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Global Outlook

Dark Gold: Shedding Light on a Mysterious Market

February 6, 2014, Thursday, 17:19 GMT | 13:19 EST | 22:49 IST | 01:19 SGT
Contributed by Euro Pacific Capital


Gold is the simplest of financial assets - you either own it or you don't. Yet, at the same time, gold is also among the most private of assets. Once an individual locks his or her safe, that gold effectively disappears from the market at large. Unlike bank deposits or stocks, there is no way to tally the total amount of gold held by individual investors.
 
I like to call this concept "dark gold." This is the real, broader gold market that exists below the surface-level transactions on the major exchanges. It's impossible to know precisely how much dark gold exists around the world, but we do know that it is enough to render "official" gold holdings insignificant. That's why I don't buy and sell gold based on the decisions of John Paulson, or even J.P. Morgan Chase. It is a long-term investment that requires a deep understanding of the nature of money - and how little Wall Street's media circus really matters.
 
 
Observing Dark Gold
 
Think of dark gold like dark matter. Dark matter is a mysterious substance that scientists hypothesize is an essential building block of our universe. All we know is that the universe is a certain size and that a huge amount of its mass is unobservable - this is what we've come to call dark matter.
 
We haven't yet looked directly at dark matter. We can only observe phenomena that suggest there is a substance we aren't seeing and can't quite measure.
 
Likewise, dark gold is an essential building block of global financial stability. But the extremely private nature that makes it so valuable also makes it nearly impossible to directly observe.
 
But every now and then, we get a glimpse into the hidden undercurrents of dark gold. In the past year, the Federal Reserve slipped up in a big way and momentarily poked a hole that we can peek through to see what's happening with some of the largest stores of dark gold in the world.
 
 
Gib Mir Mein Gold!
 
A year ago, the big news was that the Bundesbank, Germany's central bank, would begin the process of repatriating a portion of its foreign gold reserves, including 300 metric tons stored at the New York Federal Reserve Bank.
 
The controversy really started in late 2012, when Germany simply wanted to audit its gold reserves at the Fed. They were denied this access, so the Germans switched their approach. If they weren't allowed visitation with their holdings, they would instead demand full custody. In response, the Fed said it would oblige - within seven years!
 
As of the end of 2013, a Bundesbank spokesman reported that only 5 tons had been transported from New York to Germany so far, leaving the repatriation far behind schedule.
 
"But wait," some might argue, "the repatriation process might be delayed, but we know the gold is there. Central bank holdings constitute the most visible gold in the world. These institutions report their holdings to the world regularly. The gold at the Fed isn't dark gold at all!"
 
If this is a true and certain fact, then why was the Bundesbank denied a third-party audit of its gold in the Fed's vaults? The closest we've seen was an internal audit by the US Treasury last year. Of course, the US government holds the sovereign privilege of answering to no one but itself, but that hardly makes for reassuring statistics on which to base one's investments.
 
 
Golden Distractions
 
The truth is that we have no clue of the official gold reserves of any central bank in the world. All the Fed has to do to convince me otherwise is let an outside party into its vaults and count the gold. They've shown lots of paper; now show us the money!
 
It is very simple to count bars of gold where they exist. And it is clearly moral (and generally good business) to return assets that are held in trust when the creditor demands them. The Fed's reluctance on both counts suggests that there is more to this story than meets the eye.
 
Fortunately, the veracity of the Fed's claimed gold holdings has little bearing on the long-term precious metals investor. It's the same with gold futures contracts and the daily spot price. These have no effect on whether or not you have a chest of real money buried in your backyard.
 
So why is it important that intelligent investors do keep some gold "buried" in their possession? Germany's repatriation scandal begins to answer this question. The maneuverings of the New York Fed are like the patter and flourish of a magician - it distracts you from the real trick being played.
 
Or, in this case, where the most impressive piles of dark gold reside.
 
 
China Going For Gold
 
I'd bet that Western central banks are very pleased that the media has latched onto the dustup between Germany and the Fed. It means they are paying much less attention to the massive unreported stores of gold that many observers believe China has been accumulating, and which could have dire repercussions for the US dollar reserve system.
 
China last reported its gold reserves in 2009, clocking in at 1,054 metric tons. In the official rankings, this makes China's reserves the sixth largest in the world. Germany comes in second with 3,387 metric tons (or so they hope), and all nations trail the United States' claimed 8,133 metric tons.
 
Many speculate that China's reserves have grown far beyond its official number in the past five years. However, the People's Bank of China (PBOC) is playing its cards close to its chest.
 
Last year, a deputy governor of the PBOC tried to convince the world that its reserves have not changed much since 2009. He explained that the Chinese government is keeping a limit on its gold reserves, because "if the Chinese government were to buy too much gold, gold prices would surge, a scenario that will hurt Chinese consumers."
 
But a quick look at the numbers coming from the Chinese government shows that they just don't add up.
 
China is the largest producer of gold in the world, pulling an estimated 437 metric tons of gold from the earth in 2013 - way more than runner-up Australia, with only 259 metric tons.
 
On top of this, China imported far more gold than any other country in the world in 2013. Via Hong Kong alone, China imported 1,158 metric tons of gold last year - a more than 107% increase from 2012.
 
This gold is not leaving the country in large quantities. Sure, China is the biggest exporter of gold jewelry to the Western world, but the value of these trinkets is negligible compared to the thousands of tons of bullion they are creating and importing.
 
Jim Rickards has estimated that China has probably added at least 1,000 metric tons to its reserves every year since 2010, meaning it has well over 4,000 metric tons today.
 
This is a conservative estimate. Wikileaks documents claim that China actually imported more than 2,000 metric tons from Hong Kong in 2011 alone.
 
If this is the case, when China does finally reveal how much gold it's holding, it will leap from the sixth largest reserves in the world to the second, easily surpassing Germany in a single bound.
 
They might even give the US a run for its money.
 
 
Out From Under
 
It's no longer a secret that China would prefer a "de-Americanized world." Whether it's the PBOC or average Chinese consumers hoarding all this dark gold, the effects will be the same when China decides it is fed up with the funny-money central banking system long dominated by the US dollar.
 
It certainly seems like the East is preparing for this endgame. Several new physical gold vaults have opened in Singapore in the past year, Moscow recently launched a spot gold exchange, and Dubai is planning a new spot gold contract for this year. Let's not forget that the Hong Kong Exchange bought the London Metals Exchange in 2012, and there have been rumblings of physically moving it to Hong Kong.
 
If China were to initiate a gold-backed currency attractive to international trade partners, its government and citizens are poised to become extremely wealthy and powerful overnight. Americans, on the other hand...
 
 
Are You Afraid of the Dark?
 
Some investors avoid the gold market because of its innate unofficial nature. But in a time when governments are in a race to tax anything that moves and inflate anything that prints, gold's privacy becomes the difference between preserving wealth or facing destitution.
 
I challenge my readers to worry less about the short-term movements in the gold futures market, or even which central bank has what holdings. Understand that gold is a deep, global market that has witnessed the rise and fall of countless empires. Your decision is simple: you either own it, or you don't.
 
Peter Schiff is Chairman of Euro Pacific Precious Metals, a gold and silver dealer selling reputable, well-known bullion coins and bars at competitive prices. 
 
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