Gold: Worry about London, not COMEX

Alasdair Macleod – 9 April 2009

On 25 March the Commodity Futures Trading Commission heard evidence from a number of interested parties, with a view to considering the introduction of position limits on Comex to prevent price manipulation of gold, silver and copper markets. The bun-fight was essentially between the Gold Anti-trust Action Committee (GATA) with their supporters and the bullion banks, who did not comment. The problem for the CTFC is that if they were to impose position limits the bullion banks would probably look to move their business elsewhere.

There is little doubt that the bullion banks manipulate prices. This was confirmed by evidence of trading tactics presented by “a whistle-blower”, who is a metals trader in London. His account of the trading tactics of JPMorganChase is certainly authentic, and they are merely the tactics employed by powerful market-makers in any market. So this rather misses the point: it is more relevant to know whether the bullion banks are still working with the Fed and the European central banks to keep the price of gold down. There is little doubt the central banks would like to keep the gold prices suppressed, but past attempts have failed and the risk now is that they will end up selling too much of their dwindling stock. There is the added strategic piquancy of American and European gold ending up in tomorrow’s powerhouses (Russia, China and India), who are all keen to add to their holdings.

On balance, it is likely that the central bank cartel would now like to abandon its price suppression policies, preferring instead to kick the ball into touch. However, having worked closely with the bullion banks for the last forty years the cartel may not find it easy to withdraw. Simply put, the futures market is based on availability of the physical from miners and the central banking community. The miners have almost ceased forward sales, leaving the futures market mainly supported by the central banks’ leasing contracts. Furthermore, suspicions that the bullion banks have little physical bullion of their own were supported by testimony provided to the CFTC hearing by a witness who works in the London market. This witness (Jeffrey Christian of CPM Group) confirmed that the value of London’s net daily trades was typically over one hundred times the physical bullion actually backing them.

This should be no surprise to experienced operators: that is what market-makers do in all markets. Investment banks routinely lend out clients’ stock to cover market deliveries, which is effectively what the bullion banks do with central bank gold.

By way of comparison, the market makers in the London equity market typically see a turnover of £4bn daily, yet their firms expect market makers to go home with a broadly even book. However, the difference between the London Bullion Market and the London Stock Exchange is the bullion banks have no true separation between their market makers and their clients. This difference is unchallenged because bullion dealing is an unregulated activity in an over-the-counter market. Furthermore, the bullion banks run a system of unallocated accounts, with over 95% of customers’ bullion held this way. We do not know how much bullion the bullion banks actually hold against these customer accounts, but anecdotal evidence of shortages of physical for delivery suggest that very little is actually held. It goes against the grain for a banker to hold a reserve asset that does not pay interest. According to Jeffrey Christian $20bn of net daily trades may be backed by only five to ten tons of physical stock.

On this Christian was quite clear, but he made a schoolboy error in his evidence, which he later corrected: he initially stated that the shorts on Comex offset shorts in London, which is nonsense. The question that should have been pursued more aggressively, is how did he explain what appeared to be a double short position, whereby the bullion banks are short of some 640 tonnes on Comex and at the same time short to customers in large undeclared quantities on their unallocated accounts? The answer, according to Christian, is that traders have many ways they can cover their positions. While this is undoubtedly true, it does not address the fact that the bullion banks do not cover their unallocated accounts with physical. Rather, it exposes the London market as collectively turning a blind eye to its inherent insolvency. London assumes that it is extremely unlikely that unallocated account holders will ever demand delivery of physical bullion in meaningful quantities. However, times are a-changing, and investors generally are increasingly aware of counter-party risk.

There is also growing demand through ETFs, with mixed blessings. The largest ETF is SPDR Gold Trust (“GLD”) which currently holds 1,365 tonnes. GLD is not a properly constituted ETF, being closer to a UK investment trust in structure but with a very limited investment objective. Critics pick holes in GLD’s prospectus, but the most important difference between GLD and a proper ETF is GLD is free to lease its bullion, thereby providing liquidity to the bullion banks. With this exception, where GLD and other ETFs have fundamentally altered the market is by taking ownership of bullion away from traditional sources. For the first time, investors can buy bullion in certificated form, a facility that is catching on rapidly. It was estimated in 2005 that holdings of gold ETFs represented 0.009% of listed securities[i], as proxy for investment portfolio exposure. Today, the figure is about 0.05%, a five-fold increase that is still insignificant asset diversification for investors as a whole.

This can be expected to change radically when investors begin to hedge portfolio risk in earnest. Holdings of GLD increased 67% to 1,354 tonnes in the six months to March 2009, when the banking crisis was at its height, a level more or less maintained ever since. The next crisis, if it occurs, is likely to trigger a broader move into bullion ETFs, since government finances are at greater risk today than they were eighteen months ago. Fortunately for the bullion banks, GLD is able to lease its bullion and presumably does. [We have no evidence GLD is leasing its bullion, but there is nothing in their prospectus that prohibits leasing, and the management is deafeningly silent on this subject. The attraction is they can maintain ownership of leased gold for the purpose of the bar list, while generating useful income.]

These dynamics are surely being discussed behind closed doors in key central banks. While traders at the bullion banks play their games in the futures markets, it is the central banks’ gold that is actually at risk, excepting that which may be leased from GLD. With gold disappearing into private ownership around the world faster than it is being mined, this demand has taken on a new importance, because of the rapid expansion of fiat currencies and the inevitable effect over time on demand for bullion. But if the central banks prudently reduce their exposure to the bullion banks by restricting their leasing activities, they risk triggering a squeeze on physical supplies which London would be unable to handle.

Indeed, the game has moved on from price manipulation to damage limitation. The shenanigans on Comex are a side-show; the real trouble is brewing in the unallocated accounts in London, where there is a growing risk customers will demand possession of the physical, exposing the inherent insolvency of the unallocated account system. Forward thinkers in the central banks might pray for time to find a solution for this problem, but timing will more likely be determined by the pace of deteriorating macro-economic conditions in the US and Europe.



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Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm. Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director. For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

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