Nervous or Knowing? Paper Gold Changed to Real Deal
By Patrick A. Heller, Market Update
July 21, 2009
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On July 14, Greenlight Capital, the hedge fund that had been the largest shareholder in GLD (the largest gold exchange traded fund), revealed that it had disposed of its entire holding of 4.2 million shares of GLD (effectively about 420,000 ounces of gold worth almost $400 million) and replaced it all with physical gold.
This is an extraordinary move for any financial company. You can be sure that other hedge funds are studying this move to understand the profit motive behind such a strategy. They are probably poring over all the loopholes in the prospectuses of the various gold exchange traded funds looking for what they may have missed or not given serious consideration. If, and it is only if right now, any other hedge funds take a similar step, we could well see the floodgates open for the demand for physical gold.
CIT Group, which provides loans to almost a million small and medium size businesses, has to make a debt payment of $1 billion on Aug. 15. It doesn't have the resources to do so and has retained a major law firm to prepare for possible bankruptcy. Last Friday it was announced that Goldman Sachs and JPMorgan Chase had been appointed by the U.S. government to try to come up with a rescue package for CIT Group.
Why Goldman Sachs and JPMorgan Chase? Simple - the Federal Deposit Insurance Corporation may not have enough assets to bail out CIT. In fact, whether or not CIT goes under, several analysts now expect there will be enough bank failures over the next few weeks (added to the 53 bank failures in 2009 through July 10) that the FDIC will run out of assets by the end of August. Should this occur, I'm confident the federal government will find some way to shore up FDIC, since the alternative is to risk instant catastrophic bank runs in the United States.
Actually, before the end of September, there is a growing risk of a "bank holiday" similar to what was imposed by President Roosevelt in 1933. I cannot give a probability for this event, but it is not zero. Should there be a "bank holiday," account holders would not be able to access the funds in any of their accounts for an indefinite period. Even worse, there would be no access to safe deposit boxes. Any cash or precious metals stored in bank vaults would, therefore, also be out of reach for an indefinite period.
Two weeks ago, HSBC, a bank with one of the largest depositories of precious metals in the United States, notified its customers for whom it is providing gold and silver custodial services that it is getting out of that business. According to some of my company's customers, they have been told by HSBC that they must arrange to either quickly remove their holdings or to sell them. It does not make sense for a bank to abandon such a profitable activity. There are multiple reports that investors who purchased COMEX April 2009 silver contracts and asked for delivery are still waiting for delivery from HSBC. Such contracts were all to have been delivered by May 29. I don't know the whole story of what is happening at HSBC, but whatever is going on worries me.
On Friday, Citigroup reported a supposed second quarterly profit of $4.3 billion. Actually, the figure included a $6.7 billion after tax profit from its sale of Smith Barney and also a $1 billion paper write-up of the value of impaired assets. If you exclude these one-time events, which are not part of operating activities, the bank lost $3.4 billion for the quarter. But that is not the news people saw in the headlines.
Similarly, Bank of America on Friday reported second quarter profits of $2.42 billion. However, this figure included the one-time pre-tax profit of $5.3 billion from its sale of shares of China Construction Bank. Absent this event, Bank of America also would have reported a quarterly operating loss.
In a statement released last Friday, Bank of America CEO Ken Lewis said, "Difficult challenges lie ahead from continued weakness in the global economy, rising unemployment and deteriorating credit quality that will affect our performance for the rest of the year and into 2010." This is absolutely not a prediction of good news over the next several quarters.
Last Thursday, former Treasury Secretary Henry Paulson testified before the House Oversight and Government Reform Committee. He admitted that he had threatened Ken Lewis last December about Lewis's intention to back out of Bank of America's acquisition of Merrill Lynch. "I further explained to him that, under such circumstances, the Federal Reserve could exercise its authority to remove management and the board of Bank of America. By referring to the Federal Reserve's supervisory powers, I intended to deliver a strong message."
The Commodity Futures Trading Commission announced that it may consider limiting the size of commodity trades that are not done as legitimate hedging by, for instance, mines and agricultural producers. At first glance, this measure appears to strike against the two or three large U.S. banks that have huge COMEX short positions in gold and silver. However, other analysts have pointed out that such limits could prevent the Chinese and Japanese central banks from buying up so many COMEX gold and silver contracts that they could demand delivery and force the COMEX into failure.
As time goes on, it becomes more likely that we will see major drops in the values of paper assets, including those purporting to represent ownership in the value of gold and silver. I think time is running out to readily acquire physical precious metals, either by an outright purchase, or by conversion of gold or silver certificates or ETF shares or commodity contracts. In the past week, my company enjoyed a major surge in customers (especially first time buyers) purchasing physical gold and silver. We have heard similar stories from other coin and bullion dealers. Some premiums have even increased slightly. It may be prudent to take action sooner than later.
The pending legislation to audit the Federal Reserve, which if enacted, would likely disclose exactly how much gold the U.S. government still actually owns versus the amount it claims to own is touching a nerve with the public. The section of my NumisMaster essay last week that discussed the "dirty trick" used to block passage of this legislation appeared in a slightly modified form as a Viewpoint in the July 20 issue of the Lansing State Journal (www.lsj.com
). Within hours, reader comments were being posted online.
On July 21, look for the debut of the Liberty Gold Card. This is a major credit card (either VISA or Mastercard, I don't remember which) where charges to it are paid to the merchant from gold stored in a Swiss vault. For the merchants, the cards will work the same as any other charge card. When the charge is processed, the amount will be converted into a claim against the customer's gold holdings at the bank.