Gold Prices Have People Wondering: What’s in the Vault?

Published August 27, 2013

With private investors’ demand for physical gold remaining strong throughout 2013 so far, the significant price declines in recent months have taken many investors by surprise.

Attempting to make sense of this situation, speculation has arisen that the so-called ‘bullion banks’ (the mostly “Too Big to Fail” institutions that are known to work closely with the central banks) have lent out, or even sold, gold on a fractional basis, far in excess of what is supposedly held in their vaults. The result would be to multiply greatly the amount of ‘apparent’ gold in the market and thereby depress prices. Such an action would provide needed cover for the embarrassment of currency-depreciating central banks’ policies.

Much of the chatter stems from the mysterious announcement in January by Germany, the world’s second-largest holder of gold reserves, to repatriate some 300 metric tons of its gold reserves that are being held at the New York Federal Reserve Bank. It is widely believed the request was motivated by internal political demands, which questioned the continued need for Germany’s sovereign wealth to be in the hands of foreigners.

Slow Repatriation

The request represented less than 5 percent of all the gold the Fed officially holds in its New York vaults. (Interestingly, an earlier request by Germany to inspect its assets was denied by the Fed). Despite the relatively small request (relative to the total holdings), the repatriation is expected to be done in 2020.

Perhaps for fear that she might be “persuaded” to accept being “cash-settled” with U.S. dollars in lieu of gold, Germany dared not complain. Either that, or as an important member of the elite club of central banks, Germany acted “responsibly” in order to avoid threatening the ostensibly happy equilibrium of the fractional, central bank-controlled, physical bullion market.

Nevertheless, the seven-year wait for the return of a deposit rippled through gold markets. Suspicions grew that perhaps the Fed no longer held ownership of the 8,133.5 tons of gold that it reports. For years, central banks have acknowledged that they do things with their gold other than just storing it, such as lending it and engaging in swaps. Some, such as the Austrian central bank, even declare “earnings” from gold, a non-coupon-bearing instrument.

Falling Inventory

Bloomberg reports that most unexpectedly, since Germany’s request for partial gold repatriation, the gold inventory of the COMEX has fallen from eleven million ounces to some seven million, a drop of about 36 percent, the lowest level in five years. Clearly, dealers have demanded physical delivery on gold purchase contracts on an increasing scale throughout 2013.

Some dealers may even have been prompted to take delivery by the news that bullion banks, including Morgan Stanley, were rumored to have experienced serious runs on the physical gold held in their vaults for their clients. As early as January 23, 2013, The Wealth Cycles site commented, “The issue . . . is the near certainty that not all the gold recorded to be held in the bullion banks is really there. Much of it has been pledged and re-pledged against the debt that keeps the world’s monetary system afloat.”

Cash Settlement

The letter issued on April 1, 2013 by Dutch State-owned ABN-AMRO bank to holders of paper claims to gold and silver held in its vaults must have shaken complacency. Clients were advised any physical metal custodied at the bank would in the future be “cash-settled” and requests for physical delivery would be denied. Contrary to logic, the price of gold did not rise over this period of increased uncertainty. In fact, by the end of June 2013, the gold price had fallen from $1,668.25 on February 8 an ounce to $1,192, some 29 percent.

Many have understandably sensed central banks have been allowing bullion banks to take out massive naked short positions in precious metals in order to drive down the price. The previous upward march of gold was a continuing embarrassment to the current fiat currency regime.

On July 18, 2013, Fed Chairman Ben Bernanke testified to Congress that “nobody really understands gold prices, and I don’t pretend to understand them either.” This statement went unchallenged in Congress but aroused suspicions of gross hypocrisy, even evasion, by some observers. So much for deceptive “forward guidance.”

Bernanke likely would have been shocked had any Congressman asked him to explain why the Gold Forward Offered Rate (GOFO) had dipped into negative territory. GOFO now stands below both the U.S. Federal Funds Rate and the London Interbank Offered Rate (LIBOR).

Investors should appreciate two vital factors. First, gold prices may have been suppressed for years by central banks and could be set to respond as physical shortages and fiat currency debasement become clearer. Second, the enhanced value of physical possession of precious metals could be about to become manifest.

John Browne is a senior economic consultant to Euro Pacific Capital. Used with permission of