional conforming loan limits. With some exceptions, this means an amount above $417,000. A loan in excess of $650,000 is typically referred to as a super jumbo mortgage.
Banks have now resumed underwriting wealthy clients in both of these categories. In fact jumbo activity seems to be brewing even with a limited secondary market for these large payback notes.
For instance, Bank of New York Mellon’s wealth management division reports a resurgence in its high-end lending activity. “We’ve seen significant growth,” says Erin Gorman, their national director of sales. Through the end of May 2009, BNY Mellon’s jumbo lending activities are up 32% by dollar volume compared to that same period in 2008. In the first quarter of 2009, BNY’s average loan balance bounced by 23% compared to the first quarter of 2008.
Another example is found over at Coldwell Banker Residential Brokerage. In the Boston market alone 36 properties of $1 million and up went under contract in March. That figure nearly tripled in May, jumping to 105 mega residential deals.
Mellon’s Gorman currently is observing that her competitors are indeed returning to the jumbo market as the economy recovers. She notes that during the recession, “we earned a reputation as the go-to player in jumbo mortgages. And that puts us in a strong position as other lenders gingerly move back onto the field.”
BNY Mellon (BK) is one of the 10 large banks announcing that they will begin repayment of their TARP bailout monies to the US Treasury.
By Trace Mayer, on June 15th, 2009
Lately I have received many inquiries about whether the physical gold or silver people think they own and have stored with third parties is safe. Many have asked me to comb through various prospectuses or user agreements and give my opinion.
Because of reader inquiry I have thoroughly researched the GLD ETF and GoldMoney. However, due to time constraints I have not thoroughly researched other options like the Perth Mint, Kitco pooled accounts, CEF, GTU, other ETFs, Royal Canadian Mint, or plenty of other options.
ROYAL CANADIAN MINT ISSUES
On 12 June 2009 the Ottawa Citizen reported:
To halt a possible “run” on the gold it safeguards for private businesses, the Royal Canadian Mint is reassuring customers their deposits are fully accounted for and in secure vaults as the investigation continues into as much as $20 million in lost precious metals.
There have been widespread issues concerning the gold held by the Royal Canadian Mint. Supposedly some of the gold was lost, stolen or otherwise has disappeared through some type of accounting discrepancy.
PAPER GOLD VERSUS PHYSICAL GOLD
On 8 September 2008 I was featured on Adam Curry’s Daily Source Code 788 (mp3) where I mentioned in passing that there are approximately 140 ounces of paper gold for every one ounce of physical gold. The ratios may be even higher for paper silver and physical silver. As usual GATA hits on the real issue:
Yes, there well may be plenty of gold left at the Royal Canadian Mint, as was insisted upon, with great agitation and anxiety, by the paper gold marketer quoted in today’s Ottawa Citizen story, dispatched to you a little while ago — just as there may be plenty of gold left at Fort Knox. But those are not the most compelling questions. No, the most compelling questions are: Who really owns that gold? And how many people have claims to it?
Gold is one of the most transparent of assets. Au, or gold, has the periodic number of 79, a boiling point of 2,856 °C or 5,173 °F, a standard atomic weight of 196.966569(4) g·mol−1 and is metallic yellow in appearance. On the other hand, the gold market is extremely murky with many shadowy characters lurking in the unsavory places attempting to places risky barriers between owners and their gold.
UNSAVORY GOLD MARKET CHARACTERS
There are many untrustworthy agents which purport to help you answer the questions of how to buy gold or silver but really attempt to sell you paper silver and paper gold which, in many cases, is merely a form of fool’s silver or fool’s gold.
I have thoroughly reviewed the prospectus and found problems with the GLD and SLV ETFs and later found another problem with the GLD ETF where the 10-K precludes the right to audit physical gold inventories.
There are other third-party storage services such as E-gold or the Perth Mint in Australia. But in July 2008 E-Gold pleaded guilty to money laundering charges in US federal court. As mentioned earlier, the nation of Canada’s Royal Canadian Mint withheld employee bonuses and sent in external auditors to determine the cause of a multi-million dollar ‘unreconciled difference’ between the financial accounting and the physical bullion.
I recommend staying away from unnecessarily complex instruments even if issued through perceived reputable firms. For example, in June 2007 Morgan Stanley & Co. settled a class action lawsuit for $4.4 million where the complaint alleged
that Morgan Stanley told clients it was selling them precious metals that they would own in full and that the company would store. But Morgan Stanley either made no investment specifically on behalf of those clients, or it made entirely different investments of lesser value and security.
While the efficacy of the claim may still be at issue the Better Business Bureau-like complaint from unsatisfied customers who initiated litigation does not inspire confidence for those seeking to reduce risk. Most people, probably including you, neither want to get involved with an asset that you do not understand nor do you want to get taken in a scam, Ponzi scheme or other type of fraud or theft.
JOHN NADLER’S ADVICE
John Nadler is the Senior Metals Market Analyst for Kitco.com which receives about 5 million hits per week. His daily commentary is widely available to the gold community. On 12 June 2009 in Good News/Bad News/ No (Inflation) News Mr. Nadler wrote:
A brief Friday footnote. A lot of ill-informed noise has been generated by the Royal Canadian Mint’s gold reconciliation story, seen in the Canadian press of late. Some ‘market advisors’ found an opportunity in this story, to try to instigate some kind of a “run” of the custodial accounts of that, and other mints around the world. How pathetic. We need very few words to emphatically tell you that Kitco reaffirms its 100% degree of confidence in the RCMs ability to keep the customers’ metals free of any material losses, no matter what the ultimate tally will turn out to be.
The RCM has issued a letter on the subject matter, and it has assured everyone that customer metal accounts are unaffected by the reconciliation problem. We expect a complete report on the findings of an on-going investigation and continue to remain at ease with the status of both our own as well as our customers’ balances at the Mint. As well as those at any other mints around the world. Some over-zealous alarmists need to get a grip and learn how vaults, insurance policies, and such operate in the real world. Until then, we can only call them saboteurs. And anyone who listens to them, sadly misinformed.
SCALPEL PLEASE
The primary reason people own gold or silver is to reduce risk; counter-party, payment, performance, currency crisis, etc. At all times and in all circumstances gold and silver remains money. Gold and silver are insurance for when everything else fails.
The intent behind demanding physical gold or silver for immediate possession is irrelevant. In this case, Mr. Nadler remarks that market advisors attempting to instigate a run on custodial accounts is pathetic. This is followed up by a reaffirmation of the 100% degree of confidence in the Royal Canadian Mint’s ‘ability to keep the customers’ metals free of any material loss. It appears that this reaffirmation of confidence is revealing that one of the primary reasons individuals own gold, to reduce risk, is not being met.
Additionally, the Royal Canadian Mint has issued a letter attempting to assure people that their metal is there. The letter is or should be irrelevant. Very simply, the metal is either there and available for physical delivery or it is not. Additionally, Mr. Nadler seems to be encouraging people to wait for ‘a complete report’ about whether their gold is still there or not.
Ad hominem arguments, those arising from or appealing to emotions and not reason or logic, are present in Mr. Nadler’s analysis. I find particularly humorous the ad hominem attack on ‘over-zealous alarmists’ that do not understand how vaults, insurance policies and the gold market operates ‘in the real world’. I would like to know which real world Mr. Nadler is referring to; the physical world where gold is an element with a standard atomic weight or the derivative illusion where ‘gold’ is an apparitional derivative of an element with a standard atomic weight.
What exactly should these ’saboteurs’ and those sadly misinformed souls who listen to them ‘get a grip’ on? I think some physical gold would be a good idea. After all, none of these issues matter until they are the only things that matter. Demanding physical delivery of physical gold or silver bullion is always a good exercise. It keeps the third parties and vaults busy, provides jobs and allows the owner of the bullion to have a cute piece of metal to pet.
WHAT TO LOOK FOR
When combing through a prospectus or user agreement the language to find should be extremely simple and clear. Here is an example from the GoldMoney User Agreement under VIII. Section E:
A User may, by providing GoldMoney with delivery instructions, which instructions must be in the form prescribed from time to time by GoldMoney and the Vault, at any time request GoldMoney to change the goldgrams and silver ounces in his Holding into grams of gold or ounces of silver that are available for physical delivery to the User, provided that there are sufficient goldgrams and silver ounces to take delivery of a London Good Delivery bar of gold, which bar weighs approximately twelve thousand five hundred (12,500) grams, or bar of silver, which bar weighs approximately one thousand (1,000) ounces. GoldMoney will not charge a fee for its service, but fees may be charged by the Vault for acting on the delivery instructions.”
On 7 May 2009 they announced that “In conjunction with Baird & Co. customers can now redeem and take physical delivery of their gold in convenient units of 100 gram or one kilo (1,000 gram) gold bars.”
When I experimented with this option I received this message:
Only Holdings with verified owners that are resident in the following countries can currently redeem bars: United Kingdom, Guernsey, Isle of Man, Jersey. We expect to make these bars available to all of our customers in June 2009 after the initial trial launch has been completed.
I am excited to see the ability to take physical possession at any time of gold in smaller amounts than 400 ounce LBMA bars. This is an example of what to look for in the language of the legal documents of the third-party service you use to store your physical gold or silver bullion. Do not use safety deposit boxes or your precious metals may end up on Ebay.
CONCLUSION
Gold is the risk-free asset and along with silver will always be worth something. There are many shady characters in the bullion market that want to erect barriers between the owners and their cold hard gold or silver bullion.
The prospectus, user agreement, etc. should therefore be pretty simple. The owner of the gold or silver should be able to demand physical delivery at any time. There are options for third-party storage of gold or silver bullion, like GoldMoney which is recommended by Michael Maloney, Doug Casey, Peter Schiff and others, that allow for physical delivery at any time.
But sometimes even that highest guarantee is not sufficient for Chicken Little’s gold standard. In those cases, I think Chicken Little should get a grip; on their physical gold or silver bullion by demanding immediate physical possession. Why? Just because Chicken Little can.
If you determine that to satisfy your own gold standard that you will follow Chicken Little’s example and demand physical delivery and are denied I would like to know. Please leave your comments if you have had or do have any problems with any institutions failing to deliver.
Disclosures: Long physical gold and silver with no position in GLD or SLV.
By Ajay Shah, on June 11th, 2009
Two interesting readings. First, on the life of the economic policy team in the US today. From an Indian point of view, it makes you think about the lack of comparable intellectual firepower. And another, on using economics in the realworld. Generally, when we think of direct engineering applications of economics, we think of finance, but this is in a new setting: google.
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By Trace Mayer, on June 10th, 2009
NATIONAL COMMON STOCK
National fiat currencies represent the common stock of nations. Because of the large amounts of capital involved they usually move slowly according to trend. As their share price sinks despots implement doomed currency controls enforced by violence in a vain attempt to artificially increase price.
Notice how the FRN$ trended downward with the 200dma tracking the 50dma. Then a convergence happened and there was a very steep strengthening. Likewise the 50dma and 200dma have recently converged and the slope of the declining curve is particularly steep. The trend is changing.
CURRENCY CONTROLS
Currency controls, or foreign exchange controls, are imposed by governments on the purchase, sale, convertibility, or use of foreign currencies. They are gross interferences with the unalienable human right to freedom of contract.
 Most people think that currency controls are only implemented in ruthless socialistic, communistic or fascist countries like Russia under Stalin or Lenin, Germany under Hitler, Zimbabwe under Mugabe or other oppressive regimes like China, Argentina, etc. Viewing explosive history through the lens of monetary policy reveals a common thread. Dictators attempted to abrogate monetary rights and the people either killed them or were killed.
Harvard Professor Niall Ferguson wrote on page 149 of The Ascent Of Money about the French Revolution which seared the gruesome visage of the guillotine into the hearts and minds of French politicians.
Not surprisingly, some people began to anticipate a depreciation of the banknotes, and began to revert to payment in gold and silver. Ever the absolutist, Law’s initial response was to resort to compulsion. Banknotes were made legal tender. The export of gold and silver was banned as was the production and sale of gold and silver objects. By the arrêt of 27 February 1720, it became illegal for a private citizen to possess more than 500 livres of metal coin. The authorities were empowered to enforce this measure by searching people’s houses. Voltaire called this ‘the most unjust edict ever rendered’ and ‘the final limit of a tyrannical absurdity’.
Money and currency are essential and unalienable human rights. The use of force or intimidation against innocent people is immoral.
With the pot calling the kettle black Vladimir Putin said, “The only problem: your [U.S.] results were poor [Georgia] and this will always be the case because the work you do is unfair and immoral. In the long run immoral policies always lose.” Following the example of so many other failed nation-states as the FRN$ has evaporated additional currency controls have been put in place be unfair and immoral politicians.
PAST DOLLAR CURRENCY CONTROLS
One of America’s greatest tyrants, Franklin Delano Roosevelt, exacerbated the rapidly shrinking United States share price. He greatly infringed on the Great Writ of Habeas Corpus, implemented Executive Order 6102, New Deal legislation resulting in a ‘Constitutional revolution’ and extremely restrictive SEC rules.
Then on 15 August 1971 Richard Nixon, who said he was not a crook, unilaterally declared international bankruptcy for the United States by refusing to honor the promise of gold convertibility. Now the federal government has no intelligible answer to ‘What Is A Dollar?’ and yet strut around in their costumes robbing people if they do not like how their unintelligible definition is applied.
CURRENT DOLLAR CURRENCY CONTROLS
Many currency controls trammel the FRN$. For example, there are ‘qualified intermediary’ rules the Infernal Revenue Service require foreign banks to follow. The PATRIOT Act allows for ’sneak and peak’ warrants along with the ability to confiscate cash at will and in secret.
A particularly insidious but scarcely mentioned currency control was implemented by the United States Mint on 14 December 2006 which provided:
The United States Mint has implemented regulations to limit the exportation, melting, or treatment of one-cent (penny) and 5-cent (nickel) United States coins, to safeguard against a potential shortage of these coins in circulation. … Prevailing prices of copper, nickel and zinc have caused the production costs of pennies and nickels to significantly exceed their respective face values.
“We are taking this action because the Nation needs its coinage for commerce,” said Director Ed Moy. “We don’t want to see our pennies and nickels melted down so a few individuals can take advantage of the American taxpayer. Replacing these coins would be an enormous cost to taxpayers.”
Specifically, the new regulations prohibit, with certain exceptions, the melting or treatment of all one-cent and 5-cent coins. The regulations also prohibit the unlicensed exportation of these coins, except that travelers may take up to $5 in these coins out of the country, and individuals may ship up to $100 in these coins out of the country in any one shipment for legitimate coinage and numismatic purposes. In all essential respects, these regulations are patterned after the Department of the Treasury’s regulations prohibiting the exportation, melting, or treatment of silver coins between 1967 and 1969, and the regulations prohibiting the exportation, melting, or treatment of one-cent coins between 1974 and 1978.
The new regulations authorize a fine of not more than $10,000, or imprisonment of not more than five years, or both, against a person who knowingly violates the regulations. In addition, by law, any coins exported, melted, or treated in violation of the regulation shall be forfeited to the United States Government.
Notice the underlying assumptions Mr. Moy makes evidenced by ‘the Nation needs’ and ’see our pennies and nickels’. Who owns the penny or nickel in your change jar? Are one-hundred nickels five dollars? Are one-hundred pennies a dollar? What Is A Dollar?
If you own the penny or nickel then why would you be prevented from doing whatever you want with your property so long as you do not violate another person’s rights or harm their legitimately acquired property?
Often I receive questions about the ultimate form of currency control: gold confiscation which I think is highly unlikely.
INFLATION AND SHORTAGES
 Inflation leads to shortages and shortages lead to rationing. The adjusted monetary base has spiked tremendously since October 2008. Many prancing court economists seem to think that this activity is not inflationary because asset prices have not risen. They are wrong.
Inflation is an increase in the money or currency supply. Rising prices are an effect that generally results from inflation. Rising prices are not inflation anymore than wet streets are rain.
The United States Treasury Bubble is the biggest bubble of them all and there are reasons for how and why the Treasury will burst. Should the effects of this out of control inflation begin to be felt then it will be real things of intrinsic value and not paper tickets that will be of the most worth.
During these relatively calm times it is important to learn how to buy gold or silver and why to avoid the problematic GLD or SLV ETFs. There will likely be shortages, delivery delays and other potentially chaotic conditions.
Many of the complex systems society takes for granted, like the just-in-time inventory systems of our supermarkets, may become difficult or impossible to operate. Due to rapid advances in supply chain management the margin for error is getting increasingly thinner.
The marketplace and creative entrepreneurs will likely devise alternative services and digital commodity currencies, like GoldMoney, to fulfill market demand for a medium of exchange but they may take a while to be adopted in commerce.
In Zimbabwe the people are trading gold for bread at a price of about one gram of gold per loaf. I think it would be wise to set aside at least three months of food and get a 72 hour kit. Food storage is a great form of insurance that is not subject to counter-party risk. Store what you eat and eat what you store. Chicken Little may also like to have a plan for how to vanish.
CONCLUSION
Money and currency are unalienable humans rights. Infringements on these rights are immoral and always fail. As the FRN$ continues evaporating the mendacity of the United States government appears unbounded as decade after decade it keeps implementing increasingly oppressive currency controls and uses greater savagery to perpetuate its influence.
Interest rates need to rise higher for Treasuries to become attractive because of the budget and trade deficits which act like an millstone on the income statement and balance sheet of a devalued nation. At all times and in all circumstances gold and silver remain money. They constitute insurance against currency crisis. And it is the world reserve currency, the FRN$, that is in a currency crisis.
Disclosure: Long physical gold and silver.
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