THE MATTERHORN INTERVIEW – Review 2012: Alasdair Macleod
“We are quite likely to have a failure on COMEX in the silver market”
Matterhorn Asset Management is very pleased that the Christmas 2012 Matterhorn Interview is with Alasdair Macleod. We know Alasdair as a man with a lot of common sense based on a long time hands on experience in the largest financial center of the world. So here it is; straight from the horse’s mouth. Enjoy the interview.
The renowned economist and financial analyst Alasdair Macleod looks back through the rear window of twenty-twelve and comments important events and developments such as “QE to infinity.” Moreover, he gives his expectations for 2013 in general and the gold and silver markets in particular.
Alasdair Macleod started his career as a stockbroker in 1970 on the London Stock Exchange, and learned through experience about things as diverse as mining shares and general economics. Within nine years Macleod had risen to become a senior partner at his firm. He subsequently held positions at director level in investment management, fund management and banking. For most of his 40 years in the finance industry, Macleod has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapons that governments can use against the people. Accordingly, his mission is to educate and inform the public, in layman’s terms, what governments do with money and how to protect themselves from the consequences.
By Lars Schall
Lars Schall: Shall we do a review of 2012 by season?
Alasdair Macleod: Yes.
L.S.: Let’s look for the big stories last winter, spring, summer and fall. So, what in your experience was the big story last winter at the start of 2012?
A.M.: The short answer is the Federal Reserve Board extending zero interest rates until 2014, which was unheard of before. We have now got used to zero rates. And also the ECB started to abandon all sound money in order to support the Eurozone banking system and the weaker members. And that to me sets the tone for an eventual complete paper money collapse.
L.S.: Maybe you tell us a little bit about zero interest rates and what usually happens?
A.M.: Well, usually what happens is that the Central Bank manages interest rates at a level which it thinks is appropriate for the economy. In the case of the Federal Reserve Board, it is meant to balance the level of unemployment and the prospects for inflation by managing the interest rates. Now, in practice, that probably means that it sets it below what the market would normally be comfortable with or what the market would decide on its own.
But here we have a situation where the Federal Reserve Board has turned around and said, “We are going to keep interest rates frozen at zero until late 2014 at least. So, that basically means that the cost of borrowing is tied to that zero bound and there is no way that interest rates can go any lower. It is the end point of lowering interest points. Obviously, if you’re going to keep interest rates at that very low level, you’ve got to do two things: Firstly you’ve got to pump money into the system to keep rates at zero and secondly the Central Bank must satisfy any demand for money at that zero bound. And of course, the FED has been doing this, by buying government treasuries and injecting the money in payment for them into the banking system. The banks, where they have drawn down on their lending capacity, have not lent it into the economy but they have used it for financial speculation. So that’s why huge amounts of derivatives have been piling up. And the US banking system, believe it or not, is also exposed quite significantly to the Eurozone area.
L.S.: How did this exposure to the Eurozone arise?
A.M.: Well, it goes back to the beginning of this year when it was only people like you and I perhaps who worried about the possibility that Greece and Italy and Spain might be bankrupt. The average banker just looked at guarantees from the ECB, allowing them to turn 3 per cent or more on a Eurozone sovereign loan. So you end up with bank exposure to the Eurozone and the Eurozone banking system. At mid-year, according to the Bank for International Settlements, the BIS, the total was about $1.5 trillion. This was a very, very important development from the beginning of this year. The ECB at that time was insisting they were not going to print money, and they were going to be conservative in their lending policy. But under Draghi they’ve responded to a systemic banking problem and to politicians unable to deal with government finances in individual countries. And so it became obvious the ECB is the only institution in the Eurozone which can keep this show on the road. So the ECB has started to abandon all pretence at sound money. The hard-money Germans have either resigned or been basically over-ruled in the ECB. The euro, like the US dollar, is now a story of print, print, print. And then of course we had the Greek bail-out in January. The first of two bail-outs this year at least as far as I can recall.
A.M.: So that’s the first quarter. In the spring what caught my eye was the Target 2 settlement system. Suddenly Germany was on the wrong end of something like Euro 500 billion, reflecting capital flight into Germany from countries such as Greece, and also increasingly out of Spain, Italy and Portugal. Ordinary citizens in those countries began to worry about the safety of leaving money on deposit in their banks. The imbalances from capital flight today are reflected in the Bundesbank with 715 billion Euros, or one trillion dollars owed to it by other Eurozone national Central Banks. Total imbalances from capital flight within the Eurozone are now one trillion euros. So that to me was the second quarter’s feature. I think the third quarter was notable for the LIBOR manipulation story.
L.S.: Yes, we had.
A.M.: And that started with Barclays Bank and it was clear at the time, it wasn’t just Barclays but all the other major banks could well be implicated in this, from UBS to Royal Bank of Scotland. All sorts of big banks had an interest in supporting the value of their derivatives at artificial levels, otherwise their solvency margins looked bad. This is actually a major, major scandal, but it’s nothing compared with the economic damage from manipulation of interest rates by the Central Banks, with zero interest rate policies. We now have LIBOR manipulation on top. The thing that upsets people is the banks pursuing what is obviously a vested interest in keeping their asset values, the price of the bonds and other things that they have on their balance sheets, high by manipulating LIBOR interest rates down. And that I think is a very, very big scandal. It is a global scandal that implicates central banks, which I am sure knew it was happening and knew how important a low LIBOR was to commercial bank balance sheets.
L.S.: Okay. So we enter again the fall and winter season.
A.M.: Yes. There are so many systemic dangers now but I think the story I’m going to alight on is one I wrote about recently about gold and silver on the COMEX. The bank participation report came out on the 4th of December, and I was able to complete the figures for this year. Bank shorts are at or near record levels. And what is interesting is that with the prices of gold and silver well below the all-time highs there are no profit-takers in the market to sell contracts to close their shorts. And in silver it is very, very alarming. This leads me to think that we are quite likely to have a failure on COMEX and in the silver market in particular.
If you have a failure in silver on COMEX then that is going to affect the gold futures market as well. The West’s central and commercial banks have suppressed the price of both gold and silver by supplying central-bank gold and increased short positions, making prices far too cheap. The result has been a massive transfer of gold and silver to Asia. This is the relevance of the point that you have been raising about Central Banks gold holdings, and it is also going to bring into question the solvency of the bullion banks who are short.
So, I think that while it may not be obvious to many people at the moment, when we look back at the fourth quarter we will see that the conditions were in place for a huge bear squeeze, for silver in particular. I would assume that the short position in gold is more controllable so long as Western Central Banks continue to make bullion available to the bullion banks that are short either on COMEX or with LBMA. But silver is different, nobody has it for sale. There is no silver around.
L.S.: Yes, there is no stock.
A.M.: No, exactly.
L.S.: And that’s the big difference?
A.M.: Yes, and this silver position could actually destabilize other derivatives in financial markets. I blame complacency on this matter on Keynesian economists and monetarists saying, “Oh well, gold is just a commodity”. It’s absolute nonsense, we are talking about the most important money to all mankind. If you go into Asia and you ask what is money you will be told, ”Gold and silver”, not rupees, not any paper currencies issued by governments. Gold and silver, that’s what they regard as money, that is where they put their savings. And that is why we are short of it.
L.S.: Can I interrupt you because I would like to bring it both together. The Yuan in China, there’s now a lot of talk about the Yuan being the next reserve currency and we see the Chinese buying gold like crazy. Do you think they have something in mind with backing up their currency with gold?
A.M.: Yes, I do. I think they do have a plan and we don’t know what it is, but we can guess. My starting point in this is that all the Chinese and Russian Marxian economists were taught that capitalism destroys itself. Now, whether you believe that or not isn’t the point, but the Chinese economists actually have this in mind. And they can see the dangers of the way the US dollar is going. We must also understand that the dollar is for security reasons not something they want to use for their international trade settlements. Remember that every dollar transaction done in the world is reflected in a bank account in New York. So, the Chinese want to get away from the potential control and the intelligence information that it gives America. They want to use a different settlement medium.
Now, they agreed about 10 years ago with the Russians to set up the Shanghai Cooperation Organisation (SCO), and the last unsatisfied objective of the SCO is to have a common trade settlement system between the members of the SCO, which at the moment are Russia, China, and the various “stans” in middle-Asia. But interestingly, the next wave of members who will join are India, Iran, Pakistan, Mongolia and Afghanistan (as soon as NATO has left). So you’ve really got the bulk of Asia’s four billion people and they’re going to be settling cross-border trade not with the dollar but with something else. They need to be gold-rich to give confidence to their currencies. I suspect that the Chinese Yuan will play a big role in Asia. What they’re doing with Iran is interesting. They’re settling net balances in gold and gold is being re-monetized in that sense. And I think that China has accumulated a lot more gold than they officially tell us. So they have the potential to use gold as money. I can see gold being re-monetized in the loosest sense for the largest internal market the world has ever seen. Believe me, it’s happening now.
L.S.: Okay, let me then connect another thing with this question. Do you think the Chinese will get paid in gold for perhaps helping out in the euro crisis. So they’re helping to prop up the euro and they get in turn some of the European gold?
A.M.: I don’t think China is going to get sucked into supporting the Euro, no, I don’t see that at all. What I think is possible is they would very much like to cash in Euro’s for gold. I am sure they would consider taking physical gold as collateral for Eurozone loans. But for now every time a Eurozone country goes to China and says “we’ll be very grateful for some of your money, the Chinese listen very politely and then just show them the door. China is not in that role as they’ve got enough of their own problems.
A.M.: And look at it also this way, the average European has a standard of living, perhaps ten times better than the average Chinese. China is not interested.
L.S.: Let us then talk about the three big stories in gold this year, and I think the one thing out of the different campaigns for repatriation of gold reserves into the respective countries.
A.M.: Yes. That was going to be my overall story for 2012, and that owes much to the work that you have done. Teasing out of the German authorities, exactly how much gold they think they have got and where, was a great achievement, a journalistic scoop. And what I particularly liked was not only did you manage to do that but you have encouraged others to do the same thing elsewhere. The journalist in Mexico who has got the Mexican Central Bank to talk. We now discover from Austria that the bulk of their gold is in England and not only that, but they earned 300 million Euro in leasing fees. What a mistake to tell us that!
L.S.: Yes, but can you elaborate on this. Why was it a mistake?
A.M.: Well, I think it was a mistake because the sensible thing for a Central Banker to do when asked questions about this, given that a lot of the gold has probably disappeared through leasing, is actually to say as little as possible. The real reason for having gold as part of your foreign reserves is to have the ultimate protection of it for your country and currency. Are you telling us, central bankers, that you have compromised that role by leasing it with the risk that it won’t come back? You know that must be the next question you journalists will ask.
A.M.: And of course, to that they all clam up. So I think it was a mistake for the Austrian Central Bank to admit it. And the most recent story has been the Netherlands where it has just been revealed by the Central Bank after lots and lots of pressure that they have got 50 per cent of their gold in New York, they’ve got 20 per cent in Canada, 20 per cent in London and 10 per cent — only 10 per cent — in Amsterdam.
L.S.: So we come to the question what is a gold reserve. I would say a gold reserve is gold that you have in your possession and at your disposal at any time?
A.M.: Yes, a central banker has actually got to be able to go down into the basement, into the strong room, and count it.
M: It’s as simple as that.
L.S.: In Germany for example this is not the case. So what do they have. They have no gold reserve, what do they have, what kind of hybrid?
A.M.: There was a time when it made sense, with the Russian bear on the doorstep, for Germany to store her gold in New York or London or Paris. But things have changed, that’s no longer the case and they really should move it back. And I just can’t see the circumstances that have occurred or should occur for Germany whereby she needs to dispose of any of the gold, nor to keep any of it near the markets. It looks like the Bundesbank instead of physical gold has counterparty promises from the Fed, Bank of England and the Banque de France. This should be clarified.
Now, if you ask me about France I would say that France is theoretically bust, I can certainly see them selling gold in order to pay some of their debts or for emergency funding or something. Perhaps using it as collateral for loans. But for Germany it doesn’t make any sense at all, let alone have gold in any form in Paris. And I suspect that the Central Bankers in Germany have also had quite a tough time keeping gold out of the hands of various German chancellors, but that is another story.
L.S.: The argument now is, for example, that you have the gold in New York to trade with it. When you are trading with your gold reserve, what does this say?
A.M.: Well, it tells me that you’re not actually looking after it or keeping it for what it’s meant for. And if you are leasing it, then you’re being a party to a scheme which keeps the gold price, and therefore the value of your gold reserves low. Central Banks that go into leasing have lost sight of the whole point of having gold reserves.
L.S.: Why is it interesting for some parties to have a low gold price and what is the connection between the gold price and the bond market and the setting of interest rates.
A.M.: Okay, there’s quite a long story to that aspect.
L.S.: Can I challenge you?
A.M.: Yes, if we go back to the Nixon shock in 1971, the Americans decided that the Bretton Woods system of gold convertibility only for Central Banks (and the IMF and the World Bank) had to come to an end because they did not have enough gold to stem the losses resulting from dollar repatriation by the Banque de France and various other Central Banks. So, from that moment the US Treasury and the Federal Reserve Board tried to demonetize gold completely and they ran a campaign of saying that gold was old-fashioned; it was not money anymore. The dollar is king, the dollar is money and you can ignore gold.
And initially, they tried to hit the gold price to persuade speculators that gold is yesterday’s money. That failed spectacularly when the Bull Market in gold easily absorbed all the bullion the Americans sold. After that in the 1980s and 1990s, leasing developed. Gold leasing was the basis of the carry trade. A bullion bank gets a Central Bank to lease it some gold for an annual rate about a half, maybe three-quarters of a per cent. The Bullion Bank sells it into the market and with the proceeds goes and buys government short-dated bonds which at that time yielded say 5 or 6 per cent, so they got a very nice turn on that money. And they were meant to cover themselves through the London market from a producer who wanted to sell the gold forward so that he could fix the cash flow for his operations.
But what we don’t know other than by indirect analysis is to what extent these leasing operations were actually closed out by mine deliveries. Most of the gold that they sold in the 1980s and 1990s from this leasing ended up being fabricated into jewellery. And I think it was estimated that up to 90 per cent of the gold sold into the bullion market was actually going into jewellery in one form or another. That was the “raison d’être” if you like for the Central Banks trying to remove gold entirely from the financial system. I guess that the gold carry trade is now considerably reduced, because the interest rate spread is no longer there.
The other aspect of the relationship with bond yields is that physical gold doesn’t yield any interest. So, if bond yields are high, then there is a penalty for holding gold. If on the other hand interest rates are low there is no penalty and gold becomes more attractive. And that basically I think would sum up the relationship of gold with bonds.
L.S.: But now we see a move to declare gold a non-risk asset.
L.S.: Is this maybe also one of the big stories this year?
A.M.: Yes, it’s a very interesting one, because I think they’re trying to stop regulatory arbitrage, bearing in mind that derivatives markets have already accepted gold as collateral for margin purposes. And this was after some lobbying by the London bullion market. If they did nothing to stop regulatory arbitrage from bank balance sheets, it would encourage growth in shadow banking, which for regulators is not desirable. And now that the banks in America have been asked the question as to whether they think it will be a good idea to have gold as a collateral with zero or minimum haircut then of course they are bound to say yes. So I think it’s a done deal.
L.S.: It’s very important for the price, right?
A.M.: Well, I think in time it will be, because I would expect a number of bankers to begin to worry about the value of fiat currencies and it therefore makes sense to have a certain amount of asset allocation on their balance sheets in gold, just to give them protection. Gold will be on every banker’s radar screen.
L.S.: So gold will then also become a big story in 2013?
A.M.: I think it will be a story of 2013. But how important; I don’t know Lars. At this stage what I see is a potential failure in the precious metals markets. I think it’s far more important to worry about that. You know, they’re not going to get their gold and silver if this happens.
L.S.: Yes, sure. And then let us switch to the third big story in gold for 2012, and this has everything to do with Iran. They were kicked out of the SWIFT system and what did they do then?
A.M.: Well, I found this interesting because it first started with America banning the use of dollars for Iran’s payments. And that meant that no Iranian Bank and no other bank trading with Iranian counter parties could operate a dollar account because under the Nostro/Vostro correspondent system, all those dollar accounts are actually in New York, and they can be vetted and banned from that point. So the Americans turning around and saying, “No dollar settlements for Iran” is a done deal. But then you have the SWIFT system based in Brussels, which does all international currency transfers, and that was stopped.
So you have a situation where Iran, a future member of the Shanghai Cooperation Organisation and major exporter of oil to China India and Turkey, cannot be paid for its oil in dollars or any other currency. So, Iran has had to resort to external settlements in gold. This is bound to spur China on to increase her own desire for gold over dollars. She’s probably producing more gold than the World Gold Council figures actually reflect. Anyway, I am sure that not only has she been accumulating all her own production but we know China and her citizens have been buying gold whenever it is offered from elsewhere. We also know that they have invested in gold mining capacity outside China, both in Australia and also Africa. Here we have a country which is quite evidently preparing itself for the time when gold comes back as money and paper money, at least in the West, becomes useless. And all China’s suspicions that this is going to happen have not been diminished by American’s treatment of Iran.
L.S.: Yes, exactly. And so India is now paying for Iranian oil with gold.
A.M.: Yes. As I understand it India’s trade with Iran works on a net settlement basis in gold. But having said that, the collapse of the Iranian rial must have dampened Iran’s imports substantially, so Iran is probably earning a lot of gold from its oil, some of which it’s not having to give up against foreign imports.
L.S.: Now we come to your expectations for 2013, and let us begin with silver. Would you agree with me that this is the most explosive market there is, not just compared to gold but compared to all other markets?
A.M.: Absolutely. You’ve got the banks’ short position on COMEX which cannot be covered. According to the most recent bank participation reports, the banks are short of nearly 300 million ounces of silver. When you bear in mind this is an industrial metal, the vast bulk of silver consumption from mining and recycling supply goes into biocides, solar panels, electronics, et cetera. You have only 100 million ounces annually left over for investors. The short position for the banks on COMEX is three times that 100 million ounces.
There’s no way this can be covered without a price rise sufficient to kill off significant industrial demand, because there are no strategic reserves to draw on. The only country which might have strategic reserves is China but otherwise there are no reserves. And I think that the only way in which the banks’ shorts could be closed out is after a price hike which would lead to billions of dollars of losses for these banks. There will be a market crisis, and I think that they will have to suspend trading in silver and agree a settlement procedure for long and short contracts. And if that happens, it will be well over $50 an ounce. But remember, other exchanges will continue to price silver if Comex suspends, which will not help Comex resolve the problem if the price continues to rise elsewhere.
L.S.: It’s also a very difficult situation for the European banking system, right?
A.M.: Yes, it is. Last year the election of President Hollande added to this crisis because he has taken France away from the path of austerity and reverted to old-fashioned central planning and socialism. The result is that very quickly the French economy is beginning to collapse. And France in my view is at least as bust as Greece, Italy or Spain and it’s only a matter of time before that is realised in the markets. I think that is certainly an important development for 2013. At some stage in 2013, I expect Eurozone residents to turn away from the euro in favour of gold.
More generally, I would say that the systemic risks for next year are the Euro-zone, Japan (which might surprise you but note that in Japan the dissaving from elderly savers is now getting to the point where it’s reflected in a trade deficit which will lead either to higher interest rates or a lower yen). So, those are two problems for the banks – you’ve also got the precious metals market which we have already mentioned and I think is going to be the big surprise for everyone. And I know that the response to the Eurozone and Japanese problems is central banks around the world will print whatever it takes to stop this affecting their banks and bringing the banking system down. The US economy, with higher taxes, seems certain to disappoint as well. Going into 2013 I do not see progress, only problems, and a global banking system that is constantly on the verge of collapse. And if the banking system goes down, you bring down the currencies as well.
L.S.: That’s likely for sure. Okay, and with this background, what do you expect for the gold market in 2013?
A.M.: I expect it to be considerably higher because I would expect it to reflect the increased systemic risks and the quickening pace at which the systemic risks are likely to develop. I think it is going to be truly frightening or could be truly frightening. That is the outlook; but in the short run we also have a systemic shortage of bullion in the West which can only be resolved with higher prices, far higher prices in the case of silver.
L.S.: One last question; one gold story of 2012 was of course that we saw much more discussion about the gold standard in comparison to the past. Do you think this will increase and how do you view this debate?
A.M.: I think the people who are pushing for a gold standard are just indulging in wishful thinking. I really do not see a gold standard working at all, because the fact of the matter is the central banks want the flexibility to continue to issue currency without any restrictions whatsoever. As soon as you bring in a gold standard, if it’s going to mean anything at all, you impinge on that flexibility. It won’t happen, I think you can forget it.
L.S.: Do you think in 2013 we’ll go further down the road of decline?
A.M.: I’m very, very pessimistic about where we’re going, Lars. I think eventually we’re going to have a complete breakdown in value for paper currencies. I think they will become valueless and it will give me no pleasure at all to be sitting on my savings in gold and silver at a time when everyone else is impoverished. That appears to be the prospect as we go through 2013 and beyond.
L.S.: That’s the sad truth. Nevertheless, I thank you very much for this interview!
A.M.: No, not at all, it’s my pleasure!
Egon von Greyerz
Founder and Managing Partner
Matterhorn Asset Management
Phone: +41 44 213 62 45
Matterhorn Asset Management’s global client base strategically stores an important part of their wealth in Switzerland in physical gold and silver outside the banking system. Matterhorn Asset Management is pleased to deliver a unique and exceptional service to our highly esteemed wealth preservation clientele in over 70 countries.
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