Keith Weiner

Impact Of Germany’s Gold Repatriation

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Germany has announced that it plans to take home all 374 tons of its gold stored at the Banque de France, and 300 out of 1,500 tons held at the Federal Reserve Bank of New York.

Bill Gross of PIMCO tweeted:

In this article, I consider some popular reactions to the news and then present my own analysis and some ideas about what I think could happen.

Declining trust is a global megatrend. It is impossible to ignore. I proposed trying to measure it as one indicator for financial Armageddon in my dissertation.

I am sure distrust for the US government, or more likely, responding to the German voter’s distrust is among their concerns. But, I doubt that this is the primary motivation. The Bundesbank is not acting as if they are in any hurry, planning to have the gold moved over a period of 8 years (yes, I know, it all “fits”, the delay is because the Fed hasn’t got the gold, etc.) A lot can and will happen in 8 years (including the end of the current monetary system). The distrust theory has to answer: why would Germany leave 1,200 tons of gold in New York and 447 tons in London?

As a side note, if distrust grows to the point where a major government cannot trust another major government with $2.4B worth of gold, then there are some negative consequences. The gold market will not be the greatest of them, as the world experiences a collapse in trade, borders are closed to the movement of (peaceful) people, goods, and money, and the world in general moves towards world war and the possibility of a new dark age.

Some have declared that German’s gold withdrawal is a “game changer”. The game will change sooner or later, and gold will be used again as money. In this sense, German’s move is not a game-changer at all. They are just moving metal from one central bank vault to another. They are doing nothing to change the paper game into a gold game. They are not helping gold to circulate.

In any case, I don’t think this is what most pundits mean when they say, “game changer”. I think they mean the price will rise sharply. This follows from the belief that the Federal Reserve has already sold this gold, perhaps multiple times over. If this were true, then it would be obvious why Germany would want its gold back, while it is still possible to get it back. This would force the Fed to buy it back. This would cause the price to rise.

The data does not fit this theory.

At the time I prepared the chart for my appearance on Capital Account, there were less than 400,000 gold futures contracts open. Even if there were a conspiracy to manipulate the market by naked shorting futures, a big fraction of them would certainly be legitimate. There aren’t enough contracts to support the theory that Germany’s 1500 tons of gold, which would be about 480,000 COMEX contracts, was sold in the futures market (let alone that it was sold multiple times over!)

Alternatively, the Fed could have sold the gold in the physical market (albeit only once). This gives us an easily testable hypothesis. If the Fed had sold Germany’s gold and now it must buy about 1.2M ounces a year, this should show up in the gold basis. The Fed would become the marginal buyer of physical gold. This should cause the basis to fall sharply, or perhaps even go negative.

This is a graph of the gold basis (for the December contract). There has been a gently falling trend since the start of the data series in July, from about 0.7% annualized to around 0.55%.

Gold Basis

It is hard to guess how much impact would occur as a result of a new 1.2M ounces of annual demand at the margin. This would be about 5000 ounces a day, every business day relentlessly for 8 years (assuming it is disbursed evenly, which is doubtful). I think there would be an impact in the basis. We shall have to wait, and watch the basis to see.

I think the Fed does have the gold, or at least title to gold leases. If the gold is out on lease, then the Fed would have to wait for the leases to mature. The leased gold might even be in the Fed’s vaults. It has to be stored somewhere, and to a financial institution the Fed’s vault is as good as anywhere.

I plan to write more about gold lending and leasing. In short, no one today borrows gold to directly finance anything. The world runs on dollars. A gold lease today is basically a swap. One party provides gold. The other party provides dollars. And at the end, the gold and dollars are returned to their original owners; plus one party has to pay dollars to the other. Typically the party who owns the gold pays net interest (it’s like a dollar loan to the gold owner, secured by the latter’s gold as collateral).

Of course the Fed has no need to borrow dollars, so if it leases gold it must be for another reason. I can think of two.  First, the Fed might want to remove liquidity from the banking system (though not in the post-2008 world!). Second, the Fed might accommodate the case of a bank with a profitable gold arbitrage opportunity. There are several potential candidates, but one that comes to mind is temporary gold backwardation. In this case, the Fed leases gold to a bank. The bank sells the gold in the spot market, and simultaneously buys a future. The bank ends with the same gold bar and pockets a spread. It returns the gold to the Fed and even gets a little interest on the dollars it lent against the Fed’s gold collateral.

While this might have been occurring intermittently since December 2008, there is not much of a backwardation today in the February contract (around 0.1% annualized). And in any case, a lease for this purpose would be a short-term lease as there has not been any backwardation in long-dated futures, only the expiring month (less than 60 days).

Moving 300 tons of gold from New York to Frankfurt will be a non-event in the gold market in itself. However, there could be a large and unpredictable change if the gold-buying public sees this as a reason to increase their distrust of the system and runs to their nearest coin shop to load up.

Let’s not forget that the Bundesbank is also a central bank, invested in the regime of irredeemable currency. Like the Fed, it is built on faith in Keynesianism, along with some Monetarism and Mercantilism. Is there any reason to assume that they would not do the same things that the Fed is doing, when they feel the same pressures? The gold is going out of the frying pan and … into another frying pan.

What if the Fed is currently leasing out all 300 tons and the Bundesbank plans not to lease? This would remove some gold currently circulating in the market.  Will this cause the price to rise? Certainly.

More importantly, it is a move away from the gold standard, away from the use of gold as money. It is a step towards the end.

I suspect the reason for repatriating the gold has more to do with a shift in German politics than any sudden concern about the intentions of the Fed, any sudden questions about the faith and credit of a central bank, or any desire to re-monetize gold in Germany. Readers from Germany are encouraged to write me if they disagree.

Copyright © 2013 · Keith Weiner

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