Paper-Gold Fraud Now Out In The Open by Jeff Nielson

In Paper-Gold Fraud Now Out In The Open, Jeff Nielson makes the point, that I made in an earlier post, that the market price of gold is manipulated, offering the supply crunch of physical gold as the proof.  Here are some interesting tidbits:

The virtues of (actual) “free markets” are well-known to anyone familiar with basic market dynamics: they self-correct. If supply exceeds demand, the price falls to a sufficient level to discourage more supply and encourage more demand – until those simultaneous dynamics achieve equilibrium: supply and demand matching, with prices stable.

Conversely, where demand exceeds supply; prices must rise sufficiently so that more supply is encouraged and more demand is discouraged, until once again equilibrium is achieved. Thus a permanent supply-deficit is ipso facto proof of price-suppression.

The problem with the price-suppression of any kind of physical “good” is always the same, one inevitably runs out of inventory as the repressed supply and excessive demand caused by artificially low prices means that buyers will always outnumber sellers.

Now this should help explain why investor grade bars and coins are not available at bullion stores–the price is manipulated too low.  Buyers are readily available but sellers are scarce, and so physical metal is not available.

Disclosure:  I own Sprott Physical Gold Trust and Sprott Physical Silver Trust

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The physical gold market vs. phoney gold markets

The phoney silver and gold markets, e.g., the London and New York exchanges, trade in multiples of paper in relationship the actual available physical metal.  Today, a call to my local coin dealer shows that the market price is far too low.  The Canadian PMX expects to have one ounce physical coins including silver American Eagles, Silver Rounds, Maple Leafs, Philharmonics, and bars; and 1 oz gold Maple Leafs, bars, and Philharmonics only by the middle of January.  This means:  (1) the mints can’t keep up with the investor demand because the current market price is too low; (2) no one who actually already owns physical species of precious metals in the Toronto area are bringing their coins to Canadian PMX to redeem them at these pathetically low market prices.  Thus, those with physical metal know that they are holding value, while the current paper market in which traders pass back and forth many multiples of paper metal with little physical backing is an absolute farce.

I remember those who came from manipulated markets in the Soviet bloc countries during the cold war had severe supply demands.  I heard a testimony once that people would stand in line at markets for a long time, not even knowing what was for sale.  When you final came to the front of the line, they might be selling left shoes size ten, and you would buy them, as many as you could, because you never knew when you might have another chance to buy something.

Currently, the physical market is very tight. If buyers have a chance to put their hands on physical metal, they should.  You never know the next time you’ll have a chance.

Disclosure:  I currently have positions in Sprott Physical Gold Trust and Sprott Physical Silver Trust.

Why Warren Buffet is wrong about gold

NB: This post first appeared at Beating the Index.  To read or add to the comments and discussion of this post please go here.

Following the controversial Warren Buffett on Gold Investing article, I thought it would be interesting to read a different opinion on gold.  I asked my fellow blogger and gold investor Peter from the Righteous Investor if he would like to provide an alternative view on gold investing and he kindly accepted. Thank you Peter for providing us with the view from the other side.

Money is a commodity which serves both as an intermediate of trade and a store of wealth.  Money must have the following characteristics to function properly: limited quantity, fungible, portable, available.

An increase in the money supply without a corresponding increase in production of goods and services leads to inflation; inflation of the money supply leads to price increases in the following order:  (i) commodities; (ii) consumer prices; (iii) cost of labor.  Inflation therefore results in a de facto garnishing of wages.  Thus, if a government sells debt which its central bank then monetizes (i.e., quantitative easing), then government spending benefits recipients through doing irreparable harm to savers and wage earners.  Thus, if possible, retail investors must protect themselves from this harm.

Humankind has used gold and silver as money since the dawn of history.  History has shown that gold is too rare and valuable to function as the only money, for the gold standard has led in the past to scarcity, making money too little available to common people. I’ve seen first hand how scarcity of money has lead to serious problems in the Central African Republic, where the local currency is tied to the Euro, which benefits international commerce but doesn’t really help the people on the street to conduct their daily transactions because there are too few small bills and coins.  The gold standard can also lead to this sort of scarcity and that is why in the late 19th century, there were many advocates who wanted to monetize silver.  Nevertheless, the great advantage of precious metals over paper currency is the inability of a government or a central bank to create it at a whim, and therefore they are far less susceptible to inflation.

Warren Buffett’s advice about gold has had a profound effect on retail investors.  He advocates common shares in stocks as better than gold; ironically, one of the most famous articles on how companies do poorly during times of a high inflation was written by none other than Buffett himself ( “How inflation swindles the equity investor”).  So he knows very well that stocks provide little protection from inflation.  So what are retail investors supposed to do?  They can’t buy bonds or common stocks, and in Buffett’s opinion, they are speculating if they buy precious metals. But I ask, why should Buffett care?  Remember, he’s an insurance salesman and he is out to get your money.  He himself has greatly benefited from the bailouts and the monetization of the US Federal debt.  I don’t think he has the best interest of ordinary investors in mind.  And I am not alone in this opinion.

Why there is no gold bubble

An investor, particularly the value investor, must seek to avoid overpriced assets.  Value investors want to find undervalued, underappreciated investments.  There are some pretty strong reasons to believe that precious metals are oversold and not overbought:

  1. Not that much global wealth is invested in gold (see Eric Sprott and Andrew Morris).
  2. There are too many anti-gold bugs.  Despite the performance of gold in the last ten years, there are still many who, like Buffett, do not understand why it is attractive.  There is also an entire school of economics, the Keynesians, who consider gold a “barbaric relic”, and this school has an enormous influence on governments, universities, and the media.  Keynesians have been adamantly opposed to gold and silver money, because it prevents them from manipulating and controlling the economy through monetary policy.
  3. Gold is just keeping up with other commodities and is also tracking the increase of the Federal Reserve money base.  The real bubble is not gold but the US dollar.
  4. Unallocated gold and gold derivatives make up an enormous and extraordinary portion of the supply of gold in the market.  Certain banks have supplied unallocated gold certificates on a fractional reserve basis to their customers (see this explanation by Avery Goodman).  It is difficult to say how much paper gold there is, but GATA’s Adrian Douglas has estimated that there is a 40 (or as high as 100) to one ratio of paper to physical gold.  This is the crux of the matter.  If and when a physical gold run occurs we could see gold jump to 40x the current price in a few days.  For this reason, every prudent value investor should invest in some physical gold and avoid all paper gold derivatives like the plague.  The same is true of silver, but according to analysts such as Eric Sprott and the National Inflation Association, the paper to physical silver ratio is much higher than it is for gold.  This is an important warning:  Do not believe any author who says there is a gold bubble but doesn’t deal with the question of unallocated gold.  In the end, the collapse of the unallocated gold, which is so deceptively co-mingled into the gold market, may become the financial disaster of the century, eclipsing the sub-prime mortgage crisis in its wake.

How I make money from the sector

The gold sector is not safe because of its great volatility.  Since I took my first position in 2006, gold has traded in the range of $600-$1400 per ounce, and gold mining companies have experienced an even greater range of prices.  So it is inadvisable to put all of one’s saving into precious metals in a single day.  The volatility, on the other hand, lends itself to the possibility of a profitable trading scheme.  So my strategy consists of both a base position of shares that I am holding for the long haul, and the trade itself.

(1) Base position:  I started five years ago by establishing a position in Barrick Gold at CDN $33.50.  I’ve never sold those shares.  I have also averaged down, when possible  (e.g., with NGD), to establish my current position.  Here are my current positions that I have accumulated over the last five years, followed by the average cost price:

Barrick Gold (CDN $34.185; +48%), Detour Gold (CDN $14.25; +121%), Lake Shore Gold (CDN $3.41; +19%), and New Gold (CDN $1.94; +471%), Sprott Physical Gold Trust (US $12.24; +2.5%)and Sprott Physical Silver Trust (US $12.65; +37%).

Gold and silver coins and bullion must be stored in a safe place, so I wouldn’t own any unless I believed that the economic collapse was imminent.  Therefore, the Sprott physical gold and silver trusts are a means of having direct exposure to the physical metal without having to worry about being robbed.

(2) Trading:  (a) I used to trade gold mining stocks, especially ABX and NGD.  I would try to buy on dips and take profits as enthusiasm picked up.  (b) One year ago, I started to sell put options because it was safer than taking long positions, though it would reduce the upside potential of my positions.  I have been selling these puts (in ABX, GG, NGD and DGC) since 2010.  I do this trading on the US market whenever possible.  I was of the conviction that QE would cause the mining companies at very least to remain static in value vis-à-vis the US dollar, and indeed, only one out of the multiple positions that I’ve taken in put options has ever been assigned.  I try to sell the puts on dips and I will occasionally buy them back if they make considerable gains in a short period of time.

P. W. Dunn holds a PhD in theology, has taught biblical studies at the undergraduate and master’s level in Africa and Canada, and now is a DIY investor who publishes his ideas about investing and how it relates to Christianity at theRighteous Investor.  His other posts on gold can be read here.

To read the comments and discussion of this post please go here.

Is it time to buy US? II: February deficit $223 billion

I lamented in May 2010 that the US federal budget deficit was $83 billion, or about $8.90 per person per day.  Now the Washington Times (hat tip: the American Thinker) reports that the US government has posted its largest monthly deficit in history, $223 billion in February.  Now that means that the US government borrowed nearly $26 per person per day.  Clearly, the fundamentals that have caused the US dollar to depreciate against commodities is getting much worse not better:  the US government is borrowing three times as much money as what it was only 10 months ago.  This is proof that the debt death spiral is a reality in our times.

Now here is what has been happening:  (1) the US government borrows money but doesn’t find sufficient lenders whether domestic or foreign, so the Federal Reserve bank lends to them the remaining shortfall.  This is called quantitative easing because the money is created out of nothing.  But that is not the end of QE: for Bernanke is also buying old debt as it turns over and finds no new borrowers (see “Hyperinflation when?“).  QE greatly increases the amount of greenbacks that are in the money base:  view (chart below) and be afraid and weep.  (2) Next, commodities go up in price because too many dollars are chasing too few goods–food riots start happening in poorer countries.  (3) Then, consumer prices go up.  (4) Lastly, workers will get cost of living adjustments if indeed their employer can pay them at all.  In any case, the last thing to adjust to this whole mess is people’s take home pay.  But unfortunately, the adjustments will be too little too late because the next round of QE has already taken place and the spiral of hyperinflation has reached the next stage even before they receive their next pay cheque.

The newly elected Republican Congress?  They swept into power with Tea Party momentum.  But they can’t or rather they won’t fix anything.  Their puny little efforts to reduce the deficit are a joke.

My investment approach remains steady (current portfolio is up 88% above book) :

Short:  US dollar

Long:  Canadian oil & gas; Canadian gold mining; physical gold and silver (via Sprott Physical Gold Trust, Sprott Physical Silver Trust)

Finally, in my opinion, those who are telling people it is a great time to exchange your loonies for greenbacks and to go long on US stocks are really not doing their readers a favor; they seem ignorant of the fundamentals.  Yet even Warren Buffet’s famous and flippant advice about gold is little better.  What, pray-tell, Mr. Buffet, do you suggest to the American people regarding how they might protect themselves from this robbery?  Remember these words of Alan Greenspan (hat tip: Monty Pelerin):

The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. Deficit spending is simply a scheme for the confiscation of wealth.

… the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold.

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:  gold.bullionvault.com/How/UnallocatedGold