Texas Gold Depository: Possession in a World of Counterparty Risks
Possession is 90% of ownership
With little fanfare and definitely a non-event as far as mainstream media is concerned, judging from the little – scratch that – almost complete absence of coverage, the Texas governor signed into effect a bill on June 12 to build a gold and silver depository.
Once built, this secure facility, the Texas Bullion Depository, will become the first state-level facility of its kind in the nation, allowing its citizens to store their bullion and keep their funds from leaving the state. Two of the big public pension funds from the University of Texas and the Teacher Retirement System, which own gold worth more than one billion dollars, also plan to repatriate their gold from the vaults in New York.
Far from being some random innocent looking actions of a bunch of paranoid Texans deciding to move, literally, a ton of gold bricks from a New York vault to another with a Texas address which Bill HB483 seems to convey, the implications of this state level legislative bill, which contains additional provisions which we will cover further down, is much more far reaching and provides a glimpse of the tangible steps taken by some of the informed in preparation for the upcoming monetary reset.
But first a gold investment for dummies.
Physical Gold Versus Paper Gold
In the monetary and investment worlds there are two types of gold: physical gold and paper gold.
Physical gold is what its name suggests – gold bars and coins which you can touch and feel. You can walk into a retail bullion dealer and purchase a few bars or coins. For those who want to hold more than a handful of gold coins, larger quantities of gold (and silver) can be transacted on exchanges. Traditionally and until very recently, the London Bullion Market Association (LBMA) and the Commodity Exchange (Comex), a division of the New York Mercantile Exchange, provide physical exchanges where buyers and sellers of gold transact. Whereas over-the-counter (OTC, private contracts between buyer and seller, see wiki) contracts are facilitated by the LBMA, fixed sized futures contracts (wiki futures contracts) are traded on the Comex. The duopoly of LMBA and Comex which made up the center of the precious metal trading university has been shaken up with the introduction of the Shanghai Gold Exchange. The amount of physical gold actually traded in Shanghai now vastly eclipses those on LMBA and Comex.
Although large volumes of contracts are traded on LBMA and Comex every day, very little physical gold actually ends up changing hands as a result of these trades. In the case of Comex where gold futures are traded, these futures positions typically are settled and closed before the contracts expire and the differences in price are settled in cash between buyers and sellers. By and large, the vast majority of participants have no desire to see actual delivery of the contracts. Except for a small percentage of participants (producers and actual users of the metal) who use the contracts to hedge the underlying physical commodities, the rest of the people are simply speculators. In other words, these people invest (in an extreme stressed meaning of the word) in paper gold.
Another kind of paper gold exists in the form of exchange traded funds (ETF), the SPDR Gold Shares (GLD) being the best known. Physically backed by gold, retail and institutional investors alike buy and sell them just like stock shares. Instead of owning a piece of physical metal, the price of GLD, for example, is designed to track the price of a tenth of an ounce of gold. In exchange for the convenience of gaining exposure to precious metals as an investment without the trouble of handling and storing physical gold, the holders of gold shares get to own paper claims on gold.
Based on the daily trading volume and the open interest of gold futures outstanding, the amount of underlying gold involved is typically orders of magnitude greater than the amount of physical gold available in the exchange warehouses. If a mere fraction of the futures traded in any contract month demands delivery, the exchange would immediately run out of the physical gold to honor the contracts.
Monetary End Game
The unabated monetary and debt expansion since the 1970s, which culminated in the global banking crisis in 2008 triggered by the subprime mortgage crisis in the US, ushered in a new phase of the debt super cycle in the OECD economies. In an attempt to save the insolvent banking system saddled with mountains of sour loans and derivative bets with broken interlocking counterparty chains, central banks all over printed an astronomical amount of money to buy up the toxic loans in order to prop up their banks and drove down interest rates to ridiculous levels in order to allow their governments to issue more debt without getting insolvent from the resulting interest payments. With their zero and negative interest rate policies, the monetary world had entered the twilight zone.
What followed was a series of crises and resulting panic reactions by central banks, from the European sovereign debt crisis, Cypriot banking crisis and the subsequent bail-in of depositors, Japan’s mother-of-all-printfests, the ECB Quantitative Easing and negative interest rate policy to the ongoing Greek debt crisis. While governments continue to avoid making the hard choices to address the debt problems by kicking the can further down the road, any rational thinking person would realize that we are rapidly approaching the end of the road for this current monetary regime. How the monetary reset will take place and when it will occur is at this point anybody’s guess. But when the current fiat currency system based on the US dollar and other floating currencies blows up, it is likely to be replaced by another currency regime which is anchored by something which cannot be freely printed.
Gold, considered as money and a store of wealth since time immemorial, is a likely candidate to re-emerge to become that anchor.
Where Is My Gold?
In a concerted effort to remove gold from the monetary system, Western central banks had for decades been suppressing the price of gold through the sale of their gold reserves and ‘lending’ gold to bullion banks so they could lease or sell them in the open market in large quantities to overwhelm demand. Dumping of gold reserves by most Western central banks stopped after the 2008 global banking crisis, and in the ensuing years these same central banks became net buyers.
In addition to turning net buyers, some central banks have started the process of repatriating their gold which had been stored overseas, mostly with the Fed in New York and the Bank of England, since the Cold War.
Why would some central banks bother with the trouble of moving their physical gold back on home soil? Remember the gold being sold into the market by bullion banks? Where did the gold come from?
Officially the US has 8,100 metric tons of gold. Is it possible that some of the gold stock had been sold or leased? The US government claims that all the gold is there, but the inventory has not been physically audited by an independent party since at least the ’70s.
What about the gold from foreign countries held in custody by the US Fed? The Fed says it is all there, but just like the US gold in Fort Knox, it has never been verified either.
It is from here the story gets interesting.
After a request made by the Bundesbank to audit the country’s gold held in custody at the New York Fed was refused in 2012, Germany formally requested to repatriate 300 tons of its gold from the US and 374 tons from France in order to keep half of its gold reserves home in Frankfurt. Shockingly, it was told by the US Fed that it would take until 2020 or seven years to return said gold. And the amount of gold returned to Germany in 2013 from the US? 5 tons, along with 32 tons returned from Paris. It took the US until 2014 to finally resolve the ‘logistic difficulties’ and move 85 additional tons to Frankfurt.
Having learned from the German experience, the Netherlands took a different tactic and repatriated 122 tons of its gold from the New York Fed quietly and made the public announcement only after the fact. The move reduced from 51% to 31% the Dutch central bank’s gold reserves held on US soil, while leaving Dutch gold stored in London and Canada unchanged.
Citing ‘heightened concentration risk’, Austria demonstrated its lack of faith with the Anglo-Saxon system, of which London is for decades THE center, by announcing in May its plan to hold 50%, or 140 tons, of its gold domestically by 2020, by withdrawing 140 tons from the Bank of England (bringing the amount held there from 80% to 30%) and sending 47.6 tons of that returned gold to neutral Switzerland.
Ownership and Counterparty Risks
Which brings us back to Texas’ plan to build a state depository for gold and silver.
As with the case of Germany, the Netherlands and Austria moving their gold back home, the Texan move is a demonstration of distrust in the system. In a system where clear title to the gold might not be clear and the gold is held by someone else and potentially claimed by multiple ‘owners’ thanks to re-hypothecation, it creates a counterparty relationship to which the owner of the gold is a mere creditor. In the event that the counterparty defaults due to problems unrelated to the gold, the owner becomes an unsecured creditor in bankruptcy and might get a fraction of what he rightfully owns in the course of liquidation.
Prior to the just announced decision to build the depository, the Texan public pension funds had already taken the initial steps of taking physical delivery of its paper gold and having it stored in the HSBC Bank vault in New York. By moving said gold to the new depository, it removes any remaining counterparty risk arising from having said gold stored at the bullion bank.
The message: unless you have possession, ownership might not amount to much.
Gold Money System
In addition to building the first ever state owned gold and silver depository, the Texan bill also includes a provision which would prevent any attempt to seize the gold and silver in the depository by the Federal government, something which happened to the country in 1933.
Section 2116.023 of HB483 (full text) states:
“A purported confiscation, requisition, seizure, or other attempt to control the ownership.. of a depository account, .. if effected by a governmental or quasi-governmental authority other than an authority of this state .. is void ab initio and of no force or effect.”
Whether Texas would be able to stand up against any Federal emergency measures to seize the content of the depository remains to be seen. But having a depository free from the federal government confiscation and counterparty risks arising from bank failures, Texas has created a potential alternate money system where people can bypass the paper money system by transacting in silver and gold, an alternate system whose opportunity will increasingly present itself as the monetary world edges ever slowly towards the end game.
Elephants in the Room
Anyone with a passing interest in the topic of gold must be wondering why the two most active players when it comes to precious metals, namely China and Russia, have been conspicuously missing in this article. The strategy adopted and actions undertaken by these two countries on gold and their implications to the geopolitical and financial world are so significant that future articles will be dedicated to the topic on its own. Stay tuned.