Alasdair Macleod – 09 December 2013 In the jigsaw that is the Great Game of Asia pieces which heretofore made little sense on their own are beginning to slot in to give us an idea of the final picture. These disparate pieces are as varied as China’s claim of territorial rights over Japan’s Senkaku Islands,
Alasdair Macleod – 10 December 2012 I thought I had a good idea what disasters we might face in 2013, and then I saw the most recent US Commodity Futures Trading Commission’s Bank Participation Report for gold and silver. On the basis of recent BPRs these markets are heading for a crisis, which is generally
Alasdair Macleod – 22 November 2013 There is considerable disagreement about Chinese gold demand, with delivery figures on the Shanghai Gold Exchange and import/export figures for Hong Kong suggesting the real totals are far higher than those published by the World Gold Council and Thompson-Reuters GFMS. Recently Eric Sprott of Sprott Global Resource Investments Limited
Alasdair Macleod – 07th March 2014
Earlier this week Bill Gross who runs Pimco’s bond fund made a conditional case for investing in high-yielding bonds, even though on first cut the yield benefit appears insufficient to justify the extra risk. Put bluntly, he suggests that investing in bonds issued by insolvent Eurozone governments or second-rank corporate borrowers could be profitable.
Mr Gross is following some other smart and usually sceptical fund managers in appearing to throw in the towel against persistently low bond yields and equity markets that defy gravity. He is unlikely to take this stance without good reasons.
One reason could be value judgements hardly matter in this market. Investors have always bought into mutual funds on the basis that a fund manager will run their money better than they can themselves. By passing their bucks as it were to a professional, investors seem to think they are eliminating investment risk. However, they often confuse the risk that comes from a lack of their own investment skills with the price risk in the markets.
This is why mutual funds are in a tricky position when fundamentals do not support an investment case and the money keeps flowing in. And it is not just bond funds: the chart below shows the S&P 500 index, which since the dot-com bubble burst has entertained us with some pretty wild swings.
It should be obvious to the man in the street that things are not as good as a near tripling of the S&P since the Lehman Crisis would suggest. Yet his savings still go into stocks and bonds, irrespective of price. And as Mr Gross writes in his newsletter, it all depends on confidence in policymakers and the effectiveness of their policies.
This is a second reason. The fact that fund managers depend on policymakers to not to drop the ball is the same as saying free markets are a myth. Capital markets are no longer where buyers and sellers meet to buy and sell things based on perceptions of value; instead it is all about trends and trusting the Fed.
Asset classes from bonds to fine art are rising, underwritten by zero interest rates. The underlying bubble is the biggest and deliberately synchronised bubble in history, of currency itself. The rate at which it inflates does not appear to be slowing, despite the Fed’s tapering. Otherwise markets would be stalling. Instead the Fed’s tapering programme must be being offset by something like a pick-up in bank lending. If so, then all classes of investment assets can continue to rise in price and the party goes on. Indeed, if the Fed continues to taper, we can take it as a reasonable indication that growth in bank lending is fully compensating.
There is of course a significant danger that a bank credit revival will lead to price inflation before long, but that has always been tomorrow’s problem. There are also huge risks involved with surfing on a credit wave, not least knowing when to get off. For these reasons, the very experienced and well-informed Mr Gross is wise to heavily qualify his new-found optimism.
Alasdair Macleod – 28 February 2014
The chronological events of 2013 set the background for gold in 2014. It was a momentous year which should ensure a rise in the gold price in 2014.
Before 2013 demand for physical ETFs was high. At the same time Asian demand, from China, India, Turkey and elsewhere, was accelerating leaving Western bullion markets increasingly short of physical liquidity. Hong Kong and China between them in 2012 had absorbed on official figures 1,458 tonnes, and India a further 988 tonnes, ensuring 2013 kicked off with more global demand than available supply from mines and scrap.
The following is a list of subsequent important developments in 2013.
- Germany’s Bundesbank announced in January that it would recall 300 tonnes of its gold stored at the New York Fed by 2020. The Bundesbank was criticised for this decision, since gold held in New York amounted to 1,536 tonnes, so why take seven years to repatriate less than 20% of it? In the event by the year-end only five tonnes had been repatriated, fuelling rumours that it didn’t actually exist other than as a book entry.
- The Cyprus bail-in debacle in February alerted everyone to the new bail-in procedures being adopted by all G20 member states. Wealthy depositors in the Eurozone suddenly realised their deposits were at risk of confiscation. Governments were no longer going to bail out large euro depositors, let alone those with bullion accounts.
- The new bail-in regime was followed by ABN-AMRO and Rabobank’s refusal to deliver physical gold to their account-holders, offering currency settlement instead. Many interpreted this as evidence of long-term holders attempting to withdraw physical bullion.
- By end-March it was becoming clear that growing demand for physical bullion was a potential systemic problem. This was followed in April by a co-ordinated attack on the gold price to persuade the investing public that gold was in a bear market.
- The result was liquidation by weak holders in ETF gold funds. However, lower prices also triggered unprecedented physical demand, particularly from China and India but also across the whole Asian continent. Gold coin sales broke records. None of this escalating demand appears to have been expected by Western central banks, which by elimination had to be the principal source of maintained liquidity.
- In July I discovered that in the four months following its 28th February year-end the Bank of England appeared to have delivered up to 1,300 tonnes of gold from its vaults. This amount tied in with record Asian demand in the wake of the April price drop, far greater than can have been satisfied from other known sources such as ETF liquidation.
- The new Governor at the Reserve Band of India, Raghuram Rajan, who was once the IMF’s Chief Economist, introduced restrictions on India’s gold imports blaming them for the trade deficit. This overturned official policies which led to the liberation of the gold market in the early 1990s, fuelling suspicions that this move was orchestrated by Western central banks.
- Premiums in India rocketed and smuggling escalated to meet demand.
- Ben Bernanke in his testimony to Congress in mid-July said “No one really understands gold prices, and I don’t either.” Was he admitting to a policy failure over gold management?
- In October both the Swedish and Finnish central banks announced the location of their gold reserves. Additionally, the Finnish central bank’s Head of Communications added further information in Finnish in a blog run on the Bank’s website, to the effect that all 25 tonnes held at the Bank of England was “invested” (i.e. leased or swapped), and that “Gold investment activities are common for central banks”. This appears to be an admission that significant amounts of monetary gold have been sold into the market. Question: How do they get it back, when Asian demand alone absorbs the equivalent of all global mine and scrap supply?
- Chinese public demand through the Shanghai Gold Exchange and Hong Kong rose to 2,668 tonnes over the whole year. Add in 50 tonnes of coin, and it amounts to 2,718 tonnes in all. We know this because these are firm figures issued by the SGE and the Hong Kong Government, not the result of surveys, aiming to identify end-users.
- We can assume that China’s own mine production of 430 tonnes is not in these figures, on the basis that the government buys all domestic mine production and is unlikely to put gold production from mines it controls through commercial brokers on the SGE. This being the case, Chinese mine production should be added to total demand figures, raising the total to 3,148 tonnes. Furthermore available statistics do not include gold bought outside China by the Government and wealthy citizens and either imported or held in vaults abroad, so we can probably regard this figure as a minimum, even though the SGE deliveries includes scrap of a few hundred tonnes.
- Meanwhile the China Gold Association reports gold “consumed” of 1100 tonnes, and the WGC reports identified Chinese demand of 1,066 tonnes. These are the figures commonly accepted by Western analysts as total demand.
The events of 2013 persuaded investors in western capital markets that gold’s bull market had definitely been broken, and that gold would probably go lower or at best move sideways in 2014. The underlying reality is very different, with China in particular managing to corner the physical market with trend-following Western analysts caught unawares.
So far, instead of continuing to fall the gold price actually bottomed on 31 December at $1182, and since then has rallied over 13% to $1340. The position today is that some hedge funds which were short have closed their positions and there are more yet to do so. There is growing evidence for the trend-chasers that the price is entering a new bull phase, with the 50-day and the 200-day moving averages both rising and about to complete a golden cross.
Central banks appear to be facing a problem of their own making. The lesson from Germany’s attempt to repatriate her gold appears to have provided prima face evidence that central banks have little or no physical liquidity left. Minor central banks, such as Finland’s, must now be wondering if gold out on lease will ever be returned to them, so may be increasingly reluctant to make their gold available for further leasing. Instead they are likely to end current leasing agreements as they mature rather than extend them.
In 2014 there is likely to be a growing realisation that the vaults in the West are very low on stock.
2014 should be an interesting year.
Alasdair Macleod – 21st February 2014
When US money supply measured by M2 stood at $11 trillion in December 2013, I calculate that total broad money of the next largest 50 countries ranked by GDP amounted to the equivalent of a further US$67 trillion at current exchange rates. And that’s only on-balance sheet: we must add in global shadow banking, estimated by the Financial Stability Board to have been an extra $67 trillion in 2011, probably about $75 trillion today, given its recent rapid growth in China. So when we look at US broad money supply, we should be aware there is a further mountain of money thirteen times as big ultimately based on the dollar.
As long as bank lending, industrial investment and consumption are all expanding, the sun smiles. It’s when it stops that problems arise, and why markets reacted badly to the idea of tapering and are increasingly nervous about China’s credit bubble and attempts to rein it in.
More specifically the danger arises from a slow-down and possible reversal of cross-border investment, particularly with emerging economies. Between 2000 and 2007 investment from advanced economies into emerging markets grew at an annual compound rate of about 18%, and between 2008 and 2011 it slowed to about 5% (McKinsey, 2013). The beneficiaries of this investment, global financial assets (all equities, bonds and loans) averaged growth of only 1.9% annually in dollar terms between 2007 and 2011. If we could measure it today the overall return would probably be a big fat zero.
So whatever analysis of individual countries might tell us, it has been easy to miss the threat of a deepening global recession, a risk increased by diminishing cross-border flows. What a time for the Fed and the Peoples Bank of China to decide to reduce the rate of monetary expansion for the two largest economies! These actions are too late to achieve the hoped-for orderly exit from excessive monetary expansion.
If cross-border investment flows reverse, as they are now threatening to do, banks and multinational businesses will run for cover and the carry-trade will rapidly unwind. And when fear of losses finally triumphs over greed for profits the weaker currencies are usually the first to suffer.
The relationship between these currencies and the dollar is now being tested in the markets. Eventually, of course, the Fed will have to resume unlimited monetary expansion to buy off a global economic and financial crisis. In doing so it will probably take comfort in the precedent set when dealing with Lehman. We cannot be so certain of the effects of China’s future monetary policy, other than knowing that in troubled times Chinese citizens turn to gold, along with all the other Asian peoples acutely aware of gold’s ability to store wealth through difficult times.
The last crisis was just the banks. This time we are looking at a potential popping of a full-blown global currency bubble, which was generated as the solution to the last crisis. And this new bubble is all supported on an inflated US monetary base of $3.8 trillion. That’s bubbly gearing of nearly 40 times, or 163 times the monetary base on the eve of the Lehman crisis.
Alasdair Macleod – 14th February 2014
The China Gold Association this week released estimates for China’s “gold consumption” for 2013 at 1,176 tonnes. Furthermore the CGA reported China’s own gold production at 428 tonnes.
The CGA’s figures were significantly less than recorded imports into China from Hong Kong. Instead, on my analysis, the CGA figures do not represent total demand, but presumably only that portion reported to it by its members at the retail level. The purpose of this article is to set the record straight.
There are very few figures coming out of China that you can rely upon, and this is particularly true of gold imports. Instead, you have to take what is available and apply a judicious mix of logic and deduction. Mainland China does not publish imports and exports. The only figures for gold supplied to the Chinese public are of gold delivered through the Shanghai Gold Exchange and out of their registered vaults, which for 2013 totalled 2,197 tonnes. Most of this I have reason to believe is imported, only some of which is through Hong Kong. And to think that gold is only imported through Hong Kong is a mistake.
Hong Kong releases import, export and re-export statistics monthly. Exports are goods and raw materials processed locally, and re-exports are imported materials and goods subsequently exported unaltered, such as gold bars to SGE specifications.
The table below shows my calculations for total Chinese and Hong Kong demand.
All gold that changes hands in China is meant to go through the SGE. However, mine output is thought to be bought up by the government, most probably directly from the mines bypassing the SGE. All circumstantial evidence including government policy towards physical gold tells us this is true. And it is naïve to think a communist government – any government for that matter – would route gold from mines it controls through the market, whatever the market “rules” are.
The SGE has a network of registered vaults. The definition of deliveries applies to gold withdrawn from the vaulting system, which is why deliveries equate to public demand. This is not to be confused with gold delivered between SGE member firms and kept within the vaulting system.
Bars withdrawn from SGE-registered vaults and subsequently sold back into the market are recast into new bars and are classed as scrap. At current prices, this supply is likely to have diminished from over four hundred tonnes annually to perhaps two or three hundred tonnes in 2013.
So of the 2,197 tonne total, assuming all mine supply bypasses the market into government hands and scrap is a few hundred tonnes, we can conclude that roughly 2,000 tonnes is imported into China’s Mainland, only some of which comes from Hong Kong.
Hong Kong’s exports of 211 tonnes to China are fabricated gold not destined for the SGE (see the table above). In addition there are 1,284 tonnes of re-exports, which we can assume are bars for onward delivery to the SGE so are included in the SGE delivery total. Hong Kong also imports gold from China (337 tonnes), most of which is sold as jewellery to Chinese visitors from the mainland avoiding Chinese sales taxes. Hong Kong also acts as a regional hub, exporting and re-exporting gold to Taiwan, Thailand, India etc., which in 2013 amounted to 54 and 93 tonnes respectively.
Total demand in China and Hong Kong adjusted for these factors is therefore the bottom-line figure of 2,668 tonnes. This does not include gold imported directly through Mainland China and gold not sold through the SGE. Furthermore, ultra-rich Chinese can buy gold outside China and there is no way this additional demand can be estimated. Nor can we estimate any gold bought in London and elsewhere by the Chinese government.
Lastly, these figures do not include the net 48.5 tonnes of gold coin imported into China via Hong Kong, which if included takes known gold demand up to 2,716.5 tonnes. This is easily more than double the Chinese Gold Association figure for “gold consumption”.
While we cannot pin down gold imports precisely, the monopoly market for physical gold in China allows us to accurately define public demand on the mainland. Together with Hong Kong trade figures we get a far more accurate picture than that given by any other means. It should be noted that even this approach misses the activities of the government itself and of the very rich able to bypass the system.
It is a pity this is not more widely appreciated by analysts in Western capital markets.
Alasdair Macleod – 7th February 2014
When Lehman collapsed in 2008, the world stopped while the Fed implemented its plan to rescue America’s banks and the world’s financial system. This was achieved by making unlimited money available to the banks, and the stimulus has continued subsequently through quantitative easing. The post-Lehman era has therefore been one of unprecedented and coincidental expansion of narrowly defined money supply in all five major currencies, the fifth being the Chinese renminbi which has seen additional expansion of bank credit as well.
The Fed’s announcements reducing QE3 by a total of $20bn per month, together with China’s apparent determination to finally get her bank lending under control, mark the end of this era. The tide of easy money is now on the turn. The market outcome is likely to be very challenging for us all because of the response of the rich and very rich to these changing conditions, and gold may be the stand-out beneficiary.
Over the last five years the rich have done very well, increasing in number as has the value of their assets. Table 1 summarises the estimated global effect between 2008 and 2012 (the most recent estimate) for high net worth individuals (HNWIs).
|Table 1. Population and assets of HNWIs|
|’000s||Assets $ trn||’000s||Assets $ trn||’000s||Wealth|
Over these four years, the global wealth of HNWIs (these estimates exclude their principal private residences) is estimated to have grown by $13.45 trillion, and given the increased pace of money creation and the escalation of asset values in 2013, the cumulative increase is probably closer to $20 trillion today.
HNWIs are certain to reassess their asset allocation as the consequences of tightening monetary conditions become more obvious to them. Indeed, there is evidence the process is already underway. It tends to start with the ultra-rich, including the billionaires who Forbes estimates have a net worth of $5.4 trillion. Many of them are now based in countries with profligate governments and weak currencies. For them domestic business conditions so far have increased their wealth; but now that interest rates are rising and the business outlook is deteriorating, their wealth is at risk. Growing numbers of them will be considering how best to protect themselves in these changing conditions.
Assessing the potential impact of wealth reallocation requires an estimate of how HNWIs are currently invested, which is shown in Table 2.
|Table 2. HNWI Asset Allocation in 2012|
Trillion US $
Cash and deposits
|Middle East and Africa||0.80||0.76||0.52||0.50||0.49|
At the end of 2012 cash and deposits plus fixed income totalled nearly $20 trillion, and again monetary expansion in 2013 suggests that it is unlikely to be any less today. Deposits in the banking system make up the largest category, which raises an important question about the soundness of the banks. Investment in fixed income poses another serious question about rising bond yields particularly when they are denominated in a weakening currency. Investment in equities and alternatives, such as hedge funds, also need reassessing given signs equity markets may have just peaked. That leaves only the real estate category secure, which is commonly regarded by HNWIs along with fine art as the only sound long-term investment.
Investment re-allocation and future risks
Allocating money into different asset classes is bound to take into account changing global monetary conditions. So far, second-line currencies, particularly those of the emerging economies, are being hit badly. Many of these countries are facing a run on their dollar reserves, forcing them to put up interest rates to the detriment of their economic prospects. The result is that the portion of the $50+ trillion of HNWI assets invested in those currencies is potentially looking for an exit.
It’s not only HNWIs who will be wrong-footed for these new conditions, but also the international banking system. There is a heightened risk of systemic problems following on from currency instability, because of the accumulation of derivatives and emerging market debt on the balance sheets of Western banks. While cross-border emerging market exposure is smaller than the banking system’s exposure to the advanced economies, risk is concentrated in a few significant banks that have been growing their emerging market loan books. And these banks inevitably are host to much of the Asian HNWI deposit money.
The likelihood of a developing crisis in emerging market currency and debt markets requires an immediate response from the Fed to ease dollar liquidity, and for the Chinese authorities to manage the expansion of bank credit with extreme care. In the absence of these factors, it is prudent to consider how HNWIs are likely to protect their $20 trillion of cash and deposits, and how much they will seek to liquidate of the further $25 trillion they have invested in equities, bonds and hedge funds.
These decisions for HNWIs are made more urgent because bank deposits are now subject to bail-ins in the event of a future bank crisis, instead of governments being on the hook for bank insolvencies as before. Therefore deposits may be lost if a reconstruction of the West’s financial system becomes necessary.
Gold – the stand-out beneficiary
Besides real estate and fine art, the only true escape from what is basically a fiat currency problem is ownership of bullion held outside the banking system. As stated above, the first to alter their asset allocations tend to be the ultra-rich, and the first of these will have made their fortunes in China and other emerging markets. We know they are already stocking up on real estate and fine art, a trend that is spreading down through other HNWI categories. For all we know, some of this ultra-rich money is beginning to accumulate in gold and silver, but so far the price effect has been obscured by the opacity of Western bullion and derivative markets.
Today’s buyers of precious metals include the Chinese and their diaspora around the Far East, as well as India and a number of other Asian nations. Table 3 shows estimates of the HNWI numbers and wealth involved in some of these important countries.
|Table 3. Population and assets of Asia-Pacific HNWIs|
|’000s||Assets $ bn||’000s||Assets $ bn||’000s||Wealth|
As one would expect, these gold-friendly countries have seen more rapid expansion of wealth than experienced in the West. They have 1,400,000 HNWIs between them with an estimated $6 trillion to protect in 2012, which could be considerably more today. If gold is going to form just 5% of their reallocated assets, at current prices that amounts to at least 30,000 tonnes. Given that the majority of the world’s above-ground gold is already locked up in Asia and the Middle East, and that Western central banks have leased out significant portions of their own gold reserves which have also ended up in Asia, there is insufficient gold to supply anything like this quantity.
The situation facing us has parallels with the rapid increase of oil prices in the 1970s creating insatiable demand for gold from Middle-Eastern oil exporters. The other consequences are likely to be:
- The sums involved in portfolio shifts are potentially far greater than the $13 trillion the Fed committed to save the banking system in 2008. Therefore, it is uncertain that any future systemic crisis can be resolved in the same way, not only because of the numbers involved, but because the crisis will probably start in emerging markets not under the Fed’s control.
- Changing monetary conditions as envisioned herein are likely to result in significant wealth destruction. This fear is likely to drive events very rapidly once they commence.
- Buying of gold and silver by Asian HNWIs looks set to accelerate irrespective of price, setting off safe-haven trades among HNWIs worldwide.
- Given the shortage of physical metal and the potential scale of HNWI buying, both central and bullion banks will face enormous difficulties controlling the market as they have done to date.
- Confidence in all fiat currencies may be undermined if bullion prices rise as sharply as potential demand from HNWIs suggests is likely, validating yet further demand for bullion.
This is the downside to central banks’ attempts to manage the growth of money and credit. When it comes to changing tack on monetary policy, they are damned if they do and they are damned if they don’t.
Alasdair Macleod – 31st January 2014
Thanks to the Fed’s tapering, a wider public is becoming aware of currency instability in diverse economies, from Turkey to Argentina, and India to Indonesia. Indeed, on Tuesday night Turkey raised overnight interest rates by a whopping 4.5% to 12% in an attempt to stop a run on the lira.
Turkey has her own political problems, perhaps strong enough to knock the stuffing out of her currency on their own, and Argentina seems to be permanently fighting off hyperinflation. But it is a mistake to think that the idiosyncrasies of each currency are solely the cause of their downfall. The fact that these countries’ currency problems are all happening at the same time tells us the common factor is currency itself.
Over the last decade it has been fashionable to invest increasing quantities of money in these economies. Financial flows have also been instrumental in accelerating the growth of local domestic credit. Money flows are now in the process of reverting back to base and the chart below of the Indian rupee is a good example in which this effect on a currency can be observed.
Between 2002 and 2008 the rupee rose against the dollar (i.e. fewer to the dollar) reflecting inward investment, and after the Lehman Crisis it started to fall as the money-tide reversed. Since then the rupee has lost almost 40% of its value. It is also clear from this chart that the primary trend for the rupee has been firmly down for some time.
The same is true of most other emerging market currencies: before the Lehman Crisis investment flows into them fuelled both economic growth and the expansion of bank credit. Since Lehman, these flows have reversed mostly offset by yet more expansion of domestic credit.
Over much of the last century US dollar cash and deposits expanded on the back of a gold standard; in the same way today’s emerging markets have expanded on the back of a dollar standard. Therefore, the redemption of these currencies into the US dollar mirrors pre-WW1 bank runs, except on a global scale. And In every bank run a bank pretends there is no problem until it is too late.
Central banks cannot escape the fact that currencies depend entirely on confidence. Markets are now painfully reminding us of this truism, following the Fed’s second tapering announcement. A whisper in New York becomes a storm in Delhi, Ankara, Sao Paulo, Buenos Aires and Pretoria.
It is an important point. In the same way that under a gold standard a central bank had to have sufficient gold stocks to maintain confidence in its currency, an emerging market central bank has to have sufficient dollar reserves on hand. And this is why from a monetary perspective a desperate central bank is compelled to increase interest rates when Keynesian text books tell us such a move is certain to drive these economies into a deflationary slump.
The screw is now tightening. Having added unprecedented amounts of liquidity into its own economy through quantitative easing, the Fed is now reducing the pace of its expansion of narrow money. Unfortunately this is bad news for emerging market countries, who will surely conclude that international monetary co-operation has broken down.
Alasdair Macleod – 24th January 2014
By December, the most recent month for which statistics are available, the US dollar Fiat Money Quantity (FMQ) had grown to $12.48 trillion. This is $5.05 trillion more than if it had grown in line with the established average monthly growth rate from 1960 to the month before the Lehman Crisis.
By this measure of currency inflation, since August 2009 inflation is now 68% above trend. This is illustrated in Chart 1 below.
FMQ measures the difference between currency, measured by cash and deposits, and sound money by retracing the evolution of currency from gold and fully-backed gold substitutes. It is therefore fundamentally different from conventional measures of money supply, which compare changes in themselves over time. Instead it is a comparison between sound and unsound money.
Estimating monetary tightness
Since January 2013 quantitative easing (QE) of $85bn has been the principal driving force behind FMQ, at double the rate of the increase in bank reserves held at the Fed with respect to purchases of Treasuries from the primary dealers. This is because the Fed buys them from primary dealers, crediting their banks with reserves on its own balance sheet, and the primary dealers are in turn credited with deposits at their banks. Alternatively when the Fed buys mortgage assets this can also be regarded as creating deposits at both the Fed and at the banks, though there may be some timing differences involved between when banks first acquire and then subsequently sell their own assets to the Fed.
The approximate effect of QE on overall liquidity is therefore captured by taking twice the monthly QE and then subtracting the increase in FMQ, so we can estimate how dependent markets have become on QE. Note that QE is not the only determinant of monetary liquidity. The result is shown in the next chart.
At the beginning of 2013 QE was significantly greater than required by the banking system. With the exception of the March aberration (month-to-month increases in FMQ can be volatile), the Fed’s QE policy injected more fiat money into the economy than the economy actually needed, which is consistent with the Fed’s objective to kick-start the economy. This is reflected in the linear trend line which early in the year was significantly positive. Gradually however the financial system has adjusted to QE with nearly all of it now required by the financial system. This is reflected in the linear trend line which has now moved into negative territory.
Put another way, the excess liquidity injected by the Fed through QE is now being used up in the banking system. Therefore, the $10bn reduction in QE announced in December’s FOMC minutes, in the absence of other liquidity measures provided by the Fed, can be expected to eventually put pressure on overnight rates to rise as bank lending increases.
The most important factor for the Fed in deciding the extent of QE has most likely been the growth in bank lending. The next chart shows an approximation of bank lending by subtracting M1 from M2.
The fall in bank lending early in the year was the principal factor behind the introduction of QE3. The mid-year recovery in bank lending coincided with the Fed’s introduction of possible tapering into public debate, leading to the eventual decision to taper taken at the December FOMC meeting.
Repurchase agreements (reverse repos and repos)
At the year-end the Fed temporarily reduced its holdings of Treasury paper through reverse repurchase agreements totalling $316bn. This appears to have been driven at least partly by the Fed’s desire to put a floor under interest rates by draining temporary liquidity from the banks, possibly the result of year-end factors. Subsequently outstanding reverse repos have reduced by a third to $202bn.
The markets expect further reductions in QE in the coming months as bank lending continues to grow. For this to happen without tightening in the money markets, commercial banks will need to expand bank credit to compensate. In the event this is not forthcoming, rather than reverse the decision to taper QE, it is equally possible for the Fed to inject liquidity into the system through repos. Thus the replacement for QE could well turn out to be interest rate management by using repos to add liquidity and reverse repos to drain it.
In conclusion, the Fed does not have to rely on QE to maintain overall monetary growth.
The fourth chart shows the price of gold adjusted for the increases in FMQ and above-ground stocks of gold since January 1960, when gold was fixed at $35 (yellow line) compared with the nominal dollar price (red line).
At $1200 nominal, which was the gold price on 31 December 2013, the adjusted price is $76, slightly more than double the price in 1960 US dollars. We cannot put together the components of FMQ before 1959 because the statistics are not available, but at that time FMQ was similar in quantity to the discontinued M3 series at $292bn and $300bn respectively. M3 in 1933, when gold was revalued to $35, stood at $41.53bn, and above-ground gold stocks increased from 35,327 tonnes to 60,137 tonnes between 1933 and 1959. So measured in 1933 FMQ dollars the price of gold adjusted for the increase in above-ground gold stocks today is approximately $6.72.
The next chart shows gold in 2000 US dollars rebased to 100.
In these adjusted terms gold at $1200 nominal in December 2013 is 124% of its price in January 2000. At that time equity markets were in a bubble to rival the South Sea of 1725, systemic risk was the last thing on investors’ minds, and FMQ has since hyper-inflated. Furthermore the gold price in 2000 reflected protracted bear market sentiment that had built up over two decades.
Therefore, based on gold prices from the 1930s onwards gold in real terms appears extraordinarily undervalued.
The last chart shows the price of silver adjusted for the increase in FMQ and rebased to January 2000.
Since silver is mainly consumed as an industrial metal, and the strategic above-ground stocks accumulated in the last century are now depleted, it is not appropriate to adjust the silver price by changes in the quantity of silver when measuring it in FMQ terms. The adjustment over time is therefore entirely from the currency side. Taking this into account, the adjusted silver price at end-December is 85 on our index and so is at a 15% discount to the price at the beginning of January 2000, more than eliminating the price spikes in 2008 and 2011.
 See http://www.nowandfutures.com/articles/20060426M3b,_repos_&_Fed_watching.html and the spreadsheet that can be downloaded from this site.
Alasdair Macleod – 20th January 2014
According to Reuters, Deutsche Bank has decided to quit as a member of the gold and silver fixing committees in the London bullion markets. This news comes after Deutsche Bank was instructed in mid-December by BaFin, Germany’s bank regulator, to hand over documents in connection with its inquiry into suspected manipulation of gold and silver prices.
The fact that Deutsche Bank is pulling out of the prestigious fixing role four weeks after BaFin requested these documents suggests Deutsche Bank has a case to answer, even though it has been sold to us through the press as part of their overall scaling-back from commodities. Furthermore the nature of market manipulations is that they usually involve a number of banks, as the scandal over Libor illustrates. So it is perfectly reasonable to suspect that other banks in the two fixing companies are likely to be involved as well.
This should come as little surprise to close followers of bullion markets. The surprise perhaps is that the manipulation of gold prices is being seriously pursued by a G7 government regulator, when we all assumed the subject is off-limits, given the close relationships between bullion banks and central banks. However, inter-governmental relationships between the US and other governments, particularly Germany’s, have come under considerable strain recently.
To put this in context requires a brief summary of recent and relevant history. From 1952 the Bundesbank began to redeem some of its trade surplus dollars into gold bullion stored with the New York Fed, adding to their stock there every year until 1968, when it appears some of their holding was shipped or swapped to other centres. From 1969 onwards there were relatively minor changes in the amount of gold stored with the New York Fed and according to the Bundesbank’s records in 2012 it amounted to exactly 49,396,880.287 ounces (1,536.4 tonnes). There is no known record of this gold being leased.
The Bundesbank never fully embraced the anti-gold stance of other central banks, which is understandable given Germany’s painful experience of currency destruction and the development of her strong post-war savings culture. The Bank was always careful, in the absence of gold convertibility, to pursue sound monetary policies. This perhaps makes the ownership of her gold more sensitive for the Bundesbank than for most other Western central banks. Furthermore, after the creation of the ECB she has been demoted from being one of the top four central banks with a strong policy influence at the Bank for International Settlements, to little more than a regional hub with some out-dated sound-money ideas. So when growing public pressure in 2012 forced her to eventually seek repatriation of her gold it is hardly surprising her priority would be to respond to domestic German opinion rather than the gold policies of Anglo-Saxon central banks with which she has little direct involvement.
Only then did it transpire that Germany’s gold at the New York Fed probably didn’t exist. Bundesbank officials had even been refused sight of their own gold according to Der Spiegel, a point picked up by a previously secret report by the German Federal Audit Office. It is hard to justify why an official from the Bundesbank should be refused sight of his own bank’s gold. Instead the Bundesbank was forced to rely on written affirmations by the New York Fed that their gold was safely there.
The public furore over the Fed’s behaviour forced Bundesbank officials on the back foot, and while publicly defending the integrity of the New York Fed, they sought repatriation of at least some of their 1,536.4 tonnes of gold. In the event the Bundesbank announced it would only look for 300 tonnes from New York before 2020. It appears that this is all the Fed would agree to deliver, small change that could be picked up in the market over the agreed time.
According to the Bundesbank, in 2013 only 37 tonnes had been delivered, less than 2.5% of Germany’s gold held at the Fed and less pro rata than the annual equivalent amount the Fed is expected to repatriate. Worse still is the news this weekend in Die Welt that only five tonnes of this has actually come from the New York Fed, the rest from Paris, so this figure represents the total repatriated from both centres.
Parallel to the Fed’s apparent treatment of Germany’s gold, whistle-blower Edward Snowden revealed that America’s National Security Agency routinely taps Angela Merkel’s and other German politicians’ telephone conversations, news that created uproar in Berlin.
BaFin is enquiring into gold market rigging against this politically-charged background. Furthermore, BaFin is independent of the Bundesbank, unlike the Financial Conduct Authority in London which is a division of the Bank of England. So even if the problem hadn’t been muddied by the events described above, it might have been difficult enough to persuade BaFin through central bank channels to drop its enquiries: instead there is a growing level of expectation in Germany that the regulator will not be pushed around by foreign, particularly American interests. If BaFin does back off, this will almost certainly be interpreted by the German public and politicians that it has only done so under pressure. If BaFin does not back off, then the Bank of England will probably be forced to cooperate with BaFin.
Whichever way BaFin proceeds, opaque bullion markets including leasing activities by central banks look likely to become a public issue, in Germany if not elsewhere. This being the case, it is very likely that the Bundesbank will want to distance itself from all leasing activities in London for fear of being accused of not looking after the nation’s gold responsibly.
Timing for a schism between central banks over gold could hardly be worse for them. Evidence has been accumulating at an accelerating pace in 2013 of the large scale of leasing transactions by Western central banks, potentially leaving them with very little monetary gold in their vaults. Asian buyers have turned an estimated eighty per cent of this gold into jewellery, and it cannot be returned. Indeed, the circumstantial evidence suggests that with or without the Bundesbank’s knowledge, this may have been the fate of Germany’s gold.
It is a problem that should be closely followed, given the potential implications for bullion prices, the bullion banks short of physical metal, unbacked derivative markets, and ultimately for the stability of fiat currencies as well.
Alasdair Macleod – 17th January 2014
A number of readers and bloggers have recently suggested there must be collusion between America and China over the transfer of physical gold from Western capital markets. They assume that governments know what they are doing, so there is a bigger game afoot of which we are unaware.
The truth is that China and Western capital markets view gold very differently. You will hardly find anyone in the London Bullion Market who regards gold as money; and for them if gold is no longer money Chinese demand for it is not a monetary issue. Instead it threatens the bullion banks’ business that a useful financial asset, capable of earning many times its physical value in fees, commissions, turns and interest, is being leeched out of the market by Chinese aunties.
It is clear that nearly all Western central bankers share this view, believing that gold will never play a monetary role again. We also know that Marxist-educated government advisers in China have been sheltered from the Keynesians’ antipathy against gold and instead have been brought up on Marx’s belief that Western capitalism will eventually destroy itself. It therefore follows they believe that western paper currencies will probably be destroyed as well.
Otherwise we can only speculate, but the following conclusions about why the Chinese are accumulating gold seem to make most sense:
- There is a fundamental view in China that gold is ultimately money, so it is always worth accumulating by selling potentially worthless foreign currency.
- Encouraging her citizens to accumulate gold achieves two objectives: if they have real wealth to protect it makes them potentially less rebellious in difficult times; and secondly private buying of gold reduces the trade surplus, which in turn reduces the accumulation of foreign currency reserves.
- Gold is generally accepted as superior money throughout Asia, which is China’s long-term regional interest.
- The Chinese Government (and/or the Communist Party) is buying gold for itself. Assumptions it will use gold to beef up the renminbi makes little practical sense, beyond perhaps some window-dressing for currency credibility. Instead she appears to be accumulating gold for unstated strategic reasons.
- Keeping the West short of gold gives China huge leverage in today’s cold currency war, and even more if the currency war heats up.
The idea that America is colluding with China in the gold market must therefore be nonsense. The truth has everything to do with different philosophies about gold.
Advanced western economies have survived without using gold as money for a considerable time. Currency and credit inflation have created a modern finance industry wholly dependent on fiat paper and everyone in mainstream finance is conditioned to believe in the profitable world of fiat currencies. They are therefore predisposed to dismiss gold as never being money again.
That is why the West is less worried about losing physical gold than it should be, and China is glad of the opportunity to buy it. And she can be expected to continue to do so whatever the price, because she knows that in the final analysis gold is the only true money.
Alasdair Macleod – 10th January 2014
In reviewing this excellent book I should first declare and deal with vested interests. James Turk with his son founded GoldMoney, and as GoldMoney’s Head of Research he and I are co-writers with similar views. Those who think we have a vested interest in promoting gold would be right, but not quite as they would think. Our common theme is an understanding of the importance of sound money, from an economic perspective. Turk has never minced his words on the subject, so you could say that he founded GoldMoney as a bet that Western governments and their central banks would not heed his warnings and eventually destroy their currencies.
This view, which I share, has been confirmed by GoldMoney’s success. The book, co-authored with John Rubino, is partly a follow-up to their previous work, The Collapse of the Dollar and How to Profit from it published in 2004, and it brings the reader up to date following the Lehman Crisis in 2008. This was the crisis the authors foresaw four years ahead of the event in their earlier book, expecting it to lead to the dollar’s collapse. The collapse didn’t happen that time, but it was a close-run thing, requiring unlimited financial support from the central banks for the banking system.
Five years on and the financial world has so far avoided another crisis. The common perception is that the problems of the US’s housing bubble and the rescue of AIG, which were central to the massive expansion of increasingly complex derivatives, are now behind us. But as the authors point out, since the Lehman Crisis many of the problems they identified in their earlier book have actually intensified.
The Money Bubble brings us up to date with the over-leveraged banks and the alarming growth in derivatives and government debt, as well as the money bubble itself. In a nod towards Hayek they chronicle government intrusion into personal freedom and choice. They warn us that governments are increasing capital controls, and through bank bail-ins confiscation of money in bank accounts could become commonplace. The trend is already there, with desperate governments even confiscating pension property, as they did in Poland recently. They cover the widespread manipulation of markets by central banks, and take us through the inevitable consequences of supressing interest rates.
The book brings us up to date with developments in gold and silver markets as you would expect, given the authors’ views about the desirability of sound money. But you would be wrong to dismiss this as little more than the work of gold-bugs. The authors’ background knowledge of economics shines through. And yes, while there is a preference for precious metals, the book is refreshingly free of the institutional bias in economic analysis that today masquerades as progressive thinking.
Above all, the book is written so that complex subjects, such as the creation of bank credit, can be readily understood by the layman. And for those readers seeking a vade mecum on precious metals markets as they operate today, they will find it here.
I recommend this book to all financial experts as well as the layman.
The Money Bubble (What to do before it pops) by James Turk and John Rubino, available from Amazon now.