Author Archives: Keith Weiner

 

How Can the State Bank of India Pay Interest in Gold?

An article caught my eye this week. The Tirumala Tirupati Temple in India has deposited gold at the State Bank of India, and is getting paid interest on their deposit. There is something unique about this.The interest is paid in gold.

To understand why no one else is paying interest in gold, let’s first look at how one can use any asset class to make a dollar income: speculation. Buy something. Wait. Sell it at a higher price. You can use bonds, stocks, real estate, artwork, or classic Ferraris. By the way, no matter what you use, you are converting what had been someone else’s capital into your own income. This is capital destruction on a massive scale.

Using gold to produce a dollar income is simple. Just sell a covered call with a strike price a little higher than the current market price. You get paid a premium immediately. If the gold price does not rise, then you can repeat the trick and sell another call. If it does rise, you must sell the gold at the strike price. This earns you a profit, as it is above what you paid. Then just buy more gold and do it again.

If you keep your books in dollars, and trade for dollar gains, you don’t really care how much gold you have. You only care about how many dollars. If the gold price doubles, you may end up with about half the gold. But who cares, at least you’re making a steady stream of dollarst hat you can consume.

Making a gold income is something else.

You can’t just sell calls, or sell the gold itself. If you do, and the gold price rises, you will have to buy the gold back. However, the same dollars you have will get you less gold at the higher price. For example, you start with 100oz gold. Today the price is about $1,300 per ounce, and you sell a December call option. It has a strike price of $1,325 and you get paid immediately $25 per ounce or $2,500 for the contract.

Unfortunately — yes this is unfortunate as we shall see in a moment — the gold price jumps in September. It goes to $1,500 and holds steady there. In December, you deliver the gold and per your contract you are paid $1,325 per ounce. Now you have $1,325 × 100oz = $132,500 + the option premium of $2,500 = $135,000.

When you go to buy your gold back, you discover the catch. At the new price, you can only get $135,000 ÷ $1,500 = 90oz. Even after picking up almost two ounces worth of pennies in front of the steamroller, it still squeezed 10 ounces out of you. Your 100oz shrunk to 90oz.

 

TirumalatempleThe Golden Tirumala Tirupati Temple, which is reportedly the richest temple in the world.

(Photo credit: Raj Srikanth)

 

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The Machines Are Coming!

Recently, I have seen a lot of discussion about the future of employment. Many people, from futurists to Leftists, are saying that machines will replace people and most people will be unemployed. This is hogwash, though it has been popular for at least 200 years, when the Luddites were smashing machinery.

Perhaps they didn’t know better, in the early days of Industrial Revolution. Maybe they really didn’t think of machines as providing an escape from drudgery.

They might not have thought that people were freed from long days of backbreaking labor. They may not have considered that increasing productivity benefits the worker, the investor, and the customer—pretty much everyone.

Today, we don’t have their excuse. Economics teaches these points clearly, and this is not my point in writing this essay.

 

700364-real-world-robotsMotoman caught in flagrante delicto, stealing the job of a short order cook. Somebody's got to do something!

(Photo credit: AP)

 

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Like Dripping Silver Icicles

I don’t typically emphasize price charts in analyzing the market, however something unusual has been happening in the spot (physical) silver market. It did not happen in the silver futures market, nor in the gold market. I have been bearish on silver because of its supply and demand fundamentals, and the price action shown below adds a new dimension.

Let’s take a look at a candlestick chart. Candlestick charts show the open, close, and price range during a particular period. The region between the open and close prices is shaded. Green means that the price rose during the period and red indicates it fell.

In this chart, each candlestick corresponds to one hour. The numbers at the bottom are dates. The chart shows from July 17 to July 25, 2014. As with all charts in this article, times and dates are Arizona USA time (PDT).

 

Chart-1, silver hourlySilver Hourly Candlestick Chart - click to enlarge.

 

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Legal Tender Renders Planning Impossible

There is much confusion over what the legal tender law does. I have read articles, written by people who are otherwise knowledgeable about economics, claiming that legal tender forces merchants to accept dollars under threat of imprisonment. Recently, I wrote a short article for Forbes clarifying how legal tender law works in the US.

Legal tender law has nothing to do with merchants. If you want to sell steak dinners in your restaurant for silver, you may legally have at it. Unfortunately, the tax code discourages your would-be customers as I wrote in another article.

The legal tender law targets the lender. It grants to debtors a right to repay a debt in dollars. In practice, this means that if you lend gold, the debtor gets a free put option at your expense. If the gold price rises, he can repay in dollars. If it falls, of course he will be happy to repay in gold. It’s a rotten deal for the lender.

The relationship between lender and borrower is mutually beneficial, or else it would not exist. The parties are exchanging wealth and income, creating new wealth and new income in the process. The government is displeased by this happy marriage, and busts it up by sticking a gun in the lender’s face. His right to expect his partner to honor a signed agreement is violated.

Because no lender will lend gold under such circumstances, gold is relegated to hoarding and speculation only. This strikes a blow to savers, because the best way to save is to lend and earn interest. Savers are forced to choose betweenhoarding gold, getting no yield, or holding dollars and getting whatever yield crumbs are dropped by the Fed.

If there’s no lending in gold, what takes its place? The Fed force-feeds credit in ever-larger amounts, and at ever-falling interest rates.

The Fed is supposed to make its credit decisions in order to optimize two variables. First, employment shouldn’t be too high or too low. Second, consumer prices shouldn’t rise too quickly or too slowly. The Fed has little ability to predict employment and prices, and even less control over them.

 

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The Price of Shipping Is Collapsing

A recurring theme of mine is that one cannot understand the world in terms of the linear Quantity Theory of Money. Let’s look at the cost of shipping.

The money supply has certainly been expanding since 2008. And yet the price of shipping has almost completely collapsed. From a high over 11,000 it’s now down to 755. This is a drop of almost 94%.

The Baltic Dry Index is a dollar price of moving the major materials by sea. The chart shows from just before the acute phase of the crisis to today, July 16, 2014.

 

chart-1-Baltic DryI like to look at the Baltic Dry because, unlike commodities, there is no way to speculate on it and hence drive up the price. (If readers are aware of some sort of futures market or other way for speculators to use credit to bid up prices, then I encourage them to please contact me.) – via Monetary Metals, click to enlarge.

 

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Monetary Metals Silver Headfake Report: 22 June, 2014

Something extraordinary occurred this week. On Wednesday, the Fed made a routine announcement. That day, the price of silver was rising, but not out of the normal. Fireworks began on Thursday, and in 6 hours, the price of silver skyrocketed by 5%.

We have never before changed the headline or format of the Supply and Demand Report. However, it is warranted under the present circumstances.

The Fed’s announcement was mundane. It will continue tapering its bond purchases, from $45B monthly to $35B. It will continue its low interest rate policy. It cut its growth forecast. This was all expected except, arguably, the cut in the forecast.

Some pinned this move on the unwinding of the Chinese commodity finance scheme. That unwind will involve selling metal and buying futures. The impact of this is a rising basis, but probably not a rising price.

Many said that that the Fed was to blame (or credit). One commentator even said that gold had now become an inflation hedge. Apparently it wasn’t last week, but now it is. We respectfully suggest that he step back and take a deep breath.

Looking at a price chart, the action is pretty obvious. This candlestick chart is not the standard chart format we normally use in this Report.

 

chart-1-silverSilver Chart – the blue line shows support around $19, going back 7 months. In the last few days of May, the silver price broke below that line. But by June 10, the price broke out through the line sharply. The breakdown at the end of May was a false breakdown – click to enlarge.

 

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Europe Stricken With Negative Deposit Rate

On Thursday, the European Central bank announced cuts to three of its benchmark interest rates. This is nothing unusual since the global financial crisis began. We are now accustomed to desperate central bank responses. Interest rates have been falling for decades, and the trend continues. What is unusual—unprecedented for a major central bank—is to lower the deposit rate below zero.

A negative deposit rate means that when a bank keeps extra cash on account at the central bank, it pays the central bank a percentage. It’s like telling the banks that having cash is a privilege, for which they must pay. If it sounds pretty crazy, that’s because it is.  First, let’s look at what the ECB says it will do. Then we can dive in and see the likely outcome.

Mario Draghi, President of the ECB, said, “the measures will contribute to a return of inflation rates to levels closer to 2%.” The central bank has been talking a lot about the problem of deflation, by which it means falling prices. The ECB hopes to avoid this fate worse than death, by pushing more euros into circulation. It actually wants prices to relentlessly rise, for salaries to relentlessly lose purchasing power, and for savings to relentlessly erode.

With fiat money, prices rise. This is especially hurtful to people who are struggling to afford food and shelter. Pushing up the cost of living does no good to anyone, but harms the poor most of all. Only a central banker could truly love inflation.

 

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Barclays Caught Red Handed Manipulating Gold

It was all over the news last week, both mainstream and gold sites. Barclays was caught manipulating the gold price. They were fined £26M, and forced to pay a client who was damaged by their action. The trader who worked for Barclays, Daniel Plunkett, was also fined and banned from working in the financial sector. Here is a link to an article at the Financial Times.

This story is a big deal to the gold community.

It is commonly held that the gold price should be much higher than it is today. For example, many think the proper gold price is the money supply divided by the gold held by the US government. The monetary base is currently about $4T. The US Treasury owns about 261M ounces of gold. Simple math gives us $15,300 per ounce. If we use a broader measure of the money supply, the gold price should be even higher.

Also, there is the argument from common sense. Since 2008, the Fed has been “printing” trillions of dollars. Its balance sheet ballooned from just over $800B to just under $4.4T today. With all this fresh, new money flooding into the markets, why isn’t the gold price reacting as it should?

There are other theoretical arguments why the gold price should be skyrocketing. Instead, the fact is that it’s been dropping since 2011.

It must be that someone is pushing the gold price down. How else can we explain why the price is $1,300 and falling? They are keeping it thousands, if not tens of thousands of dollars, below the level where it ought to be.

And now, we have the Barclays scandal. It seems to offer the smoking gun, incontrovertible proof that the gold market is indeed manipulated.

Not quite.

Consider this analogy. Suppose a teenager stands accused of setting fire to several homes in his neighborhood. Despite investigations by the town police, sheriff, state police, and the FBI, they cannot find the sort of evidence that would convict him in court. Then, a breakthrough occurs. The kid is caught red-handed stealing candy at the corner store. Can the district attorney bring him to trial for multiple counts of arson now?

 

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The Lazy 1970’s vs. the Frenetic 2000’s

Many people today see the Fed’s Quantitative Easing as money printing. They remember what happened in the 1970’s, and they instantly jump to conclusions. However, we live in a different world. To illustrate this, consider the following story about Joe, a promising and eager young manager in a struggling manufacturing company.

Joe excitedly walks into the boardroom and pitches his idea. “Let’s borrow a billion dollars. We can use it to build a massive warehouse and to buy massive quantities of our raw materials!”

The senior management team stares at him. The CEO demands, “Why?”

“We need to have a stockpile at every level. We should start with 3 months of raw materials, and a three-month buffer of work-in-progress in between every one of the 27 steps of our manufacturing line. And even better, we need to warehouse finished product. We shouldn’t ship anything that hasn’t been sitting for at least 4 months. Ideally six, but we can start with four.” Joe has the bit in his teeth now.

He rushes on. “Bernanke has printed so much money, and Yellen is going to continue. We already have massive inflation and it’s going to get worse! By borrowing to buy stuff that is only going up in price, we can make extra profits and protect ourselves from supply shocks as the cost of commodities rises out of sight!”

The CFO leans over to whisper in the ear of a young assistant, Bill. Bill does a quick Google search and finds the price of copper, which is one of the most important raw materials the company buys. Bill puts the copper chart up on the screen. It has fallen a third over the past few years.

 

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The End (of the Silver Fix) Is Nigh

For a long time, many in the gold and silver communities have been say that the prices of the monetary metals are manipulated. Recently, one particular allegation came to prominence because it was asserted by the German regulator BaFin. This allegation is that the members of the London Fixes for gold and silver are using their position to manipulate the price. This would seem to be confirmation of widely held longstanding belief that the markets are rigged, the long-sought smoking gun.

Not so fast.

If you dig through the numerous articles that have been published on this topic, you get a slightly more nuanced picture. The allegation is not that the banks who run the Fix are keeping the price suppressed. The allegation is rather less earth shattering. They are allegedly front-running their clients. Skimming money from client order flow may or may not be illegal in London. I don’t know. It may be unethical, but that’s not my point today.

 

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Monetary Metals Supply and Demand Report: 11 May, 2014

This was another short week, with Monday a bank holiday in the UK.

Through Tuesday, the prices of the metals seemed to want to hold onto the increase that was sparked by an unemployment report. It wasn’t until Wednesday that the prices began to sag, almost but not quite to the pre-unemployment report levels again by Friday.

We are not going to lament the folly of man nor trader. We are not even going to comment on the accuracy, or lack thereof, of the unemployment data. We are simply interested in the evolving dynamic between the fundamental setters of the prices of the monetary metals and the speculators who are trying to front run them.

Read on…

 

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High Frequency Trading

If you've read about High Frequency Trading (HFT) then you may know that it's all about bad things such free markets, ruthless trading, Wall Street, banksters, greed, and profits.

Or else, you may have read that it's about good things like the American can-do spirit, ingenuity, technology, and improving markets to the betterment of all.

Both HFT’s detractors and its defenders are missing the point. It’s an exploit of a system that is grossly distorted by regulation. I don’t refer to the old-fashioned kind of regulation, such as requiring a doctor to show he is competent before doing open-heart surgery. I refer to the modern kind, in its full malignant glory of cronyism.

Richard Christopher Whalen makes the case in this article. Our markets are fragmented. They’re kept in this state, constantly on the verge of breaking, by 600 pages of regulation enacted in 2007, Regulation National Market System (Reg NMS).

 

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Gold and Silver Speculation

There is a stark difference between the states of the markets for the monetary metals. The number of open futures contracts in gold is low, while in silver it’s high. First, let’s look at the data and then we’ll discuss what it means.

Here is the graph showing the open interest.

 

chart-1-open interestThe picture is clear enough. Since the beginning of fall, the number of gold contracts has blipped up and down and now there are somewhat fewer (-3.7%). Meanwhile, the number of silver contracts has gone up substantially (+39%) – click to enlarge.

 

Now let’s look at the ratio of gold contracts to silver contracts, going back to 2010.

 

chart-2 open intThere is an unmistakable downward trend since the middle of 2010, almost 4 years ago. Then, there were about five gold contracts for every silver contract. Today, the ratio is down to two – click to enlarge.

 

OK, but what does this mean?

 

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Why Was China Carrying Gold?

Zero Hedge has run anexcellent article explaining the use of commodities, beginning with copper, to work around the Chinese government’s imposed capital controls[1]. Capital controls are intended to prevent arbitrage between the dollar interest rate and the yuan interest rate, which is much higher.To keep this gap open, and prevent the arbitrage—aka hot money—they have a choice to shut off trade with the outside world as North Korea does, or resort to capital controls.

The basic idea of capital controls is that the government thinks it can tell the difference between “good” and “bad” types of money moving in or out. As we’ll see below, arbitragers are clever and will do whatever it takes to make their transactions look like the “good” kind.

I describe one scheme used to work around Chinese capital controls, below. It’s complicated, and the details are a bit murky. I may even get them slightly wrong, but I am trying to paint the big picture in clear terms.

A Chinese company gets a letter of credit from a bank. With that in hand, it buys a quantity of copper. The copper is keptoffshore or in a bonded warehouse, so there are no duties paid to import it.

 

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Monetary Metals Supply and Demand Report: 30 Mar, 2014

The gold price fell about forty bucks, and the silver price fell about fifty cents. There are many ongoing rumors about what could be happening in supply and demand for the metals. Mostly, these are about how the world is gobbling up physical metal and the prices will soon skyrocket. A well-known commentator this week declared that manipulation is so “obvious” now that it ought to embarrass the manipulators. We’re not big on trying to embarrass anyone, but we would suggest that anyone who wants to know the truth about the persistent manipulation conspiracy theory should read on below, in the discussion on gold.

Here is the graph of the metals’ prices.

 

chart-1- pricesThe Prices of Gold and Silver - click to enlarge.

 

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