IMF Gold Sales v. the Alchemy of Gold Futures – What’s the Impact on Gold Prices?

This article is a guest contribution by J.S. Kim, of SmartKnowledgeU™.

The recently announced IMF sale of 191.3 tonnes of their gold reserves, though it caused an immediate sharp knee-jerk reaction in gold futures markets, will have a negligible effect on the long-term price of gold. Here’s why.

In December, 2009 the commercial bullion banks that serve as agents for the leading Western Central Banks were net short 303,791 contracts of gold. Each COMEX gold futures contract represents 100 troy ounces, so the Commercials were net short 30,379,100 troy ounces of gold. With the average price of gold $1,134.72 per troy ounce in December 2009, this net short commercial position represented $34.47 billion worth of gold. There are 32,150.74533 troy ounces in one metric tonne. So 30,379,100 troy ounces/ 32,150.74533 troy ounces = 944.90 metric tonnes of gold. Since gold contracts are supposed to be good for physical delivery, the commercial bullion banks that were short nearly 38% of annual world production of gold this past December should have had 944.90 physical metric tonnes of gold in their vaults to back up their short position at that time. In reality, this situation never exists.

The amount of physical gold that the COMEX delivers on a daily basis is negligible compared to the massive historical short positions that have existed for decades. For example, during a two-week span across January and February, COMEX arranged for the physical delivery of 543,500 troy ounces of gold with their contracted warehouse depositories, a figure that represents an average of just 38,786 troy ounces of gold per day. At this rate of daily delivery, it would take the COMEX more than two years to deliver all the gold represented by the current net commercial short position should the holders of long contracts ask for settlement in physical delivery.

Through the use of futures markets, the Commodities Futures Trading Commission (CFTC) has granted bankers a mechanism to perform alchemy and turn paper into gold on the COMEX by allowing them to establish obscene short positions that represent 25% to nearly 40% of annual gold production at times while simultaneously allowing them to renege on their fiduciary responsibility to actually physically possess the gold represented by their short positions. In other words, the CFTC has allowed gold to operate under the principles of the fractional reserve banking system on the COMEX futures markets. As I stated above, the net short position of the commercials in gold represented more than 30 million troy ounces yet for the past few months they almost never exceeded delivery of 0.2% of their short position on a daily basis. Many people would refute this argument by stating that COMEX only delivered a minute fraction of physical gold represented by this obscene short position because no institution asked for substantial physical delivery of their long contracts. While it is true that less than 1% of most commodity futures contracts are ever settled by physical delivery, futures markets should not exist to serve the purpose of distorting the underlying reality of supply-demand fundamentals of the actual physical commodity. With gold and silver, this has been the case for decades.

However, the real question should be, “If I asked for physical delivery of an amount of gold that I should be able to receive, would I receive it?” Why? If you were India, China or the United Arab Emirates and you wanted to buy 200 tonnes of gold at the price established in futures markets, but you knew that there was no possible situation whereby 200 tonnes of gold would ever be delivered to you via the futures markets, what would you do? Would you buy 200 tonnes of gold in the futures markets only to know that you would suffer a default of this delivery and likely be forced to pay a much higher price in the open market in the future or would you try to arrange to buy 200 tonnes of gold NOW from the IMF or another Central Bank? Of course, you would choose the latter tactic. The fact that gold cannot be printed out of thin air is the essential quality that makes gold as a form of money much more sound than the Euro, the dollar, the Yen or any other form of fiat currency.

However, tens of billions of dollars of gold exist only in digital form on the COMEX and the CFTC has allowed bullion banks to indeed achieve alchemy with gold (and silver) in the futures markets. By allowing these mechanisms to persist that have absolutely zero to do with physical supply and demand of gold and silver, bullion banks can suppress the price of paper gold and paper silver in futures markets. But in the end, they will never be able to perpetually suppress the price of real physical gold and real physical silver. There will come a time when the prices for real physical gold and real physical silver completely sever the already tenuous umbilical cord they maintain to the suppressed prices of gold and silver established by the agent bullion banks of the US Federal Reserve and the Bank of England in futures markets.

As of February 17, the CME warehouse report stated that their depository warehouses contained 1,645,000 troy ounces of registered gold and 8,292,887 troy ounces of eligible gold. Only two of their depository warehouse have significant amounts of physical gold worth mentioning, HSBC, with 4,311,493 ounces of eligible gold and 266,677 troy ounces of registered gold; and Scotia Mocatta with 3,826,013 ounces of eligible gold and 936,855 troy ounces of registered gold. What does “registered” and “eligible” gold mean? As in everything bankers do, these terms are meant to confuse the average person. Central Bankers have used the same tactics to obscure their true holdings of gold reserves by alternately labeling their gold reserves as Bullion Reserve, Custodial Gold Bullion Reserve, and Deep Storage Gold, without granting any transparency to the definitions of their gold stores whenever they arbitrarily reclassify them with different names.

“Registered” gold is gold that has been assigned ownership and cannot be sold to another party while “eligible” gold is gold awaiting registration or delivery. In other words, a large portion of “eligible” gold may not be eligible at all. Furthermore, there are many questions regarding the “registered” gold that these depository warehouses hold as to whether multiple claims exist upon this “registered” gold. Many may say that questioning the validity of "registered" gold is non-justified paranoia, but the historical deceit of bankers justifies our skepticism, not our trust, in them. Just as multiple claims exist upon every single dollar, Euro, pound and yen that shows up in your savings or checking deposit bank passbook, I still believe that the gold listed as “registered” gold may have multiple owners as well (When it comes to the money in your bank savings and checking accounts, you may have the only claim on the digital representation of the cash money that exists in your bank savings and checking accounts, but that digital representation, since it has not yet been printed in cash, is an abstract concept that exists only in your mind and not in real life).

Though “registered” gold represents gold that has already been assigned to someone, unless that physical gold is in your hands, this does not preclude the fact that bankers may have assigned this “registered” gold to “multiple” owners no matter what they claim. Remember if one reads the fine print of the prospectuses of the GLD and SLV paper ETFs, it seems very likely that multiple claims exist on the physical gold and silver that back both the GLD and SLV even though the vast majority of buyers of these ETFs believe otherwise.

Last week's Commitment of Traders report indicated that commercial bullion banks were still net short 21,342,700 troy ounces of gold. Given the definitions of “registered” and “eligible” gold, and the amounts of registered and eligible gold that exist in COMEX depository warehouses, it is obvious that bullion banks short gold with zero intention of ever physically delivering well over 90% of the gold ounces they short, even though market mechanisms require them to have the physical capacity and means to do so. Thus, if China, India or any number of Sovereign Wealth Funds wanted to buy another 1000 tonnes of gold, it would be physically impossible for them to even partially fulfill this desire. The 663.83 metric tonnes of gold that are currently represented by the physical offset of the current net short positions of the commercials that is supposed to be physically sitting in the vaults of depository warehouses contracted out by COMEX simply is not there. Furthermore, what is “eligible” for delivery may not even be eligible, and multiple claims may exist on both “eligible” and “registered” gold that exists in the contracted depository warehouses.

In the end, the announced IMF sale of 191.3 tonnes of their gold reserves, though it caused an immediate sharp knee-jerk reaction in gold futures markets, will have a negligible effect on the long-term price of gold. The IMF stated that “it would stagger the sales in order not to affect the markets too much”. However, since sovereign state buyers of gold can not get anywhere near the tonnage of gold they desire from the futures markets, the reality is that the IMF could probably dump all 191.3 tonnes on the market in one month and it would be instantly absorbed by China, India and Middle Eastern sovereign funds before any other Central Banks that also wants in on the sale could get their hands on any of it.

More than a year ago, I wrote an article describing the beginning of a disconnect between gold futures markets in Asia with those in London and New York, as well as the disconnect between physical gold and silver prices with the spot prices established in the futures markets in London. Eventually, due to the fraudulent nature of the gold and silver futures markets that have nothing to do with the physical supply and demand of the underlying commodities and everything to do with the desire of the US Federal Reserve and the Bank of England to suppress gold and silver prices, I believe that this disconnect will widen until there is an eventual total disconnect between the AM and PM London Price Fixes for gold and silver and the actual prices demanded by bullion dealers for real physical gold and real physical silver.

About the author: JS Kim is the Managing Director & Chief Investment Strategist for SmartKnowledgeU™, a fiercely independent wealth consultancy company with zero affiliations with the commercial investment and banking industry. Our independence allows us to critically analyze macroeconomic conditions with a completely unbiased eye, a crucial factor in a market where government intervention into free markets is heavily influenced by their friendly relationships with the investment and banking sector.

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