What Is Really Happening In Precious Metals Markets?
May 21, 2020
By Patrick A. Heller
In 2020, there has been another modest surge of interest of Americans wanting to own some physical precious metals, especially gold and silver. People are becoming more aware that governments’ inflation of the money supplies is almost certain to reduce the purchasing power of their fiat (paper) currencies.
There is any number of “experts” or “analysts” of precious metals who issue updates explaining what has happened in the markets and projecting what may happen. The quality of their research and forecasts has, collectively, been haphazard. If you are looking for an expert to follow who espouses your preconceived ideas, you won’t have much difficulty finding him or her.
Because precious metals markets are affected by so many factors (supply, demand, inventories, technological innovations, commodity futures markets, other financial markets, changes in currency values, political changes, as some examples) it is about impossible for any one market watcher to cover every aspect.
That is one reason why I seek information from multiple sources, even ones that I have learned over time tend to be frequently erroneous or incomplete. What I have found is that a sizeable number of researchers don’t really know what they are talking about. Another group includes those who mostly understand the markets but have difficulty expressing themselves so as to be understood. Then there are others who have a relatively good grasp of the overall precious metals markets and can clearly pass on this information. Several years ago, when being interviewed by a commodity market journalist at The Wall Street Journal, she noted that while she judged she had better information sources for precious metals commodity markets, she concluded I had better sources for physical precious metals.
A huge problem in figuring out what is really occurring in precious metals markets is the massive amount of information that is kept secret, is reported incorrectly or incompletely, or is skewed in how it is reported so as to mislead those who have access to it.
Let me give you some examples of all of these barriers to comprehending exactly what is really happening in precious metals markets.
- The International Monetary Fund regularly reports on physical gold reserves held by official agencies such as central banks. For many years, it required a double-counting of some reserves. If one central bank leased gold to another central bank, it mandated that the lessor central bank continue reporting this gold as part of its reserves and that the other central bank that had custody of the leased gold also report it as part of its reserves. This requirement was changed a few years ago to allow, but not require, that central banks only report the gold reserves for which they have actual title. Thus, IMF reports on official gold holdings cannot be counted on for accuracy.
- In 2003, China’s central bank began accumulating gold reserves. One of the traders in the London market breached client confidentiality by arranging to anonymously notify one market watcher in the US as to the dates and amounts of these purchases. This market watcher passed along this information to his readers (including me). By 2005, I had accumulated sufficient corroborating information about the Chinese central bank purchases of gold that I began to mention it in my commentaries. It was not until April 2009 that China’s central bank openly acknowledged that it had been secretly purchasing gold reserves since 2003.
- The World Gold Council and others publish statistics about gold supply, demand, inventories, official reserves, changes in hedging activities, and the like. They purport to encompass all global activity, even as they acknowledge that some data such from China and lands in the former Soviet Union may be sketchy. There are other organizations that prepare similar reports for other precious metals. It turned out that none of the analyses of the gold market included China’s 2003-2009 central bank gold purchases, which absorbed more than 3% of global gold output. As best I know, none of the annual reports for that era have been revised to correct for this significant error.
- Another way to mislead the reporting of “official” gold holdings is that governments can own gold other than just by central banks. Sovereign investment funds can hold gold without reporting it. Also, some governments, such as China, can effectively hide gold holdings by having it held by government-owned businesses and government sponsored-entities.
- In theory, the exchange-traded funds for the various precious metals have in their vaults sufficient physical inventory to cover 100% of their outstanding shares. However, if you read the fine details in some prospectuses, you will find that physical inventory held by some sub-custodians is not necessarily audited to verify it really exists.
- Some physical precious metals in vaults have been pledged as collateral to more than one creditor. Because of this, the title to ownership of this metal may be subject to ownership claims by other parties. This could happen, for example, with unallocated vault storage of physical precious metals. In unallocated storage, popular because it costs less than allocated or registered storage, the owner of metal may have a claim to some number of ounces or pieces of what is in the vault, but not to specifically identified ounces or pieces. Metals in unallocated storage are considered assets of the company operating the vault, which means they may be subject to third-party claims against that company. Because of potential multiple claims of ownership, it could happen that reported inventories might be overstated.
- In the gold and silver markets in particular, the relatively recent huge increase in COMEX futures contracts called for delivery upon maturity that is settled by the “exchange for physical” (EFP) option is worrisome. This is the most expensive way to settle such a contract. The least expensive option would be to deliver the actual physical metal, to pay cash instead of delivering the metal, or to tender shares of an exchange-traded fund representing the same quantity of metal. When settling by EFP, the short party pays some cash plus delivers another futures contract (usually in the London market) for delivery of the same ounces of metal. It now appears that the EFP method of settlement is how almost all COMEX gold and silver contracts are being settled. If the COMEX really did have in its vaults all the gold and silver it is reporting, why aren’t settlements made by physical delivery?
To try to bring more transparency to the gold market, this week the Gold Anti-Trust Action Committee (GATA) sent a letter to the US Commodity Futures Trading Commission asking five questions. You can view the letter here.
The first question in GATA’s letter is “Has your commission ever audited the gold kept in COMEX-approved vaults and reported to the commission as registered or eligible for sale and delivery?” The remaining questions ask for further details if such audits have occurred or if they are planned in the future.
If the COMEX really does have in its vaults all the physical gold that it is reporting, wouldn’t you think it would be pleased to reassure public confidence by announcing that an audit verified this to be true?
As you can see by the examples listed above, it is a major challenge trying to stay on top of what is really happening in precious metals markets. One step that can help detect the truth, even in the absence of full and accurate data, is to follow statistics over time. If available inventories are growing, diminishing, or remaining stable over time or demand or supply is changing, the trend will likely show this. A longer-term trend is much more illuminating than a one-time snapshot of data that may be taken out of context.