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Rebuttal to “Cash Futures, Physical Forwards, and London Gold's 100-to-1 Leverage"

-- Posted Friday, 23 April 2010 | | Source:

By Adrian Douglas


On April 21, 2010 Paul Tustain, CEO of BullionVault, posted an article at entitled “Cash Futures, Physical Forwards, and London Gold's 100-to-1 Leverage" in which he characterizes my comments and analysis of the LBMA as a “misunderstanding”.



The following commentary is written as a rebuttal to Mr. Tustain’s article.


Mr. Tustain argues that the characterization of the London LBMA OTC market as a “paper” market where the ratio of paper to actual bullion sold is 100:1 is incorrect because much of the “paper” trades are “forwards” which will at some future date be delivered against with actual bullion by the seller of those forwards. I will show that cannot possibly be the case.


The Bank for International Settlements (BIS) in its Q2 2009 OTC Derivatives report gives the notional value of gold forwards and swaps as $179 billion and for silver as $101 billion. In weight terms this is 193 million ozs of gold and 7,481 million ozs of silver. Over the last 50 years all large above ground inventories of silver have been drawn down so the only legitimate sellers of silver forwards on a consistent basis have to be mining companies. The US Geological Survey tells us that in 2009 the total silver reserves on planet earth were 8,400 million ozs. If the LBMA is not a paper market we would have to believe that mining companies have already sold forward 89% of the silver reserves of the world! Yet if we look at the major silver mining companies their production is largely unhedged. So who could possibly have sold forward 89% of the economically mineable silver on the planet if it was not the entities who actually own it? It must be entities who don’t own it. The inevitable conclusion is that the LBMA forward market is a paper market and is not backed by future production.


Mr. Tustain spoke about the spot market and the forward market but conveniently sidestepped the issue of unallocated bullion that is meant to be held by the LBMA. 


What I argued was that there is a large amount of gold that is neither a spot market operation which is for immediate delivery nor a forward purchase that is for delivery in the future. That category is “unallocated gold” which has been bought by investors and should be held by the LBMA on their behalf. The fact that such investors are considered “unsecured creditors” means that the gold is not vault gold but an IOU gold. The LBMA is selling much more bullion than it actually has by employing a fractional reserve system.


Mr. Tustain says “exchangeability is the source of their [futures contracts] liquidity. Forwards, on the other hand, are hopelessly illiquid. Each was custom built 'over the counter' for a specific settlement day. But forwards really are deals in physical gold – which will settle as Good Delivery bars, on almost every day of the year”


He claims that “forwards” are hopelessly illiquid. But the LBMA reports that on average 20 million ozs of gold are transferred each day and 90 million ozs of silver on a net basis. That is $6.5 Trillion of net trade on an annual basis in gold alone. That is one heck of a lot of liquidity! If the forwards are hopelessly illiquid then this trading must be almost entirely due to trading of unallocated gold. I have addressed this before in previous articles and shown that this level of trading cannot be backed 100%. In fact I estimated that approximately 50,000 tonnes of gold has been sold that does not exist in the vaults. Interestingly enough 50,000 tonnes is approximately equal to all the gold reserves left to be mined on the planet.


Finally Mr. Tustain addresses futures market manipulation. He concludes that small investors will lose money in the futures markets because they don’t have the monetary or bullion resources to play against “the professionals” (aka the Gold Cartel). This is exactly what regulations are meant to guard against. Big players are not supposed to make money just because they are big. Is it the small investor’s fault that just two bullion banks are allowed to control anywhere from 40-100% of the net short position or to hold 95% of all OTC precious metals derivatives? Is it the small investor’s fault that two bullion banks in July 2008 sold short the equivalent of 25% of the global annual silver production and 10% of the world gold production in 4 weeks?  This was not some professionals doing some arbitrage between the futures market and the forward curve. This was blatant manipulation because the financial crisis was causing a “run on the bank” of the LBMA due to investors wanting so much bullion that it risked exposing their inability to deliver. This was not “novices” as Mr. Tustain characterized them; this was intelligent and rational investors wanting to protect themselves in a credit crisis. The “run on the bank” for physical had to be stopped at any cost before it exposed the bullion bank short position. So the bullion banks went massively short on the Comex to crater the price to squash the notion that precious metals could be a safe haven. This process was accurately described by Jeffrey Christian in his testimony before the CFTC except he described the shorting on the Comex as “hedging” of the physical sales being made in London. When questioned by Chairman Gensler about this bizarre concept of going short to hedge something that has already been sold he claimed he had misspoken. But the facts speak for themselves; there were physical shortages which even obliged the mints around the world to ration supply, and yet the Comex prices of gold and silver plummeted.


In characterizing the shenanigans on the Comex as perfectly logical arbitrage trades against the forward curve, Mr. Tustain disregards the information given to the CFTC by Andrew Maguire about manipulation of the silver market by JPMorganChase in advance of the manipulative events actually occurring; he also disregards the fact that the CFTC has been investigating alleged manipulation in the silver market for over 19 months. There is a preponderance of evidence that the counterintuitive price behavior of the Comex gold and silver futures market are anything but just innocent arbitrage.


I would like to commend Mr. Tustain for taking the time to publish his comments because it is by way of following a healthy debate that market participants can be better informed. However, his arguments to dismiss my concerns that the LBMA has sold many times more gold and silver than it can deliver do not stand up to close examination.


Of course, the debate could easily be settled by the LBMA making a statement that all the unallocated bullion they have sold is 100% backed by inventory which is unencumbered in any way and publishing a third party to audit to verify it. They could further change their account agreements to make unallocated account holders “secured creditors” instead of “unsecured creditors”. They could further aid investors by publishing data on their forward contracts and details on their trading volumes and making it clear how annual net trades of $6.5 trillion can be achieved with bullion that is not hypothecated and confirming that the Comex futures are hedging real physical bullion and not paper promises of bullion.


I will not hold my breath waiting.


Adrian Douglas

Editor of Market Force Analysis

Board Member of GATA


April 22, 2010

Market Force Analysis is a unique analysis method which provides reliable indications of market turning points and when is a good time to enter, take some profits or exit a market. Subscribers receive bi-weekly bulletins on the markets to which they subscribe.

-- Posted Friday, 23 April 2010 | Digg This Article | Source:


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