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Chris Horlacher
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Chris is the Founder and Managing Director of Maple Leaf Metals Exchange Inc. He possesses a Chartered Accountant designation and is a former Senior Auditor for Deloitte & Touche LLP where he provided audit and assurance services to Fortune 500 companies, as well as independent businesses.... More
My company:
Maple Leaf Metals Exchange Inc.
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My book:
The Power of Gold
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  • Only Possession is Real Protection

    With the recent introduction of the Royal Canadian Mint’s ETR program, I thought now might be a good time to really explain why I’m in the business that I’m in and why I think that taking physical possession of your bullion is the safest, most cost effective way of investing in precious metals.

    This November 28th a new offering of a gold investment vehicle by the Royal Canadian Mint will close.  This program, known as an Exchange Traded Receipt (“ETR”), is another in a long line of paper-gold investments that are now trading on securities exchanges worldwide.  It, like all of the other programs, comes with a slew of fees, risks and other items that investors need to be aware of because they can have a serious impact on their financial security especially during these volatile times.


    The number one question investors should ask when participating in ETR’s, or any other kind of proxy gold investment, is “What are the costs?”  The Mint’s program has a number of them that make ETR’s unattractive.  The first is the 3% agent’s fee.  What this means is that for every $100 invested in to the ETR’s, $97 is used to purchase gold and $3 is handed over to the banks and brokerages as their commission for making a successful sale.  The second is the storage fee, which equates to 35 basis points, or 0.35%, per annum.  So, for every year you hold an ETR the amount of gold your $100 investment represents is reduced by $0.35.  The third is the redemption fees, of which there are many.  If you’re redeeming your ETR’s for cash, you will immediately pay a 5% fee.  So say you bought $100 in ETR’s and redeemed them the very next day for cash.  You would have immediately paid at least 8% in fees and commissions!  If you redeem for physical bullion, you will pay $100 per redemption.  On top of that you pay an additional 5% if redeeming in 1 oz coins, $15/oz if redeeming in 1 kg bars and $1/oz if redeeming in 400 oz bars (this drops to $0.25/oz after 10,000 oz’s).

    The storage fee bears further scrutiny because of the way it works.  Every year, the Mint will sell 0.35% of the gold stored under the ETR program in order to collect the fee.  This means that over time, the amount of actual gold each ETR represents will steadily deteriorate.  The longer the program operates, the greater the reduction in gold backing behind each ETR.  Compare these fees and costs to the premiums charged by physical precious metals dealers like myself and it's easy to see where and investor will come out ahead.

    Redemption Minimums

    Many programs include this, and the ETR’s are no exception.  ETR holders must redeem a minimum of 10,000 units in order to be eligible to receive physical gold.  At an initial offering price of $20/ETR this means that you have to have at least $200,000 invested before you would ever see any physical gold from this program.  Anything less is paid out in cash.  Other funds are no better.  The Sprott Physical Gold Trust has a minimum redemption of 400 oz’s of gold.  SPDR, Claymore, and iShares gold funds have a minimum of 9,730, 4,484 and 488 oz’s respectively (based on the October 26, 2011 London PM Gold Fix) and only for authorized participants.  Some funds, like the Central Gold Trust, don’t let anyone redeem for physical gold at all!

    Counterparty Risk

    Since the Mint is operating the program, an investor in ETR’s exposes themselves to a number of risks based on how successful the Mint is at operating the program.  Many programs, including the ETR program, can be terminated at the counterparty’s discretion.  At least with the ETR’s, if the Mint terminates the program, holders will be given 90 day’s notice and the option of redeeming their ETR’s for gold.  Many other programs simply allow the counterparty to declare force-majeure and pay out their unit holders in cash only.  The Mint can, however, at their discretion suspend all redemptions of ETR’s for gold, so this in effect provides investors with little security that they will receive their gold in the event of severe market events or other issues that may very well arise in the future given the economic climate.

    Furthermore the gold in the ETR program is not allocated, meaning there are no specific units of gold attached to each ETR.  The gold is not held separately from other unallocated bullion accounts held at the Mint and so all of the gold stored under every unallocated gold account will be co-mingled.  Redemptions from one unallocated program may actually affect the operations of the other programs.  The unallocated gold is also not audited or separately inspected on a stand-alone basis.  This makes it very hard for the Mint to know exactly how much gold should be assigned to each unallocated gold program.

    Another big risk that is unique to the ETR program is the fact that the Mint is exempt from many of the continuous disclosure requirements that other issuers on the TSX are subject to.  This is a clear double-standard created by the Government, giving the Mint special treatment and shielding from securities regulators.  The exemption makes it much harder for investors to get any information about the ongoing operations and financial condition of the Mint.  In the event of insolvency, unallocated gold holders are generally the last to be paid in a bankruptcy since they are listed as unsecured creditors.

    Access to Liquidity

    In an emergency, it is important to be able to access cash.  This has meant the difference between life and death for many individuals and families during times of great economic and political turmoil.  Investing in things like ETR’s can take weeks or months before you ever see any cash.  Having physical precious metals stored at home provides much greater liquidity because they can not only be easily bartered with, but can be converted to cash at a number of outlets in a matter of hours or minutes.


    All that being said, the Mint is a very respectable institution as are a number of other issuers of gold and silver ETF’s, trusts and other investment vehicles.  However, even the best of institutions can fail during economic crises through no fault of their own.  Because of the lower costs, greater liquidity, security and convenience of owning physical precious metals I feel that only possession is real protection in these markets.  There’s also something magical about holding a 1oz or even 10oz bar of gold in your hand.  The sheer size-to-weight alone is enough to impress someone the first time they pick one up.

    My company does offer storage to high-net-worth and institutional investors, but due to the risks associated with unallocated programs I felt that it would be inappropriate for a company exalting the benefits of physical ownership to operate one.  Instead, Maple Leaf Metals Exchange offers storage on a fully-allocated basis.  Bars are numbered and registered in the name of the buyer and not held on our own balance sheet so there is no risk of loss to the investor in the event that MLME meets an untimely end.  We are simply acting as your custodian.  All bullion held in our allocated storage program is fully insured in the event of loss due to fire, theft or other risks.  We use third-party, professional vaulting facilities and armored carriers provided by companies with a long-established reputation such as Brinks in order to ensure the soundness of our program.  I believe that this is ultimately the best way for investors to purchase large quantities of bullion as they will benefit from a cost structure approximating the unallocated accounts and the greater level of security provided is a key feature that guarantees that the bullion will always be there when you need it.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Nov 12 2:17 PM | Link | Comment!
  • The Canadian Moral Hazard Corporation

    On January 17, 2011 Finance Minister Jim Flaherty and Natural Resource Minister Christian Paradis announced that they would be making ‘prudent adjustments’ to the rules for government-backed mortgages. The press release was laden with the usual self-congratulatory fanfare and statements obviously designed to assure the reader that Canada has a ‘well-regulated housing sector’ and that the government ‘will continue to take the necessary actions to ensure stability and economic certainty in Canada’s housing market.’  Either Mr. Flaherty is unaware of the issues facing the Canadian mortgage industry, or is simply trying to create the illusion that the government is doing something about it.

    The Canadian mortgage market is dominated by the Canadian Mortgage and Housing Corporation (CMHC) and this government-owned company operates in much the same way as Fannie Mae and Freddie Mac.  The CMHC insures and guarantees mortgages as well as buys mortgages from banks in order to issue mortgage-backed securities that trade in the secondary market.  In comparison to Fannie Mae though, the prognosis of the CMHC is notably worse.  For instance, at the height of the housing boom in 2007 Fannie Mae had guaranteed over $2.3 trillion in mortgages, nearly a quarter of the market. As of 2010 the CMHC guaranteed nearly $900 billion in mortgages, about 90% of the market.  Fannie Mae had approximately $44 billion in net assets to cover those guarantees, giving them a leverage ratio of about 50:1.  The CMHC has about $9 billion in net assets to cover theirs, with the ratio working out to a staggering 100:1.  To make matters even worse, 74% of the CMHC’s assets are invested in those very same mortgage-backed securities.  If the Canadian housing market ever took a dive the CMHC would be bankrupt in the blink of an eye.

    The measures announced last January by the government are clearly geared towards ensuring that the CMHC doesn’t implode.  To put things in perspective, the CMHC’s guarantees are nearly twice the entire national debt.  It’s highly unlikely that every single mortgage would go into default, but even having to cover 10% of them would grow our national debt of $560 billion by nearly 17%.

    The first of the new measures reduces the maximum amortization period from 35 years to 30 on new government-backed mortgages.  The government correctly says that this will reduce the total interest payments Canadian families make.  However the problem isn’t with mortgages that are going to be made, but with the mortgages that have already been made and this measure does absolutely nothing to address it.  While it will reduce the total amount of interest paid, monthly payments will necessarily rise.   A family obtaining a $350,000, 5% mortgage will pay $113 more per month once these changes go in to effect compared to the same mortgage being amortized over 35 years.

    The second measure reduces the amount Canadians can borrow out of the value of their home from 90% to 85%.  I’m really curious as to how much effect Mr. Flaherty really thinks this is going to have.  A 5% change is an empty gesture.  After all, it only means that a person would be able to borrow $85,000 instead of $90,000 out of the value of their $100,000 home, hardly a difference that would make or break someone’s decision.  Flaherty claims that this will ‘promote saving through home ownership’ but this only reveals that our government is still completely ignorant of one of the main causes of the failure of the US housing market; homeowner’s ability to use their houses as piggy banks in the first place!

    Thirdly, the government is eliminating its insurance backing on lines of credit secured by homes.  The fact that the government only marginally reduced the amount of credit a customer could obtain, while simultaneously completely withdrawing their guarantees on that line of credit is telling.  It means that there is a fear in the government that a default is coming.  The government is already guaranteeing the house, why further guarantee their home equity line of credit?  They’re removing an exposure to losses that they’ve deemed too risky.  There is a silver lining to this measure though.  Now that the guarantee is gone, banks will be more cautious in giving out loans secured by homes in the future since they’re playing with their own money now and not the governments.

    The activities of the CMHC have, much like its American cousins, been taken to reckless excess.  Even a slight increase in the default rate in Canada will devour the company whole.  With the increasing risk of losing the U.S.A. as our major export partner and significant source of our GDP as they further endanger their currency and economy, the likelihood of this event is looking ever more probable.  The actions taken by Mr. Flaherty and Paradis show that the government is only marginally aware of these problems and clearly do not see a solution except to try and curtail further damage.  Too little, too late has been the drumbeat of every government when it comes to undoing bad policy and January’s announcement only shows that Canada is no exception.

    We have long heard shouts of denial from the media and other ‘experts’ that Canada is in a housing bubble, or could wind up experiencing a string of defaults like what happened in the U.S.A. beginning in late 2007.  Unfortunately for these deniers facts can be stubborn things, for indeed our housing prices have been rising exponentially over the past years.  A story that ran in the Financial Post last August identified a report issued by the Canadian Centre for Policy Alternatives where they argued that the residential real estate market, particularly in Toronto, Vancouver and Calgary, is “an accident waiting to happen.” If the following chart is any indication, they’re not exaggerating.

    Canadian & US Housing Price Indices

    Compared to the United States we have experienced nearly an identical boom in real estate.  The signs were, of course, everywhere.  House-flipping shows were airing practically 24/7 on television and no money down mortgages became a common sales pitch with mortgage brokers.  The availability of these loans was a direct result of the backing the CMHC was handing out like candy.

    The article later notes that the strength of the mortgage market in Canada is the reason why Canadian banks have performed so well when compared to foreign banks during this crisis.  Households in Canada have managed to meet their mortgage payments because employment levels have stayed relatively healthy.  The reality though, is that Canadians are just as leveraged as their American counterparts.

    Debt to Income Ratio of Selected CountriesConsumer Credit per Capita

    The average Canadian of 2011 looks exactly the same as the average American of 2007, and the average American lost their shirt.  They have borrowed out all the equity in their homes in the form of HELOC’s and other lines of credit and went on a spending spree.  Likewise, our savings rate has strayed dangerously low.

    The same events happening all over the globe will happen here as well.  For a number of years now Canadians have been on a debt-fuelled spending binge.  Wiley Coyote has already ventured off the cliff and it’s only a matter of time before he looks down.  The trigger could come in any number of ways.  In the U.S.A. the central bank began raising rates as a wave of mortgage resets swept by.  Debtors could no longer afford their new monthly payments and wound up defaulting.  In Canada, our central bank has said that it would not raise rates until 2012. The reasons why could not be more clear.  The government is well aware of the problems inherent within the mortgage market, but like all good Keynesians think that they can delay the pain forever with low interest rates.

    The only problem is that our economy is closely coupled to that of the U.S.A.  About 73% of our exports or 22% of our GDP comes from doing business with our southern neighbours. When they can no longer afford to buy our exports, what will happen to our export industry?  More than likely there will be a series of layoffs as firms restructure themselves in an attempt to find new customers.  Many others will simply go out of business.  The unemployment resulting from this could easily be the pin to pop our housing bubble.

    Whatever the trigger may be, our government’s reaction will likely be the same as the U.S.A.  They will sweep in to support the CMHC with bailouts and guarantees.  The Bank of Canada will continue to do everything they can to keep interest rates low in order to forestall the defaults.  These actions will only paper over the problems that are now deeply-rooted in our financial system and further debase the currency.  Furthermore, with nothing behind the Canadian dollar except for US dollars and Euros, this could happen much quicker than expected as well. For the moment though, our government seems content to continue staring in to the abyss.  They may feel differently when it begins to stare back.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Aug 24 9:41 AM | Link | Comment!
  • The Laffer Curve Gets the Last Laugh




    I sometimes come across people that, for some inexplicable reason, absolutely love taxes.  Actually, it's not so inexplicable since it's likely that they simply form part of the 47% of Americans who pay no Federal Income Tax according to the IRS.  Since they're completely detached from the real tax burden being levied on society, it's understandable that their opinions on taxes are equally as detached from reality.  Usually these people stammer on about 'trickle down' this, 'eat the rich' that and generally regard Ronald Reagan as the devil incarnate (as opposed to the phony conservatives, who think he was the second coming of Christ).  Now I'm no fan of Reagan, he turned out to be a substanceless windbag, so don't mistake this article as someone schilling for the other side.  There are, however, some things that he talked about that made sense and that need to be kept in mind when discussing economics and politics.  One of those things is the Laffer Curve.

    The Laffer Curve is something the political Left refuses to accept simply because it came from the lips of the Gipper.  Ad Hominem is an easy fallacy to make when you don't have any facts, or even theory, to back up what you're saying.  Nevertheless, the Laffer Curve is as true as the law of supply and demand when it comes to economics.  It's an economic phenomenon related to tax rates and government revenues.  The relationship was pointed out by Art Laffer, Reagan's economic advisor, though it had been known for a long time before Art ever came along.  The curve is simple and it intuitively makes sense, that is; when the tax rate is 0% the government brings in $0 in taxes (obviously).  Likewise, if the tax rate was raised to 100% (all other things being equal) the government would still bring in $0 in taxes.  The reason for this is because there's no incentive to work.  If 100% of the product of your labor is taken away from you and nothing is given in return, why work at all?  The result is that tax revenues take the shape of a curve, where increasing tax rates will get you more tax revenue only up to a certain point and then revenues begin declining back to zero.  The Laffer Curve was put forth as the reason why it would be good for US Government revenues if the Reagan administration cut rates from 70% to 28%.  Following these cuts, tax revenues soared.  This phenomenon has been replicated in many other countries as well.

    These tax cuts hardly happened in a vacuum, and so there are many other factors that could have an influence on overall revenues.  However there is other evidence to corroborate the validity of the Laffer Curve.  One such piece of evidence is known as Hauser's Law.  Hauser's law is the simple, empirical observation that since WWII, tax revenues have always been equal to about 19.5% of GDP, regardless of the tax rate.  At first this may seem counterintuitive, "How can the laffer curve be true when tax revenues have remained constant regardless of the rate?", one may ask.  You need to remember that Hauser's Law is about the relative amount of taxes to GDP, not the absolute amount of taxes.  It is what you get when you divide the total tax revenues by GDP in a given year.  If taxes and GDP both go up proportionately then the ratio will be maintained.  This gives us a way to confirm the Laffer Curve experimentally.

    Over the timespan that Hauser's Law has been observed, we have seen tax rates anywhere from 90% to 28%.  This is our experiment with the Laffer Curve and so we can be fairly certain that tax revenues are not a function of tax rates, otherwise Hauser's Law would not have been observed.    So we must then infer that it's GDP itself that's driving the change in tax revenues, which is exactly how Art Laffer described the curve working.  After all, if GDP increased then tax revenues would also increase by more or less a proportionate amount.  The notion that tax rates have an effect on GDP is not a new concept and this been demonstrated many times, most recently by none other than the former Chief of President Obama's Council of Economic Advisors



    "The resulting estimates indicate that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increases on investment."


     "Our baseline specification suggests that an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent. Our many robustness checks for the most part point to a slightly smaller decline, but one that is still well over two percent."





    So, as we can see, what's really happening is that cuts to the tax rate will increase GDP, which in turn (as demonstrated by Hauser's law) increases tax revenues by a proportionate amount.  This is proof positive that the Laffer Curve exists and is in play at all levels of society.  Like it or not, there was at least some method to Reagan's madness and we have to give him this one.  Ironically, on the off-chance that the political Left actually does accept this, I expect some sort of tax reform to be put on the agenda.  If the people pushing it have paid any attention so far, it will most likely be a 19.5% flat tax along with some provisions to exempt low-income earners from it.  The simplest way to do that would be to exempt anyone earning under a certain amount, say $35,000.  People in that income bracket already aren't paying any taxes so I expect a reform like would go through fairly smoothly since it can be empirically demonstrated that this is what will bring tax revenues to their absolute maximum, at any level of GDP.  Any attempt to collect more would lower GDP so much that overall tax revenues would begin to decline.

    Unfortunately, politics these days is based less on facts and more on pandering to the whims of largest voting blocks.  Naturally, we should expect the government to tackle the problems of shrinking revenues and growing deficits with the same bad logic as every previous administration.  They'll continue attempting to grow tax revenues with higher tax rates.  Despite having the knowledge that this can't work, it's what they feel that really counts.  These days, good intentions are all it takes to be heralded as a savior, results be damned.

    Disclosure: No positions
    Sep 07 2:49 PM | Link | Comment!
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