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Excerpt from the Jim Rickards interview.
When I was in Switzerland for Physical Gold Fund, we actually saw the gold that belongs to the investors in Physical Gold Fund. We had auditors, they had bar numbers and manifests, and we went item by item. Those bars actually belonged to the fund.
That’s not true with these LBMA agreements. You don’t have any allocated gold. That means a bank can have, say, one ton of gold and they can sell 20 tons of gold. They use the one ton to back all 20 of those contracts. In effect, they’re short 19 tons. They own one ton physical and sell 20 tons to a bunch of institutional investors or high-net-worth individuals who want to own gold, so they’re short.
They depend on their customers not asking for the gold. As long as this is all on paper, it works fine. Where it breaks down is if the customer comes in and says, “You know that unallocated gold? I would like to make it allocated and actually have the physical gold. In fact, not only do I want it allocated, but I would like you deliver it from your vault to a private vault run by Brinks or Loomis or one of the big secure logistics providers.”
That is what’s going on. People are taking their gold out of banks and putting it into new vaults because they’re losing confidence in the banking system. These new vaults are private storage vaults owned by private companies, not by banks.
Going back to my original scenario, the bank has one ton of gold and they sell 20. If even five customers show up and say, “I’d like my gold,” one ton each, you’re now short four tons. You have one ton of physical, but you have five tons of requests from five different customers. You’re short four tons, so you have to go out into the market and buy four tons of market. Guess what? That’s a big order. Good luck finding it. You can find it eventually, but you might not be able to find it quickly. So you have price exposure. You’re suddenly short the gold because your customers are demanding it.
What would you do? You’d go out and buy the futures. Now you’re hedged. You’re short to the customer who sent you the notice, you’re long on the futures, but you’re price exposure is hedged. Now you can take 30 or 60 days or however long it takes to source the physical and make delivery to the customer. The customer may think the gold is sitting in the vault and can be delivered tomorrow, but trust me, they can’t. They’ll be lucky to get it in 30 days and could even take a few months.
When I see a massively long futures position, it suggests to me – again, to be clear, I cannot prove this – that banks are turning up short in some other part of the operation, probably on these unallocated gold forwards. Customers are taking their gold out of the bank, the bank has to deliver to those customers, they’re short, they’re getting long futures to hedge, and they’re going to spend the next couple months going out and buying gold.