Founder, The Implode-o-Meter
There’s been plenty of press about the gold (and silver) “crash” of April 12 and 15th, most of it yielding a not-so-subtle schadenfreude stench. This is not so surprising, as anyone who has been openly positive about the precious metals’ prospects given today’s “new normal” of unprecedented “high-powered” money-printing is well-acclimated to being derided as a “gold bug” by a press which is institutionally hostile to the notion of resurgent gold, and in all likelihood, full of writers who fancy themselves financial mavens yet who are smarting for having “missed the boat” on gold themselves.
One of the key arguments of this press coverage as it seeks to provide a “compliant” explanation for the recent gold slam is that the “announced” sale of gold by ailing Cyprus was the trigger that caused the market to take its epic tumble. This article is typical.
Nevermind that the “announcement” turned out to be at best a leak, and quite probably, no more than a dubious rumor, as the Cypriot central banking officials quickly (and angrily) went public denying such a sale had even been discussed.
Whether or not this news is “legit”, there’s the tiny little issue of whether it is, in fact, even bearish for gold. After all, if it’s not, then it neither explains, nor justifies the gold price slide (implying that perhaps all of those investors and consumers scrambling to buy up every physical ounce of precious metals right now might be onto something), and virtually all of the financial press is either complicit in a manipulation, or has gotten the story so wrong it’s got some very rotten egg on its face.
First of all, the amount of gold would be tiny, which is not surprising, as Cyprus itself is rather smallish. The sort of proceeds expected, about $525 million, correspond to only about 11 tonnes of gold. That might sound like a lot, but as Eric Sprott has pointed out, global central banks (driven mostly by Asian and developing world countries) are actually buying net 500 tonnes of gold a year. That makes 10 or 11 tonnes look pretty piddling by comparison. And indeed, it’s ludicrous to suggest that a one-year decline of this buying from 500 tonnes to 490 tonnes would explain the recent dramatic market move.
The argument is further shown to be inane when you note, as Sprott did, that this net 500-tonne buying trend is only a recent reversal from an approximately 400-tonne a year central bank selling trend (mostly by the strapped-out G8 countries), under the Washington agreement.
If one dwells for too long on these figures, one might legitimately ask whether this dramatic swing (-400 tonnes a year of demand to +500 tonnes) has even been fully priced into the gold market!
But I digress.
Let’s assume for argument’s sake that the Cyprus “gold sale” was to be a large one. You still have a major problem for the bearish interpretation of the sale, because this gold wouldn’t be sold in the sense of simply being “dumped” on the open market, but rather, it would be snapped up by counter-parties/creditors of Cyprus who want something concrete (or, viewed another way, some “insurance”) for all their loans to the island.
But, this would perhaps not be so obvious to anyone who was not following recent years’ news about the “re-monetization” of “high-powered” gold (far be it from mainstream financial journalists to keep tabs on such “barbaric” topics. Still, I think it is not too much to impose a “should have known” standard on the financial media for such an important subject…)
What do I mean? Here’s just a small sampling:
- 2010-12-26: World Bank Boss Urges Gold as Formal Monetary “Reference Point”
- 2011-02-07: JP Morgan Accepts Gold Bullion as Collateral
- 2011-05-25: The Economic and Monetary Affairs Committee of the European Parliament has approved gold to be used as collateral confirming its status as a high-quality liquid asset
- 2011-08-23: German Minister Demands Gold Collateral for Future Bailouts
- 2011-09-21: LBMA campaigns for gold to be Tier 1 asset for banks under Basel III
- 2011-10-07: LCH.Clearnet to Accept Gold As Collateral
- 2012-01-09: Netherlands Urged to Repatriate Gold Reserves
- 2012-06-18: US Financial Authorities Assent to Gold As “Zero-Percent Risk-Weighted” Asset per Basel III
- 2013-01-15: German Bundesbank To Repatriate Gold From New York Fed
- 2013-12-13: EU Regulators To Delay Basel III Implementation Till 2014
In truth, what is going on here is that gold is being “re-monetized,” writ large. This is because we are irreversibly past a point where, financially, a “great moderation” is over, and we are in an “age of turmoil”. In such an age, when financial trust and reliability breaks down, gold shines. That’s because it’s serving its historical and best intrinsic function: as a money of last resort (of course, even in good times, it should still be held as “insurance,” otherwise one is likely to have none of it when the time comes when it is needed more “actively”!)
Global central bankers have acknowledged that we have experienced “some” turmoil, but they are still in denial (or at least, want you to believe) that it is all just a “speedbump”; that they’ve “got everything under control,” and we’re not in some extended “age” of turmoil — which they have no control over, and for which the only way out is to rebuild the economy (organically, from the ground-up — and that means most of the entrenched money and power must lose its position). Virtually all mainstream media coverage reflects this unified “just a speedbump” storyline. But, as the above reports abundantly make clear, the trend is in place, and the information is out there revealing that gold is unstoppably cycling back into its “foreground” role.
So what does this have to do with Cyprus? Well, characteristic of when gold is re-asserting its monetary role, it is because some of the largest economic entities in the world no longer trust each other, and want something more “concrete” in their dealings. Rather than discarding gold like refuse as the “sale” rhetoric might imply, it would only be “sold” because some other major entity really wants it (as is illustrated amply by the above news items). This means that the “supply” is never “hitting the market,” so it cannot depress price, and further, it means that there is more demand present than there was in the prior “great moderation”, where gold was simply being “dumped” (the biggest pool of sellers has become the biggest pool of buyers, with no one taking their former place).
This dynamic is corroborated by the switch from 400 tonnes of annual sales to 500 tonnes of annual buying, by central banks alone (per Sprott, above). This further illustrates that we have crossed a Rubicon, where now “down” (gold sales) really does mean “up” (large-scale demand for gold outstripping whatever minor sales remain).
Importantly, there is precedent for this in the early 1970s era where the previous global monetary regime of “Bretton Woods” was breaking down, triggered by the US’s 1971 default on its international gold obligations. A quick review: from the end of WWII until 1971, the US dollar, backed by gold at a fixed exchange rate, was in turn the basis for all global foreign exchange, with all other developed world currencies secondarily pegged to the dollar. As part of this system, countries could “cash out” their surplus dollars in the form of gold, and many did, as trade imbalances increased into the end of the 1960s — until Nixon “unilaterally withdrew” from the system in 1971.
In the tumultous few years that followed, the global financial authorities attempted to maintain the peg to gold at artificially low rates (implying a much more “valuable” dollar and paper money system), ultimately without success. By the mid-1970s, the gold-dollar peg was abandoned, initiating a free market in gold that culminated at nearly $800/oz in 1980.
But key for our discussion is that even before gold the gold peg was finally abandoned, central bankers really knew that gold needed to be, and was being “re-monetized” (at something closer to its true market value), and their machinations revealed this. Case in point was the bail-out of Italy by Germany in 1974:
… in 1974 the official rate of gold was at $42.22 an ounce. However, the free market price of gold reached $180 an ounce. The free market price of gold increased the borrowing power of bankrupt Italy, which had 2,500 tonnes of gold, from $3.7 billion to $15.8 billion. On September 1, 1974, West Germany lent Italy enough money to stave off complete collapse using the free market price of Italy’s gold holdings as collateral.
The most interesting part in this deal was that West Germany never collected on the gold. It was accepted on faith that if the loan could not be repaid then the gold would be shipped to West Germany. Almost overnight, the gold in Italy suddenly became someone else’s liability. However, as long as Italy was able to make their payments on the bailout then there would be no question of whether or not they would ship the gold in the event of default.
Thus, it is easy for these machinations to take place “behind the scenes” and seem to amount to nothing. And here is the real kicker:
This [arrangement] gave every incentive for both West Germany and Italy to hope for the rise in the price of gold.
(Many more enlightening details of this era of history can be found in Antony Sutton’s “The War On Gold”, if you can find a copy.)
In other words, once gold starts being used as high-powered collateral, the “incentive structure” totally shifts, and governments and other major financial entities should actually want the price to rise. It is only really a problem for parties (i.e. countries such as the US) prior to the point-of-no-return of re-monetization, who don’t have nearly enough gold to collateralize their liabilities (they are thus facing an overt default).
Viewed through this lens, the tentative Cyprus gold transaction is quite interesting: you have a proposed “sale” of gold to raise EUR 400 million, in order to secure EUR 10 BILLION of bailouts. For those keeping score at home, that means the gold collateral would be supporting as much as TWENTY-FIVE TIMES its current “paper money” valuation (depending on the concrete value of whatever other items of collateral Cyprus puts up)!!
And here’s the ultimate upshot: such a transaction would be implicitly acknowledging as much as a $35,000/oz valuation of gold (coincidentally, reminiscent of the zaaaany, “gold-buggy” predictions of the likes of James Turk and Jim Sinclair). Obviously, if the actual math of the collateral works out to even just a tenth of that, it would still represent more than a doubling of the current gold “price.” In the 1974 Italy case, it was a 4.2x “revaluation”; so it wouldn’t be surprising if the real conversion rate worked out to something comfortably in the middle of 2 and 25 times (but it would probably be towards the higher end, since governments and banks are so much more indebted now than they were in the Bretton Woods-breakdown era).
Whatever the precise numbers way, selling gold is not what any sane person wants to be doing right now. But you won’t hear that from your friendly neighborhood mainstream financial media.
The above hasn’t even touched on the other aspect of the Cyprus debacle: the imposition of a “bail-in” regime where bank depositors can actually lose money. This is another “Rubicon” crossed — that deposits are no longer sacrosanct, and it’s not just Cyprus: it has been revealed that both Canada and the EU (and even the Swiss!) have “suddenly” written such “bail-ins” into their ongoing plans. Obviously, somewhere, at a very high level, it has been acknowledged that there simply isn’t enough money for “bail outs”, and outright printing of the money is “too obvious” (after gold’s rally to $1900/oz in 2012), so it has been determined that “bail-ins” must be on the table. This is a huge deflationary change (meaning money is at risk, i.e. financial panic), which is far more gold positive than run-of-the-mill inflationary expectations.
(For further discussion of this deflationary dynamic specifically as it pertains to gold, see Professor Fekete’s latest excellent article.)
So perhaps the thesis above, that gold is moving rapidly towards “re-monetization” (informal if not formal), actually best explains the recent price turmoil — but not with Cypress as the trigger; instead, with the default of Dutch bank ABN Amro on its physical gold obligations, and soon thereafter, the shutdown of the LBMA physical gold platform (the premier large-scale buying venue) on April 12th, simultaneous with the anomalous, un-economical dumping of 400 tonnes worth of paper gold contracts on the US COMEX futures market. In other words, the key large-scale physical buying platform was shut down, leaving an abundance of major physical holders/buyers with little option besides selling or hedging on the futures exchange (see here, here, and here, for details.)
It seems to us that the scramble for physical gold, in acknowledgement of its true value (at much higher fiat money prices than the paper markets reveal today), is unabated by the prior few weeks events, and in all likelihood, has been dramatically accelerated by them… “paper” price notwithstanding.