Let Australians Save in Gold Instead of Debt

A hundred years ago, in 1913, the first Australian currency note (10 Shillings) was issued (as a blue banknote). Payable in Gold, the note was equal to a half sovereign gold coin (3.99g of 22k Gold, roughly A$165 spot value today). Australia formally departed from the Gold standard during the great depression in the early 1930s when the Commonwealth Bank Act of 1932 made Australian currency notes no longer convertible into Gold. In 1931 the Australian currency was pegged to the British Pound, in the 1970s it was pegged to the US Dollar, followed by a basket of trade weighted currencies before being floated in 1983.

Today the Australian dollar is not redeemable for Gold, it is not pegged at a fixed exchange rate against other currencies and the number created doesn't have a fixed limit (a la Bitcoin), today most Australian dollars are borrowed into existence.

I have seen it suggested that a bank must receive a deposit from which it can then lend a majority portion. In fact when someone borrows money from a bank, the bank can create new money (or credit) out of thin air. It will credit the borrower with a deposit (which might be paid in form of a cheque or deposit into the borrowers account) and will also create a loan account for which the bank charges interest on the created money (this is an asset for the bank, earning it income). 

When a bank lends money, the deposit ends up in the hands of the borrower without anybody else having less, hence we have just seen an increase in the total money available. In today's monetary system 'money is debt', it is backed by the ability of borrowers to repay their loans, that is something that should strike fear into the hearts of savers given the reckless abandon with which banks lend today.

Australian dollars can be borrowed into existence by the government running a deficit (borrowing to spend more than it receives in revenue) or via the private sector. Government debt today is relatively low, but has been on the rise since the GFC:

Increases in the government debt to GDP ratio are typically due to two occurrences: world wars (1914 to 1918 and 1939 to 1945) and responses to economic downturns caused by private debt-financed speculation: the 1890s, 1930s, mid-1970s, early 1980s, early 1990s and the GFC in 2008. The rise in the ratio before the 1890s was due to colonial government mass construction of public infrastructure. Philip Soos, Prosper

As can be seen in the above chart, private debt has been a much larger contributor to money growth over the last 40 years. Private sector debt includes household borrowing (primarily for mortgages), investment & business loans amongst other sources.

With private debt having increased at an alarming rate over the last two decades to levels not yet seen in Australia's history (relative to GDP) it should be no surprise that the government and banks are making preparations to socialise the losses across all bank depositors, should the need ever arise.
 

It's not hard to work out where most of the money created by the private sector has flowed...

By any measure Australian land valuations are at nose bleed levels relative to historical norms using several measures, with The Economist indicating our house prices are overvalued 46% relative to rents and 24% relative to incomes:

So where does this massive push of money (debt) into land values leave savers?

Many savers probably point to an increasing bank balance every year and think that their savings are growing, but if we look at real returns after inflation and tax, even the official story shows they are lucky to be breaking even:

That wouldn't be so bad (breaking even, maintaining purchasing power with the money they put aside for spending later), that is if CPI was an accurate measure of the rate at which their purchasing power was declining. For those intending to save money and purchase property in the future, their purchasing power has been eroded more significantly. The removal of land costs for owner-occupiers from the CPI in 1998 assists with hiding the loss of purchasing power in the above chart:

The resulting MacroStats cost-of-living index is plotted below against the headline CPI... We can again see how this measure tracks the official CPI very closely until 1998. Since 1998 it is 0.73 percentage points higher on average (or 3.8%), and in the period 2001-2008, it averaged 1.3 percentage points higher (or 4.4%pa). That gives you some idea of how significant the 1998 methodological shift in the CPI was in disguising housing inflation and creating a feedback loop with lower monetary policy. Rumplestatskin, MacroBusiness

To measure loss of purchasing power you really need to have a look at how the value of your savings has performed relative to what you intended to purchase with those savings. Those saving in Australian dollars over the last 15 years, with the intention to purchase property, have been severely disadvantaged by the drop in their purchasing power.

Money is primarily understood as a unit of account, a store of value and a medium of exchange, but there doesn't necessarily need to be one monetary asset to perform all these roles. The below is an extract from a Freegold blog called 'Flow of Value':

Which tool is best for which job is a subjective decision, best left to the sovereign entity (whether individual or state) evaluating their own money. The criteria used in making this subjective assessment may be infinite, but the most important of these is time: how long does one anticipate holding this money? If the answer is short term (ie. "spending money", used for current expenses), then the best form to hold it in is a fiat currency. If the answer is longer term (ie. "savings", a surplus over and above what is required as shorter term "spending money"), then the best form is gold, to protect ones buying power.

In my opinion individuals should have a choice in what money/currency they choose to save in (and/or transact with).

In the United States some libertarians have proposed to allow Gold & Silver to act as a 'competing currency' to fiat, as explained in this bill (H.R. 4248 (111th): Free Competition in Currency Act of 2009):

Free Competition in Currency Act of 2009 - Repeals the federal law establishing U.S. coins, currency, and reserve notes as legal tender for all debts, public charges, taxes, and dues. Prohibits any tax on any coin, medal, token, or gold, silver, platinum, palladium, or rhodium bullion issued by a state, the United States, a foreign government, or any other person. Prohibits states from assessing any tax or fee on any currency or other monetary instrument that is used in interstate or foreign commerce and that has legal tender status under the Constitution. Repeals provisions of the federal criminal code relating to uttering coins of gold, silver, or other metal for use as current money and making or possessing likenesses of such coins. Abates any current prosecution under such provisions and nullifies any previous convictions.

Many Gold bugs make the argument for a return to a Gold standard, however one has to question the need for this if individuals are able to maintain their own personal Gold reserves to protect their purchasing power. The need for fiat currency to be backed by Gold becomes irrelevant if anyone can save or exchange Gold freely with no red tape and taxes.

What attributes make Gold the best monetary asset to free up for individuals use to protect purchasing power? Jordan Eliseo touches on one of the most important in a recent market update:

Apart from the critique about its lack of yield, the second most commonly heard objection to investing in gold, or valuing gold at all, is that it has ‘no use’.

But what does this criticism really mean? Certainly it is accurate that gold has no (or at least minimal) industrial use. But it is an incomplete observation, for whilst gold ‘lacks use’ from the standpoint of a traditional commodity, this ‘drawback’ is of course precisely gold’s virtue.

Any commodity that did have an industrial use (and was the refore consumable), would by nature suffer from an uncertain overall supply, making it unfit as a monetary asset as unarguably the most important pre-condition for good money is stability. 

The short term price of Gold is dictated on an exchange where paper based contracts trade in place of physical metal, so price stability is not something afforded to Gold in the present climate. However, Gold does offer long term stability in price as shown by consistently returning to similar valuations relative to goods and other asset classes (including, but not limited to house prices, oil & stocks).
 
Another way Gold offers stability is in it's new supply, in fact the low increase in overall supply each year has resulted in a remarkably stable amount of Gold per capita over the last century (as previously covered on the blog):
 

1900: 1.65 billion people / 1.54 billion ounces = 0.935 oz Gold per capita
2010: 6.97 billion people / 5.46 billion ounces = 0.783 oz Gold per capita

One of the main barriers holding back people from having the freedom to use Gold as money today (either as a store of value, medium of exchange or both) is the crippling paperwork and gains/losses that would arise in the current environment, Keith Weiner expanded on this in a recent article (US centric, but same principal applies in Australia):

The capital gains tax renders it inconvenient to use gold and silver as currency.

We should repeal the capital gains tax on gold and silver. If the paper dollar serves our modern economy better than gold then people will continue to choose it. Most economists, notably Nobel Prize winner Paul Krugman, are opposed to any form of gold standard. They think that a purely paper money is good for us, and that gold won’t work. However even without coercive laws, people choose cars over horses and mobile phones over telegraphs. There is no need to force people to do what’s good for them.

So most economists have it backwards. It is the fiat dollar that does not suit a modern free market economy. People will migrate toward gold and silver when we remove the artificial barriers. This experiment will solve the mystery, and liberate people to hold and spend their money as they choose.

Capital gains tax (and in some cases GST) would make it near impossible for Australians to use Gold (and/or other precious metals) as a competing currency. Purpose should play a part in whether an asset is taxed. Consider the following scenarios...

First scenario: A family buys a $300k property in Suburb A, prices rise to $400k and they want to move to Suburb B which is also $400k and risen by the same amount. Should they have to pay tax on the $100k profit (when they sell the first house to buy the next) even though they are not better as a result (and in fact will be worse off only due to moving suburbs)?

Second scenario: A business man intends on buying an $800 laptop from overseas. While saving to purchase the laptop the Australian dollar plunges in value and as a result he is able to purchase the laptop for $80 less, should he have to pay tax on this material gain? What about if the Australian dollar had strengthened and he had to pay $80 more, should he be able to claim that as a capital loss or tax deduction?

Third scenario: A family is saving for a home in Australian dollars from 1998 to 2013, their purchasing power in order to buy a home has been decimated due to prices rising well above the level of official inflation and the after tax return on their savings. Once they have purchased the home should they be able to claim the purchasing power they've lost as a deduction/capital loss?

Fourth scenario: A family is saving in Gold (with intent to purchase a home) from 2005 to 2013 and as a result of doing so their purchasing power has increased due to a strong gain in Gold relative to house prices. Should they have to pay tax on the gain when they sell their Gold to buy the house?

Hopefully you can see the point I am trying to make. Tax isn't always appropriate, especially in a situation where people are using Gold (or another currency for that matter) as a medium of exchange or savings vehicle.

Give Australians a choice, let us save in Gold instead of debt.

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At the start of the year I posed a suggestion to the Liberal Democratic Party (forum link, requires registration to view) that they consider a precious metals policy to attract a group of voters who are disenchanted with Australia's political landscape and have a mostly libertarian philosophy. The suggestion was initially met with positive feedback:

"The LDP is always interested in attracting new members / voters to its platform, so any policy idea that achieves that aim and accords with our principles would be welcome.

I'll need to educate myself on the subject before I can add to your discussion, but your thread is definitely not pointless and I hope we can develop a meaningful policy that meets the aims stated in your original post."

However, after spending several hours collaborating with the Australian precious metals community, writing a policy and then clearing up some finer points with questions posed on the LDP forum I was provided the following disappointing response (from another senior member of the site/party):

"What you are arguing is a variation of a return to a gold standard.  There are plenty in the party who agree with that, and also advocate an end to fiat currency.

We have discussed whether we should do anything about it in policy terms. The conclusion is that there are no votes to be won and the major parties would not pinch the policy, so it's not really worth the trouble.

The only way I can see it gaining acceptance is if you made it very easy to understand and implement. Consider also how our members would explain it to their friends."

So the above post aimed to bring some focus to to the reasons it might be a good idea to allow Gold to act as a competing currency to the Australian dollar.

The core policies I would like to see a political party adopt in order to enable the above (and to tidy up some other precious metals related inconsistencies):

1. Repatriate Australia's Gold Reserves (99.9% are held overseas at the Bank of England).

Australia's Gold is stored with the Bank of England (as previously discussed on this blog). With only 1 tonne (of 80) on loan there seems little point leaving the Gold on foreign soil. Bringing it back to Australia would also act as a deterrent to the Reserve Bank of Australia (RBA) selling our Gold, a move which would not surprise given light of recent comments from the RBA's Assistant Governor, Guy Debelle: “If you think about the intrinsic value of gold, there’s not a lot. Gold often has a high price because people believe that other people believe that it’s worth a lot. When you describe other markets like that, the word ‘bubble’ gets thrown about.”

2. Increase the scope of the definitions "precious metal" & "investment grade bullion" (for taxation purposes) to include all four precious metals in the ISO 4217 currency code standard.

There are four precious metals with a currency code; Gold (XAU), Silver (XAG), Platinum (XPT) & Palladium (XPD). The first three are specifically defined for taxation purposes in Australia as "investment grade bullion" (providing they meet required finesse). Palladium is not listed, however wording in Australian tax law leaves the potential for Palladium to be included: "Any other substance (in an investment form) specified in the regulations of a particular fineness specified in the regulations." This change would specifically add Palladium to the definition of "investment grade bullion" for taxation purposes (aligning it with the other three precious metals) for uniformity.

3. Increase the scope of the definitions "precious metal" & "investment grade bullion" for taxation purposes to include coins containing Gold, Silver, Platinum or Palladium (any finesse) which are now or once were legal tender of Australia or any other nation and which trade as a function of the spot price.

Precious metals are often traded in widely recognised investment forms which don't meet the strict scope defined by the Australian Taxation Office. Investment grade bullion below 99% for Platinum, 99.5% for Gold and 99.9% for Silver is subject to Goods and Services Tax (GST). This means dealers are required to charge GST on coins which many hold for investment purposes, but aren't exempt from GST, for example American Gold Eagles (91.6% Gold), Gold Sovereigns (91.6% Gold) and Round Australian 1966 50 Cent Pieces (80% Silver). Such legal tender coins which trade as a function of spot price (consistently trade at spot + x% premium) would be made exempt from GST.

4. Repeal Part IV (currently suspended) of the BANKING ACT 1959 which allows for the confiscation of Gold from Australian citizens by requiring them to return personal Gold Holdings to the Reserve Bank of Australia at a price set by the Reserve Bank.

While this section in the Banking Act 1959 has been suspended since 1976, there are provisions in Part IV to confiscate Gold from Australian citizens (as described in detail here by Bron Suchecki). Even though suspended, repealing this part of the Banking Act would be a show of good will that the government has no intention of confiscating the Gold of Australian citizens in the future.

5. Introduce an exemption for Capital Gains Tax on "precious metal" & "investment grade bullion" and securities fully backed by investment grade bullion.

Where an individual is using Gold (or any other investment grade bullion) as a savings vehicle or medium of exchange, no capital gains tax would be applicable.

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BB.

 

What's next for Adelaide property prices?

Long term readers of the blog would be aware that my opinion of Australian property is that it represents poor value at today's prices (relative to historical norms measured against rent and incomes). My medium term expectations for property led to the sale of my (Adelaide) home in early 2010. The property was purchased with intent to live in it for a few years and then later develop it, but wanting a change of scenery my wife and I were presented with the choice to move and then rent it out (hold for investment / future development) or sell it, we chose the latter and have since rented for the past 3.5 years (with lease recently negotiated through mid 2014). We have no regrets.
 

Adelaide house prices have been falling since a few months after we sold and are still tracking below their 2010 peak while rental price increases have been minimal. While renting is suitable and preferable in my situation, I would never discourage others who want the stability of ownership and are prepared to treat housing as a consumable (rather than an investment) from buying. If you have a healthy deposit (preferably one that will help you avoid LMI), fixed interest rate (or able to service higher interest rates), protect yourself (income protection, cash buffer, etc) and expect to stay in the property you purchase for the long term (until mortgage paid off), then it shouldn't matter what prices do (rise, fall or stagnate).

Some people are happy to pay a premium for the stability and enjoyment they get from home ownership, perhaps down the track when starting a family my priorities will change and I will make the same decision. For now I will continue renting, it is far cheaper than the interest repayments would be for a mortgage if buying the equivalent, it provides more flexibility and there is a good chance that my housing requirements will change at some point in the next few years (so it's pointless buying now if I will only be looking to upgrade in a few years).

From an investment point of view I think 'buy and hold' property will continue to be a poor investment choice for a majority over the medium term (3-5 years). Of course there will always be cities, suburbs or even specific deals which can buck the trend as the exception and exceptional people who can turn a dollar in the property market no matter what the 'median' is doing. It may not be beneficial for long term investors to sell (given high transaction costs for property), but any investors looking to buy in today's market would do well to ensure they understand the risks that Australia's property market faces as we unwind from the resources boom. It is highly unlikely that the next 15 years will replicate the property price growth we have seen over the last 15.

Last year on the blog I covered the conditions and my expectations for the Melbourne and Perth property markets. 

Melbourne has surprised me having bounced strongly from the mid 2012 lows, still around 4% below the peak, but 8% higher than the lows (as measured by RP Data's daily price index). Many of the data points (high stock on market, poor yields, low number of transfers) that led to my expectation of a further decline in Melbourne prices remain in place. It's my expectation that the Melbourne price rally is a dead cat bounce driven by falling interest rates and that lower prices will be seen in the future (lower nominal prices than the mid 2012 "bottom"). I still think there is a chance of a 30-40% decline in prices in real terms, perhaps it plays out over a long time frame than I expected or perhaps I will be wrong. One thing is for sure, Melbourne property represents very poor value for money if purchasing for yield, but markets can remain irrational for long periods of time, especially when tax laws are favourable for those speculating on higher prices.

Perth has followed my expected trajectory with prices growing strongly (to the surprise of some). Flat prices for 6 years, rents growing strongly, healthy employment statistics and with the added support of falling interest rates resulted in a large push higher for prices over the last 12 months. While I think prices in Perth could continue rising into the end of the year and maybe even into next year, the strong fundamentals are already starting to wane with unemployment rising, rental prices stalling and increasing vacancy rates. The end of the mining capex boom could have implications for Perth property prices, as I wrote in the comments under last years article, "I think there is good potential for prices short term, but with the eventual commodity bust I think we will see prices in Perth reverse again, perhaps even to lower levels than today (e.g. could grow by 15% over 2 years and then fall by 20% following)." In other words I expected strong growth, but think there is a risk this growth reverses as Perth fundamentals turn south with the end of the resources boom.

So that brings me to the question in the title, what do I expect to see from Adelaide prices over the short to medium term?

Here is a quick overview of some data points that may have an effect on the Adelaide housing market...

Stock on market (SQM Research) is still at elevated levels reminiscent of during the GFC, they have remained elevated for the past 3 years, during which time we've seen prices decline. Although the last few months show a reduction in the stock on market, we have seen similar seasonal declines in the middle months of 2011 & 2012 (who wants to venture out to open homes during our cold winters!), which makes me think we could see similar this year with a rise in stock seeming likely into October/November.

Vacancy rates (SQM Research), although not as high as the worst of the GFC, are also elevated around the same levels we've seen over the last 3 years as prices declined:

Yields for Adelaide property remains low (sourced from Residex) with houses at 4.69% (below national average) and 5.19% for units (same as national average). Even with mortgage interest rates coming down these yields don't do much to wet the appetite given the risk of further price falls. Asking rents haven't increased in Adelaide over the last 12 months according to APM's June rental report.

While other states experienced a noticeable pickup in the population growth rate (MacroBusiness) into the end of 2012, Adelaide was the exception, even showing signs of rolling over to the downside (statistics for first half of this year are due late September):

South Australian unemployment (via Mark the Graph) is on the rise with an unusually large spike in the last months data, this may prove to be an anomaly, but the trend from early 2012 is still ugly:

Only Tasmania has a higher unemployment rate than South Australia now:

And with job vacancies back to levels not seen in a decade, it doesn't look like this unemployment rate is about to get better anytime soon (MacroBusiness):

With poor unemployment figures it's not surprising to see that retail appears to be doing poorly in and around Adelaide with the latest report from Herron Todd White discussing Rundle Mall (CBD) vacancies:

"There are still concerns in the Mall with several large tenancies still remaining vacant."

Further on the CBD:

"Few sales have been recorded this year, however we expect yields at best should remain stable given that rents have softened. Capital values within the CBD overall may therefore have weakened during the first half of 2013. It remains to be seen whether once the redevelopment works are completed in 2014 if there will be stronger overall retail activity in the Mall Precinct."

Glenelg (Adelaide's popular beach side suburb) not doing much better:

"While vacancy rates are still low in this precinct they are ever present and increasing with few new leasing’s evident this year. This is far cry from a decade ago where there was virtually full occupancy along Jetty Road."

King William Road and the Parade (located inner suburbs) sound similar:

"Similarly, King William Road is experiencing some weakness in new leasing activity although part of this is due to some speculative developments and part due to the general weakening of retail conditions. The Parade at Norwood retail sector is generally remaining quite strong although there are some signs of weakening conditions and some vacancies."

The report finishes on this sour note:

"The overall outlook for retail is for subdued activity with the possibility of increasing vacancies and softer rentals for many centres. The trading conditions for tenants are heavily dependent on the economy which is showing further signs of deterioration."

Other commercial real estate is also showing weakness with the office vacancy rate having risen from 9.5% to 12.1% over the last 6 months in Adelaide (Property Council of Australia), not really surprising given the rising level of unemployment:

The residential construction sector is also looking unhealthy with dwelling completions having trended lower the past couple of years (MacroBusiness):

And approvals off the lows, but still very subdued (3-month moving average via MacroBusiness):

First Home Buyer finance commitments have ticked up toward the middle of this year (but remain subdued relative to levels seen in the past):

Dwelling approvals and first home buyer commitments have likely seen their small increase in numbers due to the states Housing Construction Grant (which has now been extended through to the end of this year):

CASH payments of $8500 for people building homes will be extended until the end of the year to stimulate the construction industry.

Premier Jay Weatherill will commit $38.7 million in the State Budget to retain the Housing Construction Grant.

It was first announced last October and was due to expire on June 30. Mr Weatherill said offering the grant for longer would help remove barriers to home ownership and stimulate the construction sector.

More than 1100 people have received the grant in the seven months since it was introduced. Adelaide Now

If the Housing Construction Grant (ending December 2013) and First Home Owners Grant for established homes (ending mid 2014) wind up as scheduled, then we could see downward pressure on Adelaide house prices as a result of this stimulus removal.

Weakness in the South Australian economy has not gone unnoticed with a recent article in the AFR highlighting a report from the SA Centre for Economic Studies:

The Economic Briefing Report found real state final demand decreased by 2.6 per cent from the previous year, which was the largest annual SFD fall in the period covered by the modern National Accounts data.

Centre for Economic Studies executive director Michael O’Neil said this “sustained decline” indicated the state was in recession…

The state has come under enormous financial pressure over the last year with the government forced to grapple a bulging public sector wage bill, revenue writedowns and the loss of BHP’s $25 billion Olympic Dam expansion project.

Confidence is also low in the state’s manufacturing sector with the future of car maker Holden’s Elizabeth factory in doubt.

Like most of the country, Adelaide house prices have seen a significant rise over the last couple of decades resulting in prices which are out of reach for many, the following from Bob Beaumont (of Adelaide based Beaumont Tiles):

Australian house prices have increased 150 per cent in a decade, while incomes have grown by just under 60 per cent. In 2013 in Adelaide, the median house price is now more than six times the median income.

Since its inception in 1973, the South Australian Land Commission has watched land prices rise from $15,000 per block (in current dollars) to $160,000 per block. By comparison, the cost of building a 135sq m house increased from $97,000 in current dollars to just $102,000 over the same period. The Australian

However, Adelaide's house price index as measured by the ABS shows a sideways to lower market over the last 3.5 years and in my opinion the poor economic fundamentals for the state as outlined above point to further price weakness ahead:

Both Sydney and Perth have experienced 5-6 year sideways markets (as discussed in my article on Perth) at different times within the last decade and that is the sort of scenario I could see playing out in Adelaide, that would mean little to no price growth over the next 2-3 years.

Adelaide has a history of moderate price changes when compared with the likes of Perth or Melbourne and I think the future will be no different. I don't expect a massive bust in Adelaide real estate, but I think that prices are likely to continue tracking sideways or lower for some years to come, meaning that those saving for a deposit should feel comfortable the market is not likely runaway from them quickly, at least not until we see a significant pickup in the economic fundamentals for the city and state.

You can follow me on Twitter. I'm usually sharing links and opinions daily (@BullionBaron). You can also CLICK HERE to signup for free email updates.

BB.

 

Is Germany's Gold Repatriation Causing Lower Prices?

I continue to see articles that speculate the price decline in Gold this year (and concurrent drop in ETF/Comex holdings) is a direct result of Germany's request for a portion of their Gold reserves back from the United States (as they scramble to secure physical Gold to fulfill the request).

This image in particular caught my eye from a recent TTMYGH report:

The event alongside price activity and ETF holdings sure paints a compelling story. Surely we don't need any facts to support the narrative? Grant Williams says the following in the report:

Wanna know what I think, folks? I think the central banks have been leasing their gold out for decades to the bullion banks and now find themselves in the rather precarious position of needing to reclaim that which they are supposed to own before the shortfall is exposed. I think that creates a big problem for both sides of that little scheme.

He later goes on to say:

Now, call me old-fashioned if you will; call me a conspiracy theorist, a goldbug, a wacko - whatever you like - but if you do, will you please give me an explanation as to why this gold is vanishing, where it is going, and who is taking delivery of it? Because, from where I stand, the evidence points to the beginning of the unraveling of the fractional gold lending market, and THAT spells trouble.

In my opinion he answers the question about where the Gold is going in the text leading up to the question:

I also think that retail investors — particularly here in Asia — are, unfortunately, compounding the banks' problems by using the weakness in the paper markets to acquire as much physical metal (or, as it's known in this part of the world, "wealth") as they can.

Not that we can trace the movement of physical Gold to confirm that the metal flowing out of the Comex, GLD and other ETFs is heading to Asia, but I'd imagine some of it is (Shanghai Gold Exchange delivery vs world mining supply, via Koos Jansen):
 

As for where the rest is going, well it's certainly not 'vanishing' (except into the vaults of those who believe Gold is worth buying at these prices), but there is definitely a lack of transparency in the market which allows commentators to makeup their own narratives.

He provides no real evidence that suggests the price decline and ETF shakeout is the result of central bank leasing activity and in fact once we zoom out on the price / Comex stock chart (courtesy Bullion Vault), it looks quite natural that the inventory should fall with price, just as it increased as the price rose over 2001 to 2011:

To me the charts showing reduction in ETF / Comex holdings look like the capitulation of price speculators in the west after having battled on for the past two years of sideways/lower prices, finally throwing in the towel and selling their holdings (maybe even having been lured into the equities market which has recently appeared 'unstoppable'). The gold appears to be moving from the hands of price speculators in the west to the safes, vaults, necks and wrists of those in the east who understand Gold as wealth (and concerned with buying more at lower prices, rather than selling).

Of course my interpretation of the data can't be proven one way or the other either. I can't prove that the price rout is not a direct result of the bullion banks or central banks trying to shakeout metal from weak hands to cover their obligations after leasing the metal, but I will try and provide some context for my opinion that the repatriation request from Germany is not key to the recent price decline... 

Something that I have voiced in the comments section on various sites, but not yet pointed out on my blog, is that I believe the rate at which they are repatriating the Gold from the US (the point of most speculation) was set by Bundesbank, not the Fed. The rate (circa 50 tonnes per annum over 7 years) is the same recommended by their court the previous year (for testing/examination of their Gold):

The Court had determined the order of the Bundestag that the Bundesbank their gold reserves stored abroad scrutinized. It is disputed whether the years experienced by the Bundesbank practice sufficient to rely only on a written confirmation to the gold bullion by foreign central banks. 

The Court therefore recommends that the Bundesbank to negotiate with the three foreign banks have a right to physical examination of the stocks. With the implementation of this recommendation, the Bundesbank has begun according to the report. They also decided to bring in the next three years of 50 tons each lying at the Fed in New York, gold for Germany in order to undergo a detailed examination here. Spiegel

Presumably this rate of delivery was fixed at 50 tonnes for logistics purposes, this post from Silver Stackers forum member Big A.D. is worth considering (note that the figures include the Gold being repatriated from the US and Paris combined):

Has anyone considered the logistics of actually counting out, transporting, counting in and then testing 674 tonnes of gold? 

Assuming deliveries are evenly spread out, they'll be shifting 1.85 tonnes each and every week for seven years. If the gold is in the form of 400oz LBMA spec bars, each shipment will contain 148 bars. 

At current prices, each weekly shipment will be worth about $100 million in assets which are completely untraceable after being melted down. That is an incredibly tempting target for anyone looking to acquire a large amount of gold without paying for it. It's the kind of target that attracts professionals with military training and experience in special operations. 

Whoever is doing the transporting might well be uncomfortable moving more than $100 million at a time, or rushing delivery to the point where there is a very noticeable stream of armoured cars driving out of the Fed's vaults every day for months at a time. Whoever is insuring the shipments might feel similarly uncomfortable at the prospect of paying out to replace a lost delivery and wants to spread their risk out. The bigger the shipments, the more concentrated the risk. 

Then there is the testing that has to occur at the German end (because checking the gold is all there is half the reason for the exercise to begin with). These are allocated bars (i.e. with serial numbers) and they're Germans so they'll measure it down to the gram. 

Assay and (re)manufacture takes time and effort and a lot of expertise which will probably be contracted out and whoever is doing it will basically be melting down ~150 x 400oz bars each and every week for 7 years, or roughly 30 per working day, or roughly one every 15 minutes. All of them has to be checked, perhaps individually, so that if any tungsten is found - or more likely just some regular, boring impurities - it can be traced bar to an individual bar and that bar's history can be investigated to find out when and where it entered the system and who owes who the difference in weight. 

At current values, the gold in question is worth about $37 billion dollars. We're used to seeing that sort of figure tossed around in discussions about global finance but it's worth remembering that this isn't just fake 1s and 0s money, this is actual, physical real money and there are practical issues in handling it which is why people tend to just leave it sitting in vaults to begin with.

Based on my speculation that it was the Bundesbank and not the Fed that had set the delivery rate, I posed the following questions to Bundesbank via email:

There is a lot of speculation about the slow delivery of Gold from the United States to Germany (300 tonnes being repatriated), are you able to advise whether the rate of transfer (approximately 50 tonnes per year) was requested by Bundesbank or whether the Federal Reserve limited the amount that could be withdrawn each year (i.e. who set the transfer rate)?

Their response (which was really just a cut and paste response from previous communications and press releases):

Thank you for your enquiry.

The Deutsche Bundesbank keeps a part of its gold holdings in its own vaults in Germany, while some of its gold is also stored with the central banks located at major gold trading centres. This has historical and market-related reasons, the gold having been transferred to the Bundesbank at these trading centres. Moreover, the Bundesbank needs to hold gold at the various trading centres in order to conduct its gold activities. It is common practice for central banks to keep part of their gold reserves abroad.

Besides the Deutsche Bundesbank, other central banks and official agencies place gold in the custody of foreign central banks. According to its own data, the  Federal  Reserve  of  New York holds gold stocks for almost 60 different central banks and official agencies.

The Deutsche  Bundesbank can withdraw gold from its holdings with foreign central banks at any time.The Bundesbank's gold is stored in the form of individually identifiable bars.  Gold stocks are subjected to regular audits. Relevant inventory controls are conducted on site.

The Bundesbank applies the principles of safety, cost efficiency and liquidity to the management of foreign reserves in general, and to that of gold reserves (and, in this context, to the question of custody location in particular). As a rule, the physical transfer of gold reserves to another storage location cannot be ruled out.

Deutsche Bundesbank’s new storage plan for Germany’s gold reserves:

By 2020, the Bundesbank intends to store half of Germany’s gold reserves in its own vaults in Germany. The other half will remain in storage at its partner central banks in New York and London. With this new storage plan, the Bundesbank is focusing on the two primary functions of the gold reserves: to build trust and confidence domestically, and the ability to exchange gold for foreign currencies at gold trading centres abroad within a short space of time.

The following table shows the current and the envisaged future allocation of Germany’s gold reserves across the various storage locations:

To this end, the Bundesbank is planning a phased relocation of 300 tonnes of gold from New York to Frankfurt as well as an additional 374 tonnes from Paris to Frankfurt by 2020.

On safety grounds we cannot publish details about the repatriation.

Unfortunately their response didn't directly answer the question regarding who set the rate of delivery, but I did follow up with another question:

Thank you for the detailed reply, I have a follow up question. As is clear from the below email, Germany's physical gold bars are identifiable and audited, is there any circumstances under which the Federal Reserve could hold Germany's physical gold but lease the same gold bars into the market? Is there any way the bars could otherwise be encumbered by another party?

Which received the following response:

Many thanks for your enquiry.

Your question might refer to a recent internet blog on "missing Fed and German gold" (July 2013).

Please consider that this source is not reliable and that the hedge fund manager statements quoted are not truthful.

The Bundesbank has full control over its gold reserves.

Please find below further information on the Bundesbank's gold reserves:

http://www.bundesbank.de/Redaktion/EN/Pressemitteilungen/BBK/2012/2012_10_22_gold.html

http://www.bundesbank.de/Redaktion/EN/Pressemitteilungen/BBK/2013/2013_01_16_storage_plan_gold_reserve.html

While my questions didn't stem directly from the article to which they referred, I did check up on the article mentioned and appears to be this one from King World News where hedge fund manager William Kaye claims that (leased) central bank gold has been sold into the market and melted down:

Once JP Morgan and Goldman Sachs get the gold they sell it into the market.  So these bullion banks then become net-short gold.  And the Fed says, ‘Well, we still have a contract where in theory we can claim the gold.  So we’re going to report that we still own it in the official documents.’

Kaye concludes with the wildly speculative conclusion that Germany will never receive their Gold back because it no longer exists at the Fed. Yet another story teller taking snippets of information from various sources and adding their own twist. It seems highly unlikely that the Fed or any other central bank would breach the trust of other friendly countries by leasing out their Gold.

So in summary:
- The repatriation rate of 50 tonnes per year is a continuation of arrangement organised in late 2012 (indicating Bundesbank requested this rate, not a limit set by the Fed).
- The logistics of transporting, testing and perhaps recasting the bars will be significant.
- Bundesbank is retaining a large portion (37%) of their Gold reserves with the Fed indicating a strong level of trust.
- Bundesbank says their Gold is allocated with identifiable bars and can be withdrawn at any time.
- Bundesbank refutes the stories of KWN that their metal is leased and not at the Fed.

At the end of the day I have to side with the official story, because other narratives lack the support of more conclusive evidence.

It doesn't take much to get the precious metals rumour mill pumping out propaganda these days, for example the Bank of England recently released an internet and mobile based tour of their Gold vault facility which had text mentioning "over 400,000 gold bars" in the vaults. This ended up being roughly 1300 tonnes short of the audited figure reported earlier in the year, which some concluded meant that it was leased or sold into the market to cause the price decline... 

GoldMoney's Alasdair Macleod says that the Bank of England recently become a prolific supplier of gold – leasing out 1,300 tonnes of the yellow metal in just four months.

In an interview with the Keiser Report on the Russia Today network, the GoldMoney research director told financial pundit Max Keiser what he thinks happened to 100,000 gold bars.

While perusing the BofE's new website application, which allows you to take a virtual tour of the Kingdom's gold vaults, Macleod learned that in June the bank was holding 400,000, 400-ounce gold bars.

As a veteran precious metals adviser, Macleod noticed a discrepancy between this figure and the Bank's year-end accounting from February which reported 505,000 bars in storage. Mining.com

Thankfully there are sites out there looking for such outrageous claims and the above story was thoroughly debunked by Warren at Screwtape Files (a report which is well worth reading in full).

A point I've seen made elsewhere about the German Gold repatriation story is what would have transpired if Germany had decided to pull the 300 tonnes (or even all of their Gold) out of the US in 2 weeks instead of 7 years? No doubt there would have been articles all over the web claiming Germany is making a rush for the exit with their Gold... there will always be sites and commentators ready to peddle sensational stories, it's up to the individual to decide which ones are plausible and which ones aren't. Perhaps the day will come that the "paper gold" market breaks down and all the Gold markets dirty secrets are revealed (I have no doubt there are some), validating some of the stories that circulate on the internet... that would only ever be the icing on the cake as far as I'm concerned, there are already plenty of reasons to own physical Gold without the need to believe tall tales.

You can follow me on Twitter. I'm usually sharing links and opinions daily (@BullionBaron). You can also CLICK HERE to signup for free email updates.

BB.

 

$250k+ in an Australian bank? Beware the bail-in.

Last week the AFR reported the Rudd government was looking to introduce a deposit levy (tax):

The Rudd government plans to impose an insurance levy on all bank deposits, risking a major fight with one of the best-resourced industries on the eve of the election campaign. 

Senior banking figures indicated on Thursday night they would oppose the move and depict it as a tax on bank depositors. 

The government plans to impose a 0.05 per cent insurance levy on every deposit of up to $250,000 to protect depositors against collapses. 

The banks said they will pass on the impost, which equates to 5¢ for each $100, to customers through reduced interest payments on deposits.

The banks are up in arms over who will foot the bill and there has been a media storm over the tiny fraction of a % that this insurance will cost (for example a bank would need only lower the interest rate paid on a deposit from 3.50% to 3.45% in order to recoup the cost). While the media, banks and politicians get into a scuffle over who will fund the minuscule cost of insuring funds under $250k, there seems to be no investigation or reporting by the media on what might happen to funds over the 'guarantee' limit in the case of a bank failure...

Eric Sprott said the following in a recently released interview:

“The one event in my mind would be when it becomes apparent to everyone that having a deposit in a bank is a very risky situation. We saw that in Cyprus where the depositors got nailed on the bail-in. We’ve seen all these proposals to have bail-ins as the solution to the problem in the US, in Canada, in Britain, in New Zealand and in Europe. All the paperwork has been laid out.”

While Sprott doesn't explicitly list Australia, keen eyed blogger 'Barnaby Is Right' captured these interesting snippets from papers that are flying about between our banks, regulators and the treasury, suggesting not only are Australian banks prepared to bail-in customer funds to get out of trouble, but will do so without any warning or disclosure to the market before such an event:

In a November 2012 Technical Note on the Financial Sector Program Update for Australia, as part of their Financial Safety Net and Crisis Management Framework, the IMF has advised that there is a problem:

[Past simulation exercises revealed the need for legislative changes to prevent premature disclosure of sensitive information. Australia’s securities disclosure regime requires, for the protection of investors, immediate and continuous disclosure of information that could reasonably be expected to have a material effect on the price or value of an ADI’s securities. There is a high probability that any resolution or crisis response measures will impact the price or value of an authorized deposit-taking institution’s (ADI’s) securities.

Poor coordination of compliance with the disclosure requirements, timing of resolution or crisis response actions, and the overall public communication strategy regarding these actions could pose risks to financial stability (e.g., through depositor runs) or thwart resolution actions (e.g., through the stripping of the ADI’s assets by insiders) or cause market disruptions. Legislative changes that reduce tension between investor protection and financial stability should be pursued.]

“Reduce tension” between investor protection and financial stability?!

By making laws to “prevent premature disclosure of sensitive information”?!?!

In order to prevent bank runs, which would happen if investors were to find out that a Cyprus-style “resolution or crisis response measure” is in the offing for the bank that they have their money in?!?!!!!

It's unlikely that an event requiring a bail-in would take effect in the near future without further warning signs, but the high level of exposure that Australian banks have to residential mortgages (as recently reported by Moody's) should be sounding alarm bells for those who have deposits at risk...

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BB.

 

Gold Driven By Financial Instability, Not Inflation

While I've talked about inflation adjusted targets for the Gold price, it is not my opinion that inflation or expectations of inflation have been the primary driver of the Gold market over the last half a decade. Since late 2008 the primary driver of the Gold bull market has been (fear of and policy reaction to) financial instability, this was a significant change from earlier years when the rise in Gold price remained inline with that of other commodities (whose prices increased with demand on the back of debt driven growth).

The change in drivers is well represented by the below chart which shows the Gold/CRB Index ratio:

In box 1 you can see that Gold's growth remained stable relative to that of the commodity complex. Box 2 shows that Gold has significantly outperformed commodities in the bull market phase since late 2008, clearly indicating a shift in what drives the Gold market.

While there isn't always a direct correlation (with the short term Gold price) the below chart showing the S&P 500 Volatility Index is an easy way to confirm that stock market volatility (one sign of financial instability) was at increased levels while Gold rose strongly over the late 2008 to late 2011 time frame (although Gold was initially liquidated along with others assets earlier in 2008):

The St Louis Fed Financial Stress Index shows similar:

The events resulting in financial instability have been varied in nature, from a banking system crisis & congress disagreements on the debt ceiling in the United States, to bailouts of Eurozone countries, to the meltdown of a Japanese nuclear plant. A majority of events causing the financial instability have been a result of excessive private or public debt and the the policy reaction to patch this up by shuffling the debt around (e.g. moving it to the balance sheet of central banks) or creating more (e.g. large government deficits to spur growth). Mostly these exercises seem like attempts to give extra life to a monetary/financial system and growth model which is clearly not sustainable.

The monetary easing over this volatile period increased the level of speculation in the Gold market, with quite a few hedge funds loading up on the shiny metal.

Since late 2011 volatility in the stock market has trended lower and prices have trended higher. The market hasn't been without regular corrections, but no crashes with the ferocity that we saw in 2009, 2010 & 2011:

The cyclical bull market in equities has kept investors complacent and it has drawn money away from (long) price speculation in the Gold market with the inventory of GLD falling off a cliff over the first half of the year:

The COMEX has also seen a large drop in the net long position of large, small and managed money speculators:

It seems inevitable to me that the complacency which has spread through global markets will eventually unravel. How or exactly when is not predictable, but with global growth slowing (even as central banks engage in stimulus measures):

And now with some central banks teasing at the possibility of 'tapering' stimulus, it seems likely we could be close.

The recent shock to China's financial system could be just a taste of what's to come:

And while mainstream Keynesian economists remain positive on Japan's outlook following unprecedented monetary stimulus to reinvigorate their economy, there are likely to be unintended consequences that arise as a result.

There are some signs that the capitulation last week could have marked a significant low or the bottom (long term readers of the blog will know that I was wrong with expectation of a bottom several months ago) and a few days does not make a trend, but the strength in Gold stocks is promising. Further more we appear to be in limbo land where many chart analysts are calling for lower prices and where it's already fallen lower than the expectation of many bulls (including myself), seems like a good place to turn and surprise everyone. Also, as I pointed out in a recent post, the price of the metal is falling below mining cost for many of the marginal producers, the mid 1970s correction in Gold bottomed soon after this occurred.

What will turn the price of Gold and Silver around? In my opinion it will be the return to financial instability as a result of reduced monetary easing measures or a shift in understanding once the market realises that quantitative easing is not going to lead to sustainable and natural economic growth. The price could also be turned around if the increased level of demand in the East continues to need excess supply from the West. Chinese Gold delivery via the Shanghai Gold Exchange is almost matching newly mined supply, if this demand remains strong and Gold stops being drained from inventories in the West (such as from GLD, COMEX) then we will likely see the price rise as a result:

When the price of Gold falls there are some who attack those who advocate holding Gold, but comments questioning Gold's role as a safety haven because the price is dropping miss the point entirely. Many of those advocating physical ownership of metal are not buying to profit, but as a form of insurance. What's at stake when we see financial instability is not only the risk of losing some money, but collapse of the entire financial system (something we came close to in 2008). If such an event were to occur, the exact outcomes would be unknown (and likely differ between countries), but holding tangible assets while this risk remains real is important. For this reason, anyone and everyone should hold some Gold.

The big question on everyone's minds, should I be buying Gold & Silver at these prices? Speculators should probably wait for the price to signal that it's ready to move higher, but the precious metals investor or saver should continue adding to positions inline with their strategy. Those with no position in the metals, should see current prices as a gift... their insurance premium (to hedge against collapse of the financial system or change to the monetary system) just got ridiculously cheap.

You can follow me on Twitter. I'm usually sharing links and opinions daily (@BullionBaron). You can also CLICK HERE to signup for free email updates.

 

BB.