Jesse's Café Américain

Thin premiums remain the order of the day for the gold and silver holding trusts and funds.

Citi analyst Tom Fitzpatrick sees gold appreciating $2,000+ from here. I think quite a bit of that sort of move could happen more quickly than most might imagine.

I think quite a bit of this recent gold action is taking place on the public stage, but is being driven by private talks amongst the monetary powers that be.

There should be little doubt that a replacement for the US dollar reserve currency is being seriously considered. Especially after the manner in which a few doubtful words cast by Bernanke about QE was able to send world markets into a swoon overnight.

There are those who would discredit gold and silver as being too volatile for inclusion in a basket of currencies that would become the international trading unit of exchange.

And at the same time, there is a strong move by some countries to back their currencies in gold at least partially. They have to proceed carefully because if the price is set too low, the Western banks would swoop in and arbitrage it heavily.

One thing that is lacking today for gold and silver are reliable price setting mechanisms that are not subject to manipulation and fraud by those who hold little of the metal itself, or who have re-hypothecated it many times over.

"Hypothecation is the practice where a borrower pledges collateral to secure a debt or a borrower, as a condition precedent to a loan, has a third party (usually an affiliate) pledge collateral for the borrower. The borrower retains ownership of the collateral, but it is "hypothetically" controlled by the creditor in that he has the right to seize possession if the borrower defaults. A common example occurs when a consumer enters into a mortgage agreement, in which the consumer's house becomes collateral until the mortgage loan is paid off.

Rehypothecation is a practice that occurs principally in the financial markets, where a bank or other broker-dealer reuses the collateral pledged by its clients as collateral for its own borrowing.

You may find this article by modern monetarist Peter Stella to be interesting: What Economists Need to Know About the Modern Money Creation Process

In it Mr. Stella describes how the banking system routinely pledges the same piece of collateral over and over again without a properly risk adjusted diminution of value. No wonder the housing market is in such a mess, with the concept of title to property having been reduced to a financialized abstraction.

"In the traditional money creation process, collateral consists of central bank reserves; in the modern private money creation process, collateral is in the eye of the beholder. Here is an example.

A Hong Kong hedge fund may get financing from UBS secured by collateral pledged to the UBS bank’s UK affiliate – say, Indonesian bonds. Naturally, there will be a haircut on the pledged collateral (i.e. each borrower, the hedge fund in this example, will have to pledge more than $1 of collateral for each $1 of credit).

These bonds are ‘pledged collateral’ as far as UBS is concerned and under modern legal practices, they can be ‘re-used’. This is the part that may strike non-specialists as novel; collateral that backs one loan can in turn be used as collateral against further loans, so the same underlying asset ends up as securing loans worth multiples of its value. Of course the re-pledging cannot go on forever as haircuts progressively reduce the credit-raising potential of the underlying asset, but ultimately, several lenders are counting on the underlying assets as backup in case things go wrong."

If you think that this has not been done in the gold market you are kidding yourself. Rehypothecation is not an aberration but a fundamental principle of the modern money creation process. It is what attracts the 'hot money' because it offers the opportunity to keep levering up. And this is why gold and silver have found little favor, if not intense dislike, amongst the modern financiers, except in its most diluted paper form, because it resists their attempts at ponzification.

As an aside, the re-hypothecation of collateral is still a massive problem in the banking sector. The same collateral has been pledged innumerable times. If any of the collateral should fail, as we had recently seen in the housing sector, the domino effect becomes the great bank-killer as balance sheets turn to shredded paper.

And this is why the entire banking system seized when Lehman failed, because they did not know whom they could trust, since they were caught up in a daisy chain of control fraud.

One solution is for a non-profit oriented entity to come in and buy the dodgy paper with public money, to pledge to expose no crimes, and to provide cheap money to the banks to keep their game of musical chairs going. But that still does not restore honesty and stability to the system. Indeed, while the scheme continues to generate outsized easy profits for the participants, going slowly on reform is the order of the day. No matter how one might choose to rationalize it as prudent caution.

How ironic that what had been called real money 'since the time of Alexander the Great' is shunned and denigrated by those in the modern money business.

“Gold has worked down from Alexander's time... When something holds good for two thousand years I do not believe it can be so because of prejudice or mistaken theory.”

Bernard M. Baruch

These are interesting times for those who enjoy studying money, aberrant human behaviour, the changing fashions of ideas, and incredible madness of crowds.

Note: From time to time I do have positions of size in some of the instruments listed below. I do not take positions in GLD and SLV. That is a personal choice, and not an endorsement or advice.

"Let Ahab beware of Ahab."

Herman Melville, Moby Dick

As a reminder, next Tuesday the 28th is an option expiration on the Comex in the precious metals.

The set up in the market is interesting. I wonder who, net-net, is really holding the big physical short underpinning that inverted pyramid of paper?

Qui est le trompeur trompé?

"A baited banker thus desponds,
From his own hand foresees his fall,
They have his soul, who have his bonds;
'Tis like the writing on the wall...

"When other hands the scales shall hold,
And they, in men's and angels' sight
Produced with all their bills and gold,
"Weigh'd in the balance and found light!"

Jonathan Swift, The Run on the Bankers

"He who sells what isn't his'n
Must buy it back, or go to prison."

Daniel Drew