“Crazy, Frustrating” Month in Precious Metals Comes to a Close - Monthly Wrap Up

Announcer: You're listening to Sprott Money's "Monthly Wrap-Up," with Craig Hemke.

Craig: Well, hello again from Sprott Money News at sprottmoney.com. Hey, it is time for a new segment here at Sprott Money. We're gonna call this the "Monthly Wrap-Up." If you're a long-time listener, you know that we kind of started this back in about 2015 or '16 with me, as your host, Craig Hemke, being joined by Eric Sprott on a weekly basis. And, as most of you know, Eric's unable to join us on a weekly basis anymore, and so we kind of kept the Weekly Wrap-Up going for a while, but we thought, you know what, I think it's time to change that. And so, we're moving now to a monthly wrap-up format instead. We wanna thank everybody that has joined us over the past several months on a weekly basis, and now we hope that maybe we'll have, again, many of the same great guests, including Eric, who'll be able to join us when he can. But we'll be doing this more as a monthly wrap-up instead of a weekly wrap-up, and then we'll transition, then, into the, a new month, where we'll have the monthly precious metals projections with Chris Vermeulen. I know that's gotten to be very popular. And, of course, in between, we'll have the "Ask the Expert" segments as well.

Eric is not joining us here for this initial installment of the "Monthly Wrap-Up." Instead, though, we're gonna be joined by my old friend, and good friend, Andrew Maguire. Many of you are familiar with Andrew. He has a long history of being an advocate for precious metals, sound money, based in London, where he has a firm grasp of the wholesale market and all of the factors that influence price, not just in New York, obviously, but in London as well. So, it's always great to hear from Andy. So, Andy, thank you so much for spending some time with us on our first Sprott "Monthly Wrap-Up" segment.

Andrew: Craig, it's a privilege. I love doing stuff with you, and we free-wheel stuff, and it's amazing what pops up sometimes when we talk. And we obviously, what we talk about today is...can be officially sanctioned, because some other stuff we talk about is probably best not to put on this podcast.

Craig: I guess that's true. But, in terms of, I guess, looking back at this month, I think there's, it's been such a volatile month, and I think it'll be very valuable for folks to listen. And, again, please keep in mind that Sprott Money is your sponsor of all of this content. You'll always find great deals on physical gold and silver at sprottmoney.com, also great deals on storage of precious metal as well. You can go to sprottmoney.com to see all those deals, and, of course, you can always pick up the phone and call them at 888-861-0775.

Andy, we might as well just dive right in. It's been a volatile, frustrating month in gold and silver. You know, we got smashed after the FOMC, back in the middle of June, tried to recover, looked like we were gonna recover, and then we've been driven lower again despite what are some very positive, usually very positive, fundamentals. And we'll get to that in a second.

But I wanna talk first about the changes to Basel III. You know, many of us were, and still are, excited, interested to see how this plays out in the months ahead. But there was what seemed at first glance kind of a sucker punch late in the day on a Friday, you know, when it often seems, at least here in the States, if you want news to get covered up, you release it, like, at 6:00 on a Friday, and that's exactly what the powers that be did in England a couple of weeks ago, in their statement kind of amending how they want the LBMA and their banks to operate under Basel III. In the time since, I think we've kind of gotten, drilled down a little bit into what actually all of that meant. On my side, I had a great visit with Alasdair MacLeod, who was able to kinda provide his insights as well, but we had several questions for you about Basel III and what you make of all this, so I guess I'll just be quiet and let you pick it up and run with it.

Andrew: That's great, Craig. Yeah, Alasdair's got a good handle on things as well. And I think really, what we saw at that, and usually, and without getting into the...we've got into a lot of detail in the past. It was window dressing. And really, to be honest, it's made no difference what a, really, essentially, what all that happened there was that the clearing banks have to become an exchange. They can't take any liability on their own books, and it's their clients who must take that risk.

So, and we certainly think that these clients, although there's an incestuous relationship between the four LBMA clearing banks, the LPMCL clearing banks, and the LBMA, I think, really, Basel III puts an end to that, because you really can't afford to put that liability, roll those liabilities onto your own books on the first of January '22. But I think, looking at this month, I mean, yeah, you're right. It's been a crazy, crazy month. And I think, really what we're getting out of this, there are some changes in behavior.

So, obviously the rest, the whole globe, except London, is, the UK operations, are compliant. And I think it's an appropriate time to really have a look and take a look at the EFPs again, look at the similarities between what we're seeing now and what blew the EFPs back up in March 2020, and of course, we all covered that in detail. But, look, I think there's a good reason, although the COMEX is now compliant, the over-the-counter market's only just starting this process to buy a little market-rigging time, to exit really deeply underwater, unbacked, unallocated contracts.

And the footprints in the wholesale markets tell us that the key market-making banks on the COMEX have sneakily shifted their trading into London, where the smoke-and-mirrors unregulated world, whereas... And this is also true in Europe, where the compliant LBMA banks, such as UBS, and I don't know if everyone knows this, but certainly, UBS have cut their physical trading desk to just two people, and shifted, of course, shifted their focus onto the still non-compliant over-the-counter market.

So, that's not untypical. Really, the physical markets are now... Why do you need more than two people? Because you're not...you're really, there's a bid, there's an ask, and it's a physical price. So, you know, basically, they've really shifted this, in this period, while they're covering off all this unallocated stuff... And bearing in mind that when you're covering an unallocated contract, you know, essentially, it's a foreign exchange contract. It's 10 times larger in the over-the-counter markets than we see in the COMEX, but essentially, what you're doing is when you close an unallocated contract, what you're doing, essentially, is you're buying back the dollar leg, and selling the gold leg. But it is releasing this overhead overhang. And I think that's what we're seeing right now, you know, basically, at this moment. And that this is creating a lot of volatility, you know, you're seeing liquidity evaporate from the paper markets, and more and more and more, we're seeing the physical markets actually starting to take control.

So, really, I think, to me, if I had to sum it up, there's two things in play. I think that's the closing out of these unallocated contracts, sort of, what we've just described, that creates this liquidity gap. And I think you're seeing some air pockets because of that. But, I think this is the important point. It's not a free pass to hammer down gold into oblivion. There is a physical side to this market. And these banks are constrained, and I think this is the key thing. They're constrained by the degree they can dare to put freshly, physically-backed COMEX into backwardation. Because, why? The COMEX now has to be physically backed. So, it's a delicate balancing act. That's what we're seeing right now. And don't forget, we've got Russia, China, leading a pack of other central banks seeking to secure and repatriate physical gold, to back their respective currencies, so it's not just a club anyway. Military enemies here, who... This is not a club. So, interesting times.

Craig: You know, I reference this discussion I had with Alasdair McLeod, I guess it was about a week ago, maybe a week and a half ago. You can find this. Anybody wants to listen, it's on my tfmetalsreport.com site. It's a free thread. I mean, anybody can listen to the audio. You just gotta scroll down the page to find it. What Alasdair told us, Andy, and I just wanna see if you see it the same way, was that if you look into whatever it was, paragraph 2 and paragraph 3 of that, you know, that relevant section that came out from your authorities over there, it reads that if you're gonna continue in this unallocated business, there's gonna be essentially a financial penalty that will make it untenable going forward. And so, therefore, your only option is to take your, all of this risk of unallocated metal. If you're gonna run that type of, really, a pooled account, you've gotta have physical on hand for every unallocated ounce that you're running in that pool.

And, therefore, you know, these banks that run those schemes are gonna have to either get out, pay what is essentially a financial penalty, not to the authorities, but just the cost of doing business goes up, or find the physical metal to back it. This, to me, seemed consistent with what you've always told me about the authorities over there, kind of going, "Wait a second." Almost like they were caught flat-footed that there was another crisis brewing from the actions of these banks, with this open-ended potential loss from all these short contracts, and trying to square all that up.

Anyway, long question, Andy, but is that how you've read this as well, those changes? That we're still going in that direction of eliminating the unallocated gold, and all those risks that the banks are taking?

Andrew: And that's exactly what we're seeing right now. And it does throw some false signals into the market, but essentially, what we're saying, in simple terms, and, you know, a lot of people glaze over when we talk about Basel III and all the various rules and regulations. But, look, what we're saying is LPMCL, clearing banks must simply act as a clearing member, and not as, in this incestuous relationship they had with their own banks, and these Chinese walls that they had, which, of course, were not. And they're not market makers. That's the important thing to understand. They're not market makers. It's their clients who are, and as you just rightly said, it becomes too expensive to start rolling...

And furthermore, if you become, if you don't back, as a client of the clearing bank, essentially, if you don't back that position one-to-one with physical, that liability rolls onto your balance sheet. That's not what I think is the way forward. Certainly, this is, I think, whatever we're seeing here is extremely bullish for gold.

Craig: And in the end, again, you and I, as long as we've known each other, you know, all we've really wanted was something where price is discovered more on exchange of actual physical metal, rather than this phony baloney, you know, plastic banana, unallocated derivative contract nonsense. You deal, your day job is dealing in the physical market. What can you share with everybody here in the summertime, as we look forward into August, which is typically a pretty strong seasonal month, what can you share with everybody about what you're seeing in the physical market?

Andrew: Well, I think what it's telling us is that there is a potential exchange for physical blow up in the brew. And I think, what we're saying is, "Look, if you put, if the over-the-counter guys, if these guys, who are still prevalent inside this, who have snuck into the over-the-counter market for cover, essentially, while they unravel this huge amount, billions of dollars worth of unallocated positions, I think, essentially, what they're doing is they're just buying a little time here. And I think if they push, and this is what we've just said, if they push the over-the-counter market, the spot price, where China, Russia, any other central bank, can also buy in this marketplace... It's a foreign exchange transaction. You lock that price in, and you put the COMEX into backwardation. That will be the place where you come and take that physical.

And I think what we're seeing here is if they push this too far, and I don't think they dare recreate what happened in March 2020, is, you know, if you remember, there was, suddenly, we saw a contango dislocation between spot gold and futures. And so, really, they're dangerously pushing that today. Now, I don't think it's gonna settle below $1800, because it's simply, there is too many, we know, in the physical market, there is a lot of first-tier banks who consider $1800 gold very cheap.

But essentially, what we saw before was when these liquidity providers in the unallocated market were actually forced...were requested for delivery, the last thing they wanted was to actually be demanded for physical delivery. They're just [crosstalk 00:14:13] this game. Good God. And suddenly, everyone bailed, the bid-ask spread widened to 20 bucks. On the Tuesday, the EFPs blow up...it went to 100 bucks, and really, this lack of market depth forced them to sell their over-the-counter longs at market, whatever, almost no bid, in order to cover directly-related deeply offside rising short squeeze futures contracts. We best never forget this lesson. And this is...we're smelling this right now. If they push this too far, and I believe they would not dare do this, that... And I think this is why what I'm saying is that little encouragement here, I don't think that lesson has been learned. That would completely wreck this whole system. It's anti-Basel III, as well. So I think that's what's going on right now, this delicate balancing act between the spot market, where they're hiding, and the physical market, which is the COMEX. And Craig, did we ever think we'd be talking about the COMEX as compliant on the physical side?

Craig: Right, right. They opened that Pandora's Box, as you said about a year and a half ago, because they didn't have any choice. I mean, they had to start delivering physical off of there, otherwise it would have been... You know, I don't know that we'd call it default, but they were definitely in a jam, and they don't wanna get there again. And Andy, I look at this and I see... I guess I'm gonna transition to the final question that people had for you, and that was this lack of response so far this year in price to what are some extraordinarily strong fundamentals.

I mean, we are, you know, price was $2,100 a year ago at this time. With the real interest rates, if you wanted to, you know, quote it just by the 10-year treasury note nominal yield with CPI, they're -4% versus -1%, a year ago at this time. Or if you wanna look at the forwards, as a lot of people do, the inflation expectation forwards, at 5 or 10 years, they're at least back to, if not lower than they were a year ago at this time. But yet, gold is $300 lower. And so, the fundamental question that several people wrote in, wanted to ask you, is when will gold start paying attention to those fundamentals again?

I mean, I kind of see it as, I guess, two things. One, the banks, greedily, selfishly, manipulating price to their own ends ahead of Basel III, and things like option expiration, as we're dealing with here in this month, but also, you know, a rising gold price is not consistent with the Fed's "transitory" narrative that they're so desperate to enforce, right? Keep the bond... I mean, their big golden goose is the bond market, and "transitory" is all about keeping buyers in the bond market. And if gold was $3,000 instead of $1,800, it'll be a little harder to shove that narrative down everybody's throat. So, I see all these factors, you know, as to why we've had this temporary dislocation from fundamentals like real interest rates. But, of course, nobody really wants to know what I think. They wanna know what you think, Andy, so take it from there.

Andrew: Well, I think one of the...you know, obviously, if we have to distill, there's so much, so many inputs here. But if we have to distill one thing down, which is the major change of behavior, evidenced since June 28th, so, really, we're talking our month here, aren't we? Well, gold has actually been acting as a safe haven, alongside the dollar. And essentially, yes, okay, you go back and you look at a dollar index chart, and you're gonna see a rise in this last month. But also, despite little pullbacks, and despite the pullback, gold has also risen alongside the dollar. Now, this is an interesting dynamic shift, and what it is, is the usual algo, which is buy DX, sell GC, you know, we've seen that multiple times. You know, it's just a mindless algo. It's been offset by the requirement to manage COMEX gold backwardations from being arbitraged. And I think that, to me, is the one takeaway.

And so, sometimes, we see the dollar fall down, and come down on the day, and gold go down with it. And it's like ludicrous, crazy, that gold...that the dollar is considered a safe haven, but clearly, gold has always been a safe haven. And they kind of been lock-step at this time, which is a very strange situation.

Craig: So, do you expect, at some point... I mean, as it relates to real interest rates, again, which is sorta like a 95% correlation over the decades, Andy, do you expect that thing's gotta solve itself out one way or the other? Either real interest rates come back up to meet gold, or gold rises to meet sharply negative real interest rates? Or are we just in a brave new world, where what mattered for decades doesn't matter anymore?

Andrew: Well, I think there is obviously that element. Because we also know the algo exists between the... Which is why it's a bit confusing at this point, because, really, gold should be right through the roof, based upon what basically, at what, after, I mean, one-year lows? I mean, February lows at least, but certainly, almost a year lows, where obviously, gold should be... But I think, again, one of the things that is confusing the issue is this race, for the next five months, and it's gotta be completed in five months, to get these huge, billions of dollars worth, of unallocated liabilities, which will roll onto the books of these banks if they're not squared. And I think that's what's causing the confusion here.

But I think we're gonna see gold significantly higher, and I think what's gonna happen here is that long before they have to comply, I think within a month or two, perhaps even by October... And I would think that we'd see gold starting to unleash the coil that is actually building. And we certainly know there's massive demand coming through from Russia, China, other...and repatriations of gold coming, which started in, actually, April the 1st, 2013, when the U.S. decided they weren't gonna pay Germany's gold back in, immediately, for 300 tons that they were gonna take in seven years.

Suddenly, all these questions came up, and God, it's no coincidence that in 2013, every single central bank started to repatriate their gold. Alongside, ahead of this NSFR conditions, they already were working on it. So, within, it's taken almost 10 years, but all these central banks saw the writing on the wall, saw they needed the physical. When the Fed didn't even allow the German Bundesbank to come in and inspect their gold, and then they asked for it back, and it was gonna take seven years, my God, man. What more incentive was there? If I was a holder, if I stored my physical at a vault, and I said, "I just wanna come and get it. Send it to me tomorrow." "Oh, no, no. I'm sorry. We're gonna take a few years for you to get it back." What would I do? I mean, I'd be suing them, right? I mean, crazy.

Craig: And of course, Andy, price was smashed after holding $1,525 as a floor, down from the highs in 2011. For about a year and a half, price gets smashed in April of 2013 as well. Surely, those two events aren't related either.

Andrew: Exactly. So, I mean, like, literally. And then, that was ABN AMRO, exactly at that same time. So, we had cracks in the LBMA system right then. ABN AMRO issued that letter, which was published. And it basically, I think that was the 3rd of April, then the President's Working Group met. Do you remember? And what happened? Five hundred-buck smack. Why? They had to come buy this market, this gold back at market. So, I mean, people... It's so easy to forget the history. This is history that we've witnessed in the making. And this is huge. And I think by the time we get to the end of this year, I really would be surprised if gold wasn't at Goldman's target at the beginning of the year, which is $2,500.

Craig: Yeah. No, and I'm with you. And I'm glad to hear you kinda see it the way I do. I've been thinking that now we have some clarification, kind of final clarification, and the banks know what they're up against coming July 1, or January 1, 2022, then they're gonna try to clear out, square up as many of these positions as possible, but they're not gonna wait till December to do it. I mean, they're in the process of doing that now, which explains the malaise that we've dealt with, the counter-intuitive, counter-fundamental stuff that we've seen all year long. But man, that just distorts price, and once that's done, like you said, not on December 31st, but, you know, sometime before then, that's when we might see gold rush to catch up. Did I summarize that pretty well?

Andrew: Yeah. And there'll come a day, and that evolves, where a physical, where I wanna buy a physical, an amount of physical, and somebody will have an amount of physical to sell. And somewhere between the two of us will be a real physical price, none of this paper shit that goes on.

Craig: Right. Right, right. Andy, thank you so much. It's been, always great to hear from you. It's been a treat. I know Eric thinks the world of you and your analysis as well. We love what you do with everybody at Kinesis as well. Be sure to check out Kinesis. It's a great project Andy's been working on now for a number years. And Andy, we just appreciate all you do for the precious metals community. Thanks for your time.

Andrew: Thank you so much, Craig, and send my best to Eric.

Craig: I certainly will. And for everybody, on your way out, again, this content is sponsored by Sprott Money. We'd like to get it out there as far-reaching as widely heard as we can. The best thing you can do for us is to give us a like, maybe a subscribe, a tweet, something from the channel that your listening to this stuff on, and that'll help us get the word out. And again, remember sprottmoney.com for all your gold and silver physical buying and storage needs.

Again, our guest has been Andrew Maguire, here for your July "Monthly Wrap-Up," and we look forward to having a "Monthly Wrap-Up" at the end of August as well. Till then, thank you for listening, and from all of us at Sprott Money News and sprottmoney.com, have a great rest of your day.