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As many of you know from the comments here and on
Twitter, Victor The Cleaner just completed a great new post called GLD – The Central Bank Of
The Bullion Banks. The timing was
pretty neat. Lance Lewis' GLD Puke Indicator delivered a buy signal on 5/22
and Victor and I have been emailing extensively ever since that day
discussing my view of the GLD Pukes.
During our discussion Victor conducted an analysis
of the Puke Indicator using a hypothetical trading strategy based on buying
spot gold at the puke and selling once the gold in GLD is replenished and
found that it optimized at a puke size of about .5% of the inventory. Using
250,000 ounces as the puke size, he found that the $PoG climbed four times as
much (annualized) in only one-third of the time (between puke and
replenishment) as it did during the remaining two-thirds of the time. This
was a significant finding which, at the very least, showed that the Indicator
really does work. Using Lance's 1% threshold the trading strategy was a
little less optimal, but perhaps Lance's higher threshold is more immediately
predictive of big moves like today. I don't know.
But that's some timing, huh? Vic finally got his post up late
last night and then today we have a jumbo up-move of more than 4%! At the
very least I think it demands a little bit of attention.
Costata really enjoyed Victor's post and he emailed me with a few comments
about it. I felt that Costata had maybe missed some of what I thought was an
important thrust in the post and so I tried to summarize in one short email a
few of the things that Vic and I had discussed over nine days of long emails.
Not everything we discussed made it into Victor's post. Victor is meticulous
in his exposition while I often try to cover too much ground, requiring me to
just touch on some things which, if it was Victor writing, would require a
toy model, some characters with alphabetical names, and a fancy chart or
three.
Anyway, Costata suggested that I should post my email and JR concurred, so
here you go, with minimal polish:
Costata: "It also occurred to me just now that if this analysis is
correct, it makes the possibility of a run on the unallocated accounts with
the LBMA clearing members even more remote. The "large buyer" at
the LBMA that VTC speculates about appears to be extremely disciplined - the
BIS perhaps.
Thoughts?"
Me: No, VtC divided it into two possible theories. Large buyer who knows the
bottoms in the markets is one theory, an unlikely one. The second theory he
called “speculative interpretation” is the real message.
If the BBs are redeeming GLD shares to fulfill allocation demands, that
implies that they do not have enough 400 oz. bars outside of GLD to fulfill
those demands. And that also implies that the BBs are using GLD shares as
reserves.
Obviously 400 oz. bars come and go. They come in from mines, scrap and
hapless investors and they go out to allocation demands and deliveries.
That’s the flow. So when we see a GLD puke, we infer they were
essentially out of 400 oz. bars at the time. There is no other reason for a
BB to redeem GLD shares, even if it is performing the arbitrage. GLD shares,
for all practical purposes, are as good as 400 oz. bars not in GLD from the
perspective of a BB. As shares, the BB reserves can even be lent at interest
to those who want to short GLD. In fact, the BBs could potentially have only
GLD shares as their reserves, which is why Randall Strauss called GLD a
“central coat-check room” for the BBs. The pukes suggest to me this may be the
case.
That flow from the mines to investors is the flow. Remember when
there’s not enough supply in that flow is when the stock to flow ratio explodes toward infinity. With this view, we can infer this may be what is
happening with each puke.
We can’t really look at the size of GLD and the size and frequency of
the pukes and extrapolate a timeline. If you look at Lance’s chart, the
size of GLD peaked in 2010. If we suddenly see a puke of, say, 10% of the GLD
inventory, I’d say it’s game over starting there. The largest
puke so far was about 4% over two consecutive days last August. That was about
50 tonnes when the PoG was around $1,800. That was HUGE. Almost $3B.
So when the pukes happen, that is BB heart attack time, but then the price
rises and eventually (so far) the puke gets replenished. So as the price
rises, the reserves are stretched and so is the inflow. As Victor said, the
inflow of gold from the mines is relatively constant by weight but the
outflow is normally constant in currency terms. So they raise the price until
the puke is replenished and then they stop. That’s the message in the
post.
How they raise it, which he didn’t go into, is a little more
interesting. From that LBMA survey, we can see that the LBMA had net sales in one
quarter of 7,575 tonnes of paper gold. That’s a gross increase in the
amount of paper gold in existence over only three months. 100:1 actually
seems conservative in this light. That’s most likely FOREX use of gold
as a hedge or a currency play. But even still, the BBs have to hedge their
price exposure when selling that much paper gold. Without a hedge, that would
be a 7,575 tonne naked short position for the BBs.
So that net increase in paper gold is also a net inflow of cash for the BBs,
cash which they use to hedge that net exposure. In fact, we can see from the
LBMA survey exactly how much cash it was. It was $338B. That’s over 3
months, so it’s more like $5.4B per day inflow. That’s a small
percent considering the daily turnover in paper gold used as a FOREX currency
is $240B and the daily turnover of all currencies is $4T. So in a $4T/day
FOREX market, that’s a $5.4B/day net flow from other currencies into
gold. That was $5.4B per day in Q1 2011 that needed to be hedged by the BBs.
There’s no way they hedged all of that in the “gold” market
(Comex/mining forwards/GLD). It’s simply not big enough to absorb that
rate of flow without rising a lot faster than we saw it rise. So the BBs must
be hedging this exposure the way they hedge net positions against other
currencies in the FOREX market, simply using complex formulas and derivatives
that look at correlations between different things. Correlations change
slower than raw price changes which (they think) gives them time to adjust
their hedges if the correlations start to exceed the model parameters.
Anyway, that is a plausible way they are hedging their exposure to the price
of gold without doing so in the “gold” market per se. But they
can also hedge some of that exposure in the gold market as well, by going
long gold on the Comex or some other way. So if they want the price to rise
in order to stretch the physical side and (hopefully) replenish the GLD puke,
they would simply shift some hedges from complex derivatives into Comex.
So even though they have some control over the price of gold, they are still
relying on other market players from the physical side to respond as
expected. And from the view of GLD as their reserve pool, we can see that
reserves are not only quite finite, but they also peaked almost two years ago.
A/FOA said the ECB/BIS strategy was to “expand and support” the
dollar paper gold market so the dollar would eventually “bankrupt
itself” just to keep the gold market going and stay in the game with
the euro.
FOA (08/13/01; 07:24:30MT - usagold.com msg#96)
A very large part of that war strategy, employed by the ECB/BIS, was to let
the dollar / IMF faction hang themselves by expanding and supporting the
whole arena of this dollar paper gold market [the ECB/BIS is supporting and
expanding paper gold as a strategy]. Inflating the gold market place with so
much "paper gold" that we would eventually have to bankrupt
ourselves just to keep the dollar in the war game against the Euro.
[…]
So, don't count on this destruction of our paper gold market to mark the real
value and availability of physical gold; that ratio will split somewhere down
the goldtrail. This action will scare most harden gold investors to death;
especially the ones in leveraged gold stocks and lesser white metals!
The war between gold and the dollar has been over for a while now. The
action, today, is between the dollar and the euro arena and this is what will
break the price lock on gold. Leaving gold bugs with a lot of questions that
ask why this: both systems will strive for a higher currency price for gold;
one doing it because they have to; the other doing it because they want to!
The casualty on this battlefield will be the world gold market as we know it.
A market caught between how Western perception thinks gold's price should be
"discovered" and at what price level trading in physical gold
craters the entire paper structure. A structure of American based "paper
gold".
We have been saying for some time that this will be "the" show to
watch unfold; but only if your holdings allow you to stay still in your seat
as it happens (smile).
They shifted their war on gold to become a war on the Euro,,,, only too late.
Now, knowing that the Euro is a fact, we must have a super gold price if the
dollar is to stay in the game! The question becomes one of supporting a cheap
paper price for the sole function of keeping the market and all its bullion
players alive. With the war on gold over, they need to turn their tanks
around to face the real enemy but cannot.
So it seems that as the war switched from dollar v. gold to dollar v. euro,
the euro side helped make the dollar gold market TBTF. But with a rising
physical gold price/demand, the dollar paper gold market has to keep up
because it’s TBTF now. Too many of those “gold” FDIC
stickers out there! If those stickers fail, the dollar loses. So the
“gold” market is TBTF. Remember this from FOA?
FOA (10/9/01; 10:05:48MT - usagold.com msg#117)
What doesn't seem to be obvious is the "why for" the paper market
grew so large. It grew to dominate because worldwide dollar expansion reached
its "non-hedged" peak. In other words, the dollar's timeline was
ending as its ability to produce non price inflationary economic gains came
into sight.
In order to push dollar holdings further, international players needed and
purchased "paper financial hedges" to balance their risk. Within
their total mix of derivative hedges were found "paper gold price
hedges"; modern gold derivatives. The important thing to remember is
that these positions are not and never will be used to demand physical gold.
They are held to buffer financial and currency risk associated with holding
any form of dollar based asset. To work these items don't need to really
perform "dollar price movements" in the holders favor as much as
they are present in the portfolio to act as insurance stickers.
In that truth, these paper gold positions act like FDIC insurance at our
banks. It can and will manage only a small determined portion of bank
runs,,,,, not a full scale failure of the banking system. In a real full
banking failure we would all get, perhaps, 80% of our covered $100,000 and
10% of the rest.
The same is true for these gold position's performance; real gold delivery
along with true price performance, matching real bullion trading, would be
only for the very few. For that matter, an actual functioning paper gold
marketplace would be for the very few, too! But, in the same way a bank
account owner understands the credibility of FDIC insurance when times are
good; the international dollar asset owner will not grasp that modern paper
gold hedges cannot be allowed to work until after a real serious price
inflationary run begins.
For the first time in this portion of the dollar's timeline and our
lifetimes, such an inflation is about to show its face!
So the paper gold of the bullion banks is now TBTF. Of course that
doesn’t mean it can’t fail. It either fails, or the USG
hyperinflates the dollar as prices rise. They are related,
and each will likely cause the other almost immediately, but either one could
end up being the initial cause IMO. If price inflation forces the USG to
hyperinflate then the paper gold insurance stickers will have to fail to perform.
And if these price rises in the gold market fail to manage the flow (demand)
of physical as they have so far, we’ll likely see a 10% or larger GLD
puke at some point. That would signify more than a 120 tonne allocation
demand, a system-busting size. They might think they can rocket the price at
that point and get it back, but more likely we’ll see more allocation
requests coincident with a falling (paper) "gold" price as the
longs dump their worthless “insurance” while wishing they had the
real thing.
FOA (06/12/00; 19:48:25MT - usagold.com msg#26)
Put your cards on the table!
The current paper gold world will die (burn) as its value to users erodes,
not increases!
…Again, most everyone in the Western Gold bug game is running with the
ball in the wrong direction.
…So who is in danger of being hurt as this unfolds?
That's right, the Western paper gold long! I'm not talking about just the US
market! This is about the entire world gold market as we know it today. The
real play will be for the ones that get out in front of the move by owning
physical…
It seems every Gold bug sees only half the trade and has great faith that
contract law will favor a short squeeze. Yet, none of them see where it is
the long that will be dumping and forcing the discount!
As I have said in the past, gold is so oversubscribed through the BB's paper
gold it's more of a wonder when the $PoG rises than when it falls. Perhaps
now we have a plausible explanation for why and how it has been rising over a
decade, and also how it will end.
Sincerely,
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