There are six primary players in the London based precious metals storage market. Generally speaking, these six are the ones who store and transfer a vast majority of all gold, silver, platinum and palladium traded on the London Bullion Market Association (LBMA) and the London Platinum and Palladium Market. In alphabetical order, they are Barclays Bank (NYSE:BCS), Deutsche Bank (NYSE:DB), HSBC (HBC.B), J.P. Morgan (NYSE:JPM), Scotia Mocatta and UBS (NYSE:UBS).
Together, the "big six" have formed a corporate entity, named "London Precious Metals Clearing Limited" (LPMCL). It is the primary standards-setting entity for the alleged fractional banking scheme that is spoken about so much by the Gold Anti-Trust Association (GATA). GATA alleges, among other things, that this group of banks is promising to "store" gold, silver, platinum and palladium in what is known as "unallocated storage," while keeping almost no metal in their vaults. The issue was made infamous at hearings held by the Commodities Futures Trade Commission (CFTC) in America on March 25, 2010.
Most interesting is the fact that the LPMCL clearly states how they define unallocated storage. Many people who store their metals with these banks, however, don’t seem to understand the implications of what they are doing. According to the LPMCL, an unallocated account is "an account where specific bars are not set aside and the customer has a general entitlement to the metal. This is the most convenient, cheapest and most commonly used method of holding metal. The holder is an unsecured creditor."[i]
The most important sentence is the last one. Most customers do not understand that they do not own the precious metals they are "storing." Many seem to think that they own the metal, and are just giving the banks the right to use it, on occasion, in case of need, after which it will be returned to the vault. That is completely incorrect. The metal may, in fact, never be placed in the vault, because it may never actually exist at all except as an accounting notation on paper. The actual metal doesn’t necessarily need to exist, pursuant to the terms and conditions of the unallocated storage contract.
Admittedly, complete insolvency of such huge banks is hard to imagine, given their close ties to central banks, and the willingness of so many in government to sell out taxpayers and savers in favor of making sure that such banks are "too big to fail." However, the past may not indicate the future, and a time may come when governments are no longer able to save big banks, no matter how influential or important the banks may be. Most people do not seem to understand that, in a case of a bank insolvency, they are likely to get nothing from an unallocated gold storage contract at LPMCL.
People storing their metal in unallocated storage at LPMCL banks don’t understand that they’ve bought a nothing more than a "gold bond," subject to couterparty risk. The unallocated accounts take people’s money from them, and promise to redeem that money for precious metal, based upon the continued economic viability of the bank. In other words, precious metals depositors have to deal with counter-party risk. They are relying on the credit worthiness of whatever entity is promising to eventually return their metal. Yet, in exchange for this risk, they are receiving not one dime in interest payments. Instead, the banks accept the free cash, use it, pay no interest, are able to freely sell or lease any precious metals that might have been deposited. Their sole obligation is to return unspecified bars of metal to the unallocated storage.
But, what if the account owner, requests the metal upon demand. If the storage agent sold or leased too much metal, and doesn’t have enough to deliver bars to all requesting customers, no criminal penalties will apply. The person who thought he owned precious metal, and was storing them pursuant to an unallocated contract, never had title to the property. As a practical matter, the customers’ gold, silver or platinum has disappeared. But, bank vault executives have not stolen anything. They will not be jailed. But, the customers have lost the "insurance against bad times" that they thought they were buying. The bank messed up its accounting underestimating the percentage of people who would be demanding delivery. That's all.
The storage bank is not liable to the customer because they never really claimed to be storing anything.[ii] The depositors' lack of knowledge and understanding may cause them to lose their metal, not the way the banks conduct the storage agreement. The customer is a fool, duped by impressive names into depositing large sums of money, in exchange for nothing, not even any interest on his deposit.
By signing an "unallocated storage" contract, customers willingly signed away their metal and their rights. They also facilitate the alchemic creation of fake precious metals, because, as the banks use these metals and settle trades with them, serially, the amounts of the trades far exceed the amount of real metal. By claiming to "store" metal that doesn’t really exist, and providing "statements" to 100 customers, for example, giving them a claim on the same 1 ounce of precious metal, the banks are able to multiply the supply 100-fold and, thereby, reduce the price.
If and when a lot of customers demand delivery from unallocated metal accounts held at LPMCL banks, the banks will be unable to comply with their promise to allocate upon request, and the only recourse for the owner is to accept a paper settlement of the claim. After that happens, the precious metal holders’ claims disappear. If the customer is an industrial user of silver, platinum or palladium, it is going to be forced to go out, a few days after receiving the fiat cash, to repurchase metal at a much higher price. The key to whether or not this unsavory event will ever happen is the leverage upon which storage banks are handling such accounts. The bigger the ratio of customers to real metal, the bigger the probability that the scheme will eventually collapse.
In the past, most customers believed that the firms kept most bars on hand, for immediate delivery if needed, subject to occasional or emergency use in their business. People, for some reason, assumed that the bars would be returned to storage as soon as possible. How many would sign unallocated metals storage contracts if they recognized that the banks would have 99 parts of vault air for every 1 part metal. According to the testimony of Jeffrey Christian, a hostile witness with close ties to the bullion banks, at a CFTC hearing held on March 25, 2010, the precious metals trade is conducted in terms of so-called "financial assets"[iii], and are subject to a 100 to 1 fractional banking ratio, once you add up the derivatives and unallocated storage claims together.
So, what is the ratio of metal to vault air in the storage schemes themselves, apart from the derivatives? No one knows, and the LPMCL banks aren’t telling. Unlike the warehouse stock transparency at regulated exchanges in America, Japan and elsewhere, the LPMCL divisions of the various bullion banks are a secretive bunch. They do not publish the exact number of bars nor the number of customers wirh claims upon them. The fractional banking "leverage" may be lower or higher than 100 to 1. If it was significantly lower, we think that, given the public hue and cry, the banks would have disclosed the real ratio. Since they have not done so, we conclude that it is at least 100 to 1, if not higher.
With only a small number of bars available to satisfy a large number of claims, the possibility of a default is very real. If a large number of customers, supposedly holding large quantities of unallocated gold, silver, platinum or palladium ever actually wanted it, the LPMCL storage scheme will quickly fall apart. That may be exactly what is now happening, and the collapsing scheme may be responsible for the soaring price of silver, as people demand possession of their property.
Whether you buy metal at the LBMA, or the American futures exchanges or anywhere else, once you take delivery, make sure you do not get involved with an unallocated storage agreement. There are plenty of other options, including Via Mat, Brinks, and others. If you are an industrial user or a medium to large size insurer, bank, other financial institution, or government entity, you would be well advised to steer clear of unallocated storage schemes no matter who may be backing them. Other unallocated schemes, outside of London, exist at various Mints around the world, as well as at Kitco.[iv] Don’t ever allow precious metals to be titled in anyone else’s name but yours, except for the short periods in which you are buying and selling it. If you are now storing precious metals at an LPMCL bank, we believe there is no time better than now to get them out. The longer you wait, the more likely you will never get them at all.
To assist you with understanding the unallocated storage contract, here is a link to a blank form contract from LPMCL.
[ii] Unless, of course, the storage agent has attempted to use other markets, such as the regulated COMEX or NYMEX, to cover up a failure to act prudently before it defaults. Market manipulation to suppress prices, for example, might be the subject of civil liability for RICO based triple damages and/or punitive damages for fraud. They might also be prosecuted for COMEX/NYMEX related shenanigans, if there are any, so long as honest and forthright prosecuting attorneys can be found who have jurisdiction to do so. But, a mere default on the part of one or more bank members of the LPMCL would result in no further cost to the bank than reimbursing the stricken customer for the lost precious metal in fiat paper money. This can be easily obtained in the form of endlessly renewable near zero interest loans from various central banks such as the Federal Reserve, ECB and Bank of England, all of which have very close ties to the members of the LPMCL.
[iii][iii] As opposed to a commodity.
[iv] Kitco also now offers fully allocated storage, which is what you should choose if you want to store metals with them.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Long positions in silver.