Tues Post #2: BLOOMBERG - Silver could hit $50 by the end of 2012

Haven't done too many posts on precious metals for you lately, but your dutiful scribe has not changed his outlook on the precious metals front.

The mainstream media is alive with precious metals talk.

Above, Bloomberg is out with a story telling us Silver could hit $50 by the end of 2012.

Meanwhile, over on CNBC, the latest CNBC Commodities Corner was discussing Gold. With the yellow metal nearing $1,800 again the panel attempted to claim gold is ‘in a bubble’ and that ‘nobody actually needs gold.‘ Therefore those wishing to allocate a portion of their funds to gold should utilize an ETF.

One of their guest's, Managing Director & CIO at Swiss Asia Capital - Juerg Kiener, calmly shot down all of CNBC’s arguments stating, ‘Gold is actually money. When you believe that gold is actually money, would you rather have your money in your pocket, or give it to a loan shark? Physical ownership in your own hands is key!‘

Regarding CNBC’s claims gold is in a bubble Kiener replied: ‘I’ve never seen a bubble in which investors’ allocation is under 1%‘.

Nothing to sway the debate for either side, but interesting to see the discussions in the MSM.

 

Finally, for those interested in the topic... the latest report from Eric Sprott.

Do Western Central Banks Have Any Gold Left???

By: Eric Sprott & David Baker

Somewhere deep in the bowels of the world’s Western central banks lie vaults holding gargantuan piles of physical gold bars… or at least that’s what they all claim. The gold bars are part of their respective foreign currency reserves, which include all the usual fiat currencies like the dollar, the pound, the yen and the euro.

Collectively, the governments/central banks of the United States, United Kingdom, Japan, Switzerland, Eurozone and the International Monetary Fund (IMF) are believed to hold an impressive 23,349 tonnes of gold in their respective reserves, representing more than $1.3 trillion at today’s gold price. Beyond the suggested tonnage, however, very little is actually known about the gold that makes up this massive stockpile. Western central banks disclose next to nothing about where it’s stored, in what form, or how much of the gold reserves are utilized for other purposes. We are assured that it’s all there, of course, but little effort has ever been made by the central banks to provide any details beyond the arbitrary references in their various financial reserve reports.

Twelve years ago, few would have cared what central banks did with their gold. Gold had suffered a twenty year bear cycle and didn’t engender much excitement at $255 per ounce. It made perfect sense for Western governments to lend out (or in the case of Canada – outright sell) their gold reserves in order to generate some interest income from their holdings. And that’s exactly what many central banks did from the late 1980’s through to the late 2000’s. The times have changed however, and today it absolutely does matter what they’re doing with their reserves, and where the reserves are actually held. Why? Because the countries in question are now all grossly over-indebted and printing their respective currencies with reckless abandon. It would be reassuring to know that they still have some of the ‘barbarous relic’ kicking around, collecting dust, just in case their experiment with collusive monetary accommodation doesn’t work out as planned.

You may be interested to know that central bank gold sales were actually the crux of the original investment thesis that first got us interested in the gold space back in 2000. We were introduced to it through the work of Frank Veneroso, who published an outstanding report on the gold market in 1998 aptly titled, “The 1998 Gold Book Annual”. In it, Mr. Veneroso inferred that central bank gold sales had artificially suppressed the full extent of gold demand to the tune of approximately 1,600 tonnes per year (in an approximately 4,000 tonne market of annual supply). Of the 35,000 tonnes that the central banks were officially stated to own at the time, Mr. Veneroso estimated that they were already down to 18,000 tonnes of actual physical. Once the central banks ran out of gold to sell, he surmised, the gold market would be poised for a powerful bull market… and he turned out to be completely right – although central banks did continue to be net sellers of gold for many years to come.

As the gold bull market developed throughout the 2000’s, central banks didn’t become net buyers of physical gold until 2009, which coincided with gold’s final break-out above US$1,000 per ounce. The entirety of this buying was performed by central banks in the non-Western world, however, by countries like Russia, Turkey, Kazakhstan, Ukraine and the Philippines… and they have continued buying gold ever since. According to Thomson Reuters GFMS, a precious metals research agency, non-Western central banks purchased 457 tonnes of gold in 2011, and are expected to purchase another 493 tonnes of gold this year as they expand their reserves.1 Our estimates suggest they will likely purchase even more than that. The Western central banks, meanwhile, have essentially remained silent on the topic of gold, and have not publicly disclosed any sales or purchases of gold at all over the past three years. Although there is a “Central Bank Gold Agreement” currently in place that covers the gold sales of the Eurosystem central banks, Sweden and Switzerland, there has been no mention of gold sales by the very entities that are purported to own the largest stockpiles of the precious metal. The silence is telling.

Over the past several years, we’ve collected data on physical demand for gold as it has developed over time. The consistent annual growth in demand for physical gold bullion has increasingly puzzled us with regard to supply. Global annual gold mine supply ex Russia and China (who do not export domestic production) is actually lower than it was in year 2000, and ever since the IMF announced the completion of its sale of 403 tonnes of gold in December 2010, there hasn’t been any large, publicly-disclosed seller of physical gold in the market for almost two years.4 Given the significant increase in physical demand that we’ve seen over the past decade, particularly from buyers in Asia, it suffices to say that we cannot identify where all the gold is coming from to supply it… but it has to be coming from somewhere.

To give you a sense of how much the demand for physical gold has increased over the past decade, we’ve listed a select number of physical gold buyers and calculated their net change in annual demand in tonnes from 2000 to 2012 (see Chart A).

CHART A (click on image to enlarge):

Numbers quoted in metric tonnes.

† Source: CBGA1, CBGA2, CBGA3, International Monetary Fund Statistics, Sprott Estimates.

†† Source: Royal Canadian Mint and United States Mint.

††† Includes closed-end funds such as Sprott Physical Gold Trust and Central Fund of Canada.

^ Source: World Gold Council, Sprott Estimates.

^^ Source: World Gold Council, Sprott Estimates.

^^^ Refers to annualized increase over the past eight years.

As can be seen, the mere combination of only five separate sources of demand results in a 2,268 tonne net change in physical demand for gold over the past twelve years – meaning that there is roughly 2,268 tonnes of new annual demand today that didn’t exist 12 years ago. According to the CPM Group, one of the main purveyors of gold statistics, the total annual gold supply is estimated to be roughly 3,700 tonnes of gold this year. Of that, the World Gold Council estimates that only 2,687 tonnes are expected to come from actual mine production, while the rest is attributed to recycled scrap gold, mainly from old jewelry. The reporting agencies have a tendency to insist that total physical demand perfectly matches physical supply every year, and use the “Net Private Investment” as a plug to shore up the difference between the demand they attribute to industry, jewelry and ‘official transactions’ by central banks versus their annual supply estimate (which is relatively verifiable). Their “Net Private Investment” figures are implied, however, and do not measure the actual investment demand purchases that take place every year. If more accurate data was ever incorporated into their market summary for demand, it would reveal a huge discrepancy, with the demand side vastly exceeding their estimation of annual supply. In fact, we know it would exceed it based purely on China’s Hong Kong gold imports, which are now up to 458 tonnes year-to-date as of July, representing a 367% increase over its purchases during the same period last year. If the imports continue at their current rate, China will reach 785 tonnes of gold imports by year-end. That’s 785 tonnes in a market that’s only expected to produce roughly 2,700 tonnes of mine supply, and that’s just one buyer.

Then there are all the private buyers whose purchases go unreported and unacknowledged, like that of Greenlight Capital, the hedge fund managed by David Einhorn, that is reported to have purchased $500 million worth of physical gold starting in 2009. Or the $1 billion of physical gold purchased by the University of Texas Investment Management Co. in April 2011… or the myriad of other private investors (like Saudi Sheiks, Russian billionaires, this writer, probably many of our readers, etc.) who have purchased physical gold for their accounts over the past decade. None of these private purchases are ever considered in the research agencies’ summaries for investment demand, and yet these are real purchases of physical gold, not ETF’s or gold ‘certificates’. They require real, physical gold bars to be delivered to the buyer. So once we acknowledge how big the discrepancy is between the actual true level of physical gold demand versus the annual “supply”, the obvious questions present themselves: who are the sellers delivering the gold to match the enormous increase in physical demand? What entities are releasing physical gold onto the market without reporting it? Where is all the gold coming from?

There is only one possible candidate: the Western central banks. It may very well be that a large portion of physical gold currently flowing to new buyers is actually coming from the Western central banks themselves. They are the only holders of physical gold who are capable of supplying gold in a quantity and manner that cannot be readily tracked. They are also the very entities whose actions have driven investors back into gold in the first place. Gold is, after all, a hedge against their collective irresponsibility – and they have showcased their capacity in that regard quite enthusiastically over the past decade, especially since 2008.

If the Western central banks are indeed leasing out their physical reserves, they would not actually have to disclose the specific amounts of gold that leave their respective vaults. According to a document on the European Central Bank’s (ECB) website regarding the statistical treatment of the Eurosystem’s International Reserves, current reporting guidelines do not require central banks to differentiate between gold owned outright versus gold lent out or swapped with another party. The document states that, “reversible transactions in gold do not have any effect on the level of monetary gold regardless of the type of transaction (i.e. gold swaps, repos, deposits or loans), in line with the recommendations contained in the IMF guidelines.” (Emphasis theirs).

Under current reporting guidelines, therefore, central banks are permitted to continue carrying the entry of physical gold on their balance sheet even if they’ve swapped it or lent it out entirely. You can see this in the way Western central banks refer to their gold reserves. The UK Government, for example, refers to its gold allocation as, “Gold (incl. gold swapped or on loan)”.

That’s the verbatim phrase they use in their official statement. Same goes for the US Treasury and the ECB, which report their gold holdings as “Gold (including gold deposits and, if appropriate, gold swapped)” and “Gold (including gold deposits and gold swapped)”, respectively (see Chart B). Unfortunately, that’s as far as their description goes, as each institution does not break down what percentage of their stated gold reserves are held in physical, versus what percentage has been loaned out or swapped for something else.

The fact that they do not differentiate between the two is astounding, (Ed. As is the “including gold deposits” verbiage that they use – what else is “gold” supposed to refer to?) but at the same time not at all surprising. It would not lend much credence to central bank credibility if they admitted they were leasing their gold reserves to ‘bullion bank’ intermediaries who were then turning around and selling their gold to China, for example. But the numbers strongly suggest that that is exactly what has happened. The central banks’ gold is likely gone, and the bullion banks that sold it have no realistic chance of getting it back.

CHART B (click on image to enlarge):

Sources:

1) http://www.bankofengland.co.uk/statistics/Documents/reserves/2012/Aug/te...

2) http://www.treasury.gov/resource-center/data-chart-center/IR-Position/Pa...

3) http://www.ecb.int/stats/external/reserves/html/assets_8.812.E.en.html

4) http://www.boj.or.jp/en/about/account/zai1205a.pdf

5) http://www.imf.org/external/np/exr/facts/gold.htm

6) http://www.snb.ch/en/mmr/reference/annrep_2011_komplett/source

Notes:

ECB Data as of July 2012. Bank of Japan data as of March 31, 2012.

* European Central Bank reserves is composed of reserves held by the ECB, Belgium, Germany, Estonia, Ireland, Greece, Spain, France, Italy, Cyprus, Luxembourg, Malta, The Netherlands, Austria, Portugal, Slovenia, Slovakia and Finland.

** Bank of Japan only lists its gold reserves in Yen at book value.

Our analysis of the physical gold market shows that central banks have most likely been a massive unreported supplier of physical gold, and strongly implies that their gold reserves are negligible today. If Frank Veneroso’s conclusions were even close to accurate back in 1998 (and we believe they were), when coupled with the 2,300 tonne net change in annual demand we can easily identify above, it can only lead to the conclusion that a large portion of the Western central banks’ stated 23,000 tonnes of gold reserves are merely a paper entry on their balance sheets – completely un-backed by anything tangible other than an IOU from whatever counterparty leased it from them in years past. At this stage of the game, we don’t believe these central banks will be able to get their gold back without extreme difficulty, especially if it turns out the gold has left their countries entirely.

We can also only wonder how much gold within the central bank system has been ‘rehypothecated’ in the process, since the central banks in question seem so reluctant to divulge any meaningful details on their reserves in a way that would shed light on the various “swaps” and “loans” they imply to be participating in. We might also suggest that if a proper audit of Western central bank gold reserves was ever launched, as per Ron Paul’s recent proposal to audit the US Federal Reserve, the proverbial cat would be let out of the bag – with explosive implications for the gold price.

Notwithstanding the recent conversions of PIMCO’s Bill Gross, Bridegwater’s Ray Dalio and Ned Davis Research to gold, we realize that many mainstream institutional investors still continue to struggle with the topic. We also realize that some readers may scoff at any analysis of the gold market that hints at “conspiracy”. We’re not talking about conspiracy here however, we’re talking about stupidity. After all, Western central banks are probably under the impression that the gold they’ve swapped and/or lent out is still legally theirs, which technically it may be.

But if what we are proposing turns out to be true, and those reserves are not physically theirs; not physically in their possession… then all bets are off regarding the future of our monetary system. As a general rule of common sense, when one embarks on an unlimited quantitative easing program targeted at the employment rate (see QE3), one had better make sure to have something in the vault as backup in case the ‘unlimited’ part actually ends up really meaning unlimited. We hope that it does not, for the sake of our monetary system, but given our analysis of the physical gold market, we’ll stick with our gold bars and take comfort as they collect more dust in our vaults, untouched.

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Mon Post #1: China's bubble is starting to break

Patrick Wolff, founder and chief executive officer of Grandmaster Capital Management LLC, was on Bloomberg Television's "Money Moves" talking about China.

In his words, China's bubble is starting to break.

The thing that is really striking about China is that there is an extraordinary double standard in the world today. You know, what you have in China is a state dominated, really state controlled, economy. It's, you know, it's not really capitalism by any stretch; it's something different. And it's very striking to me that the same people who would probably be apoplectic at the idea of the US government tightening regulations even a little bit in some area--that I know you were talking about the Volker Rule earlier where obviously there is a lot of debate on that as their should be--but the same people who would be really really upset about that, somehow come to believe that the fact that China's government controls everything in China is a good thing. I don't think it's a good thing; I think it's a bad thing.

I think there have been years and years of debt-fueled mal-investment. And it's come to a head. And when it breaks, as it seems to be breaking now, it's a long way down.

Another reason we shouldn't expect HAM (Hot Asian Money) to flood in and support the Vancouver Housing Market.

(hat tip World Housing Bubble)

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Meanwhile... in Australia

Yesterday we talked about articles being published in New Zealand about their belief for trouble ahead for the Canadian Housing Bubble.

Meanwhile, over in OZ, comes another sign the Australian housing bubble is in serious trouble.

Insurance company Genworth Financial pulled the IPO of its Australian unit, sending its shares plunging by over 20% and its default risk soaring.

The IPO, which was supposed to take public up to 40% of the company's Australian mortgage business, and has instead been delayed to 2013 after “elevated” losses this year.

Said Bloomberg:

"the company cited deteriorating market conditions in the Aussie mortgage market. Specifically, the company noted elevated loss experience in Australia as lenders accelerated the processing of later-stage delinquencies from prior years through to foreclosure and claim at a higher rate and severity than expected, particularly in coastal areas of Queensland that experienced natural catastrophes and regional economic slowdowns and among certain groups of small business owners and self-employed borrowers.”

Like Vancouver, Australia has been leaning hard on Asian buyers from China to support it's bubble.  And just like Vancouver, the country is suffering as investment from China evaporates as excess funds for investments disappear as China executes it's own soft/hard landing in real estate.

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"A little is alright" - the danger of inflation

Earlier this week US Federal Reserve Chairman Ben Bernanke uttered this infamous phrase about inflation:

"A little is alright"

This blog has talked about the dangers of inflation before.  And just like interest rates, the idea that inflation could rear it's ugly head again is considered insanity by villagers on the Edge of the Rainforest.

But Bernanke has a different message, "a little is all right." Or at least that’s what he said when asked about the evidence of inflation in the U.S. recovery.

This is a change for Bernanke. In the past he has simply said he  doesn’t see inflation. The Fed chairman recently described the prospects for price increases across the board as “subdued.”

Bloomberg picked up on Bernanke's shift from 'subdued' to 'a little is alright' message and made some good points.

Looking back at history, inflation has a way of coming about suddenly and, once it does, can be very difficult to stop.

The thing about inflation is that it comes out of nowhere and hits you. Monetary policy is like sailing. You’re gliding along, passing the peninsula, and you come about. Nothing. Then the wind fills the sail so fast it knocks you into the sea. 

Right now, the U.S. is a sailboat that has just made open water, and has already come about. That wind is coming. The sailor just doesn’t know it.

“Sudden” has happened to us before. 

In World War I, an early version of what we would call the CPI-U, the consumer price index for urban areas, went from 1% for 1915 to 7% in 1916 to 17% in 1917. 

To returning vets, that felt awful sudden.

History has other examples. In 1945, all seemed well: Inflation was 2%, at least officially. Within two years that level hit 14%.

All appeared calm in 1972, too, before inflation jumped to 11% by 1974, and stayed high for the rest of the decade, diminishing the quality of life for everyone.

As central banks around the world massively increase the money supply (the true definition of inflation - it just takes several years to see it reflected in prices), we are told not to worry by Bernanke.

First he told us it isn't there.

Now he is telling us a little is a good thing.

Why will this time be any different?

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Sat Post #1: Bloomberg - Canadian Housing Market heads for severe correction

On Thursday we ruminated on the impact the plethora of mainstream media articles about the Canadian Housing Bubble and pondered what effect it was going to have on the real estate market.

How long before all the negative press convinces buyers (local and internationally) that now is NOT the time to buy?

Yesterday we noted that  TD Bank may have upped the "do not buy" ante with a note to clients in which TD economists said that a "housing correction will take hold in 2013."

Well... the negative press parade continues. Joining TD Bank's claims that the Canadian market is going to correct is Bloomberg, who headlines, "Canada Housing Heads For Severe Correction". 

As headlines go, you can't get much more specific or dire than telling your readers that the Canadian housing market is headed for a 'severe' correction.

Bloomberg interviewed George Athanassakos, professor of finance at the Richard Ivey School of Business. In the article, Bloomberg charted Canada’s housing investment as a percentage of gross domestic product, and the declines in inflation-adjusted house prices that follow when this ratio tops 7%.

According to Athanassakos, “eventually, everything boils down to demand and supply. Whenever this ratio (housing investment as a percentage of gross domestic product) goes over 7%, it signifies overinvestment in housing and two or three years later, we have a severe correction.”

Athanassakos noted that Canada’s housing market is booming as historically-low interest rates fuel purchases, driving up home prices and adding to record household debt. Canada’s ratio of housing investment to GDP has averaged 5.8 percent over the last 50 years but has recently jumped to about 7%, based on Statistics Canada figures as of the third quarter of 2011.

Hence Athanassakos' conclusion that Canada is poised for a 'severe' correction and TD Bank is joined in it's prediction that Canada's housing market is about to face a significant correction.

Will it have an impact? All those Asians with extreme gobs of money won't hesitate to snap up pricey Vancouver real estate because they 'want' to live here and the prospect of seeing their investments "severely" drop isn't an issue... right?

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Keeping the balls in the air

The email inbox overflows from yesterday's posting on the political attack video about Vancouver's Mayor Moonbeam, clearly striking a nerve on various sides of the civic political spectrum.

Today, however, we switch gears and go back to world's debt problems.

As we have commented before, debt will be the issue of this coming decade... specifically Sovereign Debt. 

The ticking time bomb in this mess is the financial product known as 'derivatives', vehicles which Warren Buffet labeled as "financial weapons of mass destruction".

I am fond of saying that what we experienced in 2008 was a deep, financial earthquake - the repercussions of which we do not fully appreciate nor understand.

I maintain that viewpoint even today.

The chain of events set into motion in 2008 still has a long way to play out. A massive amount of private and public debt  has accumulated and the system needs to allow this debt to unwind, no matter how painful this process will be (and it will be painful).

We cannot have meaningful recovery until this happens.

But Western governments have not allowed this to happen. They have intervened to prevent the pain.

The slate needs to be wiped clean but the problem is eliminating all these debts, deficits and unfunded social entitilements will trigger the gorilla in the room: the $600 trillion of derivatives created by the banks.

This is why the Euro zone and the PIIGS is such an important topic.

Bloomberg hilighted this today by reporting that JP Morgan and Goldman Sachs have disclosed to shareholders those two banks alone have have sold protection on more than $5 trillion of debt globally (much of it dependant on the debt of Greece, Italy and Spain).

Bloomberg notes, "as concerns mount that those countries may not be creditworthy, investors are being kept in the dark about how much risk U.S. banks face from a default. Firms including Goldman Sachs and JPMorgan don’t provide a full picture of potential losses and gains in such a scenario, giving only net numbers or excluding some derivatives altogether."

The banking system has enabled the creation of an unsustainable mountain of debt.

What we have watched since 2008 has been nothing more than a complex juggling act that has - so far - failed to deal with the root of the problem: eliminating the debt.

The crisis that looms on the horizion will be the biggest event in our lives and understanding/preparing for it will be the most important step you will ever take.

Future generations will look back upon the 25-year period after 2008 in a way that dwarfs the 25-year period that followed 1929.

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