Moving to the Post LBMA-Era Gold Price Reset - Watch Out

April 13, 2016

If one were to describe, in a word, the singular quality of gold that gives it value both as money and a wealth preservation asset, that quality is integrity. Physical gold cannot be printed, it cannot be conjured by a central bank or government official, it cannot be credited into existence by a bank. And over a period of four thousand years, the markets have selected gold and silver as money. The replacement of gold and silver sound money with unstable debt-based fiat paper currency by banking interests and their government partners over the past century has been a mere blip in humanity's monetary history.

Real wealth ultimately flees from markets that give corrupted price signals and this now presents an apparent existential threat to the world's pre-eminent gold and silver market, the London Bullion Market Association (LBMA), where daily is set the gold and silver reference price (or 'fix') for miners, investors, and, crucially, for Western financial markets.

Trading of unallocated gold contracts on the LBMA began in the late 1980s and, according to the LBMA, is now the vast majority of all daily gold trading volume in London. The introduction of unallocated contracts was not a pedestrian matter with Evelyn Rothschild himself allegedly directly lobbying Margaret Thatcher for this change in the gold market. The Rothschilds ran the daily Gold Fix at their bank setting the price at the LBMA from 1919 until 2004 and have been synonymous with gold over the last 150 years.

The LBMA states that these unallocated gold contracts have the holder as merely an unsecured creditor for gold and not an owner of gold. That is an important difference. While ownership of real gold can be created only by first securing and transferring the ownership of metal, which is limited, unsecured claims for gold can be created without limit - and we see this in the London gold market unallocated spot contracts that are traded.

The daily gross turnover of gold trading on the LBMA spot market is 200 million oz. - twice the world's annual gold mine production and, according to the LBMA, it is 10x higher than the net settled trade volume totals posted by the LBMA . However, as touched on above, there is an important distinction to make. The vast majority of this daily trading is not gold trading. Instead, the trading is primarily of these unallocated gold contracts representing trading of gold promises and not of gold itself. In effect, the trading of unallocated gold contracts at the LBMA has corrupted gold in this market from exchange of a limited real gold asset to exchange of an unlimited virtual or digital asset.

Where are the 10,000+ Tonnes of Gold?

Using the typical commodity trading multiplier of 2x to 3x of daily trading volume to calculate the open interest, or total claims, in the market, the daily trading volume in London implies a total open interest of gold claims on the LBMA of 400M to 600M oz of gold in the spot market - claims equivalent to 13,000 to 19,000 tonnes of gold. The LBMA is located in the small 'square mile' City of London (a form of quasi-independent city-state operating under its own rules and governance within greater London) and the LBMA does not publish an open interest figure as most raw material or commodity exchanges do.

The pension funds, corporate interests, sovereign wealth funds, private interests, etc. that hold unallocated spot gold contracts on the LBMA instead of physical gold are holding a gold substitute with these unallocated spot contracts. This supply of unallocated gold contracts creates 'gold' where there is none and the massive volume of gold trading each day can move the price of gold to almost any level as the only limit is the requirement to supply the few who historically have taken delivery of spot physical gold. Leasing-out of sovereign physical gold by central banks and the officers of the gold mining companies of the world who sell their production ultimately through the LBMA via bullion banks also provides fuel to supply this gold pricing mechanism. This has enabled the suppression of the market price of gold against the best interests of mining corporations, society as a whole, and destroying shareholder value in the process.

The manipulation of the gold price is not merely negatively impacting shareholders of the miners to the benefit of jewellery or bullion buyers in Asia - the manipulation of gold also contributes to the destabilization of the financial system, as we shall see .

Larry Summers Discovers Gold's Relationship to Real Interest Rates

Larry Summers, who served in the 1990s during both Clinton administrations and ultimately as Treasury Secretary, notes in his paper Gibson's Paradox And The Gold Standard (Summers and Barsky, August 1985, NBER Working Paper No. 1680, that real gold prices (prices in constant dollars, adjusted for inflation) have historically moved inversely with real interest rates - i.e. as real interest rates decline, the price of gold increases reflecting a movement into gold and out of bonds. Summers writes that, for the period from 1973 until the date of the paper, "... we show that the real gold price... ....displays marked negative correlation with the real interest rate..." [pg. 24] and that "...The negative correlation between real interest rates and the real price of gold that forms the basis for our theory is a dominant feature of actual gold price fluctuations...." [pg. 4].

As seen in the 1970s and early 80s, in a free market, increasingly negative real interest rates are signalled by rapidly rising gold prices necessitating higher real interest rates to draw money back into bonds from gold.

Summers paper focuses on the relationship between real interest rates (nominal interest rates minus the inflation rate) and real gold prices (measured in constant, inflation adjusted dollars). So let's take a look at real interest rates and the real price of gold since the late 1970s. Referencing the important work of Reginald Howe (, we can see below how the inverse of the real price of gold (adjusted to constant dollars using the US BLS Consumer Price Index (CPI) ) diverged suddenly from tracking real interest rates in 1987 with the real price of gold. The real price of gold declined thereafter through the year 2000 even as real interest rates became increasingly negative. In August 1987 Alan Greenspan, who had served for 10 years as a Director of JP Morgan, becames Chairman of the Federal Reserve. The late 1980s introduction of unallocated spot gold instruments on the LBMA artificially reducing demand for real gold as well as surreptitious central bank leasing of sovereign gold stocks into the market, already well documented by the Gold Anti-Trust Action Committee (GATA) and numerous other sources, aligns with this divergence of the gold price inflation indicator with real interest rates.

The method of calculating the CPI has been changed several times by the Bureau of Labor Statistics over the years. Holding constant the 1980 method of calculating the CPI (provided by John Williams' to give a uniform constant dollar measure gives an even more stark view of the 1987 break-point of the constant dollar price of gold and real interest rates. It can be seen that the price of gold actually declined even as real interest rates themselves became acutely negative - the inverse of the natural relationship - and we are all too aware of the financial bubbles blown during this period with the loose central bank monetary policies globally.

In summary, by suppressing the price of gold by creating artificial supply with 'paper' gold as a physical gold substitute in London, this key warning indicator of negative interest rates and an obstacle to inflationary monetary policy by central banks has been disabled and loose monetary policy has been entrenched globally over the past several decades. The markets and global economy have become secularly distorted by excessively low real interest rates by central banks with the consequent loose-money policies blowing destabilizing, debt-fuelled financial and economic bubbles.

According to the Wall Street Journal, debt levels globally now exceed $200 trillion globally representing 300% of global GDP compared to 150% of GDP that was an historically sustainable level in the West ( .

A further indicator of the distortion of the LBMA daily spot gold price is provided by the following graph tracking the lease rate of gold as a proxy for the availability of physical gold in London. The LBMA spot market price of gold started to drop sharply on November 2, 2015 but the over the next two months the lease rate of gold reacted strangely both surging and, notably, the various duration lease rates invert completely from the norm with the 1 week rate surging above the 6 month lease rate reflecting metal shortage in the spot gold market.

(Data source: GOFO (Gold Forward) rate: Commerzbank, LIBOR & LBMA a.m. Gold Fix : St. Louis Fed.

Note: during the fall of 2015, posting of GOFO data online was disrupted from late October through late December.)

Normal markets don't work that way. In a typical spot market for limited goods, shortages of an asset cause prices to rise, not to fall. The LBMA is an exchange where gold spot prices are driven down leading to increased demand for physical gold that drives gold shortages in the gold lease market. And this is with spot gold buyers only at the margins taking delivery of physical gold. The majority sit holding their unallocated spot gold contracts.

Although the introduction of irredeemable debt-based fiat (paper) currency is predicated on an ultimate currency collapse when the required exponential debt growth to support expansion of the money supply becomes asymptotic, short-circuiting the gold and silver markets over decades has shut down cautionary warning signals in the global gold and debt markets that would force monetary system reform.

The distortionary effect of LBMA unallocated gold contracts and surreptitious central bank leasing of their physical sovereign gold holdings into the market have increasingly shown signs of coming undone in recent years and now months. While increasing daily volatility in the LBMA gold market has previously registered merely as increased cooling fan rpm's in the LBMA's bullion bank mainframes where their digital gold is created, exchanged, and held, the real gold market is awakening. This awakening is, again, only at the margins but has already had a material effect on the gold market but not yet on the LBMA paper gold price.

London's Gold is Gone

According to data analyzed by BullionStar analysts Ronan Manley and Koos Jansen, 2013 saw a run with gold swept out of London vaults leaving empty vaults in London according to Bloomberg reporter Kenneth Hoffman ( ).

Recently, the LBMA amended their gold refinery statistics indicating that these London Good Delivery bars had been refined and reformatted in kilo gold bars and shipped primarily to Asia by revising 2013 refining statistics in August 2015reducing stated 2013 refinery activity by 2,000 tonnes and obscuring this run on London gold ( and also

The World Gold Council, financed by mining companies, and GFMS Reuters similarly do not report this run that left an estimated 6 tonnes of gold in London Vaults outside gold held by various ETFs and the Bank of England (

The LBMA thus has next to no visible London gold stocks backing the estimated 11,000 to 19,000 tonnes of spot gold open interest. And bullion banks are now attempting sell their once needed, now empty, London vaults. Only one recent vault sale of note has occurred with a Chinese bank buying the new 1,500 tonne vault that Deutsche Bank put on the market with its own departure from the London Daily Gold Fix and market (

( With major bullion banks abandoning the London market, the question arises whether there has been a quid-pro-quo between the UK and China that China, with its massive gold bullion holdings, would help to try manage the gold crisis developing in London in return for the UK being the first country to support the the China's AIIB Asian infrastructure bank in 2015 that triggered a rush of Western countries to do the same and also supporting China's Yuan as a reserve currency (

The Post LBMA-Era Price Reset

The LBMA appears now to be in an intractable and rapidly degenerating position - with the vaulted gold available outside of the Bank of England and ETF holdings largely gone from London, how do you manage the appearances of a spot gold market with turnover of 200M oz per day and a massive open interest? While gold flow from the miners provides some liquidity and enables the LBMA paper gold market to provide some gold delivery and suppress gold prices, it is obvious that a massive gold event has occurred and that this paper market will not be the same given increased pressure for physical delivery. The London market cannot sustain any material gold withdrawal as occurred in 2013.

We now approach an event that may provide the catalyst for the inevitable repricing of gold and expiry of the LBMA paper/digital gold scheme. That event is the April 19, 2016 initiation of a daily spot domestic Gold Fix on the Shanghai Gold Exchange (SGE) that will be followed at a later date for the SGE international gold market. The SGE is very different from the LBMA unallocated paper gold market in that for a standard kilo gold contract to be issued, first a kilo of 99.99% pure gold delivered directly from an approved refinery must be deposited with the SGE.

This creates a problem in that a daily spot SGE Gold Fix based on actual gold trading in Shanghai is going to diverge at some point from the LBMA daily Gold Fix trading unallocated paper gold contracts in London. A price premium on physical gold in Shanghai cannot be extinguished with paper gold from London.

To date, 10 Chinese banks have announced that they will participate in the benchmark Fix at the SGE but no Western banks have indicated that they will participate. In response to this reluctance, China has threatened that if Western banks do not participate they will loose access to the Chinese gold market (

This lack of Western bullion bank interest in the new SGE Gold Fix is understandable as it would create a conundrum that a participating bank would have to explain if there were two materially different spot gold prices posted daily that could not be arbitraged away: one price for spot gold on the SGE for physical gold and a second price for spot 'gold' in London based upon trading paper. The market will then progressively degenerate into a much higher global price for gold as the LBMA is pushed to the sidelines.

Sustained rapidly rising gold prices force up interest rates to draw capital back into bonds. The knock-on effect will be on the global bond market and financial asset prices as exploding gold prices and higher bond market interest rates end the sophism of central bank manipulated interest rates and their serial bubbles. With major banks holdings in interest rate sensitive derivatives market totalling hundreds of trillions of dollars of notional value and with western bank balance sheets that remain highly levered, there will be bank turmoil.

In summary, central banks have been running a racket in conjunction with the LBMA and the bullion banks - and the mark for this racket is 99.999% of the population.

When Bill Dudley of the NY Fed refuses to answer questions regarding whether there have been any gold swaps of sovereign US gold by the Federal Reserve, then the observer may ask if these actions are illicit (listen to Dudley starting at 50:00 minutes of this link distributed by Chris Powell of GATA and

And when we listen to the central bankers speak, we can also understand why they cannot elucidate a rational plan for monetary policy. This group have short-circuited the gold and global debt and financial markets to such an extent that central bankers are now left merely saying that they are "data dependent" and that we should prepare for negative interest rates and a cashless society as their global credit bubble collapses on itself.

The end of the LBMA paper spot gold market setting the global reference price of gold is inevitable. As to the timing, keep an eye on the new Shanghai Gold Fix and for further signs that the market realizes that paper gold is faux gold and the LBMA is being abandoned.

In closing, a decade ago Christopher Ondaatje commented that he had one more book that he wished to write and that was about the markets and "this age of paper and its abuse that will end with horrific consequences."

Watch out, people.

Post Script: 1) This story need not have a catastrophic ending. Hundreds of millions of ounces of gold remain in the hands of citizens and by opening-up mints for striking of citizen gold and silver into sound money units along with an organized restructuring of the bond market, this impending crisis can be averted. Unfortunately, the rule in politics is to "never let a good crisis go to waste". Our politicians and the financial interests who back them invariably use these crises to exert greater control over citizens and the call at this time is for banishing physical cash and expanding government control in society. Creating decentralized sound money and taking away the franchise that government and their banking interest sponsors have to create money from nothing is not aligned with those currently at the nodes of power. It is however in the interests of citizens.

2) When the gold market crisis breaks it will rapidly become apparent that one of the few sources of real gold lies in the hands of miners. When this realization occurs, it will create a hellacious run into gold mining equities of miners that have real gold and silver resources. The question is whether these gold and silver equities traded in financial markets that will be undergoing paroxysms will provide any useful investment haven.

David Jensen, P.Eng., LL.B., MBA, is a Professional Engineer with a degree in Engineering from the University of Waterloo in Canada (1987). He worked through 1993 on the F-5 Fighter Overhaul program and the Bombardier Regional Jet programs. Mr. Jensen then graduated with a LL.B. degree in corporate and commercial law from the University of Calgary (1997) and an MBA from Univ. of B.C., majoring in Logistics and Supply Chain Management (1999). Returning first to aviation then, after reading Austrian School Economics, Mr. Jensen transitioned to the mining industry from the aerospace industry in 2004 first through his mining industry consultancy, then as Vice President of Corporate Development for Western Copper Corp., and most recently as President and COO of Skyline Gold. Mr. Jensen currently serves as President and COO of a private mining company and provides strategic, operational, risk assessment, and precious metals consulting services through his consultancy, Jensen Strategic.

The total world's holdings of gold could be transported by a single solitary oil tanker.
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