Friday, October 18, 2013

Gold as a FOREX Currency

Another gold writer emailed me the other day with a few questions about my take on the apparent disconnect between the gold price action this year and "physical gold's obvious fundamentals." I explained to him how the POG (price of gold) is thoroughly and utterly disconnected from the physical segment of the gold market today. I said that any increase in physical demand (due to physical gold's obvious fundamentals) does not, cannot, drive the price higher today. It does one thing and one thing only, it stresses the current gold market structure.

The reason, I said, is that physical gold's fundamentals have nothing to do with "today's gold market." Today's gold market is "majority-owned" by gold trading as an electronic FOREX currency, which has almost nothing to do with the physical side of the market. That exchange by itself would probably make a good post, but this one is all about his primary follow-up question, which was:

"The area where I’m still hazy is the gold as a FOREX currency."

The following was my reply to his question, which I wrote in great detail with the intention of turning it into a post because it's something I haven't seen any other gold writers even acknowledge, let alone factor into their POG analysis:

As you well know, the POG rose in the 70s, but then in the 80s and 90s it fell from about $500 down to $250. During the 80s and 90s is when the CBs started leasing gold, or at least lending in gold-ounce-denominated units (lending their good name as Another put it: "Understand, they only lend their good name on paper, not the gold itself"), so that the bullion banks could help the mines hedge against the declining POG and not only keep producing, but actually increase production. From 1985 to 2000, global gold mine production increased from 50 million ounces to 82 million ounces per year, even as the POG was halved.

Checkmate is a good post for this wide view, or just watch this video by Freegoldtube, from the bottom of Checkmate, which has some relevant quotes from FOA:

This gold leasing/forward hedging started around the same time as Barrick switched focus from oil and gas to gold, around 1983, but by the mid- to late-90s it was more than mines taking these gold-ounce-denominated loans. Hedge funds wanted in on the gold carry trade too.

Meanwhile, following the closing of the gold window in 1971, gold received its official ISO 4217 currency code: XAU. This happened in either 1973 or 1981 (I'll explain the uncertainty in a moment, but I assume it was 1973 although I don't have the 1973 list). Silver received its own currency code, XAG, in 1983, platinum (XPT) in 1989 and palladium (XPD) in 1993. I mention these dates to show you how new all of this is. Mine forward hedging, CB gold lending, gold carry trade and metals trading alongside currencies on the FOREX. All very new.

Last year I emailed the currency ISO office in Switzerland to obtain this information. Here was my email and the reply I received:

Dear Sir,

I have a question about XAU (and the other commodity codes XAG, XPD, XPT). I understand that ISO 4217 was developed in 1973 and adopted a few years later. I also understand that SIX periodically publishes updates to the list, the latest being in 2008.

My question is: Was XAU on the list from the beginning in the 1970s, or was it added in one of the later published updates? And if so, what year was XAU added as a currency code for gold (as well as the other commodity codes)?

Lastly, if you could direct me to a copy of that historic publication in which XAU was added, that would be much appreciated!


Dear Mr. FOFOA,

Thank you for your mail. Unfortunately we do not have a copy of the 1st edition of ISO 4217:1973. XAU was added either from the beginning in 1973 or later to the 2nd version in 1981. I attach the 2nd version for your information. [Click here to download the 2nd edition of ISO 4217:1981]

For the other commodities please see the following amendments:

XPD (Palladium): Amendment number 65: issued: October 1993
XPT (Platinum): Amendment number 25 and 36: issued: 8 March 1989 and issued: 29 January 1991
XAG (Silver): Amendment number 8: issued: 21 October 1983

I try to get the first edition of ISO 4217:1973 from ISO and if successful I will forward it to you.

Yours faithfully,

Marianne Nikles
Secretariat of the Maintenance Agency
for ISO 4217
c/o SIX Interbank Clearing Ltd
P.O. Box
Hardturmstrasse 201
CH-8021 Zurich

Everyone knows about the mine and hedge fund involvement in the gold carry trade in the 90s, but much less attention has been paid to gold's use as a currency in the foreign exchange market (the FOREX), which continues to this day. I'm sure you are aware of the massive size of the FOREX market compared to other markets, but here's what Wikipedia says about its size:

According to the Bank for International Settlements,[4] as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion.

"Daily volume" and "daily turnover" are confusing terms, because there are different ways they are estimated in different markets. Double counting, for example, is one potentially confusing factor. But I think that the sheer size of this market is what is most amazing, whether it is $2T, $4T or $8T per day changing hands, it still dwarfs other markets.

In January of 1997, the LBMA released its "daily clearing volume" for the gold market which was an astounding 30 million ounces or 930 tonnes per day. At the price of that time, that was about $10B per day. Today, thanks to the 2011 LBMA survey, we know that "total daily turnover" is about ten times "daily clearing volume", and that "spot" (as opposed to forwards, swaps, options and other derivatives) makes up 90% of that volume. That's the "gold spot market" today! About $100B daily turnover in January 1997, and $240B per day in 2011, the equivalent of 5,400 tonnes total, or 2,700 tonnes changing hands every day! And that's from 64% of the LBMA members reporting, so it's likely higher, especially once you add in non-LBMA (retail) FOREX trading.

For comparison, the annual flow from mining and scrap recycling is about 4,000 tonnes. That's annual. So the physical flow from mines and recycling compares to the LBMA spot market like this. About 16 tonnes per day in physical versus 2,700 tonnes per day in the "spot market". Now what could possibly constitute such an enormous "spot market"? FOREX trading.

The FOREX market is a $4T per day market including all currencies, and it looks like the "gold trading as a FOREX currency" portion of that market could be $240B at a minimum, possibly higher. That would make "paper gold" a full 6% of all currency trading in the world, including dollars, pounds, yen, euro and the rest of the 178 "currencies" with their own ISO 4217 codes. Think about that.

Amazingly, this was clear to some even in 1997. That's what spawned the Red Baron series, and I think the LBMA revelation was at least partly responsible for A/FOA showing up on the scene. Who knows, maybe Another was the one who leaked it to the London Financial Times! Here's a bit from My Candid View – Part 4:

Back during the London Gold Pool years (late 60s), physical demand did drive the price of gold up. And, perhaps in the late 70s and 80s and even into the mid-90s, Comex futures were more than just a side show in driving the price. But today I think it is clear that there's much more money chasing gold in the FOREX market than anywhere else. How else can we explain the volume in the LBMA survey? And I didn't come up with that explanation. It first appeared in 1997 right after the LBMA first revealed its tremendous clearing volume. Note that clearing volume was still shocking then, but it's also much smaller than total volume. From the Red Baron series circa Sept. 1997:

"The formidable volume of daily trading strongly resembles that of currency trading."

"This suggests (at least to me) the trades are non-Central Bank transactions - and more probably commercial operations related to CURRENCY TRADING."

Now, currencies trade in pairs, like USDJPY or XAUEUR. The first in the pair is the "commodity" you are trading, and the second one is the "money" it is priced in—the denominator. So if you are long USDJPY, you are essentially long dollars and short yen. Earlier, you mentioned how it's easier to play the market from the short side when the price is falling, and I mentioned a conversation I had with FOREX Trader back in early June, which you hadn't seen.

Here is that conversation. It was about the implicit carry (interest rate differential) built into currency pairs and cleared overnight, possibly giving institutional money (like pension funds) a built-in "yield" as an additional incentive to short FOREX "gold" around May of this year. It was unusual enough that it caught his attention and he sent me an email:

Nothing new on the wire to report from my end. But I did have an interesting note for you which I've been meaning to email about, unfortunately been very busy.

The note is that carry is kind of screwed up in the FX market. As a simple example, EURUSD shorts are paying carry. Also, XAUUSD and XAUEUR shorts are as well, at least for the last couple of weeks since we noticed here in the office. Relative to the other G10 carries available, especially if you don't include the comdolls (NZD/AUD/CAD), the rate available is pretty good ($16/$1,000,000/night) on a relative basis. About a quarter of what you get for an AUDUSD long and about 4 times what you'd get on a USDCHF long.

I am very certain that this carry (combined with the technical position of the charts) is incentive for a lot of traders to short the FX pairs on leverage, carry can be a major consideration when trading a levered position. For example, we pretty much never hold overnight positions in AUDUSD or AUDJPY.

FOFOA: Can you explain this a little more? Are you saying you earn a small "interest rate" when you short the euro or gold?

FT: Surely you have heard of the "carry trade" before? Let me explain it. Basically, the original investment thesis was essentially: given two "risk free" instruments, yielding differing interest rates, a trader purchases the instrument with the higher rate on leverage, and funds that position by shorting the instrument with the lower rate, at the same amount of leverage. This allows the trader to collect the "carry" or "swap", which is the overnight interest rate differential between the two instruments.

This concept is the cornerstone of almost all financial activity which occurs, as long as there is margin to borrow. Obviously a simple example would be the "bank spread", i.e. short 1-3Y Treasuries and long 10-30Y Treasuries.

Same applies, implicitly, in spot FX. If I am long $1,000,000 AUD and short $1,000,000 USD (i.e. long 1 AUDUSD contract) then each night as the banks roll over their intraday positions (squaring the books), I earn the interest rate differential (e.g. AUD LIBOR minus USD LIBOR divided by the number of trading days in that year) from whoever is on the short side of my long (through the broker). If I am short 1 AUDUSD contract then I must pay the differential to whoever is on the long side of my short.

Currently, both XAUUSD and XAUEUR shorts are paying carry. During a technical uptrend in an instrument like AUDUSD, this is a strong disincentive to short the instrument, as the trader must pay the differential to hold the position. A technical downtrend which pays carry on the other hand, gives incentive to the trader to short, the more leverage applied the higher the multiple applied to differential earned.

FOFOA: Thanks. Yes, I understand the basic carry trade (borrow one currency and sell it short to invest in a different, higher-yielding currency). Like the yen carry trade – borrow yen, sell them for dollars, use the dollars to buy Treasuries. Or the gold carry trade. Borrow in gold units, sell them for dollars, invest the dollars. You not only earn the interest differential but you also profit even more if the borrowed unit falls in value relative to the invested unit. And if enough people are doing this, the very act of doing it pushes down the borrowed unit. It's all great until it's not and everyone rushes to unwind the trade first. Sound right?

I just need to wrap my head around it in FOREX terms since I've never traded currency pairs.

FT: Yep that is exactly right, the only difference is that in spot FX, all of it is implicit, i.e. you don't need to go out and borrow to short, or invest the dollars in Treasuries, your short is part of the pair and you can earn the overnight rate directly.

FOFOA: One thing that was confusing me was your trader lingo: "the shorts are paying carry." To a non-trader who doesn't know the lingo, that could be taken both ways. As in "the short traders are having to pay the interest rate differential," or "short positions are now being paid the interest rate differential."

FT: Sorry about that! Never even occurred to me :P

I'm not sure I remember the last time trading XAUUSD paid carry in either direction, so I thought it was quite interesting. Obviously interest rates have had a jump over the last month, but I doubt if that's enough to account for this. It seems possible that the "interbank/overnight rate" for XAU has gone down significantly, driving up the rate differential?

The way I like to think of it is, if the US 10Y yield goes from 5% to 2.5%, then this indicates there has been strong demand from the market to lend 10Y money to the US Government.

So if the XAU "interbank/overnight rate" goes down, this indicates there is strong demand from the market to lend overnight money to ...???

FOFOA: Just to be clear on this "the shorts are paying carry", if I hold a $1M short position in XAUUSD overnight (I'm shorting gold because I think the $POG is going down), do I get paid $16? Or do I have to pay $16?

FT: Haha sorry, yes, to be clear, if you short XAUUSD then you get paid $16.

FOFOA: Thanks! And now who is paying me? Is it someone who holds a $1M long position in XAUUSD overnight? Does it now cost $16/night to bet on gold in the FOREX market?

FT: The person paying you is nominally your broker, but what's happening is everyone that has a long on XAUUSD is paying the broker and the broker is disbursing that accordingly to the shorts.

The differential is not nominally symmetrical because FX contracts are denominated in the "right hand" currency in the pair (in this case USD). So it actually costs $21 to bet on XAUUSD longs. Although I believe the differential expressed in percent should be symmetrical.

FOFOA: So it sounds like this is a big incentive to be short gold on the FOREX. How do you read this?

FT: I think it could potentially be a big incentive in the same way as I've been using AUDUSD as an example. Following a trend is nice because of the potential for capital gains. Following a trend which pays cashflow is obviously nicer. Leveraging a trend which pays cashflow, nicest of all, back up the truck.

MY SUMMARY: There is an unusual incentive right now to short gold on the FOREX. You get paid to do so, and it's the longs that are paying the shorts. This is separate from the capital gains made when gold actually goes down. So if/when gold goes down, the longs are not only taking capital losses, but they are paying the shorts an interest rate differential for the "privilege" of being long paper gold (overnight).
[Note: The above exchange was back in June, and it related roughly to the April-June timeframe. FOREX Trader brought this to my attention because he thought it was an unusual situation. He couldn't recall seeing the XAU shorts getting paid the carry before, although it's not something he normally pays attention to. Another FOREX trader also brought it to my attention that this would not necessarily be available to retail traders because fees, spreads and rates are often less-friendly to the traders at retail brokerages. That's why I specified institutional money at the top.]

Also in my last email, I mentioned that with "only" 3X leverage institutional money could turn that carry into a reasonable yield in a no-yield environment, to which you raised an eyebrow. Apparently, leverage is quite common in FOREX trading. Here is my comment about leverage back in June under my "Black Gold" post:

Hello MdV,

I mentioned your comment to FOREX Trader because he doesn't really follow the comments.

Regarding 50:1 leverage, he said that retail brokers usually offer up to as high as 400:1 leverage to would-be currency traders. But he said that you'll rarely see professional FX traders using more than 20:1 leverage, and even then it's usually only the day-traders using that much leverage. He said at his office it's generally more like 3:1 or 2:1.

When you increase the leverage, there is a massive increase in the "cash flow" of the invested capital, but it also increases the potential for a margin call, which he says is obviously why retail brokers offer such high margin. For example, at 50:1, you'd only have to deposit $20,000 to hold that $1M XAUUSD short overnight and earn the $16. That equates to an annual interest rate of 21% which is HUGE. But the downside is that a 2% adverse move in the underlying is going to mean a margin call, which means you could lose the whole $20K if gold goes up 28 bucks and you don't have more cash to wire to your broker.

At 400:1 leverage (just for fun), you'd be earning a "carry" (interest rate differential) of 170% annualized. But the bad news is that gold would only have to move up $3.47 before you would either lose your whole wad or have to deposit more. Imagine having to deposit another $20K each time gold moved up $3.50 and you've only got $100K. If gold goes up $18 you'll lose the whole $100K, even if it then goes into free fall right after you went broke.

My point is, the high leverage offered by retail FOREX brokers is probably a cash cow for them (not you). But the real pros (like FT) are only using 2:1 or 3:1 leverage.

With lower leverage, he says: "This is where the technical trend comes in, allowing you to run your carry position with a tight "stoploss" that should stick unless the trend reverses. If you're a large investor with cashflow requirements (think pension funds and whatnot) then positions like this can be a moderately attractive way of earning a 5% "yield" in an otherwise yieldless market."


How many other gold writers have you seen that have even mentioned this $240B+ per day segment of the gold market, let alone analyzed its impact on the price of gold? In my last email, I told you how I answered someone who asked, "Can you point me somewhere (or perhaps you have written about it - and it has escaped me) what determines the daily (paper) Spot price. Does anyone know the factors involved?" Think about the relative weight of this $240B+ paper gold market as you read the bolded part at the end:

Have you ever noticed that the spot price is often slightly different depending on where you look? I just opened Kitco and APMEX simultaneously and the ask is $1,295.70 on Kitco and $1,296.20 on APMEX. The answer is that there is no official spot price. Everywhere you look for it the price you see quoted will either be from a live trading platform and, therefore, the opinion of thousands of traders who are looking elsewhere for reference, or else, as with Kitco and APMEX, it will simply be reporting the going price on some active trading platform. So there is no official spot price. There is only the opinion of thousands of traders who are all cross-referencing thousands of different correlated items, charts and other active trading platforms in search of an opportunity at any given point in time.

Which segment of the gold market do you think carries the most weight when it comes to determining the spot price of gold at any moment in time? GLD daily volume is around $2B. What is COMEX daily volume? Isn't it somewhere around $20B? And the LBMA reports a daily volume of $240B, 90% of which is "spot gold" or about $216B per day. So COMEX is about 10 times the volume of GLD, and LBMA "spot" is around 10 times COMEX and 100 times GLD. Does that sound about right, or am I getting something wrong here? I realize that I'm comparing "daily volume" to "daily volume" and there may be a margin of error due to differing methods of reporting "daily volume", but with an order of magnitude difference between LBMA "spot" and anything else, it's pretty safe to say that LBMA "spot" carries the most weight when it comes to determining the POG.

Here's a screen shot of a FOREX trading platform that "a big physical dealer out of the mid-east" provided to another gold writer. He said he uses this platform to purchase gold, and that he also takes delivery from the platform provider (FOREX Trader said that would be called a "physical ECN" if true). As this particular story went, he was able to buy and sell as much as he wanted, but was, on occasion, limited as to how much he could take immediate delivery on. Here's a quote from the story as it was told: "…physical orders were getting partially filled. If they ordered say 10 Kilo's they would get 5 or 4 as confirmation, and would have to wait for delivery of the balance."

I asked FOREX Trader if this screenshot looked like a physical ECN to him and here's what he said:

"There is no way I can verify based on the screenshot whether or not his access is to any physical ECN. But from my personal experience, it doesn't look like it. To me it looks more like any regular bucketshop CFD brokerage account. First of all, the spread (60c) is 10c higher than most CFD brokers offer, and definitely way higher than what you get on the interbank at 3:30PM London, 30 mins after the fix! Secondly, all you can see is the spread, you can't see the market depth even 1 level down. For example, I link a screenshot of MB Trading (which is an ECN -not interbank- broker that I do have an account with), thirdly it only seems to show the ability to buy/sell at market (as opposed to limit orders), which is another very big red flag that it's a CFD account.

However, while all three of these points trigger my skeptical side, like I said I have no real way to confirm or deny whether he is trading a physical ECN, there are a million software packages out there, each broker often provided support for at least two and there is no standard on how they should look."

I mention this FOREX Trader email for a couple of reasons. First, notice the term "interbank". Here's what Wikipedia says about the interbank:

The interbank market is the top-level foreign exchange market where banks exchange different currencies.[1] The banks can either deal with one another directly, or through electronic brokering platforms. The Electronic Broking Services (EBS) and Thomson Reuters Dealing are the two competitors in the electronic brokering platform business and together connect over 1000 banks.

The point I want to make here is that there seems to be a kind of pyramid structure to the FOREX market, with the interbank at the top tier of the pyramid. Down at the bottom of the pyramid you have the retail FOREX trading platforms available to you and me. You have to be a bank or a pretty big player, a wholesaler or a middleman to deal directly with the LBMA bullion banks as evidenced by the number of trades reported in the LBMA survey. The daily average reported was 6,125 trades totaling $240B. That breaks down to about $39M per trade, or 9/10ths of a tonne.

And that's why I think that this segment of the "gold" market could be larger than $240B per day. So what's the dog, and what's the tail? Remember that Another said, way back in 1997, "And Comex is nothing, if "only a silly game". Worldwide trading in gold could be cut in half and still equal all the metal in existence!" He also said, "Comex is a side show!"

It would be interesting to see how the LBMA would explain those 6,125 trades averaging $39M per trade, which over 36 reporting members averages out to 170 trades per LBMA member per day, each at almost 1 tonne. It's a stretch to imagine even a top tier FOREX ECN (electronic communications network) in which the average trade is $39M. So I imagine the LBMA would simply say they were OTC spot unallocated transfers between clients. But then who are those clients? I imagine they could include FOREX trading brokerages, some of which are owned by the bullion banks themselves, and each of which would carry a gold-ounce-denominated balance, directly or indirectly, with a real bullion bank that also deals in physical. A kind of FOREX brokers' gold-ounce-denominated liability clearing system for the various ECNs.

I suppose you could say that gold trading as a currency is, to an extent, "backed" by the much smaller physical segment of the market. In other words, "gold trading as a currency" requires, needs, depends upon a functioning physical market which trades at parity to paper gold. But the physical portion of the market does not require, need or depend upon the paper side. It's not a symbiotic or mutually beneficial relationship. It's more like a parasitic relationship, where the parasite cannot survive without the host, but the host will be just fine, even better, without the parasite.

How does this tie back into everything else I write about? Well, I think it should help you understand how the price of gold is not driven by the physical segment of the market, and therefore parity between the two is not as solid as it seems.

Of course there is no ironclad proof that the majority of LBMA volume in that survey is FOREX trading, but I have yet to see a better explanation, or any other explanation for that matter. As far as I'm concerned, that is the explanation until I see another contender. Can you think of any other activity the bullion banks are involved in that could account for $240B daily volume in gold trading?

I'm sure that some of that volume is straight-up unallocated gold savings (as opposed to trading) accounts, and some is probably physical changing hands, but the vast majority must be gold trading as a FOREX currency. And tell me, what would be the difference between a plain-vanilla unallocated gold account at a BB and an XAUUSD trading account balance at that same bank? The answer is absolutely nothing! Those gold-ounce-denominated credits are essentially the same thing. You can even ask for physical delivery from a FOREX trading account if it is with a bullion bank that deals in physical, which is why I mentioned that screen shot and the story from the large Mid-East gold dealer.

This astounding volume has been known since 1997, but have you seen anyone talk about it relative to COMEX or GLD? Today the LBMA "daily clearing volume" is $29.9B, and from that survey we know that total volume is roughly ten times clearing volume, so that means total volume could be up to $300B per day now. Here is the average daily clearing volume from Oct. 1996 through present, in ounces, $ value and number of transfers. The 2011 survey is the only thing concrete that we have to show how "total volume" relates to "clearing volume", but even with a margin of error, how else can you possibly explain these volumes?

We know the FOREX market is huge. We know that gold (XAU---) is part of that market. And we know the LBMA released its astounding volume data for the purpose of demonstrating that gold is a deep and liquid market. 2+2=4. I think it's really that simple, even if no other gold writer mentions it. But if anyone has a better explanation for that volume, I'm all ears! ;D

Today, any paper gold is just as good as real physical gold for the purpose for which people buy gold, which is to buy it today and sell it later, or as a hedge. Any paper is just as good as physical as long as they trade at parity!

You brought up the argument that "the people playing this game don't want gold, they just want to trade its volatility." True, and also some want it as a hedge or insurance for other investments. But what they all want is provided by paper gold as long as paper and physical trade at parity. They don't want physical because, today, there's no functional difference between paper and physical except that physical costs more to store. But when paper gold fails to perform that function for which everyone buys "gold", they'll want what the physical holders got. So it doesn't matter that they don't want delivery today. They still do want the same thing from "gold" that everybody else does, which is exposure to the price action in physical gold. But today they are only getting exposure to the price action in their massive paper gold market, which has a tenuous parity relationship with the much smaller physical market.

Here is FOA talking about how the paper gold holders think they are betting on what's happening in the physical segment of the market when, in reality, the physical segment is struggling to trade at prices determined in the oversized paper segment of the market:

FOA (7/4/99; 11:01:14MDT - Msg ID:8384)
Gold: Saving Real Money In A Time Of Transition

Clearly, the intent of this paper market, is to bet on the price of gold as it is determined by the buying and selling of other physical traders. The western public should take these trades for the concept they truly represent. ""I (the long side) bet on the "price" of gold not because we need or want the physical metal. Rather, my wager is that others will need real gold to protect themselves from bad monetary systems. In fulfilling that "need to own", these others will drive up the dollar price and I will make money while working within the confines of our good monetary system.""" The shorts make the opposite bet, in that they think the world monetary system will work itself out and induce "the others" to sell all their gold. That is, gold they bought in the first place, because they did not know that our money managers could repair the world financial system.

Yes, today Western longs and shorts are playing out these two views of the gold market. Yet, both sides are using paper gold bets to represent their beliefs. Truly, the major majority of this market does not buy or sell physical gold to represent their investment concepts. There are a few that buy coins and bullion, but, even in their large amounts, it is only a drop in the paper gold bucket.

This, my friends, is the very nature of western trading of gold. The mindset is to treat it as a concept for making currency, not protecting existing wealth. […]

There are many mental angles and philosophical side steps one can take when understanding the above. But, in this concept lies the very basis of the flaw in the current gold market. A paper market, built upon world misconceptions of currency values and the historical reasons for owning gold. The present deployment of world assets into a paper system of valuations is likened to traveling a trail of no return. History has shown that the assets accumulated in this way will never be transformed into "the things of life"! The paper wealth you currently own is nowhere near the real value your currency says it is. With the above introduction, we have begun close to the end of this journey. In the upcoming chapter one, we return several miles to walk ground already well traveled. We will observe concepts on the right and the left, not discussed by other guides. The very sights that make such a trip, "worth wile".

"You will see this trail thru the eyes of history and feel old ways as new Thoughts!" Another

I dug out a few more quotes from FOA for you, to hopefully encourage you (and others) to dig into the archives yourself. Here FOA mentions how the paper price of gold can fall even in the face of high physical demand:

FOA (8/10/99; 19:56:56MDT - Msg ID:10858)

"Another" counseled later that the gold market, as we know it was in danger of failing. In this case, failing means less and less major players are offering bids for future paper in the top tier markets because the gold can't be supplied. This loss of bids allows the paper price to fall further as present paper holders also attempt to sell. This is the "EXACT" reason that gold does not respond to the major financial events of today! Believe it! Local downstream physical dealers, because they use the Comex and LBMA paper market as a price creator, continue to sell gold at lower prices even as buyers come in droves.

FOA (8/23/99; 21:10:00MDT - Msg ID:11896)

The large funds don't want the trouble of real gold so they continue to play this game of "let's bet on the gold price and see who is right"! Today, they are learning a painful lesson that the stated price for gold is established by the same derivatives that they don't want to exercise. In their world, they are convinced that massive physical gold is but a phone call away for shipment into certified warehouses, so the derivatives price must truly reflect the real market.

FOA (9/1/99; 21:12:43MDT - Msg ID:12639)

The end work of this process has found the 3,000 or 5,000 ton per year real bullion market, is little more that a sea shell on a fifty mile beach. Everyone on the "gold net" already knows how much LBMA trades and that is small stuff compared to the other unseen world markets. The debth and liquidity of the paper market moved the bullion trade into the "pink sheets". Needless to say, today, the famed "closing bullion price" is set by the cash commitments that bid for derivatives, not the cash that bids for bullion. In the old days, really big traders would arbitrage any such paper overhang against bullion by calling for delivery. Today, with the paper market so large, any such power play would find most traders taking delivery of gold as the market is sold out from under him. Besides, this new market perspective works against any long traders because none of the present "derivative gold demand" wants delivery! They only want to settle in cash, because taking delivery would require selling their other "better performing" investments. The mindset today is that gold is only an insurance hedge, as such "an increase in its price will settle up in a cash delivery to me, to offset my other risk of cash impairment to my portfolio"! To further develop: "I don't need physical gold, I only need to participate in its price movements"!

In complete satisfaction of the current trend, derivatives fill the bill for this current gold market. Clearly, we can see that this new market is not "fraudulent". There is nothing wrong with players pouring margin money into the short side to create a demanded product! It's has evolved into a cash game. This is where GATA is fighting a war they cannot win. Gold bugs (of the last few years) were viewing the present market using 70s eyes. Indeed, they were investing in an industry that was losing primary demand for its product, even as "the need" for that product was exploding. This new gold market found a way to channel the "modern need" for gold's attributes away from physical demand and into paper supply. You simply can't create a short covering run if none of the current (insurance) longs want to take delivery. Even worse, as this trend was further developed, more and more old private physical holders were selling their gold and holding paper instead. Add to that Western dollar supporters wanting their currency to look good, and we have paper gold supply that's also used as a form of positive currency intervention. Anyone investing in the gold industry, expecting bullion to explode from all the new demand was truly disappointed. For every new Western gold bug that wanted gold for insurance, there were five paper sellers to supply him with all the gold insurance he needed, at a fraction of the cash commitment. Peter, (if you are still with me) this is only the end of this act, not the end of the play. We have been standing on the trail and looking at where we have just travelled. Now, let's turn around and look forward.


Once again, the needs of investors will redirect the method of using gold. As the wealth effect of the Dollar/IMF system goes into reverse, the process of receiving your gold hedge insurance in dollars will be perceived as a risk. At this stage, all of the past demand for gold that was channeled into cash settled paper derivatives will suddenly reverse its trend. Slowly, more and more of a percentage of settlement will be asked for in real gold. As delivery fails from increased demand, existing derivatives will be dumped upon the market place in an attempt to cash out. This very process will: First dry up all gold supply and lock down any existing private stocks. Second, cash biding on the dealer market will become convoluted and reflect only gold's currency value. It's economic / industrial use will be priced totally out of the market. Third, what was once the world price making market for gold, will become useless for delivery as its contracts are defaulted on and discounted in price. What price could the world gold price be set at, using these defaulted, bond like securities? How low does russian debt trade?

I pulled these quotes by searching the term "paper market" and, yes, there were lots of hits. Here's one quote I'm including because it could almost explain what we saw over the next 14 years up until today in the gold market:

FOA (09/06/99; 20:56:39MDT - Msg ID:12946)

Remember, the present financial system has a need for new mined gold to flow into derivatives at a low price to support the paper market. The same paper market that keeps oil behind the dollar also holds the dollar together. As of today; To further pull existing "old gold" from portfolios by forcing the street price down now invites a run from the dollar. A high physical "street price" will at least keep the dollar in play when price inflation begins. If the paper gold price rises from its present level, will gold stocks follow? Probably! But what if that rise ends quickly as the gold market begins its next "official" failure run?

Is that where we are in 2013, in the gold market's next official failure run?

Here's a little bit of the "wide view" I mentioned above:

FOA (10/31/99; 18:56:22MDT - Msg ID:17990)

Slowly, everyone is coming around to understanding how our gold markets got so far off track. The official determination of what constitutes "buying and selling gold" never started this way. In the beginning gold was wealth and people traded it as money. Jump ahead to the US timeline and we see currency a gold loan that didn't pay interest as it was the US dollar. You loaned your gold to the treasury and they gave you a contract stating that your metal was held until asked for. Your contract stated that 1/35 ounce of gold was owed you, on demand. Because no one asked for their loan to be repaid, the treasury just kept creating more loan contracts even though there was not enough gold to repay with.

After this "gold loan scam" went bust around 1971, they went back to using real gold again. The government allowed trading in physical in the US just as it was done in the rest of the world prior to this event. Then someone used the gold fabrication industry as evidence of a "need" to create a US futures market so suppliers could paper hedge risk. No need to make the point that this paper market was of little need as the gold industry had worked well for thousands of years without it. Indeed, another form of gold derivatives was just born. The gold market was destine to evolve again as the distinction between trading real bullion and betting against someone on the direction of the metal's price movements became one and the same. People accepted that a gold derivative was just as good as gold as the pre-1971 dollar was. We came full circle.

Pulling these quotes is actually fun for me, so I could keep doing this all day, but then this email/post would be 40 pages long. So I'll leave it at this for now. But there's much more in the archives. I only scanned less than 25% of FOA's posts to pull these quotes.

The point is that the paper gold portion of the gold market is where the price of gold is discovered, and it appears that gold trading as a FOREX currency is the largest portion of the paper gold market, by an order of magnitude even. The daily physical flow from mining and recycling is around 16 tonnes while the LBMA tells us that their spot unallocated flow is in excess of 2,400 tonnes per day. Here's one last quote from FOA:

5/3/98 Friend of ANOTHER

Gold is valued by the number of outstanding claims against it. Kind of like a house for sale with ten bidders. Each bidder thinks the house is in the bag because they have a valid bid ticket. Each one thinks he can have the house at any time, even though nine others want it too, because all I have to do is bid a little higher and take it! Insane, but that's what is going on! Somehow, the BIS and the major private gold holders know the total claims, as does Another.

Total loco London gold turnover in the first quarter of 2011, as reported by 36 LBMA members, was $15 TRILLION. Total turnover as reported in ounces was 10.9 BILLION ounces, or 340,402 tonnes over 63 trading days. That's a lot of trading! I wonder which market that includes "gold" has the depth and liquidity to entertain such volume, since it's obviously not the physical market, GLD or even the futures markets.

"The area where I’m still hazy is the gold as a FOREX currency."

Is it still hazy? ;D


And the light bulb goes on!

Awesome, thanks for this. I’ll re-read again and get back to you in a few days… got a bit going on right now.

Thanks again FOFOA.

Saturday, October 12, 2013

"Special" Drawing Rights

One of you asked me the other day about a couple of SDR theories floating around right now that you thought might somehow be a threat to Freegold. I thought I'd share my email response with everyone:

My basic approach to the SDR is, who cares? It doesn't matter. It would be worse than irrelevant to Freegold, it would be superfluous. It's just marginal speculation by people who haven't thought things all the way through. First of all, the SDR is only a unit of account, by design. If they make it into something else, then it's no longer a true SDR. It's something else. Might as well call it a bancor or whatever. If you hold an SDR, you hold drawing rights to a basket of currencies, but the SDR itself is nothing but a unit of account used to calculate how much of any one of the individual currencies in the basket it is worth. If you ask for one of those currencies, they will likely be printed for you by that currency's issuer and his SDR count will increase. Here are a few of my past SDR references:

From Synthesis in 2010:

Freegold is our destination with or without the euro. Even on the outside chance that an SDR or a similar super-sovereign currency is accepted as the new global reserve currency, it would have to contain gold at Freegold valuations in order to be viable, accepted and trusted, in the same vein as Randy's comment about an EMF. So any way you cut it, the future comes to us with really high value gold by today's standards.

From Unambiguous Wealth 2 in 2011:

"Virtual reserve currency" means something—like the SDR—that's primarily a unit of account for the purpose of providing monetary stability. But with the primary and secondary media of exchange becoming separate but symbiotic counterparts, stability will be automatically achieved, and a "commodity-based" super-sovereign unit of account comparing fiat M3 with a centrally managed gold price will be completely superfluous and unnecessary (i.e., as unused as the SDR).


The point is, there's a turn-key problem-solving system waiting in the wings. So whenever you hear anyone in the hard money camp or the Anglo-American press talking about something that sounds like the SDR with "gold backing" (watch out for that word "backing") don't buy it for a second. They simply don't have the full picture and, therefore, don't know what they're talking about when it comes to macro solutions. But even so, they're still right when they recommend that you get your butt out of that reclining black office chair and take personal responsibility for your wealth.

From Freegold Foundations in 2011:

So, the point about currency is, and mainly for those of you that fret over a NWO currency, or "whatever currency," an Amero or SDR or euro-whatzit... chill TF out! Currency is no big deal. Currency is not the issue that matters here. What matters is what we, as a planet, choose to save.

RS Comment: So often in commentaries of this sort that propose a “solution”, the author is strangely obsessed with the notion of replacing the dollar (as a reserve currency unit) with simply another institutional emission of similar ilk (such as currencies of other nations, SDRs, bancors and whatnot). Their avoidance of any meaningful discussion of the most obvious remedy is almost pathological in the extreme. To be sure, we don’t need to invent any manner of universal reserve currency to fill the role of a unit of account because that role is already served in a fully functional capacity for any given country by its own monetary unit.

What IS desperately needed, however, is a universally respected reserve asset capable of filling our current void with a reliable presence that serves as a store of value. And far from needing to be conjured or created by complex international committees, that asset is already in existence and held in goodly store by central bankers and prudent individuals around the world — it’s known as gold. From amid the ruins of a chaotic financial crisis that was brought about by its own complexity, a degree of sanity will prevail, and gold as a freely floating asset will arise in stature as THE important element of global monetary reserves. The floating aspect is the vital evolutionary improvement over all previous structural monetary failures which tried to use a gold standard at a fixed price (i.e., unit of account) perversely joined to the very elastic money supply of any given country’s banking system.

And from The Return to Honest Money in 2011:

The point is, once "Freegold" (nature's wrath) inflicts itself upon us all, it won't really matter what is chosen/used as the super-sovereign or supra-national currency to lubricate international trade. It could be the euro, the yuan, the SDR, Facebook Credits or even the dollar! Triffin's dilemma will be gone. And you shouldn't worry so much over the transactional currency question, because that will be chosen through the market forces of regression, the network effect and game theory's focal point discovery at the international level.

You also have to understand why the SDR was invented in the first place. Robert Triffin, as in the Triffin dilemma, was actually a proponent of SDRs and helped create them in 1969. They were "paper gold" for the time, because there wasn't enough gold at the fixed price. But once you truly float the price of gold, there is always enough gold. In essence, today's paper gold is similar to the SDR of 1970. There isn't enough gold, so you have a gold proxy to fill the additional demand. But once the price of physical gold floats, the paper proxy becomes redundant, superfluous and ultimately irrelevant.

So, suppose they have a big monetary conference, à la Bretton Woods, and decide to use SDRs. Then you also revalue gold. Whether it's a part of the SDR basket or not, anyone running a surplus, sufficient enough that it requires centralized long term settlement, could then choose between the real thing and the proxy. Proxy gold credits in any form become superfluous for settlement when there's enough of the real thing.

Also, something other than gold will likely be used to temporarily settle short term imbalances. That "something" will be either currency or currency debt. It could be something like the SDR, or it could be the euro, or it could simply be debt or base money in one of the two currencies of the trading partners. But this doesn't supplant the need for true settlement.

There's no such thing as perfect balance in the short run. There's always a little imbalance in trade, and so you need a way to account for that until later when it reverses and goes the other way. There are many ways to do that, as I mentioned above, and the SDR would be one way. But then it comes down to choices at the centralized international level. Do you want your trading partner's currency, debt in your currency, debt in your trading partner's currency, some third party currency like the euro, debt in some third party currency, or debt denominated in SDRs which is a unit of account that takes several currencies into account, administered by an international organization?

Even if everyone agrees to SDRs, that still has nothing to do with Freegold. Because in Freegold, that temporary short-term role that would be played by the SDR is still a role that must be played by something in the symbolic currency realm. And I'm not talking about "Freefiat" here! That's a very different "alternative" theory.

True settlement at the micro level precludes the need for centralized balancing at the macro level. But even individual exporting net-producer savers will carry a currency balance for the short run and, in general, that would create a (much smaller than today) current account imbalance that would need to be temporarily accounted for at the central bank level. That's where SDRs might come into play.

Savers wouldn't hold gold for the short run in Freegold, not because it fluctuates wildly, declining in real purchasing power at times as "Freefiat" predicts, but because the transaction cost of moving between currency and gold will cancel out even perpetual appreciation (similar to the performance of the best of the best collectible physical assets, i.e., stores of value, only available to the super-wealthy today) for a quantifiable period of time. So for anticipated expenses in the short run, currency balances will be the best choice. And currency balances resulting from inter-regional trade will likely be accounted for (not settled) in some form of fiat currency, which could even be the SDR.

The reason for using currency rather than gold at both the micro and macro levels in Freegold is that it is easily and cheaply reversible, because you expect temporary imbalances to be reversed in the short run. There are no transaction, transportation, storage or insurance costs, and the temporary nature of short-term imbalances reduces other well-known risks like currency risk, default and the unknown. Short term imbalances need to be accounted for, not settled. And that's what the SDR is, a unit of account that takes multiple currencies into consideration. It is for accounting, not settlement.

Physical wealth is the only means of settlement, currency is simply for accounting imbalances in the meantime. The problem today is that we perpetually accumulate trade imbalances (on all scales, from the individual to the regional) and call them savings. This exposes the entire system to the obvious risks -- currency risk, default and the unknown.


Wednesday, October 9, 2013

MTM Party Forum

Happy MTM Party day! The snapshot reported today was €989.078. The only thing a little bit interesting about it is that it's quite a bit higher than both the AM and PM fixes on Friday. The AM fix was €967 and the PM fix was €964. I guess it just goes to show the randomness of the snapshot, or not. Incidentally, there was a curious Snapshot day glitch on the LBMA website over the weekend, but it was corrected before the PM fix on Monday. Here's the updated chart:

I'm now accepting guesses for the year-end snapshot. How do you think the chart above will develop from here? ;D


Tuesday, October 1, 2013

October Open Forum

With 500 comments on the last one, a new month, a new season and a new Snapshot day upon us, I thought it was time for a fresh thread.

A few people have asked me about Snapshot day. Was it yesterday, at €984, or today, at €953? I should say that I don't put much stock in the middle quarters because they often show volatility that is not present when you only look at the major quarters. That said, Snapshot day is, in fact, this Friday, Oct. 4th. And MTM Party day is next Wednesday, Oct. 9th.

I'll show you what I mean about volatility when including every quarter. The first chart is only the annual snapshots since 2004, except for the last one on the chart which was mid-year at June 28, 2013. Aside from 2013 so far, it is a nice smooth trendline:

This second one is all of the mid-year and year-end snapshots only:

And this third chart includes every single quarterly snapshot since the end of 2001. Notice how bumpy it can be on shorter time frames:

Here's the data for all of the quarterly snapshots since Q4 2001:

2001       Q4          € 314.99
2002       Q1          € 347.32
2002       Q2          € 319.85
2002       Q3          € 326.98
2002       Q4          € 326.83
2003       Q1          € 307.80
2003       Q2          € 302.05
2003       Q3          € 329.99
2003       Q4          € 330.36
2004       Q1          € 346.04
2004       Q2          € 323.94
2004       Q3          € 332.30
2004       Q4          € 321.56
2005       Q1          € 329.76
2005       Q2          € 361.23
2005       Q3          € 393.12
2005       Q4          € 434.86
2006       Q1          € 482.49
2006       Q2          € 472.27
2006       Q3          € 474.00
2006       Q4          € 482.69
2007       Q1          € 498.20
2007       Q2          € 480.19
2007       Q3          € 520.31
2007       Q4          € 568.24
2008       Q1          € 592.75
2008       Q2          € 591.70
2008       Q3          € 627.14
2008       Q4          € 621.54
2009       Q1          € 690.19
2009       Q2          € 665.77
2009       Q3          € 683.77
2009       Q4          € 766.35
2010       Q1          € 823.13
2010       Q2          € 1,010.92
2010       Q3          € 960.58
2010       Q4          € 1,055.42
2011       Q1          € 1,007.25
2011       Q2          € 1,043.38
2011       Q3          € 1,206.40
2011       Q4          € 1,216.86
2012       Q1          € 1,243.45
2012       Q2          € 1,246.62
2012       Q3          € 1,377.42
2012       Q4          € 1,261.18
2013       Q1          € 1,251.46
2013       Q2          € 919.92

As I write this, euro gold is at €951.66. Yesterday it was as high as €989. In fact, there was a €30 swing between the AM and PM fixes today. That's some volatility!

So what's your guess? What do you think will be this quarter's snapshot to be revealed on Oct. 9? Will it be over or under €919.92? Obviously the odds favor over, but as it stands right now we are only €31.74 away from the June low, and it dropped by that much today alone! Anyone brave enough to guess under?

This is, of course, just for fun, because I don't assign much significance to a 3rd quarter snapshot either way. But I am curious to see your guesses! :D


And since Depeche Mode is currently touring the U.S., here's an appropriate tune that I enjoy:

It's Just a Question of Time!