This is Where Gold is Really Going

Dear Readers,  

The markets continue to soar into summer.

The Dow breached the unprecedented 17,000 benchmark, closing at a record 17,068.

The S&P also climbed to a new record with a close of 1,985.44.

The climb means (according to JP Morgan) that the current forward S&P 500 P/E is now 15.6x – just higher than the 15.2x of October 9, 2007.

That doesn’t mean we’re about to crash. Heck, the forward P/E back in 2000 was 25.6x.

We’ve been in a full-fledged bull market for some time now and the thoughts of a crash are no longer in the minds of investors.

But neither is investing.

According to ICI, the Investment Company Institute, investors pulled $2.19 billion from U.S. stock mutual funds in the week ended June 18, after pulling $2.8 billion the week before.

Over the last five weeks, retail investors have pulled $10 billion out of U.S. stock mutual funds.

$10 billion doesn’t sound like much, and precisely, it isn’t.

(Especially when we talk about the trillions of dollars of liquidity created by central banks.)

That’s because its not retail investors who are getting rich from the stock market, its the rich who are getting richer.

According to the ongoing Gallup Poll, stock ownership by household continues to decline.

So who is buying?

According to the Federal Reserve, 5% of Americans own directly 82% of U.S. publicly traded stocks.

Eventually, the richest 5% will cash out. And they will likely, or have already been, selling to the retail investors who are beginning to pour money back into the market.

After all, we are in a bull market.

This is Where Gold is Going

I couldn’t count the number of research articles I have read, nor the amount of advice I have been given, regarding which direction gold is headed.

In the end, the answer to this questions will come from what central banks, and other big banks, decide to do.

For the last few years, I have written about the outflow of gold from Western banking giants such as JP Morgan and Goldman Sachs. As their dump occurred, gold prices were hammered before it could reach $2000/oz.

Over the last few weeks, gold and silver have been gaining momentum and churning to climb higher.

Is this the result of technical patterns and traders? Is it the result of the geopolitical risk overseas? Or is it the result of a much bigger force (banks)?

Let’s see what the big banks are doing.

The Ultimate Trade

Just this week, Ecuador agreed to transfer more than half its gold reserves to Goldman Sachs Group Inc. for three years to give the government easier access to cash.

Via Bloomberg:

“The central bank said it will send 466,000 ounces of gold to Goldman Sachs, worth about $580 million at current prices, and get the same amount back three years from now. In return, Ecuador will get “instruments of high security and liquidity” and expects to earn a profit of $16 million to $20 million over the term of the accord. The central bank didn’t detail additional terms of the transactions, such as any fees or financing costs paid to Goldman Sachs.”

In other words, Ecuador will receive paper assets (high security, of course) in return for lending out its physical gold; thus, entrenching the world further into Fed dollars spread by Goldman.

While the details of the transaction are unclear, I am going to assume one thing: Goldman Sachs will not likely park this gold in a vault, but rather use it as leverage for other financial instruments.

And so the rehypothecation loop, Ponzi scheme, leveraged borrowing, or whatever you’d like to call it, continues.

This isn’t the first time Goldman has attempted to take control of a nation’s gold.

As I mentioned before, Venezuela – a country that has publicly announced the repatriation of its gold from abroad many years ago, almost struck a swap with Goldman to use the country’s gold as collateral last November.

Via GATA:

“Venezuela’s Central Bank and Goldman Sachs are ready to sign an agreement to swap or exchange international gold reserves, with a start date in October, as stated in the contract, and until October 2020.

The negotiated amount, equivalent to 1.45 million ounces of gold, are deposited in the Bank of England and the transfers are made directly to Goldman Sachs once delivery times are stipulated.

The operation involves the delivery of gold from the central bank, which will receive dollars from the U.S. firm. The transactions are made through the creation of a financial instrument that is traded in the international market.

During the term of the instrument is an account called “margin,” in which the central bank agrees to deposit a larger amount of gold in the event that the price of gold falls or in which Goldman Sachs deposits a larger amount when gold increases. “At the expiration of the transaction the contributions are returned to their owners,” the document says.”

And of course, if any legal disputes were to arise from the proposed swap, it would’ve been settled in Western – ahem, English courts.

While the deal was never completed, we should note that if Goldman Sachs is willing to lend out billions of dollars for gold, then clearly the big bank sees value in the yellow metal.

In Ecuador’s case, if gold falls to Goldman’s predicted $1050/oz then the deal would mean Goldman would be able to accumulate more gold from the South American nation.

Ecuador just returned to the bond market last month, selling $2 billion worth of debt with a high yield of 7.95 percent. In case you have forgotten, Ecuador defaulted just five years ago.

If Ecuador defaults again, Goldman is going to end up with a lot of gold.

These actions suggest that real hard gold is being moved back into unaudited Western vaults.

But the control of hard assets doesn’t stop there.

The Indian Swap

Just recently, the world’s once largest consumer of gold announced that it is swapping its own gold for “paper” gold.

On Wednesday, India’s central bank said it has looked for quotes from banks to swap gold in its own vaults for international-standard gold, aiming to improve the management of its reserves.

Via Reuters:

“The Reserve Bank of India said the operation would “standardise the gold available with RBI in India with respect to international standards” and the gold acquired would be delivered to its overseas custodian, the Bank of England.

By holding gold reserves in London, the RBI would gain flexibility to mobilise them if needed to defend the currency. It shipped some of its gold holdings to Britain in 1991 as part of a series of emergency measures to tackle a financial crisis.”

Translation: We’re going to sell our gold and use the proceeds to buy gold; only the gold we buy will be held at the Bank of England – the central bank to a country that has been under tremendous scrutiny for the manipulation of gold and silver prices.

This brings me once again to why I said gold and silver prices would climb a few weeks ago: rehypothecation.

Rob Peter to Pay Paul

If you missed the letter from last month, here’s a reminder on rehypothecation:

“In short, banks and brokers lend money to their clients using assets that have been posted as collateral. These assets can be anything from currency to hard assets such as gold or other base metals.

The banks/brokers can then take these assets and use them for their own purposes to create other financial instruments; metal-backed currency, so to speak.

This is called rehypothecation. And yes, it sounds almost like a Ponzi scheme.

Many times, these assets are “supposed” to be sitting in a vault or storage facility somewhere but because the “rehypothecation” process is often repeated many times over, no one really knows where the assets/metals/commodities are – if they exist at all.”

Since that letter, the “unwinding” of China commodity finance deals have continued.

As Bloomberg notes:

“Decheng Mining pledged the same metals stockpile three times over to obtain more than 2.7 billion yuan ($435 million) of loans in China’s Qingdao port, a person briefed on the matter said, citing preliminary findings of an official investigation.”

So it’s no surprise that Gold ETFs have seen the biggest inflows since September 2012 in the last few weeks.

My point here is simple: gold – the most liquid of assets amongst central banks (but not so much for countries) –  is now once again going back into the hands of Bankers.

Once in their hands, it will likely be used many times over as leverage for financing deals (as Goldman has done with Ecuador).

But that’s not all.

Moving gold out of a country and into the vault of a foreign nation means that the true amount of available gold supply will likely be hidden from the world. It could also mean that the true holder of the gold may never get it back.

We’re Not Giving it Back

Remember a few years back when I talked about Germany’s plans to repatriate its gold held in France and the U.S. – long before the mass media covered it?

Then remember when I wrote about how long it was taking for Germany to actually get its gold back from the United States?

After all of this talk, it seems that Germany has decided not to repatriate its gold back from the U.S.

As Bloomberg kindly put it:

“Germany has decided its gold is safe in American hands.

Surging mistrust of the euro during Europe’s debt crisis fed a campaign to bring Germany’s entire $141 billion gold reserve home from New York and London. Now, after politics shifted in Chancellor Angela Merkel’s coalition, the government has concluded that stashing half its bullion abroad is prudent after all.

“The Americans are taking good care of our gold,” Norbert Barthle, the budget spokesman for Merkel’s Christian Democratic bloc in parliament, said in an interview. “Objectively, there’s absolutely no reason for mistrust.”

Here’s the same story from the eyes of the East, the Voice of Russia:

“After two years of diplomatic struggles and scandals involving the US Federal Reserve, Germany gave up on its attempts to repatriate its gold. In order to save face, Bundesbank issued an official statement that underscores its “trust” in its American partners.

The saga of German gold repatriation started in the aftermath of the European debt crisis, when a grassroots campaign began pressuring the government in Berlin to bring the gold home from New York and London. After a long and difficult media campaign, Bundesbank overcame its initial reluctance and demanded a full repatriation of the Germany’s entire $141 billion gold reserve.

The Fed’s reaction was extremely irritated and the issue of “German gold” became one of the most difficult diplomatic problems in the US-German relations. Every delay and every excuse cooked up by the US Federal Reserve made the campaign for repatriation even stronger, leading to an even deeper mistrust between the parties involved in the conflict.

Finally, Bundesbank was told that it will get its gold back in seven years, clearly showing that the US central banking cartel did something nefarious with the metal it has been entrusted to safeguard. Most likely, the gold has either been sold long ago or “hypothecated” to American banks trading in gold derivatives. According to Bloomberg, after repatriating just 5 tons of gold, Germany gave up.

Bloomberg quotes Norbert Barthle, the budget spokesman for Merkel’s Christian Democratic bloc in parliament, who said that “the Americans are taking good care of our gold. Objectively, there’s absolutely no reason for mistrust.” Critics point out that there are a number of objective reasons for mistrust. One of such reasons is that there never was a German or an independent audit of the German gold store in New York or London. Moreover, the Bundesbank was never able to provide a reason for the lack of audits, claiming that it stores gold “only at central banks of the highest international reputation” and therefore an independent audit is not required.

The decision to halt the repatriation attempts bear the hallmarks of a political concession to Washington. It is very likely that in the long war Berlin will regret this decision because its chances of ever regaining control of its gold are now close to zero. However, there is still some hope left for the German gold. Hours after Bloomberg ran the story about Germany giving up its repatriation attempts, Peter Boehringer, the leader of the “Repatriate our gold” campaign, issued a statement, calling the Bloomberg piece “a ‘non-news’ article with a wrong headline, strange interviewees, old news, and with a clearly apologetic ideological approach.” He also said that the fight to bring the German gold back will continue.”

Interesting to see the stark difference between Eastern and Western media on the same subject, no?

Here’s the read-between-the-lines bottom line: Gold is once again going back into the hands of Western Bankers, who will likely continue to use the yellow metal to create financial instruments of leverage. Oh, and the gold that is supposed to exist in certain vaults, probably doesn’t.

This is my reason for why gold prices have moved higher, and may move higher in the near future.

That, along with my forecast of the TSX and TSX Venture performance, is precisely why we should continue to look at junior gold stocks for some easy short-term gains.

Here’s a chart of the GDXJ and the GDX over the last few weeks: