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The Gold Bull is Dead. Long Live the Gold Bull!

Sheesh. What was that? Markets are cracking all over the place. Confidence in the Federal Reserve to make it all better is evaporating faster than a proverbial snowflake in summer. Confidence in the Bank of Japan to make it much worse is growing by the day. And confidence in the People’s Bank of China to have even the vaguest idea of what they are doing is out the window too.

Money is a con game. It requires confidence to keep the game going. And confidence in our monetary central planners just turned on a dime.

The conventional view is that this is all because the Fed is set to unwind its stimulus program. Apparently, the US economic ship is turning around.

Don’t buy it. Something else is going on that is not quite apparent. We don’t know what it is exactly, but we’ve been warning about it for a while. Over the past month or so, we’ve been working on a new report and video presentation warning of a crash. You can see it here . We didn’t know the crash would come so soon, but we do know that it was inevitable.   

The global monetary system is straining. China, which is integral to the system’s functioning, is in all sorts. Yesterday was the day when China’s credit bubble definitively popped. The interbank lending market froze as rates soared. This is how a credit crunch starts.

The rumour was that the market pulled funding from the ‘WMPs’, the ‘Wealth Management Products’ marketed by the banks to get around lending restrictions imposed by the government last year. These products were classic credit bubble vehicles…borrowing money short term on the promise of attractive returns and lending it long term. Back in October, the Chairman of Bank of China said these products were like a Ponzi scheme.

The thing with Ponzi schemes is that they collapse when the flow of credit stops. And yesterday the flow of credit stopped.

China’s central bank, the People’s Bank of China (PBoC), has yet to act to provide liquidity to a parched market. They want to send a signal that they are serious about curbing the credit boom. This could prove to be a grave error. The time to get serious is before the credit boom gets out of control. That moment is long gone for China. It now must manage the as best as it can. And it can’t do that by standing around acting tough.

In this environment, you’d think gold would soar, right? Instead, it’s getting smashed along with everything else. But as we’ve written before, the gold market is not what it seems. The physical market follows the paper market. The ‘paper gold’ market consists of the COMEX futures market in the US and the OTC (over the counter) market in London. OTC means trading occurs privately between two parties, not via an exchange like stocks.

And most of the trading that occurs privately in London is in ‘unallocated’ gold. This is gold deposited into a bullion bank account but not ‘allocated’ to a specific account. Therefore, the bank can lend this unallocated gold to multiple parties. That’s because they’re not lending physical gold, but a paper claim on gold instead. 

So physical gold trading is minimal. For example, the London Bullion Market Association (LBMA) tells us that OTC market gold turnover for the month of April was 24.1 million ounces, or 289.2 million ounces annualised. That equates to around 8,200 tonnes, about 4 times the level of annual gold production. It’s clearly not physical gold trade trading place, but rather paper claims to physical gold. This means the price is set by the ‘paper gold’ market.

Like conventional banking, the modern gold market is a fractional reserve market. Think of it as an upside down pyramid. Physical gold is the reserve base at the bottom of the pyramid. Paper gold expands on top of this base. This market, as far as we can tell, began developing once the US abandoned its official link to gold in 1971.

The fractional reserve system in gold grew in order to provide additional supply to meet growing demand, so as not to blow the price sky high. But demand became so great that the fractional reserve gold market nearly blew up in 1999. That’s when gold last traded around or below the average cost of production…similar to its situation today.

But something saved the fractional gold system at that time, and the gold market entered into a bull phase to relieve pressure on the physical market. It was a paper bull market, physical just went along for the ride.

Now, here’s the important bit…

In a paper gold bull market, the tendency of the Western trader (who effectively sets the price) is to be long paper gold and short physical gold. That is, the trade is to sell physical and go long a futures contract or some sort of paper derivative.

But, when the paper bull market ends and all the momentum traders (who simply wanted leveraged exposure to gold…not gold itself) exit the market, the dynamic changes. It goes from bullish to bearish.

Remember back in April when the gold price plunged? While the paper holders dumped in a panic, there was a global rush to physical gold. That is, there was a run on physical gold reserves. And like any run, when reserves deplete they bring down the credit instruments that pyramid on top of these reserves. Hence the collapse in paper gold prices.

So now the gold market has gone from bull to bear, the trade has gone from ‘short physical, long paper’ to ‘long physical, short paper’. In other words, if you want to hedge your physical exposure, what do you do? Short paper gold! And because the paper market sets the price…well, that’s why the ‘gold price’ is falling.

But with each fall in price, the demand for physical will increase, which heightens the bank run and puts pressure on the fractionally reserved gold system. To relieve that pressure, the paper gold price needs to rally. If the ‘long physical, short paper’ trade continues to gain momentum, we’re not sure how much longer the existing gold market can survive.

So if you’re holding physical, hold on tight. Long physical is the trade, it just doesn’t look like a winning trade while the fractional reserve system crumbles down around it.

The gold bull is dead, long live the gold bull!

Regards,
Greg Canavan
for The Daily Reckoning Australia

Join me on Google+

From the Archives…

Truth or Dare Time for the Investment Industry
14-06-13 – Vern Gowdie

The Launch of Revolutionary Tech Investor
13-06-13 – Kris Sayce

The Architecture of Oppression
12-06-13 ­– Dan Denning

The Upside of a Dive to 85 for the Australian Dollar
11-06-13 – Dan Denning

Courting Controversy Over Australian Property
10-06-13 – Dan Denning

Greg Canavan
Greg Canavan is a feature editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Sound Money. Sound Investments, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
Greg Canavan

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12 Comments

  1. RonaldR says:

    KILL THE BIS-APRA BANK ‘BAIL-IN’ PLAN BEFORE IT KILLS YOU!
    In a case of kill or be killed, Australians must band together to kill off the bank “bail-in” plan reported in Monday’s (3 June) Australian Financial Review. Otherwise, have no illusions: in the very near future you will assuredly find yourself stripped of your savings and thrown into the same financial ruin, impoverishment, and soaring death rates as the people of Cyprus. Think “it can’t happen here”? Don’t be ruled by your own wishful thinking and downright cowardice, but consider the evidence.
    Two months after the CEC first blew the whistle on this plot the AFR reported that the Swiss-based Bank for International Settlements, “known as the bank for the world’s central banks”, has proposed that “faltering ‘too big to fail’ banks, such as Australia’s big four lenders in the event of a crisis, be wound up over a weekend and their assets carved up and sold, so shareholders and creditors—not taxpayers—incurred losses… Under the BIS plan, shareholders and creditors whose claims were ranked below other bond holders in the failing bank’s capital structure would bear the brunt of the losses.”
    “Shareholders and creditors”: that means you. The line of the BIS and its Financial Stability Board (FSB, of which Australia is a member) and the rest of the City of London-centred international financial mafia is: “no more taxpayer bailouts for major financial institutions; instead, the banks must be bailed-in.” Cyprus demonstrated what “bail-in” means: the banks just confiscated individual deposits en masse—simply stole the money out of the accounts of individual depositors. As Ellen Brown, chairwoman of the U.S.-based Public Banking Institute in the US wrote of the implications of the Cyprus bail-in, “Although few depositors realise it, legally the banks own the depositor’s funds as soon as they are put in the bank. Our money becomes the bank’s and we become unsecured creditors holding IOUs or promises to pay.”
    And this BIS-planned seizure of all deposits is no mere “proposal”, as the AFR represents it, but a reality throughout the European Union, and in the United States as well through the “Dodd-Frank Bill” written by Wall Street bankers. And though the Australian Prudential Regulation Authority (APRA) will lie and try to deny it they have fully adopted this BIS plan as well, whereby depositors are now classed as “unsecured creditors”, when Australia’s Big Four fail in the near future—as is absolutely inevitable under present policies—the savings of depositors will be seized and used to restructure and save the banks, in particular their derivatives bets—the trillions of dollars in gambling debts that caused the crisis in the first place.
    Under BIS/FSB/APRA rules, “financial stability” comes before all else. Therefore, the Australian government guarantee on deposits up to $250,000 is a witting lie. Because if confiscating un-guaranteed deposits is not enough to bail out the trillions in derivatives (which is impossible), then the FSB/APRA will simply steal every last cent from depositors, “guaranteed” or not, all in the name of “preserving global financial stability”.Australia’s banks are collectively exposed to $20 trillion in derivatives—and the FSB and its local Australian wing (APRA) have already drafted the plans ensuring that if one of them gets in trouble, those derivatives will be paid first so as to avert a default that would melt down the entire global $1.4 quadrillion [$1,400 trillion] bubble, which almost happened following the collapse of Lehman Brothers in 2008.
    This is exactly what the Cyprus victims found out when they were assured their savings were guaranteed up to 100,000 euro; instead, 70 per cent of total deposits are gone completely, and almost all of the remaining 30 per cent is frozen. This is what happened in Spain in May when depositors in the bankrupt Bankia bank were robbed of 75-90 per cent of their savings.
    The only way Australians can kill off this plan is by joining the CEC’s fight to force a Glass-Steagall banking separation through the Australian Parliament, which will do the opposite to the BIS financial death plan: it will simply cancel the derivatives bets, but protect the depositors’ savings—and their lives.
    On 3 June, the same day as the AFR reported the BIS plan, the CEC’s petition headlined “Australia Urgently Needs a Glass-Steagall Separation of Banks” was tabled in the Federal Parliament.
    The petition clearly demonstrates that not only is Glass-Steagall the only solution to this threat, but that the CEC is the only political force in Australia that is fighting for Glass-Steagall, which is now moving quickly ahead in the United States, where it has been introduced into both the US Senate as well as the House of Representatives, in the latter with 62 cosponsors.
    NOW is the time for all Australians to do what the people of Cyprus wish they had done—destroy the plan before it is implemented. Only a mass movement of the people—including you—banding together to fight, will succeed. The CEC is rushing to print one million copies of The New Citizen newspaper, to expose the BIS plan. Across the country, CEC activists are right now informing bank managers, local councillors, and state and federal MPs of their individual, personal responsibility to act to stop this atrocity before this nation plunges into anarchy and mass death, and you must do so as well. And you might remind them that it is they whom the enraged, desperate population will hold responsible when this criminal looting is enacted here in Australia. Bank regulators in Australia are already known to be nervously “joking” among themselves, “The population will hang us from the lamp-posts once they find out what we are doing.”
    This is no game, this is the worst crisis of your life, it is unfolding right now, and you need to act. Join us.
    Click here to order bulk copies of a flyer of this media release and for a free Glass-Steagall mobilisation pack which includes background on Glass-Steagall, petitions, and our “Do You Intend To Die For The Banks?” New Citizen.
    Click here to join the CEC as a member.
    Click here to refer others to receive regular email updates from the Citizens Electoral Council of Australia.

  2. RonaldR says:

    STOP PARLIAMENT FROM SECRETLY LEGISLATING TO STEAL DEPOSITS;
    DEMAND GLASS-STEAGALL LAW INSTEAD
    The Citizens Electoral Council has just discovered that legislation is being secretly prepared to give Australia’s banking regulator “bail-in” powers to confiscate the savings of the Australian people, just as in Cyprus.
    The CEC is mobilising to expose and stop this secret plan, and force the Parliament to instead fully protect deposits and essential banking services from an inevitable collapse by passing a Glass-Steagall separation of speculative investment banking from banks that hold deposits.
    Except for the CEC, the only information reported to the Australian people that “bail-in” is planned for Australia was the 3 June Australian Financial Review article reporting that the Bank for International Settlements (BIS) has “proposed” [sic] to the Australian Prudential Regulation Authority (APRA) that it grab creditors’ funds, including deposits, to prop up a failing major bank.
    However, the CEC has discovered that six weeks earlier, on 15 April, the BIS’s global enforcer of bail-in, the Financial Stability Board (FSB), reported to the G20 that “legislation is in train” in Australia to give APRA deposit-confiscating bail-in powers. [See footnote.]
    What is this legislation “in train”? Has it been passed? If not, is it planned to be rammed through Parliament in this current fortnight’s final sitting, under cover of the 200 (!) other pieces of legislation that the government intends to ram through in this fortnight?
    THE CRISIS IS NOW!
    The CEC is exposing this plot just as the global financial system is being rocked by the beginnings of thenext phase of financial meltdown—and Australia’s banks are right in the way.
    The U.S. Federal Reserve’s mutterings, that it is considering “tapering off” the torrent of hyperinflationary money-printing that it has been pumping into the global financial system for four years, have triggered massive turbulence and capital outflows globally, including the sudden rush of capital out of countries such as Australia and Brazil, which has caused currencies to plunge, and a sudden collapse of the global bond market—by almost 90 per cent in the U.S. last week—which the 13 June Financial Times warns is “threatening to halt a global refinancing wave”.
    Australia’s banks are exposed to hundreds of billions of dollars of short-term foreign debt, and $20 trillion dollars of domestic and global derivatives obligations. The last time capital fled Australia this fast and caused such a plunge in the dollar, in 2008, the big banks found that they could no longer borrow to roll over their foreign debts, and had to go screaming to the Rudd government for guarantees, warning that otherwise they would be “insolvent sooner rather than later”.
    The Big Four banks have gone on such a binge of derivatives gambling since 2008— led by CBA—that they are even more vulnerable today—a fact which makes the BIS and APRA desperate for the new “bail-in” powers, fully expecting to use them, and soon.
    WHAT YOU CAN DO
    • Join the CEC’s days of action. Thousands of copies of this flyer and the New Citizen newspaper are being distributed from coast to coast. Take extra copies for your bank manager, local councillors, and everyone else you know.
    • Call your MP, Treasurer Wayne Swan and Opposition Treasurer Joe Hockey in Parliament House, which is sitting this week and next week. Call the switchboard on 02 6277 7111 and ask for their offices, and demand they scrap any plans for “bail-in” legislation, and enact Glass-Steagall instead.
    • JOIN THE CEC AS A MEMBER.
    FOOTNOTE:
    THE FSB REPORT READS: “(1) Completing the resolution toolbox for banks – It is critical that authorities have a broad range of powers at their disposal when faced with a crisis. This is not the case in all FSB jurisdictions. In many jurisdictions, resolution authorities still lack the powers set out in the Key Attributesto achieve rapid transfer of assets and liabilities and to write down debt of a failing institution or convert it into equity (“bail-in”), although legislation is in train in some jurisdictions (including Australia, Brazil, the EU, France, Germany, Indonesia, Singapore and South Africa) to align national regimes fully with the Key Attributes.” (Financial Stability Board: Implementing the FSB Key Attributes of Effective Resolution Regimes—how far have we come? 15 April 2013, p 3.) [Emphasis added.]
    Click here to download the pdf flyer.
    Click here to order bulk copies of a flyer of this media release and for a free Glass-Steagall mobilisation pack which includes background on Glass-Steagall, petitions, and our “Do You Intend To Die For The Banks?” New Citizen.
    Citizens Electoral Council of Australia

  3. BP says:

    Greg C: “Something else is going on that is not quite apparent. We don’t know what it is exactly…”

    Well, the gold miners are w-a-y down, many 75% off their high. The West has, historically, been dotted all over with heavily worked leases, most of which rose with the gold price, but which eventually became ghost towns.

    It aint pretty…

  4. slewie the pi-rat says:

    there’s something happening, here
    what it is, ain’t exactly clear
    there’s a man with a gun over there
    etc.

  5. Lachlan says:

    The same thing happened to gold (30% sell off) five years ago and then it went up while everything else went south.

  6. BP says:

    Not sure if the ‘this-means-that’ thinking (representedness) which inspires goldbugs provides any real reassurance, Lachlan.*

    As Canavan notes: “In this (present) environment, you’d think gold would soar, right?”

    It’s interesting to see my grandfather’s leases being worked again. During the decades he was mining, WMC employees hinted their tunnels had extrcted most of the ore below his shafts.

    * But for your sake, I hope you’re right…

  7. gaz says:

    Gold bug commentaters are either fanatics, spruckers, or both. they twist and distort the ‘facts’ and the ‘truth’ in order in suit their ‘gold religion’ agender. Never trust a fanatic.

  8. Lachlan says:

    I certainly agree there is no guarantee of anything here BP. I think gold is too oversold to sell here but if the bear market does continue then somewhere just above 1000 may be the next long term support. For bulls the 1500′s area will need to be overcome before champagne can be popped.
    I believe Ben Bernanke did say something of value. People buy gold to cover tail risk. The caveat is you cannot guess where it may be valued at too easily.
    Btw BP…http://www.miningaustralia.com.au/news/coal-mine-looks-to-green-solution-to-reduce-dust
    Keep up the good work fellas ;)

  9. BP says:

    Very sensible initiative, Lachlan! I was watching a doco recently regarding new approaches to dust reduction in Aboriginal communities. Their solution was mounding around the camps and small towns.* Maybe their next step should be seed dispersal. We did note, when living ‘out-in-the-middle’ that seeds, carried hundreds of kilometres by birds, only survived in shallow depressions where water infrequently collected…

    On gold: I commented elsewhere on my son’s quick entry-and-exit into bullion. He made around $40/oz(!)
    I was therefore just a little surprised to cop a serve from a moderator… . :D

    * This initiative was claimed to have reduced two serious eye infection issues.

  10. BP says:

    I see Mr Cockburn Central has offered two l-o-n-g soliloqiues, plugged in out-of-chronology, above.

    Our banks, Ron? Most successful in the world, three years in a row… .

  11. BP says:

    While you’re at it, Jay Arrrrghhh, check out ‘plagiarism’ in an online dictionary. Are you still campaigning for a 1% (per month) interest rate rise, son?! :D

  12. Steve says:

    Yep make sure you hold onto gold while it keeps crashing. If your smart you’ve unloaded both gold and silver and buy back in when its again moving in the right direction.

    For now Gold is about as bad as it gets for an investment the trend has clearly reversed.

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