Archive for November, 2008

Precious Metals Prices: The Tale of Two Markets

November 30, 2008

In my discussion of  alternatives to physical possession of  precious metals a few weeks ago, I alluded to price distortions in the precious metals markets. A multi-million dollar purchase of gold in Toronto, at a price well above that of the official exchange, illustrated the point in a striking way. Price discrepancies of this magnitude have become so commonplace that I feel compelled to say more about them now.

Official commodities markets like the COMEX set the “spot” price for precious metals quoted at places like The Bullion Desk. Ordinarily, when you purchase bullion coins from a dealer, the price you pay includes both the spot price and a “premium.” Under normal circumstances, the premium makes up the dealer’s cut in the transaction.

About eighteen months ago, for example, the per-ounce premium on five, one-ounce Krugerand gold coins from a reasonable dealer came to around 4.5%. With the spot price at around $670 per ounce,  the premium amounted to $30 per ounce. The same premiums held for silver.

Ideally, then, the spot price should reflect the supply-demand dynamics of the marketplace, and the dealer’s transaction costs make up the premium. Today, the premium has taken on a new role: it now compensates for spot prices that are too low given the true demand for gold and silver bullion.

In the Toronto transaction I mentioned above, the buyer paid around $300 per ounce more than spot. In a November 22nd interview with Jim Puplava, veteran precious metals specialist John Dudy (The Goldstock Analyst) told of a client who received a premium of $600 over spot for gold coins.

The divergence between the spot price and the true cost of bullion has led one website to track completed transactions for gold and silver coins on ebay.  Here one finds premiums ranging from 14% to 155% depending on the coin, with the typical prices being in the 40%-60% range.  Analysts now routinely distinguish between the “paper price” of gold determined by the COMEX (that is, the spot price) and the true “phsyical price.”

Demand for gold and silver bullion has reached the point where dealers predict it will take months to fulfill orders. The Perth Mint recently stopped taking orders. The demand for precious metals results from the growing mistrust of national currencies, and in particular the dollar.

According to Bloomberg, the Fed and the Treasury have so far pledged $7.7 Trillion for their interventions to save the banks. “Fed officials have made it clear,” said the New York Times earlier this week, “they are prepared to print as much money as needed to jump-start lending, consumer spending, home buying and investment.” As further business failures cause a cascade of credit defaults through the banking system, more and more phony money will circulate through the economy. $7.7 Trillion is just the beginning. None of this bodes well for the dollar as a reliable store of value.

But why do the spot prices on the COMEX fail to measure the true demand for precious metals? The answer to this question lies in the technical workings of the COMEX. A contract to sell on the COMEX, a so called “short” position, does not obligate the seller to make physical delivery of the item he sells. In fact, most COMEX contracts settle in cash before their delivery date. The COMEX serves as much the purpose of commodities speculators as it does the consumers of commodities. The COMEX even places a limit on physical settlement of a buy or “long” contract. It limits delivery of silver, for example, to 7.5 million ounces, or 1500 contracts, per month.  But it places no limit on the number of short positions.

An analysis by Ted Butler shows that two or three large players are holding extraordinarily large short positions on the COMEX. As of July 1, 2008, two U.S. banks held 6,199 short contracts of COMEX silver (about 31 million ounces). As of August 5, 2008, two U.S. banks held 33,805 short contracts of COMEX silver (about 169 million ounces), a five-fold increase . These short positions cannot possibly be backed by actual production or inventory of the metals. But they have the effect of an increase physical supply: from July 14 to August 15, silver prices dropped from a peak of $19.55 to a low of $12.22 , a decline of 38% . The numbers for gold tell the same story.

Rising precious metals prices reinforce their role as true money, as a store of value more reliable than fiat currencies. By suppressing the price of precious metals through these fraudulent futures contracts, the banking industry maintains the apparent viability of fiat currencies as a store of value. A major shift in storage of wealth to precious metals would accelerate the devaluation and demise of the dollar. Indeed, The Gold Anti-Trust Action Committee has for years made the claim of precious metals price manipulation.

Many observers predict that some large buyers might call the COMEX’s bluff by demanding physical delivery on futures that come due for settlement in December, putting the COMEX in default on these contracts. It’s hard to say how likely this scenario could be. But the wide divergence between the COMEX prices and the physical market has to lead to a reconciliation of some kind: a conspiracy of this magnitude, I hope, cannot go on indefinitely.

© 2008 Philip Glaser


How Do We Pay For The Bailouts?

November 21, 2008

The Federal Reserve and Treasury are making a desperate attempt to prevent the kind of deflationary spiral that led to the Great Depression.  In such a spiral, creditors, coping with defaults on existing credit, refuse to lend or lend only at prohibitive interest rates . As less money flows through the system, people lose jobs and cannot spend. Others fear losing their jobs and become conservative in their spending. This reduction in spending further reduces the flow of money, resulting in further job losses.  It’s an ugly scenario.

A major focus of the prevention effort lies in purchasing the bad mortgage and credit card debt held by major banks. By exchanging bad debt for cash, the Treasury enables the banks to remain viable because their balance sheets will demonstrate cash in place of bad debt. When they are viable, the banks will resume lending. Lending will increase the flow of money through the economy, which in turn will cause a resumption of what mainstream economists refer to as “economic growth.”

It would be a good thing if these actions in fact prevent a prolonged recession or depression. But I want to briefly explain some rather disturbing consequences of what the government is doing. I’m afraid the discussion will be rather technical, but I believe that it is important for folks to understand some of the mechanics of money creation, debt, and currency valuations. So please bear with me.

Revenues from taxes do not provide the funds with which to purchase the bad debt from the banks. So the government has to borrow the money. To do so, the Treasury issues bonds. In 2009 the US government will have to find buyers for upwards of two trillion dollars in new debt.

China has been a major buyer of US Treasury securities. It had a surplus of American dollars because of its exports to the US. By exchanging the dollars it received from its exports for Treasury debt, China helped finance the US debt and, in a self-reinforcing cycle, enabled the US to continue importing China’s products.

But the reduced spending and imports by US consumers has diminished the amount of cash with which China can purchase securities. (This may explain recent slowdown in the growth of dollar- denominated debt instruments held by foreign countries.)  And now, China plans to spend over $500 billion on its own domestic  stimulus package. To finance this package, it may sell some of its dollar reserves. China may be poised to shift from being a net buyer to a net seller of US securities.

The supply-demand dynamics of the credit markets could counteract the Federal Reserve’s effort to increase money flow by lowering interest rates. When the level of debt to be sold exceeds the number of willing buyers, the buyers must be rewarded with higher interest rates. Very simply, the “investment” must be made to appear more attractive. But the Fed must avoid raising interest rates: high interest rates constrict the flow of money and impede economic growth.

The Treasury and The Fed can take a couple of different routes to financing the debt without increasing interest rates. the Federal Reserve can create money out of thin air. When no other buyer can be found, the Fed can “monetize” the treasury debt by exchanging it for money that comes into existence at the flick of a switch. When China purchased US Treasuries, it exchanged cash already in the system for those debts. The effect was to exchange existing money for the promise of future money. It did not increase the amount of money in the system. But monetization increases the amount of money in circulation. Thus the Fed’s inevitable purchase of billions of dollars in treasury debt will increase inflation significantly. Some observers believe that monetization has already begun. Indeed, by its own numbers, the aggregate base of money has increased in recent months by almost 800%.

A deliberate and coordinated devaluation of the dollar could also help with the debt problem. A dollar devaluation would enable foreigners to buy US debt at a discount due to the relative strength of their currencies, without raising interest rates. It’s not clear to me exactly how such a devaluation could be controlled, though unleashing the Plunge Protection Team on the currency markets might do the trick.

Both monetization and devaluation would hurt anyone who saves their money in the traditional “safe haven” assets: certificates of deposit and US Treasury securities. I have already said a good deal about how to protect one’s assets against this type of scenario in this blog. You might to review past articles to get a feel for these options.

© 2008 Philip Glaser

How Our Monetary System Harms The Environment

November 6, 2008

I can’t imagine a more exciting time to be an American. After eight years of deterioration in our foreign relations, civil rights, and economic policy, Barak Obama will bring meaningful change to our country. My parents had the privilege to witness the rise of Martin Luther King as our country’s greatest civil rights leader. I am priviledged to witness the election of America’s first Afro-American president.

Facing the worst economic crisis since the Great Depression, Obama is wasting no time in putting together an economic security team. His consideration of Paul Volker for the post of Treasury Secretary has great significance. For several years now Volker has been observing with increasing alarm the economic imbalances that lead to the current crisis. As Fed Chairman under Jimmy Carter in the 1970s, Volker restored confidence in the dollar by raising interest rates. Doing so took a great deal of vision and courage because high interest rates impede economic growth. But he succeeded in putting the economy on solid footing for the longer term. Considering Volker for the post of Treasury Secretary demonstrates that Obama understands the type of economic leadership our country needs.

But the current crisis is merely a symptom of the deep structural problems in our world’s financial system, problems that also lie at the root of our environmental crisis.

Catherine Austin Fitts’ audio seminars on The Falling Dollar introduced me to fiat currency and the likelihood of a monetary collapse sometime in the next decade or so.  In her interview with James Turk she pointed out that some environmentalists do not like precious metals. However, though improper mining practices do have a negative environmental impact, she argued that the long term effects of fiat currency and the fractional reserve banking system have done far worse. James Turk added that in the 1960’s Paul Einzig predicted the detrimental environmental outcome of our world’s monetary practices.

I have been planning to research Enzig’s writings to develop my understanding of this problem. Then, today, Providence dropped this wonderful video presentation, Money As Debt, into my lap.

Aside from explaining with great clarity why our monetary system must eventually crumble under its own weight,  Paul Grignon’s fourty-seven minute presentation demonstrates the incompatibility of our fractional reserve banking system with ecological sustainabilty.

In our economic system, the consumption of natural resources must keep pace with the growth of money-debt supply to avoid hyperinflation (hyperinflation can only be avoided when the material output of the eoncomy keeps pace with the growth in money supply). The system makes plundering the earth’s resources not only profitable, but continuously necessary.

Anyone interested in sustainable living must understand and embrace this understanding of our monetary practices. To save the planet, we must develop an alternative system, one that does not require exponential growth in both the money supply and the consumption of natural resources.

And if you choose to protect your personal assets by purchasing precious metals, know that doing so constitutes an act of economic and political protest. By withdrawing value from the monetary system and storing it in a way that does not require interest payments from any counter party, you undermine the money-debt mechanism that our banking system feeds on.

Please watch Grignon’s presentation and think about these ideas. He gets to the sustainability problem at the end of the video, but please watch all of it: very few people have presented the history and practices of fractional reserve banking with this level of clarity and insight. And then bring your questions and comments back here for discussion. I’m really excited about the level of clarity that Grignon brings to these issues.

Note: I recommend that you mute the sound on the video and let it run all the way to the end without watching it, and then rewind it to the beginning and unmute. This way you will buffer the entire video and avoid the annoying interruptions that occur when streaming video content over the web.

Have a great day!

© 2008 Philip Glaser