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Turning paper into Gold Bullion at the emerging-world’s central banks…

CENTRAL BANKS are becoming modern-day alchemists, says Christopher K. Potter, principal of Canadian-focused hedge fund Northern Border Capital Management Inc., which he founded in 2002.

India’s big gold purchase late last year was a game-changer, Potter here tells the Gold Report, and more and more central banks will follow suit – he believes – successfully managing to turn the paper money their countries accumulate into Gold Bullion…

The Gold Report: Just after the Reserve Bank of India (RBI) bought 200 tonnes of gold last November, you wrote an article entitled Game Changer, highlighting previous transactions such as China’s Central Bank 99-tonne purchase gold in ‘02 and Argentina’s 55 tonnes in ‘09. Since no other central bank has stepped forward in the months since India’s announcement, was that really a game changer?

Chris Potter: I think so. For as long as I can remember, gold bears have warned that central bank gold is a massive source of supply that is capable of overwhelming any conceivable demand scenario. They said that this would make it very difficult for the Gold Price to rise significantly. It’s been an easy argument to make because one fifth of all the gold ever mined is sitting in central banks’ vaults.

But what we’ve seen over the last nine years is that argument being steadily dismantled, piece by piece. Year after year, signatories to the Washington Agreement have sold less than their quota of gold. We’ve also seen various central banks add and talk about adding to their gold reserves. Then when the world became aware that the International Monetary Fund – which I think is the third largest holder of gold – was a potential seller of 400 tons, there was all kinds of speculation that this would have a very detrimental effect on the Gold Price.

Well guess what, the opposite happened when the Reserve Bank of India announced that it not only bought 50% of what was for sale but bought it at market prices! All of a sudden people realized that central banks might be net buyers rather than net sellers of gold. This was a big development. We still haven’t heard about who is going to buy the other 200 tonnes but the market no longer seems concerned that a buyer will be found. You mentioned that no other central bank has bought gold since the Reserve Bank of India announcement – well, we don’t know that that is the case. If you were a central bank interested in increasing your gold reserves, you would not likely telegraph to the market that you were doing that until you were finished buying.

TGR: Is the IMF actively trying to sell the other 200 tons?

Chris Potter: They reported that they planned to sell 400 tonnes so I see no reason to believe that they have changed their minds about the remaining 200 tons. It had been rumored that the central bank of China was going to buy the whole piece and that is why the Indian announcement was such a surprise. Perhaps China buys what’s left.

We’ve heard that the Chinese Central Bank has been a consistent buyer of gold over the last several years, but we haven’t heard anything officially. I suspect that they do not want to signal that they have a lot of gold to buy, because that would just drive the price up. If they are negotiating with the IMF for the remaining 200 tonnes, we won’t hear about it until the deal is done.

TGR: Could China just be buying it in such small increments that it might take them a year to buy it but they wouldn’t have to report it?

Chris Potter: I’m pretty sure that the US Federal Reserve is required to report purchases and sales of gold and other assets. I’m not familiar with the reporting requirements in other countries, but I would take any lack of disclosure about Chinese purchases of gold with a large grain of salt. In other words, just because they have not announced that they have been Buying Gold does not mean that they have not been.

TGR: Jon Nadler, Kitco’s senior investment products analyst, suggests that central banks’ acquiring gold is no more than re-balancing their portfolios. It’s part of a natural course of events since their portfolios are growing, and in that case, it shouldn’t affect the price of gold one way or another. What do you think of that view?

Chris Potter: By purchasing 200 tonnes of gold, the Reserve Bank of India increased its gold holdings by 50% – I would hardly call that rebalancing. But what is even more important than the amount of gold that central banks are buying is the realization that they are buying and not selling. This is a brand new idea and completely alters market perception about supply and demand. This kind of change in perception can have a very meaningful impact on price. So no, I do not agree with Jon Nadler’s suggestion.

TGR: So how do you look at it?

Chris Potter: If I were running a central bank and I had the ability to create money at virtually no cost and I could then exchange that costless money for one of the earth’s scarcest resources, why wouldn’t I do that all day long? Why not exchange something that costs me nothing for something that is incredibly rare and incredibly valuable?

TGR: It’s not a central bank’s role to print money for the purpose of Buying Gold, though. Creating more money creates other negative trends in the economy.

Chris Potter: Sure, it’s inflationary. But take the example of India buying 200 tonnes of gold. That’s a very large amount of gold, but relative to the amount of money that they are creating for other purposes, it has a very minor inflationary effect.

TGR: I’ve always had the impression that central banks were held to a higher standard to do what’s best for the economy.

Chris Potter: Well, maybe what they’re doing is best for their economies. If you’re a central bank and you’re observing that around the world vast amounts, unprecedented amounts, of new money is being created, you have to realize that somewhere down the road every one of those currencies is going to take a big hit. So, how do you distinguish you currency and your economy from your neighbors’?

Well, one thing you can do is Buy Gold. So maybe the Reserve Bank of India is being proactive about their economy. They are saying, "Look, we can Buy Gold now for $1000 an ounce and five years from now, when we are all swimming in newly printed money, gold might be $5000 an ounce. We can increase our wealth without inflating our currency to the same extent as other nations." Essentially they are hedging against a decline in their currency and that is good for their economy.

TGR: A lot of financial advisors tell investors they should have assets that include 10% to 15% precious metals as "insurance." Are the central banks looking at this as an insurance policy, too, or in some other way?

Chris Potter: I suppose you could call it an insurance policy and that is the way a lot of people think about gold. But that is not the way I think about it. I view gold simply as a currency whose supply and demand characteristics are vastly superior to other currencies. Perhaps that is a more accurate explanation for why central banks are exchanging their paper for gold.

TGR: Gold’s been trading around $1100 for the past few weeks. There seems to be some resistance at that level. Some gold bugs say gold will be at $2000 before the end of the year. Where do you project as a trend for the physical Gold Price through 2010?

Chris Potter: I have a much stronger view of where the Gold Price will be in two or three years than I do over the next few months. It’s had a good run so I am not surprised that it is taking a breather here. If I had to guess I’d say we’ll see new highs before the end of the year. I just think that the path of least resistance is up because the amount of debt that continues to mount around the world is staggering – a lot of that has to be monetized.

Everyone talks about deleveraging but the US ran a budget deficit of $1.4 trillion or $1.5 trillion last year, and it looks like we’re going to do something similar this year. I think I just read we’re trying to increase the debt ceiling here by $1.5 trillion Dollars to $14 trillion. These numbers would have been unheard of a couple of years ago. I think back to a speech that Bernanke gave in January of 2007, in which he worried that the US budget deficit would approach 9% of GDP by the year 2030.

TGR: Oh, we’re way beyond that already, and 2030 is still 20 years away!

Chris Potter: Absolutely. Last year at $1.5 trillion, our budget deficit was more than 10% of GDP. Bernanke’s great fear about what the budget deficit might do occurred 20 years early and it happened not because of our unfunded Social Security and Medicare liabilities that he worried about but because of the global financial meltdown. When we layer on the unfunded liability issues we have a really gigantic problem that will be extremely difficult to grow our way out of, despite what Washington tells us. That is why I say that the path of least resistance – the solution to this – is to inflate these liabilities away.

That requires printing money. It requires a lot of new Dollars, a lot of new Renminbi, a lot of new Yen, a lot of new Euros, a lot of new Roubles. I think you’re going to see all of those currencies depreciate against other assets, and probably most against gold. I imagine that will continue this year, but anyone who has been involved in the gold market over the last seven to nine years knows to expect some scary rides up and down.

TGR: You’ve laid out a compelling argument about all governments increasing their money supplies and we’ll have inflation worldwide. How much higher do you think gold can go?

Chris Potter: It’s always difficult to put a number on it, but the inflation-adjusted Gold Price, depending on your assumptions and in which year you start, is somewhere between $2200 and $3100 per ounce. I’ve run a number of different models to see where the Gold Price could go and have come up with anything from $1500 to $3500 an ounce. In the end it’s anyone’s guess as to what the ultimate high will be, but as I said, the path of least resistance seems to be up.

TGR: If you follow the gold patterns, the summer months have historically been relatively low, with prices picking up again for the holiday seasons, particularly in India. Given that more gold is being bought as an investment or as insurance now, do you see that seasonality coming into play over the next two to three years?

Chris Potter: As you point out, more often than not we’ve seen a rise in the Gold Price in October and November, which coincides with the Indian wedding season. I have no particular expertise here, but I’ll guess that that seasonal pattern will continue. Ultimately though it is not a primary driver of the Gold Price If you look at a nine-year price chart, those seasonal moves are just blips.

TGR: Should investors be looking at physical gold, the majors, the juniors? How should they play what you see as upward trends in Gold Prices over the next several years?

Chris Potter: My strategy is to own both physical gold and mining stocks. I focus on the smaller capitalization gold companies, the exploration companies, the early-stage producers just because if you get those right, they have a lot more leverage to a rising price for the metal.

The problem with owning only Gold Mining equities, and no bullion, is that in a market sell-off, they can go down with everything else. I know people who were managing gold funds who had a very difficult time in 2008 despite the fact that the Gold Price was up. As we saw, gold mining companies were decimated. Many of those equities were down by 50% to 90% in 2008, and the Gold Price was actually up.

TGR: So is the combination of physical and equities a kind of a hedge against each other?

Chris Potter: I wouldn’t characterize it as a hedge. I would just say that it gives you a greater chance of participating in a rising gold market under various market scenarios.

TGR: As I understand it, you consider the Canadian market somewhat less efficient than the US market, thus making it easier to uncover attractively valued companies. What do you think accounts for the discrepancy, and is it specific to small caps or also true of large caps?

Chris Potter: It’s really true of both large caps and small but it’s not a permanent discrepancy. It’s more of a lag. What I mean is that US investors take a lot longer to recognize and buy high quality Canadian companies than US listed ones. I used to be concerned that this lag would somehow be arbitraged away, but I’ve been doing this now for 12 or 13 years, and it has not.

There are a lot of reasons behind that. For one thing, there seems to be an apathy or ignorance on the part of US investors about almost everything Canadian. There’s also a perception that the Canadian securities laws are lax, that its investment community is run by mining promoters, and that US investors won’t get a fair shake up there. While there are certainly landmines to look out for when investing in Canada, they are no more dangerous than those in the US

To characterize the entire Canadian investment scene as corrupt because of the Vancouver mining community and the Bre-X Scandal in the late ’90s ignores the fact that the US has had plenty of its own investment scandals such as Enron and a banking system that perpetrated the greatest financial fraud in history this past decade.

But I can’t tell you all of the reasons for the valuation lag that I continue to see between US and Canadian companies.

TGR: Thanks so much for your time, Chris. This has been great.

How best to Buy Physical Gold today? Go to BullionVault, and slash your costs "dramatically" (Financial Times), using the "most secure way to invest in Physical Gold" (Daily Telegraph)…

Source:21st Century Alchemy

You can’t keep a good market down. Nor a bad market up…

ON 18 SEPTEMBER 2008 – three days after the collapse of Lehman Bros. – US regulator the Securities & Exchange Commission issued what it called an "emergency order" banning the short-selling of 799 financial stocks.

The order, running for 10 business days, came amid of flurry of short-selling restrictions – first demanding that all stock sold short be delivered to the buyer within 3 days, and then that all current open shorts be closed – made under emergency powers granted by the Depression-era Securities Exchange Act of 1934. It came two months after a separate ban on selling short the stock of Lehmans, Fannie Mae, Freddie Mac and 16 other securities firms.

Some success that proved.

"Unbridled short selling is contributing to the recent, sudden price declines in the securities of financial institutions, unrelated to true price valuation," said SEC chairman Christopher Cox the next day, announcing the new defense of 799 ailing firms’ capital base.

"The Commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets."

News that "market manipulation" was over, along with the forced rush to cover existing shorts, saw the sector jump more than 12% higher in one day as priced by the SPDR Financial Select ETF (XLF). You can see that day’s jump in trading volume on the chart below, too.

Without the selfish hedge-fund black hats knocking perfectly sound companies lower, America’s finest financial firms could get back to making money rather than hemorrhaging risk capital at the NYSE. Or so the logic (or what passed for logic) ran in Washington.

Yet by the time the Sept. order expired at midnight 2nd October, US financial stocks were back where they’d started before the SEC invoked this power. Two days later, they’d sunk to a fresh six-year low. By the end of Oct. they had fallen a further 21%…and were on their way to a loss of more than two-thirds by the following March – and all this with the anti "naked shorts" regulations still firmly in place.

Glancing back from the comparative calm of late autumn 2009, you might think that short-selling was perhaps contained by the order. The plunge was worse after it lapsed, after all, and the market didn’t quite get to zero. But even when extended for four months or more elsewhere, similar bans around the world met with similar success.

The UK’s Financial Services Authority lifted its short-selling ban – begun the same day as the SEC’s order (and just as the Bank of England was pumping £61.6 billion, then $110bn, into the two largest failed banks) – on 16th Jan. 2009, by which time Britain’s banking stocks had lost a further 61% of their value. Greece didn’t get round to lifting its short-selling ban until 1st June 2009. Nor did South Korea. Australia was a week earlier, but by then the ASX-200 Financial index stood lower by one-fifth from just after the Lehman’s collapse, albeit turning higher from the 34% drop to March ‘09.

The financial authorities in Vietnam, meantime, have been facing a different kind of problem – and chosen to meet it with a different kind of exchange control, too. The results to date, however, look equally equivocal.

Vietnamese consumers, suffering cost-price inflation of 25% by June 2008, were exchanging capital in the form of Dong into gold. Indeed, the world’s largest market for investment gold bars outside the West during the first quarter of last year, Vietnam had already imported 60 tonnes of gold – paid for by a net outflow of $1.8 billion – during the first five months of the year. That was twice the pace-by-volume set in early 2007.

So the communist authorities, rather than addressing the plight of the Dong – which had already slipped further in the black market, despite an outright devaluation of the regime’s US-Dollar peg two weeks before – opted instead to ban gold imports altogether. Because if Buying Gold was how people were choosing to defend themselves, then just like US funds short-selling the lamest financial stocks, they must in fact be part of the problem. Right?

Doubling import duties on gold to 1% in May 2008 hadn’t helped. An outright ban remained to be tried. But the upshot? Seventeen months later – and with domestic gold owners blamed for profiteering as new would-be buyers sought refuge in gold – the ban was lifted at last. By early Nov. ‘09, however, Vietnamese gold prices stood some 42% higher, thanks both to the rising international price but more especially to the lack of inflows of metal.

The Dong, in short, had lost ground to the Dollar but sunk versus gold. And all along, Vietnam’s appetite for new metal was part-sated regardless. The GFMS consultancy reckons than 30% of gold imports to Thailand found their way across the border during the second-half of 2008.

Even with new gold now flowing into the country, gold still trades above 27.58 million Viet Dong per tael – south-east Asia’s variable "street dealing" unit, equal to 1.2 troy ounces in Vietnam. That puts the domestic cost of gold roughly $52 an ounce higher than international spot pricing according to figures from Vietnam Gold Market News…which is down from the $150 premium achieved just before Hanoi relented, but still a marked premium for Vietnam’s capitalist-communist citizenry.

"Taking advantage of unstable international Gold Prices and peoples’ concern that prices will rise further, local speculators have [still] pushed prices to a very high level," as central bank governor Nguyen Van Giau said when he lifted the import restriction two weeks ago.

Aimed at "stabilizing the gold market and preventing speculation", the central bank’s statement in fact helped send the Vietnamese Dong to a 16-month low on the currency market, down 6.4% on 1-year forward contracts, thereby pushing local gold prices higher again!

Since then, and with the currency still falling, Hanoi’s foreign currency reserves have now shrunk by one quarter to $16.5 billion from the start of this year. Fighting to defend its Dollar-peg in the market – by buying up Dong with overseas money – the government admitted that it’s target trade deficit for 2009 was already seven-eighths spent with another two months to go. So this week, it opted to raise interest rates – the obvious route to stemming a currency run – but not until December. It’s also devalued the Dong yet again, down 5.44% from Thursday morning per Dollar, but still only playing catch-up with the black market exchange rate once again.

Commercial banks are meantime banned from trading in Dollars if the Dong moves 3% or more away from its target exchange rate. Quotas also remain in place for importing gold, with licenses for 10 tonnes issued this week according to Reuters. Some 6.8 tonnes of bullion have already been imported, the state TV station reported today, since the import ban was lifted a fortnight ago.

"These imports will have an impact on the local gold market," reckons Van Giau. But then he also says the latest Dong devaluation and interest-rate hike – from 7% to 8% –represent a "solution to strongly intervene." Whereas HSBC’s chief Asian economist, Robert Prior-Wandesforde, sees Vietnamese interest rates rising further to 11% by year-end, while GFMS analyst Rhona O’Connell notes how "The change in the Vietnamese government’s policy over gold imports [in fact] illustrates that demand remains strong at grass roots level."

Oh sure – government policy helped stem the last global bull market in gold. Raising the margin requirement on US Gold Futures took the heat out of the metal’s parabolic surge of late-Jan. 1980, coinciding with what then proved a 28-year record at $850 an ounce. But unlike blaming short-sellers for the collapse of the banks, it was only by addressing the true fundamentals that the authorities could hope to reverse the flight into gold.

Double-digit returns offered to cash-in-the-bank killed the need to defend savings with metal. And this time around, not even import bans could take the heat out of Vietnamese hoarding.

Source:Emergency Orders & Exchange Controls

The age of de-leveraging is upon us. Bad news for the US economy; good news for gold…

FOR THE PAST 60 years, corporate debt has grown faster than the economy, writes Chris Mayer in the Daily Reckoning.

The volume of corporate debt has swollen by 4.1% annually, compared with only 2.7% for the economy as a whole. In short, more and more debt went toward producing each Dollar of GDP growth.

What if this 60-year trend reverses?

In fact, I think that is the likely scenario. The deleveraging will take some time…and it won’t be fun.

"Today’s overleveraged assets will become tomorrow’s underleveraged assets, and vice versa," QB Partners, a hedge fund, explained in a recent letter to shareholders.

What will this new world look like? More people will save more money. And they will focus more on preserving that wealth than on making a big score. We’ve been here before. Michael Farrell, the chairman of Annaly, says the psychology of people will change as it did for those of 1930s, as he discussed on his company’s first-quarter conference call.

Exhausted by the uncertainties of the 1930s and 1940s, the older generation just felt lucky to be alive and they settled into a time of saving, preservation of capital and lowered expectations as consumers.

If that kind of financial orthodoxy takes root, then leveraged assets like real estate and bank balance sheets face a long period of stagnant returns as they continue to deliver – that is, as borrowers and lenders ratchet down the debt on these things. (I find it ridiculous that government officials want us to believe that the US banking system is OK at 25-to-1 leverage. The banking system’s insolvency will become more apparent as it continues to take losses from bad debts made during the bubble.)

Deleveraging puts pricing pressure on leveraged assets. Banks must raise capital, diluting their shareholders and hurting their stock prices. Real estate owners must sell property to raise capital to defend other properties, thus putting pricing pressures on real estate assets. And so on…

So as an investor, it will pay better to stick with the unlevered assets, which face no such head winds. After all, there is no pressure to sell an asset with no debt, no ticking clock. "What are the most underleveraged assets?" you ask. QB Partners gives the answer: hard assets and natural resources.

The ultimate unlevered hard asset may be humble old Gold Bullion.

In fact, something important is happening in the gold markets right now. All through the 1990s to the present day, the world’s central banks were net sellers of gold. Europe’s central banks, for instance, have sold 3,800 tonnes of gold in the last 10 years. According to the Financial Times, this move cost them $40 billion, and that was with gold at $900 an ounce.

Well, too bad for them. But suddenly, that recent habit of selling gold is changing. Last year, central banks sold only 46 tonnes, which was the lowest amount in 10 years.

As the FT reports: "Sales in Europe have slowed to a crawl and fresh demand is emerging elsewhere and the financial crisis has helped to highlight gold’s value in turbulent times." In fact, we may soon see central banks flip to net buyers of gold.

China has doubled its holdings of gold this year and is now the world’s fifth largest holder of the metal. China is likely to be a buyer of gold for years because its gold holdings are still very small relative to the size of its total reserves. Gold represents only 1.6% of China’s reserves, versus a global average of nearly 11%. To further diversify its reserves – just to get to average – would require significant amounts of gold.

In a post-2008, deleveraging world, it is the unleveraged assets that will outperform against those saddled with debt. It’s another plank in the case for gold, which just seems to get stronger with each passing month. "A new chapter has begun in the gold market," the FT opines. Indeed, it has.

The International Monetary Fund, never known as a wise handler of money, is selling a bunch of gold. India bought half of it. A number of emerging market central banks are also upping their gold exposure. Maybe these CBs are onto something.

Russia’s gold holdings now make up 4% of its foreign reserves, compared with only 2.2% at the beginning of the year. Smaller central banks are also being crafty. Ecuador’s gold holdings have more than doubled since the start of the year – to 54.7 tons, from only 26.3 tons. Gold now represents 32% of that country’s reserves. Even Venezuela is Buying Gold. Gold now makes up 36% of its reserves, compared with only 23% in 2009.

So who is the sucker here?

Perhaps central bankers see more clearly than most what the effect of all their money creation will be. In recent months, we’ve seen a truly unprecedented boom in bank reserves. Bank reserves drive money creation. More money means money buys less – and the Gold Price should rise.

Then there is this chart of the Shadow Gold Price. In the old days of the Bretton Woods Agreement, countries had to maintain certain ratios of gold against their currencies. The Shadow Gold Price aims to replicate this discipline. So for the US, the Shadow Gold Price is Federal Reserve Bank liabilities (bank reserves) plus money in circulation divided by US gold holdings. Also on the chart, you can see the spot price of gold.

The important thing here is that you see how massive amounts of money creation have barely made an impact at all in the Gold Price – so far. Gold is fundamentally cheap compared with all the money added to the system in recent months.

As Paul Brodsky and Lee Quaintance of the hedge fund QB Partners write:

"If one allows for even a small probability of a future monetary system that reflects more honest/tangible money, then a quick glance at the graph above makes it easy to conclude that spot gold is fundamentally cheap. Even if this is too far a stretch for market participants skeptical of such a radical change in monetary policy, it is reasonable to conclude that the prices of spot gold and the Shadow Gold Price should converge somewhat over time."

They note that the spot Gold Price has never been so cheap compared with the Shadow Gold Price. For parity to set in, gold would have to trade for $16,000 per ounce! No one is predicting $16,000 per ounce gold. In any case, it shows you the risk of holding paper – and bonds – on the eve of a massive devaluation of the Dollar. Maybe the central bankers of Russia, Venezuela and Ecuador understand all of this better than they let on and that’s why they are buyers of gold.

It seems pretty obvious to me that if you create a lot of money, you are going to destroy the value of that money. And in that case, you want to own something other than that money.

"If there’s an easier way to Buy Gold, I’ve yet to find it," says one BullionVault user…

Source:Good Cause to Buy (More) Gold

Aug. 4 (Bloomberg) — Touradji Capital Management LP, the $2.7 billion hedge-fund firm founded by Paul Touradji , bought shares of a gold exchange-traded fund in the second quarter and sold stock in EnCana Corp. and other energy companies.

Source:Touradji Capital Buys SPDR Gold Shares, Sells Energy Stocks (Bloomberg)

If AIG was a hedge fund, missing the BCCI scandal was its regulatory model…

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Source:From BCCI to AIG…