Monday, April 19, 2010

A Gold Ponzi of Mass Deception?

A Ponzi scheme one tends to associate with back street traders of dubious reputation and an unprofessional con man out for a quick buck.

But only recently Adrian Douglas from the Gold Anti Trust Association (GATA) confirmed in testimony to the U.S. Commodity Futures Trading Commission (CFTC) that the London Bullion Market Association is operating a massive fractional reserve gold market which he refers to as a Ponzi scheme.

This has also been confirmed by Jeffry Christian of the CPM Group who noted that the London "physical market" is actually trading a hundred times more paper gold than there is physical metal to back those trades.

One might wonder how the LBMA can sell gold bullion that they do not actually have in their vaults.

This is done through the allocated and non allocated account system.

In an allocated account, an investor will have specific bars of gold specifically assigned to him and when the gold bars are purchased the investor will be given the serial numbers. That investor has full title to that gold bullion and the dealer acts as a custodian, holding the gold on behalf of the client. The LMBA describes allocated accounts as"

"These accounts are opened when a customer requires metal to be physically segregated and needs a detailed list of weights and assays. The client has full title to the metal in the account, with the dealer holding it on the client's behalf as a custodian."

An allocated account is where the investor has on deposit with a financial institution specific bars of gold or silver that are segregated for him and he is given their serial numbers. This gold and silver can be audited and the customer can have confidence that his investment is safe insofar as it really exists, is being stored on his behalf, and he has title to it.

With an unallocated account, however, the situation is vastly different. The gold or silver is held by the bullion bank but not identified by serial number. So when a client buys unallocated gold they do not get allocated bars of gold. If, for example, two customers each buy 200 ounces of gold they could together be assigned one 400 ounce London Good Delivery (LGD) gold bar. So each client is not assigned a specific gold bar but a real bar is held 'on their behalf.'

The LBMA description of unallocated precious metal accounts states:

"Unallocated accounts. This is an account where specific bars are not set aside and the customer has a general entitlement to the metal. It is the most convenient, cheapest, and most commonly used method of holding metal. The units of these accounts are one fine ounce of gold and one ounce of silver based upon a .995 LGD (London Good Delivery) gold bar and a .999 fine LGD silver bar respectively."

One would think, therefore, that if 20,000 unallocated account holders collectively bought 200 tonnes of gold, there would naturally BE 200 tonnes of gold resting in the vaults.

However, The LMBA definition of unallocated also goes on to state:

"Transactions may be settled by credits or debits to the account while the balance represents the indebtedness between the two parties."

"Credit balances on the account do not entitle the creditor to specific bars of gold or silver, but are backed by the general stock of the bullion dealer with whom the account is held. The client is an unsecured creditor."

So, as Adrian Douglas of GATA correctly points out, "The balance on the account is a measure of "indebtedness between the two parties." In other words the account balance is an IOU for bullion. It is NOT really a "method of holding metal" as first described by the LBMA. No, the unallocated account is backed by the general stock of the bullion dealer -- and that may be, as Jeffrey Christian has confirmed, only one
physical ounce for every hundred ounces that have been sold in unallocated accounts."

Importantly, it also states that "The client is an unsecured creditor." If 10 tonnes of gold are bought for 10 clients with allocated accounts, those ten clients are secured, but if the accounts are unallocated, then they are unsecured and there is no guarantee whatsoever that there is gold to cover that clients holding. Otherwise why describe them as unsecured. This opens the door to operating a fractional-reserve basis and, while that might be acceptable for currency, it is certainly not acceptable for gold being held in trust for clients.

Unallocated accounts are not then, "the most convenient, cheapest, and most commonly used method of holding metal." Rather, they are an unsecured way of holding an IOU for gold or silver bullion. Just a paper promise.

Indeed, an unallocated account holder is really just lending money to the bank at a negative interest rate, as the customer is the one that is paying the fees for the privilege of lending the bank money. The only real connection between gold and the 'loan' is that the loans are index-linked to the price of gold bullion.

The message is then, there is nothing so secure as holding actual physical gold and if one has to have gold held for one, ensure it is an allocated account and have the attendant security that goes with that gold. You should also have the serial numbers of the bars you own so you do know you indeed actually own some gold.

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