There’s something fishy going on in the gold market

Central banks are leasing gold out

In January, the contrarian investor in me won out: I decided to buy into gold miners.

In March I talked about how increased activity in the gold market might mean the precious metal has turned a corner.

But today, I ask that you forget all about gold’s recent price action. That’s a story for another day.

For now, let’s focus on what really matters: what I think are potentially explosive actions in the physical gold market.

Paper beats rock

Now, bear in mind that the physical gold market (dealing in wholesale bullion delivery) is tiny in relation its paper-based cousin (futures, options, leveraged trades, collateralised obligations, ETFs, etc).

In fact, it’s estimated that the paper gold market – which should be a derivative of the physical market – is actually some 100 times larger than the physical market – ie, if everyone holding paper gold ‘stood for delivery’ at the same time, it would be impossible for every party to fulfil their obligations.

The central banks don’t like it

Because the derivative market is so large, paper gold makes physical gold’s market price.

This is a problem for nervous central banks because when prices are perverted in this way, it causes anomalies in the market.

The big one right now is how the gold price seems to be completely out of kilter with underlying demand.

For example, how on earth can China and others be importing such massive amounts of physical gold – and yet the gold price refuses to budge?

All sorts of theories have been posited. One is that major Western central banks have been providing physical supply to balance the books, by leasing gold into the market.

But here’s the rub: this gold may belong to other nations, which is causing anxiety for countries that rely on the Western depositories to store their gold.

Sign up for a 4-week FREE trial of MoneyWeek magazine

MoneyWeek magazine signup

"The only financial publication I could not be without."
John Lang, Director, Tower Hill Associates Ltd.

World to banks: Where’s my gold?

First, it was the Venezuela’s Hugo Chavez that kicked up a stink. He demanded Venezuela’s gold back from London and the US. That was a few years ago now.

Some astute nations took note. After all, Venezuela’s holdings are the 15th largest in the world – this was no piddling amount.

Then about a year and half ago, Germany was rumoured to be asking for an audit of its gold held in foreign depositories. Supposedly the American custodians said take a hike.

We don’t know if that’s true or not. But what we do know is that shortly afterwards, the Germans asked for much of their gold back. 674 tons, in fact – 374 from Banque de France and 300 from the US Fed in Manhattan.

Now, this certainly wasn’t a piddling amount either. But if the stuff was in the vaults, then what’s the problem?

Well, you can only imagine the Germans response to the announcement that the transfer, of their gold back to them, would take eight years to fulfil.

“What? Eight years? The Venezuelans took delivery within a couple of months. What’s going on here?”

What indeed? Perhaps the Americans placated the German delegation thus: “Now, now, keep calm. Don’t make a fuss. If you rock the boat and everyone gets nervous, this process could take a lot longer! We don’t want anyone else getting concerned.”

A full year after Germany asked for its gold back, a trifling 37 tons had been delivered. That’s way off the 87 tons envisaged… and even that figure was allowing eight full years for delivery. What’s more, a paltry five tons came from the US. The rest was from Paris.

When asked about progress on getting its gold back, the Bundesbank was rather coy.

Don’t worry, they said.

They would, though, wouldn’t they? It would hardly help to have other nations knocking on the Fed’s door asking for theirs back too now, would it?

The rumour mill is back in action

More recently, Austria was said to be giving its London custodians a prod.

A report in Austrian magazine Trend suggested they were planning to send auditors to check on the country’s gold holdings in the Bank of England.

Hey up, this is how the German repatriation thing started!

And Austria is no gold slouch either. Its IMF-reported reserves top 280 tons. That’s nearly half Austria’s foreign exchange reserves. They like the stuff!

In response to the rumour mill, Ewald Nowotny, governor of Austria’s central bank, recently played down matters:

“I acknowledge the request. Any grocery store is obliged to do inventory once a year.”

So the rumours of the audit appear to be true, then. And once again, the central bank tells everyone there’s nothing to see here. As I said – they would, wouldn’t they?

If there’s going to be a run, then get in line early, and don’t go shouting about it.

The perfect crime

Everything I’ve laid out above is conjecture, of course.

But don’t be surprised to learn that the central banks have been ‘leasing’ gold into the markets. In fact, we know for sure that they do – they’ve admitted as much.

And unlike dumping the stuff in the market – like Gordon Brown did with half our pot – lending the stuff can be done more surreptitiously.

In fact, it’s the perfect crime. This way they can dump it on the markets, and still record it on their own balance sheet.

And why not? The stuff is supposed to come back again after the lease is up.

But this isn’t like shorting shares. In the bullion markets, once the bullion has been lent short and dumped on the market, it’s mostly smelted into new bars that are demanded in Asia. It’s then shipped and stored in brand new vaults all over the globe.

Getting this stuff back after the lease is up could prove difficult for all the banks and hedge funds that have been shorting the stuff. ‘Only five tons delivery in one year’ kind of difficult!

Of course, if this story has legs, then it won’t be endorsed by any official any time soon. Mum’s the word.

It makes you wonder, doesn’t it? Venezuela, Germany, Austria… where are the whispering rumours gathering next?

And could there be an almighty run on the Western custodian banks to come?

Watch this space.

How to buy gold in 2014

At MoneyWeek, we've always believed in the power of gold. It's been exchanged for thousands of years & a proven store of value. We think you should put at least a proportion of your wealth in the metal.

So to help you make an informed decision, we've compiled a FREE report called 'The Gold Profit Plan'. It'll show you exactly why gold is such a powerful asset – and how you can go about buying it.

To claim your free report and start receiving MoneyWeek's free daily email Money Morning, simply enter your email address below.

Simon Popple
Metals and Miners

21 Responses

  1. 06/06/2014, steveH wrote

    So, if this is right, what do I do about my holdings in
    Blackrock Gold & General
    XGLS (DB Physical gold)

  2. 06/06/2014, Richard2011 wrote

    The actual Germany request was for 2,350 tonnes of gold in Fort Knox which hold 8,200 tonnes and the USA have offered 300 over 7 years – and over the last 30 years USA has exported more gold than imported – final in 2009 China stated they had just over 1,000 tonnes – so if they stated holding now at it was 5,000 tonnes where did come from ?

  3. 06/06/2014, kajoda1954 wrote

    Well Bengt, You are correct in your assumptions. But, why. has it taken so long for the penny to drop ?
    You know as well as me that gold should be much higher. Are you journalists now preparing for the inevitable revaluation of gold (and even more so silver)
    Some truth and not hints would now be in order. I do understand your dilemna though. Fighting central banks is not easy and can be un-profitable. Take heart though I have about 50 % of my estate (5 million gbps) in PM and I am not stupid, In fact I am entirely comfortable with my position.

    • 09/06/2014, Ellen12 wrote

      Yes, I think by now it’s pretty much assumed that gold and silver are even more rigged by than libor and forex. Anything that maintains the illusion of the US dollar supremacy may be assumed to be rigg(able).

      But shorting gold was never the problem. It is the naked shorts that distort the market. But central banks role, I believe, is far more direct than that of a nervous bystanders. When the gold market was crashed in April 2013, I believe the FED was not expecting so many to see the crash as a buying opportunity. I think it was crashed by the FED, maybe by using Goldmans or JP Mrogan, to enable them cover their short positions by shaking out weak hands or using technical stop loss selling. But, I would guess, most of the weak hand have been flushed out, speculation of the widespread manipulation of precious metals have gone mainstream – since the unexplained resignation of Deutsche Bank from the, appropriately named, ‘London Fix’. And nobody knows how much of whose gold the FED has spent trying to splurge QE around and simultaneously prop up the dollar to maintain its undeserved ‘reserve currency’ status.

  4. 06/06/2014, Dave k wrote

    Also the gold price is below the cost to produce it , that can’t last.
    REM up 110% , good call.

  5. 06/06/2014, MGC Andy wrote

    Is there likely to be a gold grab by BOE if they are pushed to return other peoples that they have lent and had smelted down now ? Is bullion Vault London covered or is it time to shift it to Zurich Vault or vault under house ? Stranger things have happened !

  6. 06/06/2014, Mauritius wrote

    If they do get to audit it, do they just look at it or do they actually check it’s 100% gold? I heard a story of The US sending ‘gold bars’ to China which when checked had a Tungsten core with gold around the edge.

    I suspect any physical gold backing paper gold such as ETF’s and the like will be confiscated. Be very careful.

  7. 07/06/2014, Oscar Foxtrot wrote

    MGC Andy: I don’t know if the authorities could confiscate gold held in London with Bullionvault, but I am cost averaging from the Zurich vault as a precaution.
    kajoda1954: I admire your 50% PM holding. I thought mine was high at 25%. I suspect we will be rewarded – not sure when though!
    Well done Bengt with REM – 80% up since I bought.

  8. 10/06/2014, quark wrote

    The Gold Cartel by Dimitri Speck, is a book I mentioned in another post. It really is an eye
    opener. A must read for anyone interested in the Gold Price. And no, I am not the publisher or connected in any way to the author; but I found it fascinating and disturbing. How do we know that Bullion Vault isn’t lending out its Gold? How do we know, if our designated gold bars are being borrowed from some institution or being lent to Gold Miners? Now, my experience with Bullion Vault is first rate. And they are part owned by The Gold Council and Rothschilds; but I do wonder that if armageddon arrives, whether, like the banks, the vault owners will just close the doors. So I’ve come to the conclusion, that owning and storing Krugerands at home, is the only answer. Problem is, I would have a nervous breakdown every time I left home for the evening. There seems no doubt, that the Gold price is rigged, just like everything else where central banks are concerned.

  9. 10/06/2014, Borderer wrote

    Gold as a hedge? Maybe. But hold as Britannias. Worst case scenario they are VAT and CGT free and in my safe are not going to be confiscated by anyone. Bid -offer spread is painful when buying from e.g. bullionbypost but fairly liquid if you are prepared to take a further 1% hit from the supplier.

    But, oh, they are so lovely to weigh in your hand.

    Colour me romantic!

    • 23/06/2014, John Wynne wrote

      Hi Borderer

      A good call, I think. I believe Britannias are 22 ct. What weight are they, please? Happy days are coming for gold bugs, methinks.

      • 28/07/2014, Borderer wrote

        Hi John

        2013 & 2014 gold Britannia are 999.9 pure gold (24 carat). Earlier coins are 22 carat. I think Britannia are a better bet than sovereigns because their premium per ounce to the gold spot price is much less.

        Regarding where the gold price is going, I’m not ashamed to admit I’m mystified. But holding 5% or so of your portfolio as a VAT free and CGT free “insurance” seems to me a good idea.

        To quote my old Granddad, “if someone cleverer than me wants to buy it, then I want to keep it”.:)

        • 28/07/2014, Borderer wrote

          Er – but he would have been wiped out if he had lived in Holland in the 17th century and took the same view on tulips!

  10. 01/07/2014, Pinkers Post wrote

    The only “fishy” thing about gold is the ?precious metal itself. It’s in desperate need of a polish: Entry 11 April 2014 (pls scroll down)

  11. 01/07/2014, Pinkers Post wrote

    The only fishy thing about gold is the ?precious metal itself – clearly in need of a polish!

    Gold has been a bit of an unruly child recently, responding in an erratic and unpredictable manner to hitherto reliable indicators such as the threat of inflation (QE!), political turmoil and currency movements. This new, rather random ‘behaviour’, appears to have coincided with the rise of Exchange Traded Funds (ETF) that have introduced more flexibility and ease of trading and hence facilitating more speculative trading. Dubbed as a ‘cheaper’ and more ‘user-friendly’ platform, the ETF appears to have eroded gold’s traditional role as a trusted hedge and insurance policy.

    It is a myth to believe gold is a constant store of value. Like anything else, the price of gold is created by supply and demand.

  12. 03/07/2014, Pois fisher wrote

    Have any of you read “the Death of Money” by James Rickards. Scary stuff. I know it’s easy to think well of a publication when it’s views closely align with yours, so other viewpoints would be helpful, but it does all seem like common sense to me. Of course, it could just be the old guy in the market holding up the “end is near” board.
    How about a review from you Bengt.
    Think I’ll buy the real thing and bury it!

  13. 15/07/2014, at wrote

    I looked at a 20 year chart and gold appears to have risen more steeply from around 2008-2009 than in the previous 15 years. Assuming the very steep rise was a reaction to the 2008-2009 banking crisis and that we are out of the crisis now, the projected level of gold is around $1400/oz.

    Since 2008 gold has risen by 62.5%.

    I do not know what would be a fair comparison for gold, house prices, maybe, emeralds? (up by 6% since 2008), I am not sure, but the steep rise of gold price is way above the consumer price index.

    Assuming a 3% inflation each year, since 2008, the compound inflation would be around 20%.

    I think therefore that gold is overvalued by around 40% on the 2008 price, ie today’s price ought to be around $955 as inflation would dictate.

    Assuming a 5% inflation each year, since 2008, the compound inflation would be around 34% yielding today’s gold price around $1072.

    Disclaimer: I have invested heavily in gold, at quite high prices, so I hope my calculations are completely wrong.

  14. 22/08/2014, dizpila wrote

    This guy talks about gold, penny stocks… AAPL (which he predicted it would be drowning by now)… he knows about wines, cooks, builds houses… he’s your true renaissance man!

  15. 26/08/2014, Bankrobber wrote

    P M ??

  16. 12/09/2014, common sense wrote

    if you want to keep gold and are worried about security, dont let anyone know you have got it, then they wont burgle your house.
    dont by by post
    pick it up from bank / dealer and dont give your name and address/ pay cash
    I dont know if you can do this in the uk, but where i live in europe, you can pick up up to 15 without ID

Comment on this article

MoneyWeek magazine

Latest issue:

Magazine cover
Heading higher?

Or are house prices set to fall?

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues

'Would you rather upset God, or have Him just ignore you?'

In the first of three interviews with Merryn Somerset Webb, Hugh Hendry, manager of the Eclectica Fund, talks about what it takes to be a good hedge fund manager – and how he learned to stop worrying and love central banks.

21 November 1969: The first permanent Arpanet link

A milestone in the formation of the internet, the first permanent Arpanet link was established on this day in 1969 between researchers in the United States.