Monday, December 24, 2012

Stephen Koukoulas on Gold, beans & vending machines

For those not familiar with Stephen Koukoulas he is an economist who has (in the past) worked as an economic advisor to the Prime Minister (of Australia) as well as Chief Economist for two major banks and currently runs his own advisement firm Market Economics. I believe he also makes regular appearances on business news and mainstream media channels. He is quite active on Twitter as @TheKouk. His articles promote/support a Keynesian approach to resolving the crisis we face today and he has been quite vocal (negatively) on Gold over the last half of this year. Here are some tweets on the subject:

Summary: Gold has zero yield and is expensive to hold.

Summary: Gold as a security asset is the equivalent of a can of beans.

Summary: Gold is a dud investment in AUD terms taking into account yield and cost to hold.

Summary: Republicans are freaks (or perhaps just those advocating a Gold standard?). Gold standard is equivalent of burning witches. A soya bean standard would be better. Gold is like every other commodity.

Summary: Gold has no fundamental basis as a store of wealth.

Summary: Moving to a Gold standard will not solve any fundamental problems.

Summary: Gold a bubble. Iron ore rises 60% in a couple of months and no mention of bubble.

 Summary: Gold is in a bubble because it's sold out of vending machines.

So let's take a look at these sound bites one by one.

Gold has zero yield and is expensive to hold.

Well from a personal investment perspective Koukoulas is correct, Gold doesn't pay a yield if you buy and hold the physical metal. At least not in Australia. Up until recently those depositing Gold with banks in Vietnam were paid interest, however that has recently changed. Central Banks and institutional Gold owners may be able to lease their holdings for a small return (Gold Lease Rate). Last financial year the RBA returned approximately $200k from leasing Gold, however they don't advise the cost to store it with Bank of England (99.9% of Australia's Gold stored with the Bank of England is a story I broke a week ago).

As for expensive to hold... that is debatable as it depends on whether you want to hold and store the metal yourself and cost may vary depending on scale and investment size. Someone with only a small amount of Gold may feel comfortable holding it at their home and it may be covered under their contents insurance (e.g. CGU covers cash & bullion up to $1500). Assuming we are talking a larger (investment sized) amount, safety deposit boxes with local banks can be rented for various prices, some for as little as $15-20 per month could store half a million in Gold bars quite easily (+ insurance on top if you want). Alternatively various storage options are available with bullion dealers these days at low cost, for example Bullion Money's basic allocated storage is $11 per ounce per year, this works out to around 0.7% holding cost per year with Gold at AUD$1600. It's not a lot to spend for peace of mind. Last I checked my superannuation account was hitting my pocket for more than this in fees when they don't even manage my allocations (most invested in direct equities). So if Koukoulas thinks that Gold is "expensive to hold", perhaps he can clarify, in comparison to what?

Gold as a security asset is the equivalent of a can of beans.

When Chris Becker (The Prince from Macro Business) suggested Gold was a security asset, Koukoulas said so is a can of beans which has doubled in price over the last 10 years. He then suggests that you could eat them if the price goes down. I think Koukoulas misunderstood what Becker meant by a security asset, in a past post this was the explanation provided: I treat physical gold as a “Type Zero” security asset, a small insurance hedge against financial instability – a “Minsky Metal”. Do beans rise in value during periods of financial instability? Probably only in the case we saw a complete melt down of the financial system, resulting in a breakdown of society.

For the record Becker's treatment of Gold is not for everyone. As recently pointed out by FOFOA, Gold plays many roles depending on how it's used by those buying it:
If we could get everyone in the West to vote in this poll, I think "gold is an investment" would win in a landslide. If we could get everyone in the precious metals blogosphere to vote, then "gold is money" would probably win. So, to most Westerners, gold is an investment. To the gold bugs and HMS crowd, gold is money. And to the bullion banks, gold is a currency (ISO code XAU) upon which credit is issued and traded. So what did A/FOA mean by the statement that gold is wealth, not any of these other things? I mean, surely gold is whatever its users think it is, subjective use value and all, right?

Actually, that's exactly right! Gold is whatever its users think it is. And the point A/FOA was driving at was that the vast majority of the above-ground gold, today somewhere around 165,000 tonnes, is held by people who understand it as wealth. FOFOA
Not all buyers/holders of Gold are holding it as the end of world apocalypse ticket that Koukoulas seems to imply in his comments. 

Gold is a dud investment in AUD terms taking into account yield and cost to hold.

Hmmm... Gold priced in AUD is a dud investment? Over what time frame?

Over 3, 5 or 10 year periods Gold has performed exceptionally well, priced in Australian Dollars and basically any other currency. Granted it has performed better in USD and some other currencies than in the AUD, but a 10.9% annual return over 10 years is nothing to sneeze at. Even if we threw in a cost to hold at 0.7% (tax deductible) it's still a great return and comes with taxation advantages that put it ahead of cash (50% CGT discount if held longer than 12 months). Koukoulas, please explain?

Republicans are freaks (or perhaps just those advocating a Gold standard?). Gold standard is equivalent of burning witches. A soya bean standard would be better. Gold is like every other commodity.

Koukoulas likes to complain when others use labels or names, but he seems to do it quite regularly with the Gold crowd (and for other "fringe" groups such as the Tea Party movement), calling them "freaks" and "loonies".

I'm not sure what he meant by equivalent to burning witches, but I assume he simply meant that it was an outdated practice with no relevance in today's modern society. Those advocating a return to sound money are generally just looking for monetary policy which is based on a stable and sustainable foundation. Gold is not a perfect solution, but if it had continued post 1971 it's likely to have restricted governments from running massive budgets deficits, which has (several decades later) resulted in many countries with unsustainable debt to GDP levels. It's scary that suggesting we return to sound monetary policy today is compared by Keynesian economists such as Koukoulas to burning witches, rather they would prefer to have the same men and policies that got us into this mess try and get us out.

Gold is like every other commodity? I think not. It's Golds unique properties which have seen it used as money or a store of value for thousands of years, it's durable, divisible, consistent, convenient, and has value in and of itself.

Apart from it's physical attributes Gold is very different from commodities in another way... most mined and refined Gold in history is still in an easily retrieved form, where other commodities are generally consumed and above ground supply remains minimal (or where there is ample above ground supply it suppresses the price):

Of course there are other difference as well, but this post is starting to turn from long post into thesis in size. Bottom line is that suggesting Gold is the same as other commodities is showing ignorance of facts and history.

Gold has no fundamental basis as a store of wealth.

Gold has been used for thousands of years as a store of wealth. Many of Gold's unique physical qualities make it the perfect store of wealth/value (see YouTube clip posted in the last section). Individuals, institutions and banks have used it as such throughout history. If not being used as a store of value (in the form of reserves) to protect from currency debasement, perhaps Koukoulas could explain why there are many central banks adding to their positions today? The below from Wikipedia:
A gold reserve is the gold held by a central bank or nation intended as a store of value and as a guarantee to redeem promises to pay depositors, note holders (e.g., paper money), or trading peers, or to secure a currency.
Perhaps Koukoulas could provide an example of ANY other asset which transcends both time and geographical location as a store of value in the same way that Gold has and does?

Moving to a Gold standard will not solve any fundamental problems.

As pointed out by @ShervinD (and discussed above), it would have made it difficult for governments to issue excessive amounts of bonds had we remained on a Gold standard. A return to a Gold standard today by the United States would probably not be feasible, but a change to the monetary system whereby Gold was used as a point of reference (such as discussed in my recent post on Freegold) or to restrict the amount of fiat issued globally would solve many fundamental problems. Koukoulas appears to believe that infinite money in a world restricted by finite resources isn't a fundamental problem worth solving...

Gold a bubble. Iron ore rises 60% in a couple of months and no mention of bubble.

I found it amusing that Koukoulas referred to Gold as a bubble and in the next breath was talking about another commodity which has risen much higher than Gold (in percentage terms) over the past decade (as well as a 60% spike in recent months), that is iron ore:

As an asset with no yield it becomes difficult to substantiate whether Gold is over, under or fairly valued at any one point in time (in hindsight one can draw a conclusion from what the price has done, e.g. Gold in 1980 was clearly a bubble, which was made obvious after the peak when it collapsed roughly 50% in 3 months). 

One of the valuation methods I have used on this blog is comparing it in a ratio with other assets, such as to oil, houses or stocks. Another interesting measurement is to compare an ounce of Gold with Australia's weekly wage, which results in a ratio today around middle of the road.

Other methods of identifying whether Gold is in a bubble is to compare the value of Gold assets as a percentage of all financial assets to previous peaks, this chart only shows to 2009, so the percentage would be higher today, but still well below any previous peaks:

In the tweet that Koukoulas said Gold was in a bubble, he also said that it would deflate to less than $1000. I hope for Australia's sake that it does not as cash costs for many Australian Gold producers are not much lower, it would put a lot of marginal producers out of business:
Mr Holland said industry cash costs in Australia were about $US800 to $US850 an ounce, which was 20 per cent to 25 per cent higher than the average across the global gold industry.

"It is probably also one of the reasons you've seen gold production go down 30 or 40 per cent. Australia used to produce 450 tonnes a year; it's now down to 300." The Australian
And Gold is an important export for Australia:
Australia’s major export – iron ore (22% share) – and third biggest export – gold (7% share) – rose by $882 million and $158 million respectively,  whereas Australia’s second and fourth biggest exports – coal (15% share) and gas (5% share) – fell by -$300 million and -$29 million respectively over the month (see below chart). Macro Business
I followed up asking for the reasons that Koukoulas thought Gold was in a bubble to which I had the response...

Gold is in a bubble because it's sold out of vending machines.

Anecdotal increases in Gold's visibility to the public can point toward a bubble like mentality, but is the Gold vending machine really anything more than a convenient (albeit expensive) way to buy Gold? By the same logic should we make the presumption that stocks are in a bubble because I can buy them via an App on my mobile phone? Or cash is in a bubble because I can draw it out of an automatic teller machine in a similar way to drawing Gold out of a vending machine?

This is certainly a point of view I didn't understand and when I questioned Koukoulas for some substance to his comments that Gold was a bubble he responded that he would "Get back to me". Granted it's the holiday season, so I'm not expecting a response tomorrow, but a post or article from Koukoulas on why Gold is a bubble and perhaps to clear up some of the ambiguity around his other comments (if he feels he has been taken out of context) above would make for some interesting reading...


It's concerning to see that popular economists who have led our banks and country still have such a poor understanding of Gold. At least that seems to be the case in many western economies. Economists and finance officials in China and other eastern countries clearly have a grasp on the importance of Gold:
In 2009, State Council advisor, Ji said that a team of experts from Shanghai and Beijing had set up a task force to consider expanding China’s gold reserves. Ji was quoted as saying "we suggested that China's gold reserves should reach 6,000 tons in the next 3-5 years and perhaps 10,000 tons in 8-10 years”. Zero Hedge
Even Koukoulas can see that emerging economies/policies will have a greater impact on Australia and the rest of the world in the future:
These are extraordinary changes. They reinforce the scenario that in the next 10 to 20 years, trends on the Shanghai or Mumbai stock exchanges will be as important, if not more important, that what happens on Wall Street. It means that in the not-too-distant future, policy changes in Indonesia will be more important that in the UK, France and even Germany.

As a demonstration of the rising living standards and the closing of the gap between developing and developed countries, the OECD estimates that average GDP per capita will grow by around 3 per cent per annum over the next 50 years, a stark outperformance relative to the average 1.7 per cent in the OECD area.

The bottom line of this, according to the OECD, is that “GDP per capita in the poorest economies (in 2011) more than quadruples … whereas it only doubles in the richest economies. China and India will experience more than a seven-fold increase of their income per capita by 2060.”

It is Asia, so very clearly, where Australia needs to maintain and build its economic, investment and cultural engagement. It seems so obvious.

Let’s hope that government, business and the general population of Australia warm to these trends. Europe, the US and the UK will still be nice places to visit, but the economic future is at our doorstep, a point confirmed by the OECD report. Stephen Koukoulas, Business Spectator
So why shouldn't the west also warm to the importance that China, India, Russia and other countries place in Gold?

Given all the above comments from Stephen Koukoulas and little facts provided to backup his presumptions, assumptions, rhetoric and opinions about Gold I was pleasantly surprised to see that he would be turning a new leaf and sticking with the facts in the new year:

That is assuming he was looking to take this approach himself as well as hold others to the same account... that's a good New Years resolution that @TheKouk will be sticking with, I look forward to this as well as his comeback post on why Gold is in a bubble at $1665.

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Friday, December 21, 2012

Pascometer: Contrarian Indicator Rings "Buy Gold"

Those who have been reading this blog for awhile would know that articles mentioning Gold from Michael Pascoe (Gold aways discussed in a negative light with "gold bugs" mocked) often rings a bell for the bottom of price corrections. He is an excellent contrarian indicator, see this chart from an earlier post:

His negative posts on Gold marking the bottom of corrections led to the creation of the Pascoe Indicator or Pascometer meme (if Michael Pascoe says something, the opposite is likely to occur).

In Pascoe's latest bearish post on Gold he suggests to sell it in order to buy base metals:
Sell gold, buy base metals at the End of Fear

In case you missed it, 2012 is finishing as a dud year for gold. And according to RBS Morgans economist and analyst Michael Knox, 2013 is going to be worse as we enter the “World at the End of Fear”.

After this week’s dip, gold in Australian dollars is up just 2.17 per cent since January 1 – below the inflation rate. Over 52 weeks, gold is actually down 3.13 per cent. Even in US dollars it’s been poor – ahead only 0.67 per cent.

But that’s just taking a cheap (yet irresistible) shot at the gold bugs as such random calendar points as 12 months don’t mean much. Pick another set of dates and you can engineer another outcome. Much more important for all investors is the big forecast sent out to clients by Knox last Friday, before gold took at tumble to a four-month low and iron ore prices continued to firm.

Despite various on-going headlines, Knox argues that we’re entering the end of fear, that financial markets in 2013 will see their lowest volatility since 2006.

In brief, after two international banking crises in five years, we’re getting over the fear that there’s another one around the corner. With central banks pumping out liquidity, keeping interest rates down, lower volatility and less fear will mean investors will have less demand for “precautionary assets”, those  that are held out of fear, “just in case”: gold and US treasuries.
So based on his suggestions we can expect 2013 to bring a large increase in the price of Gold and a lot more volatility as the market complacency breaks down? I suspect this will be the case, but obviously not only due to the Pascometer meme.

It's interesting that a very similar conversation took place in the comments section of Macro Business only hours before Pascoe's piece on Gold and fear... coincidence?

Peter Fraser had the following to say:
I’m less optimistic for gold BB. I see buying gold as a fear play, with concerns about hyperinflation and the collapse of fiat currencies. Now that the market can see that hyperinflation is not a current threat and fiats won’t collapse, with the USA economy getting stronger, fear has subsided. I think the driver for gold at the moment is fear.
To which I replied:
I do think fear has played a part in Gold’s rise, there have been short term periods where this has been especially noticeable e.g. when the USD and Gold rose together during the worst (so far) of the Euro-crisis. But I don’t think fear is the only driver, for example demand from central banks buying is a new driver added to the market in the past few years (where earlier in the decade they were net sellers). Only last night we had news of Brazil doubling their Gold reserves:

Also I think it’s preemptive to suggest that the fear should have subsided over currency debasement, especially given the strong words out of Japan a few days ago:

And the recent announcement by the Fed that they would increase their bond buying.

That’s not to suggest hyperinflation is around the corner (in fact I think we would see changes to the monetary system before that was allowed to occur in the US), but I think the environment which Gold has thrived in for the last few years is set to continue, namely one of negative real interest rates, irresponsible fiscal policy and debasement of currencies. So expect a higher Gold price in the near future, but as I said above “Time will tell”
And another user cangaceiro99 followed up with:
Just to add to what BB has already touched on, where interest rates are low, the opportunity cost of holding gold is low also.
Given that the amount of sovereign debt is so large that a rise in interest rates would make sovereign debt unserviceable for many countries (relative to their tax income), I think you will continue to see govt central banks try to maintain this “co-ordinated” policy of low or negative real interest rates indefinitely.

As to central banks buying gold, perhaps they are copying the Europeans, where in 2000 they had perhaps 1/3 of the euro backed by gold and 2/3 by foreign reserve currency holdings. 12 years later, gold now makes up 2/3 of their holdings (based purely on valuation changes, not volume) and foreign reserve currencies 1/3.

I’m not confident will see hyperinflation in the future, I think the world is too interconnect for this to occur over a prolonged period, so I would concur with BB, a quick reset at some point is more likely.

The thing that confuses me about fiat is that given the USD (the world’s reserve currency) is borrowed into existence at interest, unless they keep creating more money, there is not enough money that exists to pay the interest on the existing money that has been created.

So despite talk of deflation, money printing must continue, for the system as we know it to continue.

As there is so much money around, interest rates must be kept low to service the debt. Once the interest rates spike, the debt becomes unserviceable.
That bolded text really is the bottom line.

Growth is currently being generated by increasing levels of public debt as private household debt stagnates or is falling. This debt shuffling doesn't solve the underlying issue (a massive debt bubble formed over the past several decades). Until we see real change to the burden this debt presents, through massive inflation, a debt jubilee, global defaults or some other reset or reduction, I don't see the crisis as resolved. Gold will continue to perform well in the face of continued efforts to paper over the problem and may perform even better in the case that it is used in the final monetary solution (e.g. as discussed in my recent post on Freegold).

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Monday, December 17, 2012

RBA: Australia's Gold held at the Bank of England

I received the following email from a reader today that I thought may be of interest, it's a response from an RBA FOI officer to several questions posed regarding the location of Australia's Gold:
1. Could you please confirm the total 'physical' and 'tangible property' gold holding by the Reserve bank of Australia in kilograms as at financial year end 2011. For clarity, the term physical refers to gold in possession and control of the Australian Government and not a derivative, financial instrument or promissory note.
Answer:  At the end of the 2011 financial year (30 June), the gold holding was 80 tonnes at a valuation at the time of A$3 473 million.

2. Are any foreign countries holding the physical gold on behalf of the Australian Government?
Answer: Yes.

3. If so please provide a breakdown of foreign gold holdings in kilograms identifying the country where this is held.
Answer:  At 30 June 2011, 99.9% of the gold is held in the United Kingdom, at the Bank of England. The other 0.1% is held by the Reserve Bank of Australia. This distribution remains in place presently.
Please note that we have answered your questions as a routine enquiry (on the basis that your request was for answers to questions, rather than seeking documents).  The FOI Act concerns itself with the release of documents, rather than answering questions, so a request must be seeking documents to be valid.  You may be interested in details of the Reserve Bank of Australia’s Official Reserve Assets, which are published each month on the Bank’s website. Additional commentary about Reserves Management is also contained in the Bank’s Annual Report (please see the ‘Operations in Financial Markets’ Chapter).

If you have any further queries regarding this information, we invite you to contact our Media and Public Relations Office in the first instance as generally they will be able to answer questions for you.  Consistent with guidance from the Office of the Australian Information Commissioner contained in a recent charges review report, the Bank is committed to releasing as much information as possible outside the provisions of the Act (via routine release of information and responding to general requests).  If you feel that your needs are not being met outside the provisions of the Act, you are welcome to lodge a formal application seeking documents relevant to your question(s).
The above is interesting, as I have seen past requests for this information denied by the very department the FOI officer suggests (below from 'Tears of the Moon' on ABC Bullion blog):
On the where the 80 Tonnes of gold is stored, Australia or offshore, I received this response from the RBA's Media & Public Relations Office today:

"Thank you for your email.

The Bank does not publish the location of its gold reserves."

Make of that what you will. Personally I didn't think it would have killed them to say "Australia", after all it is a big place, plenty of space to hide 80 tonnes of gold with giving anything away.
With 99.9% of Australia's Gold stored with the Bank of England it makes me wonder where the final .1% is stored (80kg), perhaps the bars are used as paperweights around the RBA office in Sydney...

So why keep the majority of it stored with the Bank of England?

I suspect it may be a throwback to times past when the bank lent out a signficant amount of Gold. Today the RBA only has 1 tonne of Gold on loan, but in the 1990s it was a lot more (FOI Document, December 1996):
"The Bank currently holds about 250 tonnes of gold (about $A3.8 billion at current prices) as part of official reserve assets. Unlike other components of official reserve assets, the management of which was upgraded significantly at the start of the 1990s, the management of gold holdings has been passive apart from participation in the gold loan market. The amount of gold owned by the Bank has not changed since the late 1970s."

"In order to increase returns on gold holdings, the Bank has expanded its gold lending activities in recent years. Currently, about half the Bank's gold is on loan."
Bundesbank recently made similar reasoning for it's Gold being stored predominantly outside of Germany (Bundesbank on Gold reserves):
Why doesn’t the Bundesbank bring the gold back to Germany?

The reasons for storing gold reserves with foreign partner central banks are historical since, at the time, gold at these trading centres was transferred to the Bundesbank. To be more specific: in October 1951 the Bank deutscher Länder, the Bundesbank’s predecessor, purchased its first gold for DM 2.5 million; that was 529 kilograms at the time. By 1956, the gold reserves had risen to DM 6.2 billion, or 1,328 tonnes; upon its foundation in 1957, the Bundesbank took over these reserves. Further gold was added until the 1970s. During that entire period, we had nothing but the best of experiences with our partners in New York, London and Paris. There was never any doubt about the security of Germany’s gold. In future, we wish to continue to keep gold at international gold trading centres so that, when push comes to shove, we can have it available as a reserve asset as soon as possible. Gold stored in your home safe is not immediately available as collateral in case you need foreign currency. Take, for instance, the key role that the US dollar plays as a reserve currency in the global financial system. The gold held with the New York Fed can, in a crisis, be pledged with the Federal Reserve Bank as collateral against US dollar-denominated liquidity. Similar pound sterling liquidity could be obtained by pledging the gold that is held with the Bank of England.
Australia's Gold is only a fraction of it's foreign reserves (less than 10%) compared with Germany (over 70% according to Wikipedia) and with less than 1 tonne being loaned into the market at present (see page 24) it makes me wonder what benefit there is in keeping it with the Bank of England.

What say you Australia, time to bring home our Gold?