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Q BYTES – 21 November 2009 – WHY THE GOLD MARKET COULD BE A BIG SCAM!

In this newsletter:

… WHY THE GOLD MARKET COULD BE A BIG SCAM!

… EVIDENCE THAT THE GOLD MARKET OPERATES ON A FRACTIONAL RESERVE BASIS

… CUSTOMERS HOLDING UNALLOCATED GOLD ARE NOTHING MORE THAN UNSECURED CREDITORS

… AN EASY WAY TO BUY AND STORE REAL GOLD BULLION

WHY THE GOLD MARKET COULD BE A BIG SCAM!

Fascinating stuff this week, with another bull market in gold. As I write, gold is hovering around $1,150. (update – a week later – about $1,180) People are certainly freaked out by the declining dollar, as the US government try harder and harder to support the bankrupt greenback.

But further evidence has recently emerged of how the whole gold market is operating on a fractional reserve basis. We’ve long said (and advised in our Gold Report) that if you want gold as a safe haven hedge, you must buy real physical gold and not ETFs, certificates or anything else that is not literally solid gold.

Our “Swiss Mountain Guide” friend Frank Suess recently brought a new report to our attention, and now seems like an excellent time for me to bring this to YOUR attention…

EVIDENCE THAT THE GOLD MARKET OPERATES ON A FRACTIONAL RESERVE BASIS

“Alternative I: on average there is more than one ownership claim on each gold bar conforming to London Good Delivery. Essentially, the (gold) market operates on a fractional reserve basis. If it is true, the next phase in the gold bull market will be a religious experience for anyone unfortunate enough to be short of gold.”

Paul Mylchreest, ‘Thunder Road Report´, October 15th 2009

by Frank Suess, BFI Group, Switzerland

Gold has recently started behaving bullish beyond our short-term expectations. At BFI, we have been watching this phenomenon with interest. Obviously, there are the fundamental reasons that we and others have discussed at length: The medium- to long-term trend of gold certainly has much to do with ‘Easy Money´ liquidity and the related fears of future inflation.

However, inflation is currently on few peoples´ minds and, in my opinion, it is the lesser of two imminent evils. My primary concern is for deflation, or a Deflationary Phase II, if you will. But the reasons for gold´s current strength are possibly a result of more technical reasons. In his Thunder Road Report of October 15th, analyst Paul Mylchreest asks a simple but very important question: how many ‘London Good Delivery´ gold bars are there?

Just like us, Mr. Mylchreest believes that there are fundamental reasons for the surge in gold, amongst them growing fears by individual, institutional and sovereign investors about the real value of fiat currencies, most notably the US dollar. The supply of gold is finite; the supply of dollars is infinite. Certainly, US authorities are printing dollars as if they were going out of style. But Mr. Mylchreest has also researched two more technical scenarios worth consideration:

Alternative 1:

“On average there is more than one ownership claim on each gold bar conforming to London Good Delivery (LGD) standard on the ´pool´ of gold which acts as liquidity for the massive OTC gold trade based in London. Essentially, the market operates on a fractional reserve basis, but if a sufficient number of market participants become concerned about this and there is a stampede to take delivery of physical bullion, there is a risk of market failure. Such a process could be delayed by central banks lending gold to the market, although this would likely be obvious by a spike in gold lease rates, or by a much higher gold price in order to encourage holders to sell bullion. In this scenario, the gold price could soar at any time and the gold market, which is subject to little regulation, is basically an accident waiting to happen;

Or:

Alternative 2:

“There is far more gold bullion held in private hands than is acknowledged by current industry estimates. It is the large amount of additional gold on top of known gold stocks which provides sufficient liquidity to support the high volumes traded through London. The most likely source for this gold dates back to the Japanese conquest of Asia from 1894-1945 when Japan is alleged to have looted the gold and valuables of 12 nations – it is best known as the story of Yamashita´s Gold. If true, my analysis shows that particularly heavy volumes of this gold may have been laundered into the London market during 1986-90 and the mid/late 1990s. In this scenario, the continued evolution of the gold bull market could be more protracted, if supplies of this gold continue to enter the market periodically.”

At the following link, we have uploaded the full Thunder Road Report of October 15th, 2009, titled “Gold market – accident waiting to happen or crime scene? Don´t shoot the messenger”. I recommend you take the time to study this excellent report.

I recently had a group of clients ask me why I was putting so much emphasis on holding precious metals, and why I was so adamant about holding at least a substantial part of it in physically allocated format and in a safe jurisdiction outside of your country. Well, I hope that Paul Mylchreest´s report will give those of you who have the same question a solid answer.

CUSTOMERS HOLDING UNALLOCATED GOLD ARE NOTHING MORE THAN UNSECURED CREDITORS

Here is how he puts it:

• “Customers holding unallocated gold are nothing more than unsecured creditors from the bank´s perspective – they have even less protection than a holder of a typical current bank account. If the bank became insolvent, the holder of unallocated gold could lose some or all of their money – this is perverse when one reason for holding gold is protection from financial crises;

• “The unallocated gold is nothing more than a financial liability for the bank (not a liability to be paid in bullion unless demanded by the customer). The gold, if it´s there, is the property of the bank (part of its working capital) which can do what it wishes with it, e.g. keep it in the vault, lend/swap it, or even sell it – while retaining a financial liability to the holder of the unallocated account; and

• “From the bank´s perspective, the gold can be used as an interest free loan, since the banks can sell, lend or structure derivative trades with the gold. One could argue that there is an incentive, therefore, for banks to operate unallocated gold accounts on a FRACTIONAL RESERVE basis in the belief that it is highly unlikely that most holders of unallocated gold will suddenly demand either physical delivery or conversion to allocated gold accounts.”

AN EASY WAY TO BUY AND HOLD PHYSICAL GOLD IN SWITZERLAND OR AUSTRIA

For more guidance on WHY and HOW you can privately and safely keep your PHYSICAL precious metals, you need to talk to Frank Suess. Frank’s firm BFI Wealth Management has a solution. Under strict Swiss privacy laws, his firm can sell you actual physical bullion that can either be stored for you in secure, insured Swiss vaults, or you can have it physically shipped to you almost anywhere in the world.

For more details of the program, check this link…

Kind regards, until next week,

Peter Macfarlane

by Frank Suess, BFI Consulting

For centuries, gold has attracted investors seeking to protect their wealth and provide a ´safe haven´ in troubled or uncertain times. This remains a reality for modern investors too, although there are also a number of other reasons that underpin the widespread renewal of investor interest in gold. Gold can add an element of potentially outstanding capital gains to your safety-oriented portfolio. And, if structured adequately, gold will entail a minimal downside risk.

We consider buying gold “the right way” to be a HOT topic and unique opportunity in achieving the following benefits:

• Diversification out of continuously devaluing paper currencies, thereby protecting one´s assets against a loss of purchasing power AND, at the same time, setting it up for capital gains.

• Retaining liquidity and purchasing power for the next upturn in business cycles (which in our view has NOT arrived yet), thereby securing the opportunity of taking part and benefiting from it. It is important that the gold format one chooses is supported by a liquid market, i.e. you want to be able to buy and sell rapidly if need be.

• Safe haven: In volatile and uncertain times, there is typically a “flight to quality” as investors seek to protect their capital by moving it into assets considered to be safer stores of value. Gold is among a handful of financial assets that do not rely on an issuer´s promise to pay, offering refuge from default risk. It provides insurance against extreme movements that often occur in the value of traditional asset classes in unsettled times.

• Paper Currency Hedge: Gold is often used as an effective hedge against fluctuations in fiat currencies. In particular, a close relationship tends to exist with the U.S. dollar. When it appreciates, the dollar gold price falls, while a fall in the dollar relative to the other main currencies produces a rise in the gold price. While this may also be true of other assets, gold has consistently proved among the most effective in protecting against dollar weakness.

• Added asset protection and privacy: Structuring your strategy appropriately can provide a considerable level of privacy. Depending on the format gold is bought in, there are considerable privacy and safety related differences. More specifically, buying gold “the right way” can mean avoiding reportability and minimizing confiscation risks.

• Portfolio diversification: Most investment portfolios are invested primarily in traditional financial assets such as stocks and bonds. The reason for holding diverse investments is to protect the portfolio against fluctuations in the value of any single asset or group of assets that react in a common fashion. Portfolios containing gold are generally more robust and less volatile than those that do not.

• Physical or virtual ownership: You can buy gold in its physical form and store the coins, gold bars or jewelry that you have acquired. However, storage fees must be considered. And, one must consider a lower level of liquidity compared to a gold certificate or metal account (also referred to as a claim account).

BUYING AND STORING PRECIOUS METALS “AT HOME” OR OVERSEAS?

A key issue that needs to be addressed is whether an investor should buy gold offshore or “at home”. The answer will not be the same for everyone. Depending on your specific objectives and situation, you may be better off keeping your assets in your home country and storing physical gold in your local bank´s deposit box. You might, however, be well advised to buy and store physical gold offshore. Or, maybe, you should consider a mix of both.

Buying Gold “At Home”

Obviously, this is (a bit) more convenient, simply for the fact that you are not dealing with time and language differences. Furthermore, you can have the gold delivered to your home or directly to the local bank or storage facility of your choice with more direct control over your assets. However, a key issue arises — and this applies to U.S. investors in particular – in regards to the risk of government confiscation when buying and storing gold “at home”!!!

How might a gold confiscation be possible nearly 70 years after the last one occurred? This question is best answered with a series of other questions: Firstly, how will the massive U.S. federal debt (nearly $6 trillion and growing) and the outstanding international dollar float (resulting from the U.S. trade and budget deficits) be reconciled?

Currently, the U.S. dollar (still) enjoys a special status around the world as the primary reserve currency. This status encourages central banks and individual investors around the world to hold it. Leaving the various circumstances and potential scenarios aside, what would be the outcome if the stilts that propped it up were kicked out from underneath this built-in dollar market?

How might the U.S.government react to an economic emergency in which individuals, beset by either a devastating domestic inflation or a deflationary nightmare — or both — were fleeing the banks and equity markets for gold as a means of preserving their personal capital?

Historically, confiscation has all too often been the option taken by governments beset by an economic breakdown. Just as gold is the asset of last resort for the individual portfolio doing service in the most financially threatening times, it is often times the asset of last resort for troubled governments as well. As recently as 1998, during the Asian Contagion, both South Korea and Thailand implemented “voluntary” gold call-ins. The temptation presented by its citizens´ gold holdings was simply too facile to resist.

No matter how you look at it, investors must beware of government confiscation risks that rise exponentially in times of a severe economic crisis (as seen under U.S. President Franklin D. Roosevelt in 1933).

Buying Gold Offshore

The advantages of buying and storing gold offshore are primarily related to PRIVACY and ASSET PROTECTION. However, what is required to reap these benefits is a structure that allows you to re-allocate your precious metals rapidly and store them safely. Ideally, this is done in an efficient and low-cost mode despite any geographic distance issues.

Some clients may prefer buying and storing physical gold over a “virtual” gold account or certificate. They perceive a higher degree of safety in this strategy because of the fact that they are allocated a specific and tangible lot of gold. However, storing physical gold is obviously more costly. And, it is generally less liquid than its “virtual sisters”.

Despite higher holding fees, in today´s environment, BFI ultimately recommends holding physically allocated precious metals, preferably in bullion coin or bar format.

Conclusion

Both options, buying gold offshore or “at home” have their advantages over the other. The offshore option is more complex in execution and requires a larger investment. This is not a “do-it-yourself” commodity, unless you have lots of time and like to travel. Therefore, we recommend taking advantage of a full service program as offered by BFI Consulting and some other firms.

When going the offshore route, beware of strategies that sound too simple. Think the process through. And consider the hefty fees and taxes (VAT) you will pay in some European countries.

The “at home” solution is more convenient and efficient. The key risk, in case of a severe crisis, is government confiscation. It appears, however, that if approached cleverly, these risks can be minimized.

Further reading: Frank Suess Jr is CEO of BFI Capital in Switzerland. His firm provides solutions for buying and storing physical gold bullion, as well as offering a range of excellent portfolio management services for high net worth individuals. He can also assist with Swiss Bank account opening.

If you would like to read more about how to buy, hold and store physical gold bullion offshore, visit our Offshore Precious Metals page. You will also find good information for free here on Gold and Silver Investments.