gold

The gold ponzi scheme II: Jim Rickards’ anecdotal evidence

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A few days ago, I suggested that paper gold was ponzi scheme.  Banks are selling unallocated gold certificates to customers on a fractional reserve basis.  This is what is called a “naked short”.  It is naked because the banks don’t have access to the assets to cover their short.   Jim Rickards reported an anecdote that would verify this very point in an interview with (hat tip Business Insider’s Gus Lubin):  The owner of a ton of physical gold, who had placed it in safe keeping at a Swiss bank, recently asked for delivery, and it took the bank a month to comply with his request, only after requests from lawyers and threats to expose the bank publicly.  The story is told at about the half way point on the MP3 that can be heard here.  The best explanation for this delay in delivering their client’s gold is that that the bank had shorted it, and it literally took them a month to buy back the ton of gold; but they were supposed to be holding it in their vault for the client.

Needless to say, I’m not investing in banks–even the “safe” Canadian banks like the Bank of Nova Scotia; my last position was closed when I bought back a put option on BNS on 21 Oct–I’ve become convinced that banks are far too complicated for a simple guy like me to own.  When they have to cover the gold and silver that they’ve shorted, it will make the sub-prime mortgage crisis seem insignificant by comparison.  Yes, they have shorted silver too.  This is the conclusion of this video (@ 26:35):

Peter Schiff is a mensch

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I enjoy the tenacity of Peter Schiff and his willingness to speak against the consensus. Schiff has been consistently critical of the debt bubble in the US and he predicted the fall of housing prices in the face of mocking and shouting down by other “experts”.  Consider this 2006 video from Fox News:

For a long time, Schiff has recommended precious metals and continues to do so despite many who say that gold is “hyper-overbought” (Dennis Gartman, September 29–when gold was trading at $1300).  Against those who think that there is a gold bubble, Eric Sprott claims, “I am pretty convinced that gold will go a lot higher because it is under-owned as only 1 per cent of people’s money is in it.”  Now, there is a new Tech Ticker debate between Peter Schiff and Gary Schilling.  If it is appropriate to call people who insist that gold is the best investment as “gold bugs”, then Gary Schilling is a “bond bug” because he is inflicted with a disease now appropriately named as “Fiat Currency Fever“, the irrational view that the US dollar is a the best and safest investment–despite the severe and secular bear market that the dollar has suffered since 1971 when it was taken off the gold standard.  At a certain point, Gary Schilling claims that the Federal Reserve doesn’t create money–a trillion dollars that banks have received from the Fed is just sitting in the banks.  But unfortunately Schilling seems to be dead wrong on this point, because the banks have been lending this money to the US government, and it has actually gone out into circulation in the form of food stamps, federal employee wages, unemployment benefits, Social Security benefits, etc.  There is some serious monetization of debt going on in America (cf. Monty Pelerin), for Bernanke is trying to re-inflate all the bubbles.

Despite being right most of the time, Peter Schiff still faces fierce opposition from critics, including economists–you know the guys with PhDs, who claim that gold is barbarous relic.  I agree with Schiff.  For I believe that only God can create something out of nothing, and when a central bank expands the volume of fiat money inflation is the inevitable result.  This is an immutable law of economics.  When hyperinflation hits in earnest, then all those who own precious metals will be very thankful that they listened to Peter Schiff.

The gold ponzi scheme

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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

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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:  gold.bullionvault.com/How/UnallocatedGold

Gold at $56,000 per ounce?

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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 http://www.schiffradio.com/pg/jsp/charts/audioMaster.jsp?dispid=301&pid=51169 ).

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: