Tuesday, August 3, 2010

Janes Turk's Take On The BIS Gold Swap

James Turk suspects the hidden party behind the BIS gold was was Portugal, becuase the Portugese government recently announced that they will be posting collateral against derivative transactions in order to reduce funding costs and that same government has long been active in the gold market. The revelation that commercial banks were on the other side of the trade made him modify his theory:
Before it was announced that the BIS completed the swap with a commercial bank, the mainstream interpretation was that a troubled sovereign borrower or perhaps even the ECB itself needed liquidity, so they used gold to borrow currency. But given its two-sided nature, there was also another potential reason for the swap even if it received little attention – the BIS may be running out of physical metal for its interventions in the gold market. So it needed to get its hands on some physical metal. Consequently, it swapped currency for physical gold (or perhaps to deliver on calls it had sold and was exercised).

Then after the BIS announced that it had completed the swap with a commercial bank, many observers – including me – were perplexed. If it were a traditional swap, the commercial bank would have 380 tonnes of gold in its possession, which is a highly unlikely proposition. Commercial banks are not in the business of owning gold; they are in the lending business. Clearly, if any commercial bank had owned gold, which is highly unlikely I might add, the gold would have already been loaned out....

Now consider for a moment, what if that gold loan had been made by Portugal to Citibank or some other zombie bank? It wouldn’t look very good on Portugal’s balance sheet to be owed 380 tonnes of gold by a near-bankrupt institution. Given that Portugal is taking steps to “to reduce its funding costs” as the FT reports, it would be logical for it to get rid of that gold loan.

The best choice of course would be to demand repayment of the loan and put the 380 tonnes of gold back in its vault. That action though would drive the gold price sky-high, given the dearth of sellers of physical metal at current prices. Sky-high prices would blow-up the gold cartel and its efforts to continue capping the gold price as it operates its staged retreat, letting gold rise every year but not too much so as to not draw everyone’s attention to it and the resulting consequences of ever-depreciating fiat currencies. So enter the BIS.

It swaps currency for the gold loan at the commercial bank. In other words, the 380 tonnes of gold is now owed to Portugal by the BIS, improving considerably the quality of Portugal’s balance sheet. After all, who would you rather have owing gold to you? Some commercial bank like Citibank or the central banks’ own central bank, the BIS? Clearly, being owed gold by the BIS instead of a zombie bank would be one way for Portugal to “reduce its funding costs” by improving the quality of its balance sheet.
He ends by saying lack of transparency means we'll never know the real reason(s) behind the swap.


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