Central Banks Mismanaging Our Gold Reserves 10 comments
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During the current blow off in commodities, and particularly in gold, talk is again getting stronger that the gold price is manipulated. That’s a hot topic and something GATA (www.gata.org) has been saying for years. Conspiracy theories often contain some truth. Nevertheless, I would not call it manipulation, but definitely mismanagement.
It is a known fact that central banks as the most powerful organized group in the gold market with holdings of approximately 30,000 t use gold lending as a tool to manage their assets more efficiently. The USA as the biggest holder of gold with approximately 8,000 t has always been in the line of fire regarding the gold manipulation conspiracy. I think that gold lending has nothing to do with more efficient asset management as central banks most likely believe. Many investors who don’t accept gold as an asset class are always coming up with the argument that gold does not pay dividends or interest. It’s kind of a dead investment from a cash flow perspective.
I agree, but does an asset class per se have to pay dividends or interests? No, this is not a must in my opinion. As an example, an investor who puts money into equities is not primarily focused on dividends, he is focused on capital gains. Investing in biotechnology or technology stocks is like investing in gold (or non interest/dividend bearing assets) or do you buy these stocks for their dividends (which very likely will never be paid)? I suppose most central banks think they have to generate interest out of gold. So, they invented gold loans for gold carry trades. Central banks are lending their gold to other market participators (mainly well known investment banks) and get an interest in return (q.v. gold lease rates). After doing so, they believe this has been a good deal and call it efficient asset management and are happy to generate some interests. I call it mismanagement!
With these gold carry trades, central banks are destroying value and trigger many negative effects which they are not fully aware. Central banks also own bonds and stocks – if they want to maximize their returns on stocks, they should allow borrowing & lending transactions which means central banks allow that their stocks are been lend, in return they get a fee.
So what is a lender doing with these stocks? They are used for short selling. Short selling puts pressure on the stock price and if the quantity is big enough leads to a lower share price. In other words, the loss on value because of a lower share price is outnumbering the lending fee. The same effect exists in the gold market but the magnitude and implications are even bigger. Central banks are supporting artificially lower gold prices with lending transactions and help to suppress the market value of gold.
Gold carry trades are a big business and one that was very lucrative especially when gold was in its bear market. Remember, central banks think they have to manage their gold assets and therefore allow lending and get some interests – the counterparty was selling the gold and invested the sales revenues into other asset classes. As long as the price of gold didn’t rise, the strategy worked out perfectly. The so called gold carry trades were used very likely to buy US treasuries and gain the interest difference between the gold lease rate and the treasury interest.
This is working as long as gold (which the gold carry trader is short) is not rising or the US treasury bonds are not collapsing. Since these trades have been done for many years and it has been tolerated by central banks which also had an interest since these trades were supportive for treasuries and consequently supportive for the US dollar. Gold was the ‘perpetuum mobile’ for investment banks and central banks. I guess most investment banks involved in these trades never hedged their positions and they are very likely short physical gold since it has been sold in the physical market. So what’s going to happen if central banks are calling back their gold? Short squeeze on the physical market will be the result. Since we learnt in the sub prime crisis that the financial community is very good in creating highly complex products with huge leverage and which are not understood by anybody (including the creators).
It is therefore very likely that the lent gold has been used partially as underlying for highly complex derivates and structured products. These products are leveraged which means that the underlying physical amount of gold is not fully covered by the issuer. It’s the same as with loans – banks don’t have to cover their loans fully with net equity.
The trigger to activate this time bomb is coming from two sides: if central banks want to have their gold back or if the holder of the paper long position in gold is asking for physical delivery. That would be bad news for the issuers of such paper gold products since they very likely don’t have the gold available. Central banks know about this situation and will not call for their gold.
So how can this problem be solved? Only unwinding of leveraged paper gold positions will help, either in buying physical gold or in reducing the paper gold positions. But reducing the paper gold positions is something the end buyer decides who is long and not the bank which is short.
So what happens if the paper gold positions are not been sold but even increase? In this scenario, the seller of the paper gold (bank/broker, etc.) has to buy gold back physically to solve this unbalance. This of course has the potential to trigger a short squeeze in the physical gold market and kick the price of gold up dramatically.
It is also a known fact that the gold market is in a supply shortage for years (peak gold already happened in 2001!) and only central bank selling is balancing the market out. So what happens to the gold price if central banks from the emerging regions become net buyer?
As you can see in the following table, countries such as China, Japan, Russia or India which have a significant portion of their currency reserves invested in US dollar paper assets (e.g. bonds from Freddie Mac (FRE) or Fannie Mae (FNM) and similar ‘smart’ investment ideas), are holding very little gold.
If you compare these holdings with countries such as the USA, Germany, France, Italy or Switzerland, then you can imagine what kind of gigantic backlog demand is in the workings for these emerging countries with their global currency overinvestment and gold underinvestment.
It’s also important to recognize that a ramp up of the current gold reserves to 10% of central bank reserves in China, Japan, Russia and India would require a purchase of approximately 9,300 tons of gold or the entire gold production for the next 4 years.
In general, central banks would be wise to add up on real assets to hedge their paper exposure, I’m not only speaking about the US dollar - I’m speaking about a shift of power and a major devaluation of the current ‘global currencies’: US dollar, pound, euro, etc. Higher economic growth in the emerging countries lead by Brazil, China or India compared to the developed countries will appreciate currencies such as the Yuan Renminbi or the Indian Rupee, etc.
This economic shift will make goods traded in one of the global currencies cheaper and on the other hand assets denominated in US dollars, pounds, or euros less attractive to hold. Since gold is traded in US dollars, it gets cheaper (converted into one of the emerging countries currencies) and since most of these emerging countries - especially China - are sitting on huge amounts of US dollar, they are most willingly to protect their assets from devaluation. The ultimate store of value is gold. So far the gold market is mainly focused on the euro/dollar exchange rate which is positively correlated to gold – if the US dollar rises, gold falls et vice versa. I expect that gold will soon be influenced by this global macro shift towards the emerging countries in a positive way. The correlation between these emerging currencies against the developed currencies will be strongly positive for gold.
So what does this mean for our central banks? Since they manage our gold reserves, I’d be happy if they make sure that our gold is still around or at least they can get it back. So far our central banks have shown little understanding of gold as unique asset class and underlying of all the paper money in the system. Remember the Bank of England or the Swiss National Bank have sold lots of their reserves only some years ago virtually on the bottom at approximately $300 or lower. This is a complete lack of understanding the fundamentals of financial stability and unfortunately it’s done by the central banks which are required by law to obtain monetary stability and contain inflation. They did an incredible poor job, M3 has skyrocket and inflation is at highs not seen for many years. Instead of backing up the paper assets with real assets, they even decreased the ratio between real assets (gold) vs. paper assets (FIAT currencies or inflated bonds, stocks and real estate).
The natural hedge against inflation and a global currency devaluation is a long position in gold, either physically or by listed ETFs such as the SPDR Gold Shares (NYSE: GLD). Be smarter than our central banks, buy gold and stay long!
Disclosure: The author is fund manager for a mining & metals fund. The author’s view reflects explicitly his personal opinion.
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This article has 10 comments:
All I know that leasing at 0.6% per annum (carry trade) is in full swing now as there are just too many opportunities around the world to invest procceds from GC leasing.
Traders (Bullion Banks like JP Morgan, UBS, Barclays, Goldman Sachs, Bank of America, Sumitomo, Commerzbank, Citibank to name few but there are more) lease,leased and will continue to lease GC from anybody who will lease it to them and as much as possible.
Reason?
GC has run it's course,economies around the world are declining but not the high yield opporunities as interest rates are still higher in many developed countries than in the USA.
At lease rates for GC in 12 months at 0.6% Bullion Banks are not speculators and it allows them this low risk carry trade,where they just invest for difference in government bonds of other high yield countries,the procceeds they get from selling GC at futures markets with longer maturities.
GC for June 2013 delivery is 990$,160$ or 18% higher than current GC spot price.This carry trades already have been proven very successful and every trader big or small will follow successful trading strategy.
I think it is not a secret to many that soon all the major stock indexes will crash as global economy is already in recession,depression call it as you like.Banks know that GC is considered luxury same as Patek Philippe watches,art deco sculptures,Ferrari cars,Salon Champagne Vintage 1982 and luxury goods are selling better when economy is growing than the opposite.
GC is still used mostly in Jewelry as end product and your dreams about China and India eating and drinking GC is wrong,those two countries just got poorer again and people are not buying anymore at this prices same as bankrupt Americans are not buying anymore with their credit cards Asian imports.
Bottom line reality check:
GC will not stop at 830,800,760,600? maybe?or 500 more likely (Yamada magic number is 760$ an Oz,she was so damn wrong on Treasuries last year nd this,when she said they will never cross 112,today they are 118).
GC is in a downtrend,trend,trend.
Bullion Banks make money on carry trade,a lot of money,hedge funds just went short GC too as they want to join the bandwagon,speculators went short too.So where is the bottom for GC?
I don't know,but according to my own research which is secret but very simple,bottom will be 610$ around.Of course there will be short covering rallies but it is only precedent to short more for Smart Money.
This is a perfect article defining exactly what central banks mismanagement/manipula... looks like within the Gold marketplace. Call it what you will, it is a reckless misuse of power and has put us in a dangerous situation in regards to the valuation of the dollar.
Absolutely irresponsible, and I believe criminal misuse of power.
So much for the credibility of this deranged hater. Go back to your 'secret research'. The real world doesn't need it.My guess is that it is closely linked to 'Meinkampf'.
Butt out bozo.
Congratulations!
Look at yourself, and your collection of hate filled comments filling the web. I won't report you because I would much prefer to leave it up where it is available for all to see.
Best Regards!
Last month 40,000USD,I know many of you are billionaires here and for you 40K$ is nothing but for me it is a lot of money,that's why I can afford to go for picnic with my Mercedes E Class Avantgarde ( I know for you Mercedes is pennies as all of you drive a Rolls Royce or at least Lamborghini,but for me 49,000EUR I paid 2 years ago for this car is a lot of money ) and just bought NIB Rolex Daytona 18KYG deliverd next week I hope,for 15,000$ ( I know Rolex is nothing for you as all of you wear Patek Philippe for 80,000$ or at least Breguet for 50,000$ or maybe Lange & Sohne for 70,000$) but for me 15,000EUR is a lot of money.
For those of you pikers,I am ready to send my pics I made today while on picnic where you can see what car I have.And soon my Rolex just submit your e-mail billionaires below,picture will be sended by tomorrow.
Let's focus on trade,not hatred and not comment on what toilette paper you think I use,then there will be no fight,just pure trade.
My email is jewsaredead@live.co.uk after receiving statement from any of you (especially Lieberman's would be interesting) I immediately will forward mine,with real addresse so you will be surprized where I am from.Deal or no deal,cowboys-billionai... your balls are too light to open the cards?LOSERS.
I must leave you till tomorrow,made 3000$ on NatGas (bought my 4 miniNG shorts at 7.80$ that were sold on Thursday at 8.10$) as NYMEX pit opened today 2 hrs before than usually.
Go sell some NG I promise you will make a lot of $£$£ on it.
Your hard Labour Day will be paid to NYMEX beasts.Good luck all Jews,Chritans,Muslims.
Lend it to a short seller and you are making a bet that they have the financial ability to withstand losses - pure counterparty exposure.
Lend it to a manufacturer of gold products (be it jewellery, refineries, mints) and that is less of a problem as they have the gold, it is the work in progress. The central banks might still be exposed if they company goes bankrupt and they haven't put in place any legal protections (eg title remains with lender), but not as risky and the metal has not be sold into the market, so no negative impact on the price.