Wednesday, July 31, 2013

There is a Serious Shortage of Gold

"I think it’s just been one big scheme to try to get people dissuaded from owning gold and to cause supply to come out. As you mentioned, because of it (central planner actions) we have the gold forward rates (for gold) being negative, backwardation, and inventories plunging, all of which have been manifested because there is a shortage of gold.

I believe there is a huge shortage of (available physical) gold. You have had many people comment on that -- Andrew Maguire over in London, who talks about all of the delays in shipments from the the LBMA, and people commenting that perhaps there will be a COMEX failure to deliver.

All of my work tells me that there is a serious shortage of gold on an annual basis. The central banks have supplied it in the past, but they don’t have the ability to supply it anymore. So I think we are getting set up for a big run in gold. It looks like we’ve already seen the bottom and I think we are well on our way here."

- Eric Sprott via King World News:

Monday, July 29, 2013

Phenomenal Story For Silver

It’s impossible for China to replace, if they imported over 800 tons of gold last year, and let’s say you couldn’t really buy it, the number they would have to buy is something like 48,000 tons of silver to replace that (gold equivalent). We only mine 25,000 tons a year, and there’s only 10,000 tons of that available for investment. And it looks to me like they (India and China) are buying it all right now.
So I think if this data is true we have the most phenomenal story for silver that you could possibly imagine. We will just nail those paper sellers to the wall here.

- Eric Sprott via King World News:

Saturday, July 27, 2013

COMEX Inventories Declining Rapidly

"In my mind what happened was the powers that be thought, ‘What are we going to do here? We can’t have people find out that the central banks don’t have any gold because it’s all been leased and sold to Asia. So, what are we going to do? Well, let’s go bomb the COMEX (price), and maybe everyone will sell their GLD, and we will go in and buy the GLD and redeem the (physical) gold.’
As you know, 600 tons of gold was redeemed. 600 tons is a big number. So we’ve had a 30% increase in supply because of the GLD liquidation. Of course during this time period, all of the investment advisors who told people to sell were the same people that covered their shorts. So they (bullion banks) have gone from being short gold to being neutral on the COMEX.

We have seen the COMEX inventories decline rapidly. We know that all of the dealer inventory on the COMEX has already been spoken for by delivery notices, so essentially there will be zero (inventory) if they ever make the delivery."

- Eric Sprott via a recent King World News interview, read the full interview here:

Monday, July 22, 2013

There is NOT That Amount of Silver

There is only a certain percent of the silver market which can go into savings because a lot goes into industrial. But here is the ‘piece de resistance,’ they said (India) imported 720 tons in April (annualize 8,000 tons). In May it went to 900 tons, annualized call it 11,000 (tons). We’re going from 1,900 tons (of silver Indians were purchasing) to 11,000 tons, in a 25,000 ton market. That’s impossible. There’s not that amount of silver available for investment.

- Eric Sprott via a King World News interview, read the full interview here:

Saturday, July 20, 2013

Central Banks, Bullion Banks and the Physical Gold Market Conundrum

Submitted by Eric Sprott and Etienne Bordeleau,

The recent decline in gold prices and the drain from physical ETFs have been interpreted by the media as signaling the end of the gold bull market. However, our analysis of the supply and demand dynamics underlying the gold market does not support this thesis.

For example, Non-Western Central Banks have been increasing their holdings of gold at a very rapid pace, going from 6,300 tonnes in Q1 2009 to more than 8,200 tonnes at the end of Q1 2013 (Figure 1a) while physical inventories are declining (Figure 1b) (or being raided, as we argued in the May 2013 Markets at a Glance)1 and physical demand from large (Figure 1c) and small (Figure 1d) scale buyers remains solid.

Figure 1a -1b
Figure 1c -1d

Source: World Gold Council, Bloomberg, Hong Kong Census and Statistics Department
Average premium calculated as the average premium for the following 1oz. coins, as reported by the Certified Coin Exchange (CCEX): American Eagle, Maple Leaf, Krugerrand, Philharmonic, Panda, Isle of Man and Kangaroo.

In previous articles we have argued that Western Central Banks have been filling the supply gap to satisfy the demand for physical gold.2 As shown in Figure 1a above, the official amount of gold held in the Western Central Banks and international institutions like the IMF has been steadily declining since 2000, only to stabilize at around 23,500 tonnes since 2008. Officially, this gold has primarily been sold by continental European Central Banks under what is known as the “Central Bank Gold Agreements” (CBGA) (also known as the Washington Agreement on Gold).3 Under this agreement (which expires after five years and has been repeatedly renewed since 1999), the “undersigned institutions will not enter the market as sellers, with the exception of “already decided sales” and “The signatories to this agreement have agreed not to expand their gold leasings and their use of gold futures and options over this period”. Sales under the CBGA are shown in Figure 2 below.


Source: World Gold Council

The two points referenced above are particularly interesting because gold leasing (or swaps) has been the primary instrument used by central banks and bullion dealers to suppress the price of gold over time (Alan Greenspan testified, on 24 July 1998, to the House of Representatives that “central banks stand ready to lease gold in increasing quantities should the price rise”).5

It is important to remember that bullion banks (members of the London Bullion Market Association, or LBMA) hold gold in their vaults for their clients.6 Most of those clients, according to the LBMA, deposit their gold (or purchase gold) through an LBMA bank, for example ScotiaMocatta, in what is called an unallocated account. “This is an account where specific bars are not set aside and the customer has a general entitlement to the metal. It is the most convenient, cheapest and most commonly used method of holding metal.”7 However, what the LBMA doesn’t say is that, just like regular fractional banking, the bullion bank does not need to keep the whole value of the gold deposit in gold, but only keeps a fraction of it in its vaults, hoping that not all depositors will request their gold at once. This creates a potential shortage of physical (and an increasing supply of paper) gold and is one reason why bullion banks sometimes need to lease gold from central banks. Leasing gold is analogous to a swap or a collateralized loan, where a Central Bank gets cash in exchange for gold as collateral, and pays an interest rate on the cash loan.

The gold leasing mechanism works in the following way (also shown in Schema 1 below):8

A Central Bank leases its gold to a bullion bank for a pre-specified period (say 1 month). In exchange, the Central Bank receives cash for the value of the gold and has to pay the Gold Forward Offered Rates (GOFO) to the bullion bank. Then, the Central Bank lends the cash on the market and receives LIBOR for 1 month, with net proceeds of LIBOR minus the GOFO, which is called the lease rate. If the lease rate is positive (and it usually is), then it is profitable for the Central Bank to lease its gold. A high lease rate increases the incentive for Central Banks to lease their gold.

The bullion bank, once it receives the gold from the Central Bank, sells it on the gold spot market and collects the cash (depressing the price in the process by increasing supply in the market). For the bullion bank, this transaction is cash flow neutral and pays a carry (the GOFO rate) (the bullion bank can also buy the gold forward one month to make this a risk free transaction, or hope the price of gold stays constant or declines when it’s time to buy it back). Thus, the GOFO rate is a measure of “how much the bullion bank desires physical gold”. If it is small (relative to LIBOR, which implies a large lease rate), the bullion bank wants gold. If it becomes negative, then it means the bullion bank is ready to pay (negative carry) the Central Bank for the privilege to lease its gold (presumably to deliver physical gold to clients that redeem physical gold from their unallocated accounts).


In theory, at the end of the month, the bullion bank buys the gold back from the market and gives it back to the Central Bank. If the bullion bank repurchases the gold from the market, there is no net effect on overall gold supply. We say in theory because, as highlighted above, the language used in the CBGA hints at something else.

It is our hypothesis that, in practice, the bullion banks do not purchase the gold back in the market at the end of the lease to give it back to the Central Banks. Instead, they only roll the transaction over with the Central Bank, resulting in gold IOUs (paper gold, referred to as “gold swapped or on loan” under Central Bank accounting jargon, in other words, a claim on gold that someone else holds) instead of real bullion in the Central Bank’s vaults. This can be seen in Figure 3 below. There is a clear negative relationship between the amount of gold leaving the vaults of the New York Federal Reserve Bank (other Central Bank’s official gold reserves) and the lease rate (how much carry a Central Bank owns by leasing out its gold). To us, this is a clear indication that Central Banks have been leasing out their physical gold against IOUs from their bullion bank partners.

Figure 3_2

Source: Federal Reserve Bulletin, Foreign Official Assets Held at Federal Reserve Banks, Earmarked Gold & LBMA. The 1-month lease rate is shown as an annual average.

Also, oddly enough, it seems from Figure 3 that the gold bull market started at about the same time (mid-2001/early 2002) as Central Banks and Bullion Banks stopped flooding the market with leased gold.

Another interesting observation is that the timing of official sales by European Central Banks and the International Monetary Fund (IMF) (Figure 2) do not really correspond with the outflows from the NY Fed’s vault (where most of the world’s Central Banks’ gold ex-US is stored; about 30% by our calculations). This is where the “already decided sales” concept referred to earlier comes into play.9

According to the IMF, they disposed of 403.3 tonnes of gold between 2009 and December 2010.10 However, the net outflows of gold out of the NY Fed’s vault were zero for those two years (and the NY Fed is the main vault for the IMF).11 If this rather large quantity of gold did not come from another vault, then it is plausible that it came out of the NY Fed’s vault, which experienced a net drawdown of 408 tonnes in 2007-2008, a full two years ahead of “official schedule”. Given this inconsistency, it is reasonable to believe that the IMF leased its gold reserves (in the manner explained above) to tame the gold market and rescue the bullion dealers, which probably got a lot of physical gold redemption requests they couldn’t meet during the financial crisis. Then, later on, they “sold” their paper gold to the dealers to net the IOUs and settled in cash.

A similar observation can be made of the European Central Banks’ CGBAs, which all happened well after all the gold outflows from the NY Fed’s vaults.

We are of the opinion that this is what an “already decided” sale is: a Central Bank leases gold to a bullion dealer, that dealer sells the gold (or delivers it to a client) but never pays back the Central Bank its physical gold. Then later on, to balance things out, the Central Banks declare official “sales” of gold, but all that changes hands at that point is paper gold and cash, the real gold is long gone.

Lessons for the current market

It is important to remember that the bullion dealers are the same banks that are deemed too big to fail by their respective governments. Thus, it is very unlikely that Central Banks would abstain from intervening à la Greenspan in order to save their bullion bank partners from a “bullion run” (analogous to a bank run). On the contrary, if the bullion dealers get in trouble because their reserves of physical gold are too small to match redemptions of physical (anecdotes) and risk a bullion run, Central Banks will use their firepower and “stand ready to lease gold in increasing quantities should the price rise” (Greenspan, 1998).

The thing is, it might not be that simple anymore… Since the beginning of the financial crisis, we have seen unprecedented demand for physical gold (see Figure 1a-d above) while at the same time, gold miners are shutting down mines and Central Banks have been relatively quiet in terms of official gold sales (Figure 2) (depressing supply). In fact, the announcement by the German Bundesbank (the second largest gold reserve in the world according to IMF data) that they would repatriate their gold from the NY Fed’s vaults can be seen as a sign that European banks are no longer as keen to lease (or swap) out their gold.12 Other very detailed documents released at the same time show that since 2008, the Bundesbank has not made use of gold leases or swaps.13 To us, this signals that Central Banks are less and less willing to participate in the gold leasing scheme.

Still, the price of gold has experienced a large decline over the past few months, only slightly recovering over the past 2 weeks or so. Given the strong physical demand, we think that this decline was engineered by a bullion bank that flooded the COMEX (paper market), only to then redeem physical gold from the various available sources at depressed prices (i.e. ETFs, see our discussion of this topic in the May 2013 Markets at a Glance). To further support our price manipulation hypothesis, we overlay the 1-month GOFO rate with days where the gold price suffered significant declines (more than 3%) in Figure 4. Unless it is the actual price drop that sparks all this increased demand, it seems counterintuitive that the gold price would decline precipitously before large declines in the GOFO rate, which implies increased demand for physical gold from bullion dealers.

Figure 4_2

It now seems that bullion banks are in desperate need of bullion, as evidenced by the increasingly negative GOFO rates we are seeing (Figure 4 below). Remember that a negative GOFO rate signifies that the bullion banks are ready to pay holders of physical to lease their gold, in this case for a month. Historically, negative GOFO rates have happened in very few occurrences. The last one was in November 2008 at the height of the financial crisis and after which gold rose 156% from through to peak. Before that, we saw negative GOFO rates in March of 2001 (about the start of the bull market) and September of 1999 (announcement of the first CBGA).

In our view, the bullion banks’ fractional gold deposit system is testing its limits. Too much paper gold exists for the amount of physical gold available. Demand from emerging markets, who do not settle for paper gold, has perturbed the status quo. Thus, our recommendation to investors is the following: empty unallocated gold accounts and redeem your gold in physical form (while you still can), invest in allocated, physically backed products (like the Sprott Physical Bullion Trusts) or in those that have access to physical gold in the ground (gold miners).

- Source, Sprott's Thoughts:

Thursday, July 18, 2013

Why the Gold Bull Market Isn't Over

Recent dramatic declines in gold prices and strong redemptions from physical ETFs (such as the GLD) have been interpreted by the financial press as indicating the end of the gold bull market. Conversely, our analysis of the supply and demand dynamics underlying the gold market does not support this interpretation. Many major buyers of gold are adding to their stocks, while at the same time supply is flat or even decreasing, compounding an already vast imbalance.

Many recent events suggest that the central banks are getting close to the end of their supplies and that the physical market for gold is becoming increasingly tight.

- Source, Eric Sprott via the Globe and Mail:

Tuesday, July 16, 2013

They've Lost Control

"They've lost control of the market in my mind, and that’s why they are so desperately trying to get us all to forget the word ‘taper.’ In fact, we probably won’t even hear the word ‘taper’ any more because it has such a sickening reaction to people in the bond market, and perhaps even people in the stock market. They will probably do away with the word. But the system is totally out of control. And then weave got this quadrillion dollars of derivatives. It just blows blows my mind to think about what could really be going on behind the scenes."

- Eric Sprott via King World News:

Sunday, July 14, 2013

People Lose Trust in the Currency

"Eric Sprott discusses how to protect yourself during 2013 with the coming fiscal cliff, economic collapse, currency wars, QE3 to infinity and more."

Monday, July 8, 2013

The Whole System Comes Crashing Down

"When you have a notional (one) quadrillion dollars of derivatives and they change by 1% on one quadrillion, that’s 10 trillion dollars right there. It’s just incredible. It would wipe out the (entire) banking system.

It’s a zero sum game, except the guy who’s losing can’t pay. Then of course they whole system comes crashing down because everyone worries about counter-parties...."

- Eric Sprott via King World News:

Saturday, July 6, 2013

Indians To Buy More Silver

As they (Indians) can’t buy gold, they are going to buy silver. If you tell the Indian population they can’t buy gold, they want to buy something real. They don’t want fiat paper. They are going to buy silver. And maybe in June or July, which we don’t have data on, when the restrictions and costs have shot up here (in India to buy gold), maybe they will buy even more (silver).

- Eric Sprott via a recent King World News interview, read the full interview here:

Thursday, July 4, 2013

Total Insanity Amongst Central Planners

"I just think we are going to be many times higher than we are today. It’s going to be a long-run, we are going to have this bull market go on for another 5 to 7 years. I just don't know how high the price is going to be (for silver). There is total insanity going on amongst the central planners right now. You tell me how desperate central banks are going to be and I can tell you how high the price is going to go.”

- Eric Sprott via a recent King World News interview, read the full interview here:

Tuesday, July 2, 2013

Eric Sprott - Have We Lost Control Yet?

By Eric Sprott & Etienne Bordeleau

Recent comments by the Federal Reserve Chairman Ben Bernanke have shocked the world financial markets. It all started on May 22nd, 2013, at a Testimony to the US Congress Joint Economic Committee, where he first hinted at tapering the Fed’s quantitative easing (QE) program. Then, on Wednesday, June 19th, during the press conference following the FOMC meeting, the Chairman outlined the Fed’s exit strategy from QE.

Since the first allusion to tapering, volatility has been on the rise across the board (stocks, currencies and bonds) (Figure 1A). Moreover, the yield starved, hot money that had flown to emerging markets has been rushing for the exits, triggering significant declines in emerging market (EM) equity and bond markets (Figure 1B). Finally, the prospect of the end of monetary accommodation has triggered rapid and significant decreases (increases) in the price (yield) of longer dated Treasury bonds (also Figure 1B).


It has been clear to us for some time that the Fed was uncomfortable with the relative certainty (i.e. Bernanke Put) that has prevailed in the markets since the introduction of QE-infinity last fall. Officials definitely wanted the market to start thinking about a future without non-conventional monetary policy. However, we seriously doubt that the resulting chaos is what they had anticipated. This was evident in the Chairman’s response to a journalist’s question about the rapid rise in rates, saying the FOMC was “a little puzzled by that”.1 The genie is really out of the bottle now.

Indeed, we believe that the recent “market appeasement rhetoric” by James Bullard and Narayana Kocherlakota (Presidents of the St. Louis and Minneapolis Federal Reserve, respectively)2,3 are further proof that the Federal Reserve has realized it went too far and that it is now in damage control mode. (Update: William Dudley, President of the New York Fed mentioned in a June 27th speech that “asset purchases would continue at a higher pace for longer” if the economy was to grow slower than the FOMC’s estimate)4.

However, as the Bank for International Settlements (BIS) so elegantly put it in its most recent annual report, “[…] central banks continue to borrow time for others to act. But the cost-benefit balance is inexorably becoming less and less favourable.” To this they add: “expectation that monetary policy can solve these problems [deleveraging, financial stability] is a recipe forfailure”.5 Clearly, the Federal Reserve knows this and wants to exit their QE program. But can they really?

A large portion of the current economic growth depends on housing. However, mortgage rates are closely tied to long-term treasury rates. While housing affordability is still relatively good because of low house prices, significantly higher mortgage rates might slow the housing market. Furthermore, banks are still very cautious about lending and most borrowers have difficulty accessing credit. While gentle increases in yields are good for banks (who lend long and borrow short), meteoric increases in yields (as in Figure 1B) are damaging because they are hard to hedge and create large losses on the banks securities portfolios (mostly composed of government bonds and mortgage-backed securities) as well as mark-to-market losses on their derivatives portfolios. So, the large and rapid increases in rates the talk of tapering has engendered will damage the economic growth the Fed has been working so hard to engineer, potentially requiring even more stimulus down the line.

The US government itself would also suffer from increases in yields. In its Annual Report, the BIS shows that even a small increase in interest rates would have a large impact on the projected government debt-to-GDP ratio. As shown in Figure 2, under the CBO’s base case scenario (bottom line), the US debt-to- GDP ratio would hover around 110%, whereas a 1% increase in rates would take it to 118% in 10 years (middle line). According to the Chairman’s comments, the fiscal drag that has been partly to blame for the lackluster performance of the economy should subside going forward. But, larger debt servicing costs (because of higher rates) will put more pressure on government finances, forcing it to spend an ever increasing portion of its budget on interest payments. This will have the effect of increasing the fiscal drag, going against the hopes of the Fed.


Sources: IMF; OECD; US Congressional Budget Office; BIS calculations.

To add to all this uncertainty, the situation in the Euro Zone’s periphery is far from stabilized. Following the surprise Cyprus bail-in, international bank regulators have made a push for a democratization of this alternative to outright government bail-outs of banks. This idea is quickly gaining traction amongst central planners. We recently discussed the shortcomings of the BIS’s “Template For Recapitalising Too-Big-To- Fail Banks”.6 The BIS, again in its annual report, reiterated that “we need resolution regimes to make it possible for large, complex institutions to fail in an orderly way.” As uninsured depositors and bank bond holders realize that they do not benefit from government guarantee anymore, bank funding costs will rise and funding might dry up for peripheral European banks.

Conclusion: at the last FOMC meeting, by prematurely announcing the timeline and the specifics of an exit from QE, Bernanke might have lost control of rates and volatility. The current US economic growth is still feeble and hinges on housing, which would be slowed down by raising rates. Banks, while better capitalized than pre-crisis, are still not lending to most borrowers and would be dearly affected by too fast increases in rates. Moreover, European woes still threaten the stability of the international financial system and the recent rush to the exit might further exacerbate funding pressures for weak European banks. Finally, the US government (amongst others) debt load, while already unsustainable, would keep on climbing if rates were to increase only by 100bps.

The chaotic reaction by market participants and the corresponding increase in yields now risks destabilizing this very fragile equilibrium. It is yet unclear whether or not the damage control from the other Fed Presidents will put a lid on yields and market volatility, or if the damage to the Fed’s (poorly executed) exit strategy is permanent.

- Source, Sprott Global: