Wednesday, December 24, 2014

BitGold: The Digitalisation of Metal

Earlier this year I wrote about several attempts to back cryptocurrencies with Gold (The Truth About "Gold Backed" CryptoCurrencies). Most of those I covered weren't backed by Gold in the conventional sense (i.e. a fixed amount of Gold that could be redeemed per currency unit), instead offering only partial backing. There were exceptions such as Ripple Singapore which offers fully backed units on the Ripple network, but totals held are still very modest (not quite 53 ounces of Gold).

Since that article I've noticed new entrants being marketed in this space and interestingly two competing products appear to be jostling for the same name, BitGold.

The first of those to market comes from Bitreserve, a company offering a digital wallet service where you can transfer between Bitcoin, various currencies (USD, EUR, CNY, YEN, GBP) and now Gold (stored and audited by GBI) all through their 'card' system. Think of it like having accounts in various currencies, you can only deposit funds into their system using Bitcoin, but once deposited you can diversify that value across any of the aforementioned currencies if you don't want exposure to Bitcoin's fluctuating value. Bitreserve maintains real reserves to cover their obligations to customers which are published live on a status page.
With our Gold Card, we are reviving gold for the purchase of goods and services. Bitreserve members can convert their bitcoin to bitgold, whose value is substantiated by bullion in our reserve, but still spend it as bitcoin. By creating a bridge between the revolutionary Bitcoin protocol and good old gold bullion, we enable our members to instantly send or spend bitcoin from the ounces of gold held in their Bitreserve wallet. Our Gold Card makes this ancient store of value instantly transferable, infinitely divisible and accessible to anyone with a networked device. Now anybody with some bitcoin and a Bitreserve wallet can have the Midas touch. Old King Croesus would be chuffed. Bitreserve
They're also introducing a similarly structured card that offers their customers exposure to the oil price.
For the first time in history, oil will become a form of payment and compete against all major global fiat currencies. Using Bitreserve’s Oil Card, anyone can hold their value as oil — the fuel for the modern world economy — and transfer that value instantly and for free.

Bitoil™ will work just as bitgold does today. Oil value can instantly be converted into five currencies, gold, or bitcoin at very low cost and can be spent immediately. Oil has a massive and direct impact on the global economy, and a currency that tracks oil prices could become one of the world’s most widely used digital currencies. Whether you are a consumer looking to hold money that’s tied to gas prices, or a business with a large portion of your expenses in oil related activities, Bitreserve’s Oil Card gives you yet another welcome currency option for holding and spending digital value. Bitreserve
To be honest their system sounds quite innovative, but I am still skeptical about attempts to digitise physical assets as I will explain shortly.

The second "BitGold", is being launched early next year. The site is taking email addresses for pre-launch access at and they've raised C$3.5 million from investors. The founders are Roy Sebag (CEO of Natural Resource Holdings Ltd) and Josh Crumb (Former Senior Metals Analyst at Goldman Sachs).
"The Toronto-based company will allow account holders to purchase bitcoins and exchange them for gold redeemable in various vaults around the world, as well as convert the metal back into the digital currency. Customers will also get a debit card, said Sebag, 29.

The company is trying to muscle in on traditional bullion dealers and gold-backed exchange-traded funds, two of the most popular ways for retail investors to get hold of physical gold." Bloomberg
Interestingly the name that both of these new products are launching with, Bit Gold, has already been used by Nick Szabo to describe what could be considered the inspiration for Bitcoin. 
The Bit Gold proposal, by Nick Szabo, describes a system for the decentralized creation of unforgeable chains of proofs of work, with each one being attributed to its discoverer's public key, using timestamps and digital signatures. It is said that these proofs of work would have value because they would be scarce, difficult to produce, and securely stored and transferred.
His early proposal was so closely worded to the way Bitcoin works that many speculated Nick may in fact be Satoshi Nakamoto (or form part of a team that wrote the Bitcoin whitepaper).

Even ignoring the naming issue, I'm still not convinced that trying to link physical Gold with a digital representation is a good idea and here are some reasons why...

Counterparty Risk: As I said in a recent post (How Safe Are Unallocated Bullion Accounts?), I own precious metals because they have a lower level of counterparty risk, putting other parties between myself and a claim on the physical metal is counterproductive to one of the reasons I hold them. Some of these products are structured so that your claim is with the company providing the digital wallet service, while the actual custodian of the Gold may be another layer or two down. Even if regular audits occur, I would not be comfortable that my Gold would be easily retrievable if something were to go wrong (and not all are offering the ability for redemption of the Gold).

Trusted Third Party: One of the key attributes of Bitcoin and many other cryptocurrencies is the lack of need for a trusted third party to confirm the transfer of units. Transactions occur on a shared public ledger (called the block chain). With no physical asset to account for this can all occur through the use of private keys to sign transactions. The benefit of this is lower transaction costs. Introducing a physical asset to the mix means that you do need a trusted third party (sometimes multiple) to verify the assets, even if a public ledger is still used for transparency of transactions.

Spending Gold: Around 12 months ago I stumbled across a comment from Pierre Rochard talking about the consumer behaviour of those spending Bitcoin, he claimed "Consumers making payments generally replenish their bitcoin balance simultaneously, so it's a net zero." My response, why not just hold their Bitcoin balance steady and use fiat currency to make the purchase? Those introducing these digital Gold products assume there's lots of people out there who want an easier solution for 'spending' their Gold. My Gold holdings are not held for the purpose of short term spending on groceries or electrical goods, I'm not interested in giving up the security of possession for the ability to spend it more easily.

Capital Gains Tax: As I have covered on this site before, Gold (Let Australians Save in Gold Instead of Debt) and cryptocurrencies (Glenn Stevens Talks Bitcoin & Competing Currencies) are not really setup from a tax perspective to facilitate their use as a regular currency (despite the ATO recently giving a break to those using Bitcoins). It's likely that in most situations those using these digital wallet services are expected to keep records of any capital gains or losses (relative to their Australian Dollar value) to tally at the end of year for the purpose of declaring a loss or gain. The Australian tax system is not setup to cater for the use of assets (other than the Australian Dollar) as money and I suspect it would be similar in many other countries. We don't have competing currencies despite Glenn Stevens (Governor of the Reserve Bank of Australia) insistence that we do.

Government Regulation: The idea behind most cryptocurrencies is to have a distributed electronic method of creating and transferring value with no need to be in a specific physical location. Adding Gold to the mix literally destroys the advantages of a cryptocurrency because the asset it's linked to is stored centrally, leaving it vulnerable to the negative effects of government regulation.

One advocate for the mixing of these two assets has been Jan Skoyles, CEO at The Real Asset Company, whose opinion was recently covered by a Forbes contributor:
Jan’s argument therefore that there is demand for both a gold-backed currency, and a fully-transparent and accessible gold-trading system, is a persuasive one. By recording gold purchases on a block chain style ledger, the currency can be used not only as a medium of exchange, but also to facilitate gold ownership, and challenge the status quo for clearing and settlement in the gold market. In other words, you can buy your gold, and you can spend it too.
The article goes on to say that The Real Asset Company has their own product in the works. I tried to reach Jan (by email and Twitter) to confirm that's still the case and get some clarification on how it would work, but I'm yet to hear back (will update this post if I do). I'd think most Gold investors would prefer a level of privacy for their 'digital stack', something a public ledger wouldn't easily accommodate.

Everyone has different wants and needs from their assets, especially those used as a monetary resource, so perhaps there are some individuals who are prepared to look past the described shortcomings of a digitalised Gold product for the flexibility and convenience that it offers. If you are one of those people I'd love to hear your reasoning in the comments below.

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Thursday, December 18, 2014

Reserve Bank of Australia Audits Our Gold Reserves

Gold Bars Stored at the Bank of England
Two years ago the news was publicly broken on this site that 99.9% of Australia's Gold reserves are stored by the Bank of England in the United Kingdom. Attempts by another blogger, interested in the whereabouts of Australia's Gold, had been rejected by the RBA only several months earlier, "The Bank does not publish the location of its gold reserves."

Decisions like this don't happen in a black hole. Something changed the RBA's mind, between August 2012 and December 2012, on making the location of Australia's Gold reserves public.

From my observation, the RBA tends to follow the lead of other Central Banks, so the decision to release information on the location of Australia's Gold may have been a result of Germany's Central Bank (Deutsche Bundesbank) deciding to do so in October 2012 (interview containing the information originally released is no longer published on the site, but available via Web Archive). Only a month later, in November 2012, the Austrian Central Bank released the location of their Gold reserves, revealing that 80% resided in the UK, 3% in Switzerland and 17% in Austria. Cue the RBA feeling comfortable to release the location details of Australia's Gold around 1 month later.

A recent experience of mine with the RBA further highlighted their desire to follow in the footsteps of other Central Banks rather than to think for themselves. An FOI request I made for the Gold bar list was initially rejected, but after lodging an appeal with the OAIC, highlighting that the United States published a list of their Gold bars details (sans the serial number), the RBA decided to follow suit (Reserve Bank of Australia Releases Gold Bar Details).

Earlier this year I spotted a line in the RBA's annual report indicating an audit had been performed (not something I have seen mentioned in previous years):

A question posed by email to the RBA earlier in the year suggested that RBA officials had performed the audit themselves.

I decided to lodge another FOI request.
"I request that a copy of the following documents be provided to me: All documents pertaining to the audit of the RBA's gold holdings performed during the 2013/14 financial year, as was specified in the 'Operations in Financial Markets' section of the Reserve Bank of Australia Annual Report 2014 ("During the year in review, the Bank audited its gold holdings")."
Two months later (decision on the documents was delayed due to consultation with the Bank of England) I received the following list of documents that would be provided (on payment of fees, which were reduced from an original quote due to the small number of documents that could be released):

And today the documents arrived. Here's what we know...

In February 2013, the Assistant Governor (Financial Markets) requested Audit Department include in its audit program a review of the Bank’s gold holdings at the Bank of England (BoE). The Chief Representative in EU approached the BoE to facilitate this review and in late May 2013 initial planning discussions were held with BoE staff with tentative agreement that the review would take place in September 2013.

The audit included:
  • An on-site physical verification commencing 23 September 2013, which will take 4-5 days to complete, assuming two RBA auditors are involved given the proposed scope.
  • Inspecting a sample of RBA Gold bars (list to be provided in advance), including checking the details of these bars against the Bank’s inventory list and weighing of the bars by BoE staff using their equipment.
  • Randomly selecting additional Gold bars from the inventory list and observing these bars being located and retrieved from their vault (plus verifying the details and weighing them).
  • Obtain a high level understanding of the BoE gold safe custody service.
  • Continuing discussions for a comprehensive safe custody agreement between the RBA and BoE.
As the above document list shows, those relating to final audit results were not provided. I would assume the audit was successful, but no doubt that would be a highly contested opinion in the Gold blogosphere. The following reason was provided for denying access to the report:
Documents 10, 11 and 12 are drafts of the report prepared by the RBA’s Audit Department detailing the findings of the audit and document 13 is the final of that report.

Denial of access to these four documents in terms of s33(a)(iii) is appropriate because release of the information (which relates to procedures for the conduct of the audit with the BoE and the subsequent results) ‘would, or could reasonably be expected to, cause damage to’ the relationship between the RBA and the BoE.  This belief is soundly held by us on the basis that we are aware that the BoE provides safe custody services not only to the RBA, but also to other central banks around the world.  Disclosure of the information in these documents could damage the relationship between the BoE and its other central bank clients, and by extension (as the source of the information), the relationship between the BoE and RBA.  As foreshadowed to you in earlier correspondence, we consulted with the BoE in relation to these documents and they affirmed the views we held regarding the damage that would be done to the relationship between the BoE and RBA if the redacted information were disclosed.

Denial of access to these four documents is also appropriate in terms of s47E(a) (‘disclosure would, or could be reasonably expected to, prejudice the effectiveness of procedures or methods for the conduct of tests, examinations or audits’ by the Bank) and (b) (‘disclosure would, or could be reasonably expected to, prejudice the attainment of the objects of particular tests, examinations or audits conducted, or to be conducted’, by the Bank).  The documents in question concern the ‘procedures and methods’ within both the RBA and the BoE regarding the conduct of the physical check of a sample of gold bars (for the purpose of conducting the audit).  Disclosure of this information would, of course, reveal those procedures and methods, and by logical extension render them less effective. Also, the ability of the Bank to attain the objects of the audit (which is to reveal whether the Bank’s arrangements are robust and secure) would be prejudiced. These considerations apply to both the audit currently the subject of your FOI request and also any other audits undertaken by the RBA. A key requirement for undertaking a successful audit (of any aspect of the RBA’s work) is that there is as little opportunity as possible for individuals to take steps to predict what an auditor may choose to focus on, and/or how they will conduct the audit. It is self-evident that if such procedures and methods are revealed, then the opportunity to circumvent them is greatly increased.  As s47E is a public interest conditional exemption, I must take into account whether the giving of access is in the general public interest (in terms of s11A(5)).  When deciding whether access is in the public interest, I must take into account the following from s11B(3) and have noted my views in each case:

Section 11B(3) factors favouring access to the document in the public interest include whether access to the document would do any of the following:

(a) promote the objects of this Act (including all the matters set out in sections 3 and 3A); release would be contrary to some sections, particularly sections 2(a) and 3(3)

(b) inform debate on a matter of public importance; the Bank’s gold holdings, while important and of interest to some, are not a matter of public importance generating any level of debate

(c) promote effective oversight of public expenditure; release of the information would not do this

(d) allow a person to access his or her own personal information; the request is not seeking personal information.

Taking into account these factors, and the implications release of the information would have on the Bank’s audit processes, I have decided that it is clearly not in the public interest to disclose the information in these four documents (10, 11, 12 and 13).  Disclosure of these documents would manifestly harm the public interest by way of reducing the ability of the RBA to successfully conduct audits and tests of its operations going forward.
The released documents (mostly a chain of various emails) also suggested the RBA have been invited back for another review in 12 months.

One interesting point from the documents, the Bank of England was emailing clients in June 2013 (those for whom they're providing custodial services) inviting them to audit samples of their Gold:

Click Above Text To Enlarge
However discussions on the RBA audit were already well advanced at that time.

Given that the RBA has followed the lead of other countries to release reserve location details, perform audits and release (some) bar list details, it will be interesting to see whether they go further and follow the lead of the many countries now deciding to repatriate some or all of their Gold reserves...

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Monday, December 8, 2014

Attention Traders: The Value Of Cash Is Not Absolute

Over the last few years, as the price of Gold declined, several professional traders and financial commentators have taken it upon themselves to unleash their wisdom about the metal being "just a trade". They've decided that everyone should see the financial world through their narrow lens and have used it's declining price as "proof" you should always have a stop and be prepared to exit your position.

The way I've framed the above might suggest I have a problem with their view. In fact I don't, it's one way of looking at the assets in your investment portfolio. However, to take their view you also have to give thought to ALL positions and that includes cash, which should also be considered a trade as it's value can change.

Earlier this year I wrote about Ritholtz's position on gold bugs ('Barry Ritholtz Mischaracterizes Gold Bugs'), one of the rules in his article was:
The Danger of One-Way Trades: What would make you reverse your biggest present holding? What facts or situations would force you to change your views and sell? If your answer to that question is, “Nothing,” you have a huge, devastating flaw in your approach to investing.
I hear traders talking day in and out about 'going back to cash' or 'sitting in cash' after exiting all positions, but if a trader was to think about what they are doing logically, as they would any other position, they are simply moving from one asset which fluctuates in value to another.

What facts or situations would force a trader to consider a position in cash being unsafe? Answer that and you might be on the path to understanding the reasons that some investors choose to hold physical Gold.

A reader of my Ritholtz article commented: "Ritholtz essentially supports his analysis by treating fiat currencies as a bedrock, i.e. asset changes are all relative to this unchanging fiat value." I agreed: "Ritholtz claims to be ‘asset class agnostic’, but then measures the performance of other assets back to fiat which doesn’t have static value."

Newsflash: Cash / fiat currency is not a neutral position.

There is no asset which remains absolute in it's price or value relative to everything else (and yes that includes cash or Gold).

I tried to explain this briefly to one trader (Mark Dow) who regularly has a crack at gold bugs on Twitter, to my amusement he suggested that you don't have to hedge against fiat currency because it's "legal tender".

Click Image to Enlarge
How could anyone think that a currency being legal tender protects the holder from changes in it's value?

Sure it's a unit of account and may remain a constant relative to some assets, for example a $10,000 loan will always require $10,000 in cash (+ interest) in order to repay it, but the value of currencies can be affected in various ways, sometimes to devastating effect.

So how does one hedge or insure themselves against fiat currency and the financial system?

This question reminds me of a discussion that took place in the comments on Cullen Roche's site (comments since disabled, but they were here) a couple of months back when he suggested that those wishing to hedge against the financial system should take a short position on the finance sector. 

Imagine taking out insurance against your house burning down and then leaving the only paper work you could use to make a claim inside the very same house.

That is basically what Cullen proposed. Some of the sensible responses below his suggestion included:
“Gold like cash is a unique hedge because unlike options, or bonds or financial hedges it has infinite duration.”

“I have an allocation to gold and silver because its the only way that I can be 100% sure that my “insurance” isn’t someone else’s liability.”
Precious metals are unique in the sense that they are one of few assets which can be held physically outside of the financial system & can't be diluted in the same way as fiat currencies.

Some traders might argue that significant changes in the value of cash occur so infrequently that it's not worth worrying about (tell that to someone living in Russia, Japan, Cyprus, North Korea, Venezuela), but that's exactly the mindset that some of these traders criticise others for, that is, having a baked on view that holding an asset poses no risk. 

Holding a 100% position in any asset is risky, whether that's cash, Gold, Silver, property or anything else. Diversify or be prepared to wear the consequences if the value of that position moves against you.

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