The gold ponzi scheme

I have written a couple of posts on how there is more gold paper than there is physical gold.  A year ago, Adrian Douglas wrote that there were four owners for every ounce of physical gold that is traded.  Recently, he told Peter Schiff that 45-100 times more gold paper exists than physical gold (see this post).

I concluded yesterday that banks which sell gold certificates do so on a fractional reserve basis.  How can they dare take such risk?  If the price of gold doubles, so would their liabilities!  I was thinking about it after writing yesterday’s post.  It is clear that the banks count on always being able to sell new certificates as their old customers begin to cash in the old ones.  Thus, they count on an active trade in gold certificates and continue to make a profit on the premiums, as well as continue to lend out the proceeds from the sales.  The Bank of Nova Scotia, which today has a market capital of 55 billion dollars, had 3.5 billion in Gold and silver certificates and bullion liabilities in their 2009 Annual Report.  Now let’s imagine a scenario in which the majority of holders of gold certificates become anxious and therefore go to their banks and demand delivery of physical gold–a bank run–and that this happens not just in Canada to Scotia Bank but globally to all the sellers of paper gold.  Suddenly a 3.5 billion dollar liability could become a 35 or even a 350 billion dollar liability, as banks scramble to buy physical gold, but suddenly gold becomes scarce instead of plentiful because no one is accepting the paper anymore.   This is something that could bankrupt the banks–indeed, it is the classic means by which banks have bankrupted themselves.  They issue more paper than what they have physical money, and people suddenly all come in to redeem their paper for real money (gold and silver).  Some financial institutions have even charged their clients storage fees for the gold and silver that they were supposedly holding for them! (See e.g., regarding Morgan Stanley).

Now, perhaps an esteemed reader of this blog says to me, “The banks wouldn’t be that stupid.”  But these are the same banks that bundled good and bad mortgages and sold them to the world in the form of derivative products called “CDOs”, saying that the housing market will never go down; this resulted in the sub-prime mortgage crisis and it has proven that banks are not run by the brightest people, but rather by immoral people whose desire to become rich leads to destruction and chaos.

Gold certificates vs. Sprott Physical Gold Trust

I picked up some shares of Sprott Physical Gold Trust on a tip from a friend who is a lawyer at a Bay Street firm here in Toronto.  What backs up Sprott Physical Gold Trust?  Its Net Asset Value (NAV) as of close Friday is $11.60 per share, based upon 820,753 oz of physical gold held in the Canadian Royal Mint.

It is possible to buy Gold certificates from major banks.  What backs up the gold certificates of banks?  Well, the Bank of Nova Scotia says,

Scotiabank gold certificates are backed by the assets of The Bank of Nova Scotia.

And this:

Allocated gold is bullion held by a bank on behalf of the owner. The gold is separated from other metal that may be held by the bank and is identifiable by its unique bar numbers.

Unallocated gold is a claim on The Bank of Nova Scotia for the ounces entitlement to a specific quantity of gold bullion.

And finally, this:

RSP Gold Certificates sold through Scotia McLeod are allocated, while all other non-registered certificates are unallocated

This means that the Bank of Nova Scotia likely sells a great deal more gold certificates than the physical gold that they have to back it up, because they only hold allocated gold if the certificates are bought within an RRSP plan at their Scotia McLeod brokerage.  The rest is just paper.

The idea, therefore, that there is far more gold paper than there is physical gold is not at all far fetched.  This was exactly the point of a previous post that suggests that gold should be worth $56,000.  But because there is many more times more paper gold than physical gold, the gold market is actually flooded with worthless papers.  The Bank of Nova Scotia is not alone in this practice of selling unallocated gold.

The fractional reserve system of gold selling is a dangerous practice and it puts the buyer in a position of assuming the bank’s default risk.  If you put your money in a savings account, it is insured up to certain amount.  But it doesn’t seem that unallocated gold certificates are insured at all.  This website seems to give a pretty good explanation of unallocated gold certificates:

The Business Insider: the National Enquirer of Financial Sources?

Anchorage, AK, May 4 2005 (some rights reserved), click on photo for Flicker source

I’ve grown to really dislike the Business Insider.  I consult it regularly because for every two bad articles they provide a good one.  They provide excellent access to people like Peter Schiff, John Mauldin, Marc Faber and Gonzalo Lira.  But the tendency is for them to be liberal in orientation; so the editors themselves, while begrudgingly recognizing certain fundamental laws of economics, nevertheless are quite often shills for the Obama administration, the Democrat party, and Keynesian style economics.

But today a flicker picture appeared in their article on poverty in America and the increasing gap between rich and poor.  Gus Lubin writes:  ”

While politicians gloat about our “recovery,” our poor are getting poorer, our average wages are still falling behind inflation, and social mobility is at an all-time low.

Read more:

Now I wasn’t very interested in the charts and statistics that Gus Lubin wished to present.  I was interested in the photo of the desperate man with the sign saying “Homeless Please Help!”  and the background behind the man.  The scene was familiar.  If I’d seen it once, I’d seen it a million times:  Mt. Wolverine and the Chugach Mountain range which forms the backdrop of my home town Anchorage, Alaska.  I lived twenty years on the foothills of those peaks.  I went to Flicker which was linked to by Business Insider as the source of the photo.  The photo is from 2005 and is presumably of a native Alaskan.

Now this is just bad and unethical journalism.  The story of this photograph is not remotely related to the widening gap between rich and poor in America in 2010. Sorry.  Other narratives are more suitable:  Perhaps the man was a stranded Inupiat, Yupik or Athabaskan man, far from his village home–maybe he had a problem with alcoholism.  Who knows the story behind this photo?  It looks really sad.  But what does it have to do with the Business Insider article?  This man was standing at this Anchorage street corner five and half years ago, over two years before the recession even started.

American Thanksgiving

The reason why socialism doesn’t work is that it provides no personal incentive for work and productivity.  Human nature chaffs against it and hates it.  Each person wishes to work above all to provide the needs of his or her own self and family, not for the common good.  This is an immutable (at least humanly speaking) characteristic of all humanity.  Today, I wish to thank God for instituting private property rights via the Eighth Commandment:  “Thou shalt not steal.”

Reason TV has made the following video explaining the true meaning of American Thanksgiving:

Hat tip:  Monty Pelerin

P. S.: Craig Carter mentioned yesterday on his blog meeting the people of Acton Institute at SBL.  Their core principles include these two regarding government and wealth creation:

Rule of Law and the Subsidiary Role of Government – The government’s primary responsibility is to promote the common good, that is, to maintain the rule of law, and to preserve basic duties and rights. The government’s role is not to usurp free actions, but to minimize those conflicts that may arise when the free actions of persons and social institutions result in competing interests. The state should exercise this responsibility according to the principle of subsidiarity. This principle has two components. First, jurisdictionally broader institutions must refrain from usurping the proper functions that should be performed by the person and institutions more immediate to him. Second, jurisdictionally broader institutions should assist individual persons and institutions more immediate to the person only when the latter cannot fulfill their proper functions.

Creation of Wealth – Material impoverishment undermines the conditions that allow humans to flourish. The best means of reducing poverty is to protect private property rights through the rule of law. This allows people to enter into voluntary exchange circles in which to express their creative nature. Wealth is created when human beings creatively transform matter into resources. Because human beings can create wealth, economic exchange need not be a zero-sum game.

The socialist, utopian dream is not possible.  It will result in the poverty of everyone except the ruling classes.  Respect of private property and the limited role of government is necessary for a society to flourish.  I like especially that the Acton Institute stresses the core principle that government must promote the “common good”.  The redistribution of wealth, i.e. socialism, is not the promotion of the common good, but the good of some to the detriment of others.  Most of what liberal democracies do today is socialistic: education, health care, welfare.  We need to see government limited to the roles of common protection from enemies both foreign and domestic (i.e., military and police) and providing a justice system to punish crimes and to arbitrate between competing interests.  Beyond that, government has few legitimate roles.

Gold at $56,000 per ounce?

There is a story going around that the London Bullion Market Association has sold as much as 45-100 times the amount of gold futures as there is physical gold underlying the notes.  I first heard about this story from Monty Pelerin’s blog which featured a Max Keiser interview with Jim Willie (see videos below).  Then, on the Peter Schiff Radio Show, Adrian Douglas claims that gold should be selling at $56,000 per ounce. Even Peter Schiff was incredulous about it (see ).

Now, thanks again to Monty Pelerin, I’ve read Vincent Bressler’s “Empire of Fraud“, saying:

The futures markets are fractional reserve systems running at very low reserve ratios, something like 45 to 100 ounces of electronic gold and silver obligations for every unencumbered ounce of physical gold or silver. The day is coming when the physical price of gold and silver disconnect from the electronic price and they can not be brought back together again except through a massive devaluation of the dollar in terms of gold and silver. On this day the future’s markets in gold and silver will be stopped. There will be secret meetings. Those holding electronic gold tickets will be paid in be paid in dollars at the price of gold before the disconnect. And then I believe that there will be an explicit devaluation of the dollar with respect to gold on the order of 20 to 40 times.

Once this happens, the dollar will be further devalued against a large number of other commodities and will probably actually collapse altogether as the world’s reserve currency.  Few believed the warnings about fraud which was going on in the real estate market and yet that bubble collapsed.  Lying, manipulation and greed is the common story in our times.  I’m preparing for this one.  I am long on Barrick ABX, New Gold NGD, Lakeshore Gold LSG, and Detour Lake Gold DGC; and I’ve now also taken a long position on Sprott Physical Gold PHY.U, which claims to keep actual physical gold in the Canadian Royal Mint.  I’ve sold puts on ABX, GG, DGC and NGD.

Here is Max Keisar interview Jim Willie in three parts:

Part One:

Part Two:

Part Three: