Monday, September 27, 2010

Which thimble is the gold under?

Suspicion is growing that the United States's supposed gold reserves are largely vapor, and that the government and the Fed are playing a game of sleight-of-hand. Dennis Mangan has a posting about the lack of transparency in their gold holdings. You'd think the American people would have a right to an independent accounting, wouldn't you? It's their money, isn't it? 

No, and no. It appears that the government would sooner reveal all it knows about captured UFOs, if any, than the actual status of the gold it claims to have socked away.


It's not an academic issue. With faith in all major currencies sinking rapidly, gold is luring investors who don't want to see their dollars or pounds sterling or yen dissolving in an acid bath of hyperinflation. A planned second round of "quantitative easing" (dubbed QE 2) risks further diluting the value of currency.

It's been decades since dollars have been legally convertible into gold or silver, but the U.S. dollar has generally kept its place as the international primary medium of exchange because of the country's financial strength — scratch that one — and the assumption that ultimately the gold hoard was there as a backup.

If the second condition is shown to be false, the economic fallout not only for the United States but for the world monetary system could be catastrophic.


Meanwhile, the debate over gold's role as an investment vehicle rages. Its price continues to rise, although relatively gradually, which is probably a good sign that it will continue its upward trajectory. Some commentators believe gold is just another bubble, like tech stocks or real estate, and point to the metal's long slump after scraping the sky in the early '80s.

Tyler Durden, at Zero Hedge, disagrees:
The only reason the market has found some validation to the September risk asset surge, is the "certainty" of QE2. Were this to be taken away, stocks would plunge, as would all other assets. And since the Fed is uncontrollable, and unaccountable to anyone, it is now impossible to prevent this line of action, whose outcome is what some may be tempted to call, appropriately so, hyperinflation. 

The direct outcome will be an explosion in all asset prices, although we continue to believe that of all assets, gold will continue to outperform both stocks and bonds, as recently demonstrated. Those who are wishing to front-run the Fed in its latest and probably last action, may be wise to establish a portfolio which has a 2:1:1 (or 3:1:1) distribution between gold, stocks and bonds, as all are now very likely to surge. 

We would emphasize an overweight position in gold, because if hyperinflation does take hold, and the existing currency system is, to put it mildly, put into question, gold will promptly revert to currency status, and assets denominated in fiat, such as stocks and bonds, will become meaningless.
This might be a good time to ponder La Rochefoucauld's aphorism: "Nothing is as bad — or as good — as it seems."

Assuming you want to get on the gold train before it leaves the station, you are confronted with the hotly argued question of what form to buy and hold it in — principally, in an ETF like GLD or as coins and bullion. GLD was previously discussed here and here.


It seems to me that no format for owning gold is risk-free. If you own physical gold and hoard it through a hyperinflationary crisis, you might come out way ahead … once the crisis is past, but you are unlikely to be able to benefit from it during the crisis, when it will probably be subject to government confiscation or criminal larceny (assuming there is any difference). If you hold your precious metal through an intermediary such as an ETF, you are probably safe from losing it in a home burglary, but confiscation will be even easier. And as noted in the earlier postings, there are doubters about the actual holdings of the intermediaries as well.

In my own case I unloaded my GLD shares. Even though I thought the risk of flim-flam on the sponsor's part was small, it was more risk than I wanted to take on.

But I've again become convinced that it's a good idea to put some of my family's assets in gold. This is not advice. Do your own research and make your own decisions. I have discovered a gold open-ended fund that I am a little more comfortable with, ETF Securities Physical Swiss Gold Shares, SGOL. The company says:
ETF Securities commissions a biannual independent audit of the bullion held in the Trust vaults. The audit is carried out by Inspectorate International. Inspectorate International is a global company providing inspection, testing, and analysis of commodities worldwide. There is one audit that takes place at year end, 31st December and one random audit that is carried out at the discretion of ETF Securities management. All audit reports are published on our website The audit focuses on the amount of bars and that they are LBMA or LPPM good delivery standard.

In addition to the stringent audit procedures set in place by ETF Securities, the custodian also conducts their own audits as part of their custodial duties. 
The auditor, Inspectorate, seems about as solid as you can ask. A sample audit report is available here — click "Download audited gold bullion bar count."

Aside from all that, SGOL is relatively little known at the moment, so it presumably has nowhere near the volume of gold that GLD says it holds, making auditing easier and the possibility of fiddling less. Even so, it is not absolutely safe. My professional work involves risk management. In my line we understand that risk can only be mitigated, not eliminated.


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