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Do You Know Where Your Gold Is?

Counterparty and Systemic Risk: How
They Converge
Dubai Precious Metals April 2014
Private and Confidential. Not for distribution
John Hathaway
Bundesbank Gold Repatriation Request; other CBs
Disappearing Comex Gold
Synthetic vs. Physical Gold
Dark Pools of London
Gold as a Source of BB Funding
Eastern Migration of Physical
Creeping Collateral Grab
Your Liquid Wealth is Naked
Systemic Risk; Thermostats and Reactors
Wealth Insurance
How to Own It
January 2013 request to repatriate 300 tonnes from NY Fed and 374
tonnes from Bank of France by 2020
Only 37 tonnes returned last year, of which only 5 tonnes from US
300 tonnes could be shipped in two or three transatlantic flights
Repatriation schedule is in constant flux
Possible reasons:
Gold is no longer in the Fed vault
It is there but not in its original bar form
It is there but encumbered by complicated leasing agreements that
would be disruptive if unwound
Bundesbank Repatriation Request
NY Fed holds 6,700 tonnes of non US gold in custody for foreign
Half of Swedish and Finnish gold is held in London; total custodial gold
held at BOE as of 6/13 = 4,977 tonnes
Total central bank gold reserves = 28,715 tonnes as of 12/31/2013
Therefore, 40% of central bank gold reserves may be subject to leasing,
hypothecation and rehypothecation
Sovereign gold held in world financial capitals is the basis for fractional
gold reserve banking system
Any fractional reserve system is based on trust
Bundesbank Repatriation Request (cont.)
According to the Federal Reserve Bank of New York website:
None of the gold stored in the vault belongs to the New York Fed or the Federal
Reserve System. The New York Fed acts as the guardian and custodian of the gold on
behalf of account holders, which include the U.S. government, foreign governments,
other central banks, and official international organizations. No individuals or private
sector entities are permitted to store gold in the vault.
All bars brought into the vault for deposit are carefully weighed, and the refiner and
fineness (purity) markings on the bars are inspected to ensure they agree with the
depositor instructions and recorded in the New York Feds records. This step is vital
because the New York Fed returns the exact bars deposited by the account holder
upon withdrawalgold deposits are not considered fungible.
Bundesbank Repatriation Request (cont.)
Registered stocks are lowest since 1998
Disappearing Comex Gold
Hypothecation and Rehypothecation
93:1 leverage (according to Reserve Bank of India)
LBMA trading volume is 9,000 tonnes and $413 million daily or $99 billion per year
vs. annual mine production of 2,800 tonnes or $128 million per year
Synthetic vs. Physical Gold
Source:, The CPM Gold Yearbook 2011.
In the UK, an unlimited amount of the customers assets can be rehypothecated and
there are no customer protection rules from The Sizable Role of Rehypothecation in
the Shadow Banking System.
London, the birthplace of offshore banking, provides endless loopholes for US financial
corporations and many US banking catastrophes can be traced substantially to those
companies London offices. (Treasure Islands by Nicholas Shaxon)
Number of subsidiaries of four largest US banks:
1990 - 3,000
2011 - 11,000
2014 - ???
Regulatory probes of London gold fix mechanism by FSA and BaFin launched in 2013
The culture of banking
$43 billion of fines imposed as of year end 2013
Dark Pools of London
Gold as a Source of Bullion Bank Funding
Cost of gold funding = lease rates + basis risk (gold price)
Symbiotic relationship with high frequency traders: over 90% of Comex volume;
50% of US equity trading; FX & interest rates ???
Ownership of HFTs by bullion banks
Virtu Financial (only 1 losing day out of 1,238 days)
Gold as a Source of Bullion Bank Funding (cont.)
Virtu Financial trades $150 billion daily across several markets
NY Attorney General probing HFT fairness and predatory behavior
Synthetic Gold market has huge capacity
Derivative creation by bullion banks to accommodate HFTs is highly profitable
Daily trading gains are miniscule but very predictable
Therefore, sizable leverage must be employed
Gold as a Source of Bullion Bank Funding (cont.)
Borrowed gold is an important source of funding
Therefore, incentive to manage the basis risk of gold is substantial
Gold as a Source of Bullion Bank Funding (cont.)
Eastern Migration of Physical
Launch of London based renminbi gold futures contract
Gold producers shipping increasing amounts of ore to be refined in China, bypassing
Eastern Migration of Physical (cont.)
Source: Bloomberg
Investor rights to securities held in a financial intermediary are security entitlements under
articles 8 and 9 of the US Uniform Commercial Code
This entitlement concept has been adopted by the EU
This arrangement extends even to segregated assets
Hypothecation borrower pledges collateral securing a debt; collateral is hypothetically
controlled by the creditor which has the right to seize possession of the borrower defaults
Re-hypothecation bank/broker-dealer reuses collateral pledged by clients as collateral for its own
borrowings or trading
In the case of insolvency of the financial intermediary (MF Global, Cyprus etc,) the investor
(entitlement holder) has only a pro rata share in the intermediarys interest in the asset in question
Therefore, financial assets held in custody at banks, brokerage firms etc., even if segregated, are
compromised and at risk through hypothecation and rehypothecation
Global derivatives = $700 trillion (BIS)
Global GDP = $70 trillion
All gold mined = $8 trillion
US treasury debt $18 trillion
Market cap of US equities = $19 trillion
Therefore, global derivative business cannot exist without massive rehypothecation
Creeping Collateral Grab
FATCA (Foreign Account Tax Compliance Act) 2010
Foreign financial institutions must declare to US tax authorities all holdings of US
Waiver of bank secrecy:
The Bank is authorized and may submit all historical data related to past and present
accounts of the undersigned to the IRS, Department of Justice or any other US authority.
Severe tax penalties for noncompliance
Account freezes
Cooperation by most tax havens including Switzerland
Your Liquid Wealth is Naked
Fed and other central banks use equilibrium models (thermostat)
Bell curve with random outcomes that can be modeled probabilistically
Evidence for complexity and non equilibrium states is convincing
Power curve, a system of random outcomes that cannot be modeled
probabilistically, but emerge spontaneously and unexpectedly from a complex
dynamical system that is highly dependent on initial conditions (nuclear reactor)
Complex systems exhibit an exponential relationship between system scale and
severity of outcomes
Capital markets are complex systems and their scale has continued to inflate
Conclusion: central bankers, policy makers, and most investors are clueless as to
systemic risk
Systemic Risk; Thermostats and Reactors
What is so special about gold?
Millennial record as a store of value; the most widely recognized and universally accepted
valuable in the world
The only tangible, non-financial asset that is always liquid and practical to own without involving
the financial system
Universal acceptance and ready liquidity at transparent price under virtually any market
conditions across all of the worlds financial centers, without exception.
Gold bullion markets are global, deep and liquid, with institutional trading taking place almost
around the clock in New York, London, Zurich, Dubai, Hong Kong, Singapore and Sydney
Unique combination of global liquidity and independence from currencies and financial
institutions is why central banks around the word hold a portion of their reserves in physical gold
Not only does the US hold the largest gold reserve in the world, it holds it entirely outside the
financial system - at Ft. Knox and at West Point
Reserve must perform if conventional arrangements fail, which is why reserve holdings must be
fully decorrelated from the risks inherent in conventional arrangements. In the case of investment
portfolios, conventional arrangements revolve around financial assets, currencies and financial
Wealth Insurance
Coins and bars
Gold mining shares
Tocqueville Bullion Reserve
How To Own It
Broker Dealer
Stock Exchange
Authorized Participants
ETF Trust
Non-Bank Vaults
The TBR Model
Directly redeemable warehouse
receipts fully backed by gold
held in non-bank vaults.
The ETF Model
Exchange-traded indirect
claims against an allocated
gold bank account.
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