By Hard Assets Alliance Team
By Robert Ross, Hard Assets Alliance Senior Analyst
Grant Williams, chief investment strategist for Mauldin Economics' Bull's Eye Investor, recently published a piece in his weekly newsletter Things That Make You Go Hmmm… that I thought loyal Hard Assets Alliance readers would find very interesting.
At its core, the article gives a different take on the recent downturn in gold markets.
But it's much, much more than that, mainly because he's connected dots no other market critic has come close to piecing together. Until now, most mainstream pundits have based the downturn in gold markets on macro factors, such as tapering by the Federal Reserve, a slowdown in China, etc.
However, as with many things, Grant sees it another way.
His theory starts in 2011, when Venezuela requested to repatriate its gold from offshore holdings in the US. He surmises that the gold due to Venezuela—and in another instance Germany—had been loaned out, either to gold fund ETFs or other banks, and that the recent downturn in gold prices has been orchestrated to allow the big central banks to buy the gold they already owe at a discount.
He then points to a few examples that support this thesis, including a strange letter from a Dutch state-owned bank claiming those who had their gold stored with the bank could only redeem their holdings in cash, along with the mysterious fall in COMEX gold inventories, among others.
It should be noted that not many people could piece together a scheme like this. Grant has years of experience on his side (26, to be exact)... not to mention he's currently the portfolio and strategy advisor for Vulpes Investment Management, a hedge fund worth over $280 million.
Although we would have liked to reprint the original article in full, it was quite long, so I felt the best way to get the information to you was to take excerpts directly from the piece.
Let's start at the beginning, where Grant explains the significance of a simple chart, which he claims to have studied "every day for over a decade":
As many of you recognize, this is a chart of the spot gold price over the last four years.
However, in addition to the spot gold price, Grant added two lines: one to show the date when former Venezuelan President Hugo Chávez demanded the repatriation of 99 tonnes ($13 billion worth) of gold being held in the Bank of England on his behalf, while the other line represents the date on which the Bundesbank announced it wanted to repatriate 674 tonnes of gold from the Federal Reserve Bank of New York and the Banque de France.
Here's an excerpt of Grant's analysis of the first date:
"As you can see, the immediate reaction to the commencement of the global game of central bank musical chairs was perfectly understandable and completely explicable: the price soared (to a new all-time high, no less). After all, that's what generally happens when somebody says "I want a large amount of a reasonably scarce commodity and I want it now"—or at least that's what generally happens if said commodity needs to be bought in the open marketplace."
He then goes on to explain why this simple supply-and-demand force may have not worked exactly how you'd expect:
"Within 17 trading days the price had fallen 16%, bottoming at $1,608 on September 28. During that time, nothing much happened in the world—unless you count the Arab Spring and the Libyan civil war, Moody's downgrading of Japan to Aa3 and the resignation of the Noda cabinet, Ben Bernanke's promising more QE at Jackson Hole, Hurricane Irene hitting New York City, the SNB's pledging to print unlimited Swiss francs in order to defend a peg to the euro at 1.20, or the beginning of the "Occupy" movement—so it was hardly surprising that the price would fall."
With those points in mind, it's understandable that normal supply and demand dynamics may have taken a back seat. But when prices started falling (again) in January 2013 after the Bundesbank issued a similar request, things started to look suspicious:
"Once again, an initial move higher quickly morphed into a concerted move lower; and this time, with the quantity of gold required to be delivered to satisfy the Bundesbank three times greater than demanded by Chávez, the downward move in the price was correspondingly greater—to a degree that has caused consternation amongst gold watchers all around the world."
In another twist, the Federal Reserve and the Banque de France responded by saying it will take seven years to transport the requested 300 tonnes of gold from New York City to Frankfurt, and five years to bring roughly 370 tonnes from Paris to Frankfurt:
"OK ... time for a little math, methinks:
The Bundesbank wants to repatriate 300 tonnes of gold, which is, of course, sitting, untouched, at the Federal Reserve in New York.
That 300 tonnes equates to 300,000 kilograms.
A Boeing 747-400, set up in a standard cargo freighter configuration, has, according to its manufacturer, a maximum payload of 112,630 kg, a range of 5,115 miles (4,445 nautical miles), and a typical cruising speed of 0.845 mach (560 mph).
The distance between New York and Frankfurt is 3,858 miles.
So the German government could charter three 747-400s, send them to New York, load them up with their gold, and still have 37,890 kg of space left, which would allow for the mother of all shopping trips to Woodbury Common Premium Outlets in Harriman, NY, where Angela Merkel could buy enough Ann Taylor outfits to ensure a fresh one for every EU crisis meeting between now and 2016 ... okay, 2015.
By way of additional perspective, between takeoff and landing, if those on board wanted to watch the entire Lord of the Rings trilogy (theatrical versions, minus the credits, NOT the extended versions), they would be forced to circle Frankfurt airport for fifteen minutes before touching down.
But ... seven years.
Next, Grant goes on to offer a few theories on what could have happened (which he quickly debunks):
1: What if central banks don't lease their gold reserves out; and, in fact, all the gold they own is stored exactly where they say it is, in the exact quantities accounted for on their balance sheets?
He then points out that central bank chairmen—including Alan Greenspan—have noted that central banks routinely lease out gold reserves, and that it's a huge red flag that the Federal Reserve stated it will take a whopping seven years to deliver the gold to the Bundesbank.
After reasoning away the first premise, Grant goes on to offer a more likely scenario:
2: What if the gold in the central banks vaults has been rehypothecated and is no longer held in quantities even approaching those advertised? What would happen then?
Well, if that were the case, there might be a great need for this or that central bank to buy a lot of gold in a hurry, and in such dire straits that the bank(s) would at least want the price not to take the inevitable path higher that would normally accompany such a set of circumstances. If there were some way to make it actually go down in the face of such demand, well, that would be amazing, not to mention remunerative—but surely that's impossible, right?
Grant then cites a few examples of how this could have played out, starting with a strange letter from a Dutch state-owned bank called ABN:
"Paraphrasing, ABN declared that any holders of physical gold that had custodied their metal with the Dutch bank would, henceforth, be cash-settled and could not request physical delivery of their gold (or silver—TTMYGH is very definitely an inclusive publication).
There's a word for that where I come from: confiscation."
For me, this is the point where things really started to get fishy; how could a major Dutch bank with over $500 billion in assets simply refuse its customers the gold they had stored?
But then Grant moved on to the well-publicized fall in COMEX gold inventories, and the pieces started falling into place:
"Let's begin our little foray into the warehouses with a look at what has happened to COMEX gold inventories thus far in 2013:
A steady decline. However, the extent of that fall becomes clearer if we take a step back and look at the COMEX inventory over the last five years, at which point "steady" becomes "precipitous":
He then notes—which we have mentioned in previous HAA letters—the strange way GLD and other ETFs work in terms of exchanging your paper shares for physical gold.
In short, it's nearly impossible:
"Although every ten shares of GLD are supposed to be a proxy for one ounce of gold, in order to exchange your shares for that gold, you have to have what is termed a minimum "basket" size. That is 100,000 shares. These shares are created (and redeemed) by only a limited (but mostly rather familiar) group of "authorized participants":
JPMorgan, Merrill Lynch, Morgan Stanley, Newedge, RBC, Scotia Mocatta, UBS, and Virtu Financial.
These authorized participants transfer gold to the trustee (HSBC London) for share creation and receive the shares in return. The redemption process works the same way but in reverse and can only be activated in round "baskets" of 100,000 shares (with a basket currently equating to around $13,000,000—hardly a retail trade)."
To loyal Hard Assets Alliance readers, this should be of no surprise.
That said, Grant really brings it all back home with his last chart, which plots the spot gold price, COMEX inventories, and ETF holdings all on one graph:
"So what does all this look like if we put it together on one chart? Well, it looks like this:
As you can clearly see, virtually from the day that Germany demanded to have its gold delivered back to the Bundesbank, three very clear phenomena have occurred:
1. The gold price, which had been trending sideways, has plummeted.
2. The physical gold held at the COMEX has been pouring out of the warehouses.
3. The amount of physical gold held by the ETFs has stopped rising and started falling.
Coincidence? I very much doubt it.
Wanna know what I think, folks? I think the central banks have been leasing their gold out for decades to the bullion banks and now find themselves in the rather precarious position of needing to reclaim that which they are supposed to own before the shortfall is exposed. I think that creates a big problem for both sides of that little scheme.
I think the smash in paper was specifically designed to shake out loose holders—and it has worked to a degree, but only amongst the weaker holders of the ETFs, who tend to "rent" gold rather than own it. I think the stronger hands have been getting their gold out of the official warehouses as fast as they can; and central banks in places like China, Russia, and all over the rest of Asia and South America have been trying to buy and, crucially, to take delivery of physical gold while they still can.
I also think that retail investors—particularly here in Asia—are, unfortunately, compounding the banks' problems by using the weakness in the paper markets to acquire as much physical metal (or, as it's known in this part of the world, "wealth") as they can.
To paraphrase Everett Dirkson, "A few hundred ounces here, a few hundred ounces there, and pretty soon you're talking real problems."
And there you have it. If you're someone who was a bit skeptical about the recent downturn in gold, I'm sure Grant just gave you some intellectual firepower to support your claim.
There are questions that still need to be answered, the most important being how long can the big banks get away with it. That remains to be seen, but in the meantime, holding physical metals—rather than paper trading with GLD and other ETFs—is the best way to guard against financial calamity.
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