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International Business Research; Vol. 8, No. 3; 2015
ISSN 1913-9004 E-ISSN 1913-9012
Published by Canadian Center of Science and Education
190
The Gold Market and the Value of the U.S. Dollar
Adam Abdullah1 & Mohd Jaffri Abu Bakar2
1 Faculty of Economics and Management Sciences, Research Institute for Islamic Products and Civilization,
Universiti Sultan Zainal Abidin, Malaysia
2 Faculty of Economics and Management Sciences, Universiti Sultan Zainal Abidin, Malaysia
Correspondence: Adam Abdullah, Faculty of Economics and Management Sciences, University Sultan Zainal
Abidin, Gong Badak Campus, 21300 Kuala Terengganu, Terengganu, Malaysia. Tel: 609-668-8275. E-mail:
aabdullah@unisza.edu.my
Received: February 1, 2015 Accepted: February 22, 2015 Online Published: February 25, 2015
doi:10.5539/ibr.v8n3p190 URL: http://dx.doi.org/10.5539/ibr.v8n3p190
Abstract
The aim of this research is to determine to what extent the price of gold is suppressed, thereby revealing an
internal structural problem within the global monetary system. Historical manipulation could only have been
done by controlling the value of money under a fractional reserve gold standard through the physical demand for,
and supply of gold, in relation to official reserves held at a central bank. More recently, the price of gold is
largely influenced through paper trades, as a function of the operation of the gold market involving gold
derivatives, in conjunction with physical trades and changes in official reserves. This research adopts a
qualitative interpretation and numerical analysis to analyze the extent of market concentration and price
manipulation. Our findings reveal that the gold market is largely deterministic rather than stochastic in nature. It
also reveals that markets are not only subject to a fractional reserve banking system, but also a fractional reserve
gold market, highlighting systemic instability inherent within the modern monetary system, and especially the
value of the U.S. dollar and related dollar denominated assets.
Keywords: gold market, gold derivatives, monetary policy
1. Introduction
This research (Note 1), is within the field of monetary and financial economics, and seeks to demonstrate the
extent of gold price suppression as a function of central bank monetary policy, as identified by Abdullah (2013,
2014, 2015). The gold price is a measure of value and its manipulation is an extension of modern monetary
policy, as admitted by Governor Angell whom disclosed that, “the price of gold is pretty well determined by
us…we can hold the price of gold very easily; all we have to do is to cause the opportunity cost in terms of
interest rates and US Treasury bills, to make it unprofitable to own gold” (FOMC, 1993, pp. 40-41). Ultimately,
the opportunity cost of holding, selling, lending or trading in gold is a function of real rates of interest generated
on other financial assets. However, in what manner do economic agents conduct themselves within the
framework of the gold market, and in particular from 2000-2010, which witnessed not only a financial crisis, but
also a significant increase in the price of gold. What started as a sub prime crisis in 2007, quickly developed into
a global banking, then a sovereign debt crisis, with countries such as Greece confronting a debt to GDP ratio of
175%. The problem is that settlement cannot be achieved through remittances involving a monetary system
backed by debt. A debt cannot settle a debt, and yet that is the nature of the fiat monetary standard. Rather than
backed by the promise of the United States, the monetary balance sheet of the dollar is backed by debt. The U.S.
has a gold stock worth USD11,048 million valued at an historical cost of USD 42.2222/oz, or 261,663,296 ozs.
By end June 2003, and re-valuing U.S. gold reserves at the prevailing London PM fix of USD347.70/oz, the U.S.
gold was worth USD 90.5 billion. Equally, from the Federal Reserve ‟s balance sheet, M3 was USD 8,971.6
billion (Table 1). Thus, each dollar is backed by 1% of gold and 99% by debt.
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Table 1. Monetary balance sheet of the U.S. dollar (Bns) at June 2003
Assets
Value
Liabilities
Value
Gold @ $347.70/oz
90.5
Federal Reserve Notes
658.9
IOUs Owed to Banks
8,881.1
Bank Deposits
8,312.7
8,971.6
M3
8,971.6
Sources: Federal Reserve Statistical Releases H.4.1 & H6; U.S. Reserve Assets 3.12.
The Federal Reserve System‟s 50th Anniversary Edition annual report of 1963 stated that, “the function of the
Federal Reserve System is to foster a flow of credit and money that will facilitate orderly economic growth, a
stable dollar, and long-run balance in our international payments” (Duncan, 2003, p. 90). Clearly, the Federal
Reserve has failed in its strong dollar policy, except for the period at the end of the 20th century – why did the
dollar pause before continuing its trend of exponential decay? The answer requires an analysis of the gold and
silver markets. “Despite the importance of gold in central bank reserves and its value to investors as a store of
wealth and potential risk diversifier, there is relatively little academic literature that attempts to estimate the price
determinants [of gold]” (Oxford Economics, 2012). Accordingly, this paper attempts address the mechanics of
the gold market, with also a reference to silver. This research consists of six sections of which the first section
provides an introduction and research background; section two analyzes the gold markets and derivatives;
section three provides an analysis of the nominal and real price of gold, supply and demand; section four
presents important analysis on the Bank of International Settlement (BIS) data; section five analyzes LBMA data
to assess the extent of unallocated gold within the gold market; and section six provides some concluding
remarks.
2. The Gold Market and Derivatives
The world is still submerged in a global financial crisis, and the dollar is the international reserve currency, but
given that the U.S. faces insurmountable fiscal obligations, run-away budget and trade deficits, an un-repayable
national debt and an unsustainable credit market, why has the dollar not already collapsed? The answer to this is
that the strong-dollar policy, so often advocated by the U.S. government, involves gold price suppression. Two
mechanisms are used to suppress the gold price: (1) the sale of gold by central banks and also the sale of gold by
private commercial bullion banks of leased gold from central banks, and (2) the sale of futures contracts on
exchanges such as the Commodity Exchange (COMEX) in New York.
In terms of the commercial bullion banks, their self-interest is that the gold price should decrease in order to
repay leased gold at a future lower price. This coincides with the political interest that several central banks have
in maintaining the value of the dollar by ensuring that the price of gold does not increase in an unmanageable
way. In reality central banks allow bullion banks to conduct their work for them, but have the ability to intervene
and sell official gold reserves into the market if needed. If there is a 5% increase in the retail demand for gold,
rather than wait for an expensive increase in mine production to increase supply and thus reduce the price, this
can be met by only a 0.4% sale of office gold reserves (Note 2). This inevitably leads to coordination between
central banks and commercial (bullion) banks. Commercial banks in the U.S. are regulated by the Office of the
Comptroller of the Currency and National Administrator of Banks (OCC), with the demise of the largely
unregulated U.S. investment banks in 2008, all activities of U.S. commercial banks have now become more
transparent, including bank participation in regulated exchange-traded derivatives markets, such as on COMEX.
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Figure 1. COMEX gold short positions
Over 2006 and 2007, typically 4-5 U.S. banks traded in gold derivatives on COMEX (Figure 1), however by
December 2008, only 3 U.S. banks (primarily J. P. Morgan and HSBC USA) accounted for 68% of all net short
positions and were net short 218% of deliverable gold on stock at COMEX warehouses. At that stage, gold went
into „backwardation‟ where the futures price was selling lower than the spot price. Most commodity traders
would be happy to sell their physical gold now, and buy it back in the futures market at a discount for delivery in
30 days. However, investors increasingly did not believe COMEX physical gold was available for delivery in 30
days time. The amount of short positioning being concentrated and far higher than COMEX stocks, resulted in
an increase in delivery notices, causing the futures price to trade lower than the spot price, as investors were not
lured into giving up their physical gold for paper gold, which they saw was simply not available. The situation is
even more exacerbated with silver short positions (Figure 2).
Figure 2. COMEX silver short positions
From 2006-2007, 3-4 U.S. banks were trading silver derivatives, by 2008 just 2 US banks accounted for 98.6%
of all net shorts for COMEX silver futures, and were net short 153% of deliverable silver stock at COMEX
warehouses, and for the same reasons as gold, the silver price also went into backwardation. However, perhaps
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to ensure that silver did not re-emerge as a monetary asset, the silver price collapsed just as J. P. Morgan
acquired Bear Sterns (in March 2008). Allegedly, Bear Sterns‟ considerable silver short position was transferred
and added to J.P. Morgan‟s silver short position: if Bear Sterns has been allowed to go bankrupt, the silver price
would have escalated exponentially to around USD100/oz from USD20/oz, thus bringing down other bullion
banks including J. P. Morgan. Instead, the price subsequently decreased to USD10 and in so doing, ultimately J.
P. Morgan itself survived and profited in the process by buying Bear Sterns for a nominal sum and absorbing
Bear Stern‟s silver derivatives. J. P. Morgan and HSBC USA also dominate U.S. bank activity in gold derivatives
with 99% market share, worth a combined USD112.8 billion by 2007 (Figure 3). However, by 2010, J. P.
Morgan has single-handedly secured an 85.3% market share worth USD163.8 billion.
Figure 3. U.S. commercial banks‟ gold derivatives
Pre-financial crisis in 2007, J. P. Morgan ‟s exposure was actually worse. By 2010, and post-recapitalization, the
exposure is less, but still profound (Table 2).
Table 2. J. P. Morgan‟s derivatives exposure
2007
2010
Total Derivatives (Tn)
84.87
78.66
Gold Derivatives (Bn)
77.01
163.83
Total credit exposure (netted current & future exposure) (Bn)
469.98
345.43
Assets (Tn)
1.56
2.12
Equity (Bn)
123.22
176.11
Risk-Based (tier 1 & tier 2) Capital (Bn)
112.25
130.44
Nominal U.S. GDP (Tn)
13.81
14.76
Annual Gold Mine Production (MTs)
2,476
2,689
Ratio of gold derivatives : total derivatives
0.09%
0.21%
Total credit exposure (netted current & future exposure) to risk-based capital (tier 1 & tier 2 capital)
418.7%
264.8%
Ratio of total derivatives : assets
64
48
Ratio of total derivatives : equity (implied leverage)
689
447
Total derivatives : U.S. GDP
6.15
5.33
Gold derivatives MT equivalent (Note 3)
2,873
3,628
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The share of gold derivatives has increased, but is still relatively low by comparison to its entire derivatives
exposure (0.21%). From the perspective of credit-worthiness, total credit exposure (netted current and future
exposure) of its derivatives, versus tier 1 capital and tier 2 capital, has improved, but still at 265% (419% in
2007); meanwhile every dollar of assets supports 48 dollars of derivatives (64 dollars in 2007). However, the
implied leverage is that every dollar of equity is supporting 447 dollars in derivatives (689:1 in 2007) - in fact, an
implied leverage of 10:1 would be regarded as brazen, 100:1 might be in the realms of an extremely aggressive
hedge fund, but 447:1 is still beyond Long Term Capital Management‟s status of 417:1 (Note 4) before its
demise in 1998. The notional value of J.P. Morgan‟s 2010 derivatives is 5.33 times the entire output of the
United States (6 times in 2007) - and all this from a prime Wall Street bank and Dow Jones blue-chip stock.
Other than at an institutional level, wider evidence of price irregularities can also be found in the trading patterns
within the gold market. One cannot detect these irregularities by merely observing the daily AM and PM fixes
(Figure 4).
Figure 4. Gold price, daily London AM and PM fixes, 1970-2010
However, we have updated and expanded upon the methodology of Douglas (GATA, Aug. 2010), by analyzing
gold price data over 11 years from 2000 to 2010. Figures 5 and 6, demonstrate that the price of gold has
consistently been bought upon the PM fix and being sold proportionally upon the following AM fix: this being
the same modus operandi of the London Gold Pool, which the Gold Fixing Ltd historical timeline describes as
historical fact, that by 1961 the “Gold Pool of US and main European central banks set up to defend $35 price,
by selling at fixing to contain it” (Gold Fixing) - thus, they sold in to the fix to suppress the price with the
obvious co-operation of the commercial bullion bankers. Whilst, the Gold Pool disbanded in 1968 upon suffering
large outflows of bullion due to the demand for metal when the price of gold was floated, however, the practice
remains in situ even if not formally recognized - it is covert rather than overt price suppression.
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Figure 5. Cumulative intraday and overnight changes in the price of gold, 2000-2010
The more the price of gold is rises in the Asian markets, the more it is sold down into the PM fix during trading
in London and New York. For the large bullion banks which are now dominating the market such as J. P. Morgan
Chase and HSBC, the profits are obvious by being long overnight (during the New York/Asian trade) and short
intraday (during London/New York trade) - between 2000 and 2010, the cumulative overnight trade was a
positive USD1,680/oz and the cumulative intraday trade a negative USD 615/oz.: a combined trading profit of
USD 2,295/oz.
Figure 6. Cumulative intraday (inverted) and overnight changes in the price of gold, 2000-2010
Figure 7 reveals that the cumulative amount of gold is consistently being sold down at the AM fix, in an almost
perfectly linear proportion to the cumulative amount bought up from the PM fix in the overnight Asian trade.
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Figure 7. Cross plot of the cumulative overnight and intraday changes in the price of gold, 2000-2010
Moreover, whilst the gold price has increased by 400% during the same period, 89% of those changes remained
within a very narrow trading band of +/- 1%, which also implies a tight control of the market (Figure 8).
Figure 8. Intraday price change in the price of gold, 2000-2010
The above price irregularities show how the dollar value of gold is being rigged to give a false impression of the
real value of the dollar, which would otherwise have continued its exponential rate of decay in terms of value
and thus purchasing power.
3. Gold Price, Supply and Demand
From about 1995 onwards, an explosion of gold derivatives has suppressed the gold price, and continues to exert
enormous downwards pressure, but the tsunami of debt and fiat money entering the financial system, when
combined with decreased central bank gold lending activity, has created a pressure-cooker scenario with the gold
price (Figure 9). The gold price has not kept pace with inflation. Current prices have now run up in excess of
USD1,200/oz, whilst nominally more than the last high achieved during the Iran-Iraq War of USD850/oz on 21st
January 1980, the price of gold is, in fact, relatively low in real terms: adjusted for inflation (Figure 10), the real
price of gold should be USD2,546/oz in constant 2013 dollars (Note 5), and as we know from COMEX data,
shorting the gold market continues at the hands of a dwindling number of U.S. banks, but to less effect given the
dwindling supply of official gold.
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Figure 9. CPI and the price of gold, America, 1971-2009
Figure 10. Nominal and inflation adjusted price of gold, America, 1970-2009
Indeed, a Citigroup analyst report of 21st September 2007 states, “our sense is that central banks have been
forced to choose between global recession or sacrificing control of gold, and have chosen the perceived lesser of
two evils” (Citigroup-b, 2007, p. 7), and again in a commodity report dated 17th September 2008, “it is notable
that the hard-core gold-bugs have been proven correct in the decade-long contention that an overwhelmingly vast
and complex pool of nested financial derivatives would ultimately result in cascading defaults and ruin for major
portions of the banking industry. Frankly, we‟re surprised that gold is not already at USD2,000 per ounce”
(Citigroup-a, 2008, p. 2). And a higher price has occurred despite the fact that total mine supply (Table 3) has
actually increased in recent years.
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Table 3. Gold supply and demand (MTs), 2003-2010
2003
2004
2005
2006
2007
2008
2009
2010
GOLD SUPPLY
Mine Production
2,593
2,463
2,549
2,484
2,473
2,410
2,589
2,689
Net Hedging
(270)
(427)
(92)
(410)
(447)
(352)
(236)
(103)
Total Mine Supply
2,323
2,036
2,457
2,074
2,026
2,058
2,353
2,586
Official sector sales
617
471
663
370
485
232
34
(76)
Old gold scrap
939
834
898
1,129
977
1,316
1,695
1,645
Total Gold Supply
3,879
3,341
4,018
3,573
3,488
3,606
4,082
4,155
GOLD DEMAND
Fabrication
Jewelry
2,478
2,618
2,709
2,285
2,401
2,304
1,814
2,017
Industrial
380
410
432
459
461
461
410
466
Sub-Total
2,858
3,028
3,141
2,744
2,862
2,765
2,224
2,483
Investment Demand
Bar & Coin
310
391
411
424
446
879
778
1,149
ETFs
39
133
208
260
253
321
617
338
Sub-Total
349
524
619
684
699
1,200
1,395
1,487
Inferred Investment
672
(211)
258
145
(73)
(359)
463
185
Total Demand
3,879
3,341
4,018
3,573
3,488
3,606
4,082
4,155
London PM fix ($/Oz)
363
409
444
604
695
872
972
1,225
Sources: World Gold Council, Gold Fields Minerals Services (GFMS).
The unwinding of the mining company hedge book has helped, indeed, the closing out/delivery into hedge
programmes has been one of the supporting factors in driving the gold bull market, since the gold producer‟s
hedge book (Figure 11) has declined from 2,924 tonnes in 2001, to as little as 146 tonnes by 2010. However, as
we shall see from BIS data below, these levels do not justify the amount of gold lent or swapped out of bank
vaults to provide liquidity for the gold derivatives market, which although down from 2007 is still enormous.
Figure 11. The declining gold producer's hedge book, 2001-2010
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In order to provide sufficient short selling cover, central banks must continue to supply official reserves; once the
source of the gold carry trade dries up, the ability to continue to suppress the gold price is also affected. Official
central bank gold reserves in 2010 were 27,220 tonnes, and including 2,814 tonnes of gold held at the IMF and
501 tonnes of gold by the BIS, total global gold reserves are 30,535 tonnes. With reduced lending by central
banks and short positioning on futures markets by bullion banks, central banks have been increasingly unable to
hold down gold prices (Figure 12), hence the run up from about USD300/oz in 2001, to around USD1,400/oz by
the end of 2010. At the same time, official central bank reserves (excluding IMF and BIS stocks) have dropped
from 29,643 tonnes in 2000, bottoming out to about 26,500 tonnes in 2008 due to official gold sales, but the
trend has reversed in recent years, alongside a higher gold price.
Figure 12. Official central bank gold reserves and the price of gold, 2000-2010
To maintain control over the price of gold requires international co-operation, which was substantively echoed
by Mr. W.R. White, Economic Advisor, Head of the Monetary and Economic Planning Department at the BIS,
whom stated in the opening remarks of the June 2005 BIS annual conference, that central bank co-operation
extended to influencing the gold price: “And the [fifth objective], the provision of international credits and joint
efforts to influence asset prices (especially gold and foreign exchange) in circumstances where this might be
thought useful” (BIS, 2006, p. 2). Tacit admission of central bank involvement and collusion in gold price
manipulation, was exposed in a legal complaint filed on 7th December 2000, against the BIS that quoted Edward
George the former Governor of the Bank of England (BoE) and a Director of BIS, describing to Nicholas
Morrell (Chief Executive of Lonmin PLC) in relation to the activity of certain central banks attempting to quell
the sharp rise in the gold price, following the Washington Agreement (WAG) on 26th September 1999 (Note 6):
“We looked into the abyss if the gold price rose further. A further rise would have taken down one or several
trading houses, which might have taken down all the rest in their wake. Therefore, at any price, at any cost, the
central banks had to quell the gold price, manage it. It was very difficult to get the gold price under control but
we have now succeeded. The U.S. Fed was active in getting the gold price down. So was the U.K.” (GATA, Dec.
2000, p. 55).
Officially quoted reserves (as required by the IMF) treats gold-in-vault as well as gold receivables from gold
lending activity as a same-line-item, which therefore serves to disguise the true amount of gold left physically
owned and controlled by central banks. The GFMS Gold Survey of 1998 stipulated that “…the lending of gold to
the market, in most cases, by a central bank in order to generate a return on its gold holdings results in a physical
sale, either directly by the borrower, of after a series of interconnected transactions” (Mylchreest, 2007, p. 83).
Therefore, “there is a net short position in the gold market that is equivalent to the outstanding stock of borrowed
gold. This net short position is unique since it corresponds to a „physical‟ short position” (GATA, 2000, p. 25).
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Indeed, “the best approximation of the total net short physical position in gold arising largely as the result of
gold lending in one form or another by central banks is the total notional value of gold forwards and swaps as
reported by the Bank for International Settlements and converted into tonnes” (GATA, 2007, p. 6), conducted in
the OTC market captured in BIS data, which also eliminate double counting that would otherwise occur with
reporting entities on both sides of the same contract. On the basis of the BIS June 2001 data, GATA had already
estimated in 2002 that gold lending “by the central banks themselves would imply a short physical position in
excess of 15,000 tonnes” (GATA, 2002, p. 8), which represents 46.3% of official gold stocks at 32,413 tonnes
according to 2002 World Gold Council (WGC) data.
4. BIS Analysis
The BIS in fact publishes three OTC derivatives reports, (1) semi-annual Regular OTC Market Statistics covers
the notional amounts and gross market values outstanding of the worldwide consolidated OTC derivatives
exposure of major banks and dealers in the G10 countries plus Switzerland (BIS, 2011); (2) the Quarterly
Review covers a survey of derivatives on the books of banks and dealers in 30 countries, including the G-10 and
Switzerland (BIS, Dec. 2010); and (3) the Triennial Central Bank Survey of derivatives on the books of banks
and dealers in 54 countries, released every 3 years (BIS, Nov. 2010). In the BIS Quarterly review, we learn that
total notional value of OTC derivatives in 2007 was USD595,341 billion, and exchange traded futures and
options was USD79,099.1 billion, which combine for a total of USD674,440.1 billion: given that, according to
World Bank data, global GDP in 2007 was USD54,347 billion, then the global trade in derivatives has ballooned
to 12.41 times the value of the entire output of mankind (Figure 13).
Figure 13. Total notional amount of OTC and exchange traded derivatives
Far from being a tool for risk management, no argument can justify this as a necessary form of hedging, whereby
derived paper trades ultimately dominate and distort the pricing of the underlying physical trade in goods and
services. Warren Buffet stated in the Berkshire Hathaway annual report of 2002 “derivatives are financial
weapons of mass destruction” (Berkshire, 2002, p. 15). Indeed, in a narration from Hakim ibn Hizam: “Hakim
asked (the Prophet): „Apostle of Allah, a man comes to me and wants me to sell him something which is not in
my possession. Should I buy it for him from the market?‟ He replied: „Do not sell what you do not possess‟”
(Abu Dawud 23: 3496) - direct possession and ownership (milkiyyah) of commodities is quite different from
trading in the transfer of risk, and as we may observe from the Islamic legal maxim “reward begets risk”
(Majalah, Art. 87), risk is a prerequisite for lawful income in Islam.
With respect to gold derivatives, the BIS publishes two surveys: (1) the semi-annual OTC Regular Updates from
G10 plus Switzerland, and (2) the Triennial Survey from 54 reporting countries. The gold derivatives data
included in the Quarterly Review is also derived from the semi-annual G10 plus Switzerland survey. Hence, the
twice a year G10 plus Switzerland survey is more regular, but not as comprehensive as the, albeit less regular,
Triennial Survey. The notional value of derivatives can be converted into ounces by dividing the notional figures
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by the London PM fix USD gold price/oz at the (month-end) reporting date, and then converting ounces into
tonnes at 32,151 (Table 4, and Figures 14 and 15). The G10 data showed for forwards and swaps that gold
lending has reduced since 2007, and by June 2010, the same reporting date as the Triennial Survey, G10 gold
lending represents 20% of official reserves excluding the IMF (= 5,601/27,614 MTs).
Table 4. BIS semi-annual survey of OTC gold derivatives on the books of banks and dealers in the G10 plus
Switzerland
Gold Price $/Oz
Ldn PM fix
Forwards & Swaps
US$ Bns
MTs
equiv.
Options
US$ Bns
MTs equiv.
Total Forwards Swaps
& Options US$ Mns
MTs equiv.
Jun-98
296.30
103
10,812
82
8,608
185
19,420
Dec-98
287.80
76
8,214
99
10,699
175
18,913
Jun-99
262.60
87
10,305
102
12,081
189
22,386
Dec-99
290.25
119
12,752
124
13,288
243
26,040
Jun-00
288.15
120
12,953
141
15,220
261
28,173
Dec-00
274.45
101
11,446
116
13,146
217
24,592
Jun-01
270.60
88
10,115
116
13,333
204
23,448
Dec-01
276.50
101
11,361
130
14,624
231
25,985
Jun-02
318.50
118
11,523
161
15,723
279
27,246
Dec-02
347.20
136
12,183
180
16,125
316
28,308
Jun-03
346.00
134
12,046
169
15,192
303
27,238
Dec-03
416.25
154
11,507
190
14,197
344
25,705
Jun-04
395.80
129
10,137
189
14,852
318
24,989
Dec-04
435.60
132
9,425
237
16,923
369
26,348
Jun-05
437.10
109
7,756
178
12,666
287
20,422
Dec-05
513.00
128
7,761
206
12,490
334
20,250
Jun-06
613.50
148
7,503
301
15,260
449
22,763
Dec-06
632.00
139
6,841
501
24,656
640
31,497
Jun-07
650.50
141
6,742
285
13,627
426
20,369
Dec-07
833.75
200
7,461
395
14,736
595
22,197
Jun-08
930.25
222
7,423
428
14,310
650
21,733
Dec-08
869.75
152
5,436
243
8,690
395
14,126
Jun-09
934.50
179
5,958
246
8,188
425
14,145
Dec-09
1,087.50
201
5,749
222
6,349
423
12,098
Jun-10
1,244.00
224
5,601
193
4,826
417
10,426
Dec-10
1,404.50
230
5,093
166
3,676
396
8,770
Source: BIS semi-annual Regular OTC Derivatives Updates, Table 19 or D-4.
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Figure 14. Notional value of OTC gold derivatives, G10+Switzerland
Figure 15. MTs equivalent of forwards & swaps/gold lent by G10+Switzerland
However, the more comprehensive Triennial Survey from 54 reporting central banks (Table 5, Figures 16 and
17), showed a significant increase in forward and swaps since the last Triennial Survey in 2004, resulting in an
extraordinary increase to 34,008 equivalent metric tonnes. Total official reserves including IMF „owned‟ gold
was 30,142 tonnes at June 2007 according to the WGC , and excluding IMF gold of 3,217 tonnes, was 26,925
tonnes. BIS gold of 148 tonnes is still included, since the BIS gold may readily be lent to bullion banks and sold
into the spot market. Hence, gold swaps equivalent to 34,008 tonnes against national and BIS reserves of 26,925
tonnes. In reality, according to Redburn Research only about 80% of gold lending and swaps transactions results
in a spot sale (Mylchreest, 2007, p. 89), an assessment that implies a figure of approximately 27,000 MTs. Either
all the official stocks have been lent and sold into the market, or there are simply many more claims against
physical gold.
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Table 5. BIS triennial central bank survey of OTC gold derivatives on the books of banks and dealers in 54
countries
Gold Price
$/Oz Ldn
pm fix
Forwards
& swaps
US$ Mns
MTs
equiv.
Diff. 3-yr &
semi-ann.
Options
US$ Mns
MTs
equiv.
Diff. 3-yr
&
semi-ann.
Total forwards
swaps & options
US$ Mns
MTs
equiv.
Diff. 3-yr
&
semi-ann.
Mar-95
392.0
88,318
7,008
58,938
4,676
147,256
11,684
Jun-98
296.3
149,705
15,715
45%
78,016
8,190
-5%
227,721
23,904
23%
Jun-01
270.6
141,178
16,227
60%
136,178
15,653
17%
277,356
31,880
36%
Jun-04
395.8
156,415
12,292
21%
202,503
15,913
7%
358,918
28,205
13%
Jun-07
650.5
711,241
34,008
404%
339,685
16,242
19%
1,050,926
50,249
147%
Jun-10
1,244
384,810
9,621
72%
284,308
7,108
-52%
669,118
16,730
60%
Source: BIS Triennial Survey, Tables E.41 and E.49.
Figure 16. Notional value of gold OTC derivatives, 54 countries
Figure 17. MTs equivalent of forwards & swaps/gold lent by 54 central banks
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204
In fact, with a decline in the June 2010 Triennial data for 54 countries to 9,621 MTs equivalent (72% higher than
the G10 figure of 5,601 MTs equivalent), implied official gold lending still nominally represents 35% of official
reserves of 27,614 MTs, which includes BIS stocks of 449 MTs, but excludes the IMF stocks of 2,934 MTs (=
9,621 / 27,614 MTs). Assuming only 80% of gold lending and swaps transactions results in a spot sale, then in
reality 80% of 9,621 MTs would have been sold into the market, or 7,697 MTs equivalent, which equates to 29%
(= 7,697 / 27,614 MTs). This is an improvement on 100% from 3 years earlier, but as central banks are either
unable (with stocks already lent) or are unwilling to deplete stocks any further, official gold lending has reduced
and in fact there was a modest gain in official sector purchases in 2010 (of 76MTs as per Table 3), contributing
to a higher price, and yet still requires a significant volume of trade in derivatives to maintain control of the
value of the dollar, in the face of an exponential increase in the supply of money and debt.
5. Fractional Reserve Gold
Interestingly, “gold trading is often conducted „loco London‟ in unallocated gold, with the implication that the
gold market operates on a fractional reserve basis. Furthermore, many clients have been encouraged to hold gold
in unallocated form also, which is nothing more than an unsecured claim on a general pool of gold in a bullion
bank. Therefore, if every central bank, bank, gold trader and private individual demanded physical delivery of
the gold bullion they have a claim to, the shortfall of gold…is not just gold from central bank vaults, but also
relates to unallocated gold accounts at bullion banks.” (Mylchreest, 2007, p. 89). Accordingly, as the 34,008
equivalent tonnes suggest, there maybe many more claims outstanding against physical gold due.
Indeed, by updating the analysis of Douglas (GATA, Jul. 2010) and Mylchreest (2009), in evaluating the
fractional reserve gold market, the average daily volume of gold traded through the LBMA, for example, in mid
2010 (May-June) was 22.7 Mn ozs or 706.05 MTs (= 22,700,000 ozs/32,150.7 troy ozs per MT). According to
remarks before the LBMA conference in Kyoto in 2008, made by Gerhard Schubert, a Director of Fotis Bank in
London, “One of the most important objectives of the LBMA was to strengthen the loco London contract so that
more OTC business could be settled and delivered through London. This objective has clearly been reached with
at least 90% of the daily OTC turnover being settled and cleared…through London” (Schubert, 2008, p. 2). By
interpreting “at least 90%”, we may assume 91%, as per Mylchreest (2009, p. 7), thus we obtain 24.945 Mn ozs,
or 775.88 MTs per day, which over 253 trading days (less weekends and holidays), we arrive at 196,297 MTs.
According to the WGC, annual mine production was 2,689 MTs in 2010, which the LBMA is managing to clear
every 3.81 days (or 2,689/706.05). Total mine production and scrap for 2010 was 4,334 MTs, and so the ratio of
total gold traded to physical gold traded = 45 (or 196,297/4,334): this means that for every 45 ozs of gold being
sold by the gold market via unallocated gold, only 1 oz is real, and 44 are paper ozs, which implies a fractional
reserve ratio for the gold market (FRRG) of 2.27% (or 1/44 x 100). Assuming an average nominal price of gold
of USD 1,244.53/oz for 2010, the real price, absent of any paper ozs, should be about USD 54,000 (or
1,244.54/0.0227).
We may obtain a similar FRRG in terms of the USD. According to the U.S. Treasury the gold stock of the United
States is 261.5 Mn ozs (UST), which at the average nominal price of gold for 2010 at USD 1,244.53/oz, valued
the gold stock at USD 320,215 Mn. The estimated average M3 money stock for 2010 was USD 14.01 Tn (SGS),
hence the USD has an FRRG of 2.29% (or USD 320,215 Mn/USD 14.01 Tn x 100), and the real price of gold
should be USD 53,600 (261.5 Mn ozs/USD 14.01 Tn). Although the USD FRRG in 2013 was a similar 2.38%, it
has not been static, and depends on the amount of M3 being created by the Federal Reserve each year divided by
the value of the gold stock, with the value of the gold stock being a function of the physical stock of U.S.
owned-gold and the prevailing price of gold. In fact, figure 18 presents the FRRG for the U.S. from the collapse
of the London Gold Pool in 1968 until 2013. Since 1968 the FRRG has been anything but constant - in fact, it
has varied by a factor of 9.13 times, with a minimum of 0.88% and a maximum of 8.05%. When a monetary
system unravels, the trend towards real gold away from paper gold increases. The price of nominal gold will
increase until its effective limit will be the price related to physical gold, so that all paper substitutes are rejected
and discounted towards zero.
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Figure 18. Fractional reserve ratio for gold, 1968-2013
6. Conclusion
In essence, we can conclude from our analysis that the gold price is subject to active manipulation by the BIS,
the BOE and the Federal Reserve in terms of gold sales and lending. There is coordinated self-interest between
the central banks and commercial banks, primarily J. P. Morgan and others in selling short the price of gold on
COMEX. The gold market is selling on average 45 ozs of gold for 1 oz of physical gold, and is backed by 2.3%
of gold. The real price of gold is about USD 54,000/oz absent of the unallocated gold, in the presence of which,
the market price of gold has been reduced to about USD 1,200/oz. The value of the USD is therefore 45 times
over-valued (= 54,000/1,200). A „strong dollar policy‟ requires a money illusion involving unallocated gold to
hide the true value of the dollar. The value of one „gold‟ dollar was defined under the Coinage Act of 1792 as
being 24.75 grains of pure gold, so that the official price of gold was USD 19.3939/FTO (= 480/24.74), hence
the „paper‟ dollar is now worth today only 1.6 cents (= 19.3939/1,200), but absent of the „paper gold‟, it is worth
only 0.0004 (1.6 cents/45). Any prudent wealth manager would no doubt accordingly advise their clients to own
allocated physical bullion, preferably outside of the fractional reserve bullion banking system, to protect intrinsic
wealth against not only the erosion in the store of value function of fiat money, which in real terms in terms of
gold affects the returns of fixed and financial assets, but also the counterpart risk of the financial intermediaries
that are selling them financial assets.
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Notes
Note 1. This research project was supported by Universiti Sultan Zainal Abidin (UniSZA), through research
grant UniSZA/13/GU/(031).
Note 2. In 2010, the retail demand for jewelry was 2,017 MTs, which at 5%= 101 MTs, being 0.4% of the total
official gold reserves of all countries excluding gold held at the BIS and IMF at 27,220 MTs.
Note 3. 2010 = 163,831,000,000/$1,404.50 per oz/32,151 oz per MT = 3,628 MT; 2007 =
77,010,000,000/$833.75/32,151 = 2,873.
Note 4. USD1.25 trillion of notional derivatives to USD3 billion of equity.
Note 5. Nominal PG 21 Jan. „80 x (CPI Dec.‟ 13 / CPI Jan.'80) = Real PG adjusted by inflation at Dec. „13.‟ 850
x (233.049/77.8) = 2,546.
Note 6. The Washington Agreement (WAG) was signed by 11 European central banks to limit official gold sales
to 400 tonnes p.a. in order to stabilized the gold market following the U.K. announcement in May 1999 to sell 58%
of its gold reserves (415 tonnes) through Bank of England auctions, as a result of the failure by the U.K.
supported campaign of Robert Rubin, the U.S. Treasury Secretary, to persuade member nations to sell IMF gold.
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