Things That Make You Go Hmmm... Like Gold

As we have exhaustively noted, given the various macro factors bringing influence to bear on the yellow metal, the bizarre price action of the last six months has run counter to most logical assumptions and has been a source of great frustration to many - including Grant Williams. Cyprus should have been a hugely positive tailwind for gold. But it wasn't. The ongoing money printing should have provided support for gold. But it hasn't. The talk of tapering should have had a minor but noticeable effect on gold, given its healthy recent correction. But it didn't. Sustained data suggesting a voracious appetite for the physical metal not only in Asia but in Western countries, too, should have led to a bounce on the COMEX. But it hasn't. The whole thing is as baffling as Kim Kardashian's fame.

Grant Williams provides an all-encompassing collection of the facts, explanations, charts, and data of the whats and whys of recent gold price action that we have been discussing:

1. Central banks have, over the years, leased out an undetermined amount of their gold.
2. In January, Germany demanded repatriation of a large amount of gold from the NY Fed.
3. That repatriation will take an extraordinary (and unexplained) seven years to complete.
4. The price of paper gold futures contracts has been hit incredibly hard since April.
5. Physical gold is being withdrawn at a phenomenal pace from multiple custody locations.
6. Rumours have been rife of shortages at LBMA and COMEX warehouses.
7. Investors & central banks are buying physical in record amounts.
8. In the face of massive physical buying, "the gold price" continues to fall.

Given that knowledge, one might assume that, in the rush to perfect ownership of physical gold, certain "interests" that happen not to be in a position to deliver said commodity to large, important, and extremely powerful customers might want to try and "shake the trees" a little to see what drops out.

The trees have been shaken mightily, and it certainly looks as though some weak holders of the GLD shares have delivered bullion into the hands of the authorised participants - but is it enough? I doubt it.

Meanwhile, over at the COMEX, gold is being removed from the warehouses, bound for destinations unknown. We can't tell for certain where it is headed, but I suspect a significant amount is being placed in private storage, out of the grasp of the bullion banks who need it the most.

So what does all this look like if we put it together on one chart? Well, it looks like this:

As you can clearly see, virtually from the day that Germany demanded to have its gold delivered back to the Bundesbank, three very clear phenomena have occurred:

1. The gold price, which had been trending sideways, has plummeted.

2. The physical gold held at the COMEX has been pouring out of the warehouses.

3. The amount of physical gold held by the ETFs has stopped rising and started falling. Fast.

Coincidence? I very much doubt it.

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.

I think the smash in paper was specifically designed to shake out loose holders - and it has worked to a degree, but only amongst the weaker holders of the ETFs, who tend to "rent" gold rather than own it. I think the stronger hands have been getting their gold out of the official warehouses as fast as they can; and central banks in places like China, Russia, and all over the rest of Asia and South America have been trying to buy and, crucially, to take delivery of physical gold while they still can.

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.

To paraphrase Everett Dirkson, "A few hundred ounces here, a few hundred ounces there, and pretty soon you're talking real problems."

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.

There's one last puzzling development that does however fit neatly into the scenario laid out here today, and that is the curious action of something called the GOFO rate. GOFO is the Gold Forward Offered Rate, and it is the rate used for gold vs. dollar swap transactions. If you hold gold and want dollars in a hurry, you can use your metal as collateral, which reduces your rate significantly.

Ths week, the GOFO rate did something it has only ever done a handful of times in its long history: it went negative out to three months, which means somebody was willing to pay to have gold instead of dollars right now. The FT takes up the story:

(FT): The cost of borrowing gold has risen to the highest since the post-Lehman Brothers scramble for supplies, as the bullion market adjusts to a new era in which western investor demand is less dominant.

The niche gold lending market, largely the preserve of a few big banks and central banks, has been uneventful in recent years as investors have built up large holdings and lent them out on the market, keeping rates depressed.

But as investors have turned sellers in recent months, availability of gold in the lending market has been squeezed, bankers said.

The squeeze has triggered a sharp rise in gold leasing rates — the implied interest rate for lending gold in the market in exchange for dollars. The one-month gold leasing rate has risen from 0.12 per cent a week ago to 0.3 per cent on Tuesday, the highest since early 2009.

The move reflects the dramatic shift in the gold market over the past few months as investors have liquidated their holdings en masse, triggering a 25 per cent collapse in prices since the start of the year.

Strong buying in Asia has created additional demand for physical gold, with refineries operating at full capacity to meet orders.

The lack of liquidity in the leasing market has pushed gold forward rates, known as "gofo", into negative territory, meaning that gold for future delivery is trading at a discount to physical market prices — a rare situation that has occurred only a few times in the past 20 years. The last time forwards were negative was in November 2008, when a scramble for physical gold spurred a sharp price rally.

The degree to which the underlying structure of the physical gold market has changed over the last few months has yet to make itself apparent; but the first time we get an "event" that makes it necessary for people who don't have gold to buy some, and for people who do own it to have more, we will see how things have changed.

The gold price has been falling heavily for several months, but when the need to own gold jumps again - and it will; this is a long way from over - all the pieces of this jigsaw puzzle of the weird and wonderful forest of gold manipulation that we have dropped onto the table will slot neatly into place.

What if, when that happens, there just isn't enough gold to go around?