On the LBMA and Their Unallocated Holdings - 'Tightness' In Gold Bullion - Backwardation

"We looked into the abyss if the gold price rose further. A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake. Therefore at any price, at any cost, the central banks had to quell the gold price, manage it."

Sir Eddie George, Bank of England, September 1999

Below is a partial transcript of an interview with Jim Rickards on The Gold Chronicles from July 16, 2015.

You may listen to the entire interview here. This transcript is for the portion that runs from about minute 31 through 42. It is a very interesting interview and if you have the time you might wish to listen to the whole thing.

The reason I wished to share this transcript is the nice, compact description that Jim gives of the LBMA and how they manage their gold bullion contracts.

What provoked this discussion was an earlier question about the reported very large long positions of two banks, JPM and Citi, on the Comex that were noted back in May-June of this year.

Jim's supposition is that they must have had a physical gold short exposure elsewhere, and possibly on the LBMA.  As Jim relates it the Banks do not typically take large positions in one direction but tend to work on spreads and make their profits with leverage on those fairly thin trades.  And Jim should know since that massive buildup of leverage on thin trades that refused to perform is what blew up LTCM while he was there.

As is clear from this interview, the LBMA is a 'fractional reserve' exchange, with much of the gold being hypothecated some number of times.

IF there is a shortage of physical bullion developing, it will most likely appear in either London or Switzerland.  That is because London is the gold hub for the West, and they tend to operate on some multiple of claims to actual free holdings.  And Switzerland is where the gold is procured and refined for the formats of the Asian markets

As you know, I have been looking carefully for some time at the odd happenings with physical bullion on the Comex.  At least they seem very odd to me if not to some others.   You can be the judge.

And as you may recall, there were some pieces in the news about the 'tightness' of gold in London and the dearer prices being paid for gold available for immediate delivery.  Again, nothing huge, but another point of data.

And of course there is Goldman in there taking delivery of bullion for their house account reportedly.

And this flurry of schemes coming out of India to do more domestic mining, and monetize the gold held by private individuals and their temples, to stem the demand for bullion imports.

IF the Banks were short of physical bullion in London around July when Jim gave this interview, then by his estimates we would tend to see the strains on the free holdings of physical bullion about--  now.

I do not know what has caused Jim to say that "people are taking their gold out of banks and putting it into new vaults because they’re losing confidence in the banking system. These new vaults are private storage vaults owned by private companies, not by banks." I do not have his level of contacts.  But it does seem that there is a slow but steady bleed of bullion out of the Comex warehouses.  And 'deliverable' gold is at record low levels.

One would hope that the Banks were wise, and would not pyramid their web of wagers in size and term, hoping that the shortages of physical gold do not become deeper and more stubbornly set.  This could turn into a feedback loop of shortage and demand that would have Sir Eddy George back staring into the abyss once again.

But alas, this time the central banks are net buyers, not sellers. And the gold manipulators must contend with the great engines of physical demand in the East.  Surely by now the Banks must have learned their lessons about recklessly gambling with other people's money and assets.

What have we learned, at long last, about bailing these fellows out?

What makes this a more potentially serious problem is that the willful battering of the miners may make a resilient source of non-central bank supply more difficult to ramp up   A typical gold project takes many years to get into meaningful production.

Perhaps the central banks will use the people's sovereign wealth, this time in the form of gold as well as paper, to bail out their banking buddies from their reckless wagering once again.

So here is something to add to your knowledge.

Let's see what comes of it.


Related:  Bullion Bank Apologist and Physical Versus Paper
               How Many Good Delivery Bars Are Left in the London Vaults - Ronan Manly


Here is the excerpt from the Jim Rickards interview.

When I was in Switzerland for Physical Gold Fund, we actually saw the gold that belongs to the investors in Physical Gold Fund. We had auditors, they had bar numbers and manifests, and we went item by item. Those bars actually belonged to the fund.

That’s not true with these LBMA agreements. You don’t have any allocated gold. That means a bank can have, say, one ton of gold and they can sell 20 tons of gold. They use the one ton to back all 20 of those contracts. In effect, they’re short 19 tons. They own one ton physical and sell 20 tons to a bunch of institutional investors or high-net-worth individuals who want to own gold, so they’re short.

They depend on their customers not asking for the gold. As long as this is all on paper, it works fine. Where it breaks down is if the customer comes in and says, “You know that unallocated gold? I would like to make it allocated and actually have the physical gold. In fact, not only do I want it allocated, but I would like you deliver it from your vault to a private vault run by Brinks or Loomis or one of the big secure logistics providers.”

That is what’s going on. People are taking their gold out of banks and putting it into new vaults because they’re losing confidence in the banking system. These new vaults are private storage vaults owned by private companies, not by banks.

Going back to my original scenario, the bank has one ton of gold and they sell 20. If even five customers show up and say, “I’d like my gold,” one ton each, you’re now short four tons. You have one ton of physical, but you have five tons of requests from five different customers. You’re short four tons, so you have to go out into the market and buy four tons of market. Guess what? That’s a big order. Good luck finding it. You can find it eventually, but you might not be able to find it quickly. So you have price exposure. You’re suddenly short the gold because your customers are demanding it.

What would you do? You’d go out and buy the futures. Now you’re hedged. You’re short to the customer who sent you the notice, you’re long on the futures, but you’re price exposure is hedged. Now you can take 30 or 60 days or however long it takes to source the physical and make delivery to the customer. The customer may think the gold is sitting in the vault and can be delivered tomorrow, but trust me, they can’t. They’ll be lucky to get it in 30 days and could even take a few months.

When I see a massively long futures position, it suggests to me – again, to be clear, I cannot prove this – that banks are turning up short in some other part of the operation, probably on these unallocated gold forwards. Customers are taking their gold out of the bank, the bank has to deliver to those customers, they’re short, they’re getting long futures to hedge, and they’re going to spend the next couple months going out and buying gold.

Gold Daily and Silver Weekly Charts - The MIsguided Paperati and Bifurcated Markets

"In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly.

In a depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved."

John Kenneth Galbraith

There is a short excerpt of a video interview with hedge fund titan Ray Dalio at the Council on Foreign Relations below.

I think it is priceless.   Ray lays out his thoughts on wealth and hedging with gold to the chuckles and sniggers of the pampered ruling class  in a very clear and straightforward manner.

There is also another video interview in which Dalio discusses his views with the smirking chimps from CNBC.   It is almost a scene out of Huxley's Brave New World,  with Dalio as some kind of monetary savage trying to explain reality to those who have been incubated in an artificial currency regime of King Dollar and know nothing else.

Here is why I think that this is important.

The gold market in particular seems to have bifurcated, or split into two: one market for largely paper speculation and high leverage, and another for the purchase and distribution of actual physical bullion.

Is this a problem?

Yes it is.  Because the attitude towards gold among the status quo in the West has become rigidly dogmatic, supported by years of lazy thinking and a determined campaign of ridicule and propaganda to attempt to extend the unsustainable.

You can see it emerge every so often in sites and media outlets and analysts who can be considered as creatures of the establishment, to use an older phrase, for whatever reason they may have.   Some of the economist manservants of the ruling class talk about gold with the same sneering manner that a Victorian aristocrat might have discussed the 'rights' of the peoples of India or of China.

And I do not necessarily think they are bad motives, in the dishonest sense at least.  Some may actually believe what they say, although for the most part I don't think that the fortunate care what is good or what is true, if it serves their own special interests.  This is how they have been taught to be, how life is.

If you have been brought up, bred, and bombarded with certain points of view for most of your life, it is no surprise that you may reflexively tend to adhere to and promote those views without regard to any intervening facts, past or present.  You have been programmed by your education and, dare I say it, class.  I see it all the time.

And it can sometimes lead to odd divergences in reasoning.   This is why certain Founding Fathers found it perfectly acceptable to declare that 'all men are created equal' and also own slaves.  Or to seek to curtail the rights of the non-landed and women in terms of ruling and voting.   They are running on what they knew, without proper and rigorous examination.

It is hard for someone who has come from outside that system to understand how they can rationalize such a glaring discrepancy.  But if you put yourself in their place, and honestly examine some of your own habitual thinking, it is not so hard.

Hypocrisy, maybe.  And maybe it is just the unexamined prejudices of the fortunate.   Sometimes even what seems to be an obvious truth can only be seen clearly through tears.  And we have quite a surplus of the exceptionally fortunate these days, who have been pampered and privileged by an order which care very well for them, but that seems to be passing.

A big change is what we are heading for.   We have a financial system that still holds a vast amount of gold in the central banks, including the US and Europe according to their reports at least.  And more importantly, it is on a mad increase in the East with the central banks and the people buying in ever increasing amounts.   Those who serve the power circles of New York, Washington, and London do not want to hear about it, anymore than Winston Churchill had a regard for the thoughts of Mr. Gandhi.

And despite the huge change in the global supply and demand for bullion, we have a holdover, a significant price discovery mechanism in New York and London that is increasingly diverging from the physical realities of supply and demand.

There is going to be a reconciliation of attitudes and realities at some point.  And it may be quite impressive.  The longer that the status quo and their courtiers try to maintain their modern aristocracy, like vast tectonic plates unable to move but building greater and greater pressure, the more dramatic that change may be when it finally comes.

And alas, so many of our politicians are servants, although well paid and well taken, of the moneyed interests.  So they will do nothing that would perturb their true lords and masters, if they wish to also become fabulously rich and rise within the existing system.

The thought of the harm that this careless disregard for justice and right reason is doing to a very large group of relative bystanders and innocents, whose proper role is to be protected by those who have been gifted with greater talents accompanied by oaths of office, is almost disheartening.

Speaking of the pampered paperati, the FOMC will be giving us their pronouncement on interest rates tomorrow afternoon.  It will most likely be an exercise in cognitive dissonance, no matter what they do.

Have a pleasant evening.

SP 500 and NDX Futures Daily Charts - FOMC Tomorrow - Chain of Fools

“He who makes a beast of himself gets rid of the pain of being a man.”

Samuel Johnson

Stocks were on a tear higher today ahead of the FOMC announcement on interest rates tomorrow afternoon.

The economic news is coming in weakly, and I suspect that the market is guessing that the Fed will defer on their first interest rate increase of 25 basis points for a few more months.

There is probably going to be a split on the the FOMC between the hawks and those who view the Fed's mandate a bit more broadly with an eye on the real economy.   I fancy Stanley Fischer to be the leading hawk, although others will speak more loudly on it, and Janet Yellen to be the leader of the doves.  Janet I suspect is also going to serve as a scapegoat and patsy if things go badly, but that is a thought for another day.

There are quite a few who identify with the ruling class because they think it also will bring them riches and privilege.   A lot of these fellows have sold themselves because they have bought the line that the moneyed are trying to uphold freedom and liberty, whereas all they are doing is finding new rationales for their greed, cheating, and looting.  Little do their supporters realize that they, in the end, are just somewhat useful fools, in a very long chain of fools.

Personally I don't think a 25 basis point is going to make a big difference to the real economy given all the policy errors and damage that the Fed and their Bankers have already accomplished, with heaping helpings of bad decisions from the political class.

The chart formations are inconclusive, so we'll all be watching what happens tomorrow afternoon quite carefully, but especially the world's reaction and what happens in the trade going into the weekend.

Have a pleasant evening.