Gold (19 page)

Every three months the London market was trading twice as much gold as had been mined in all of history.

G
OLD IS A MAD BAZAAR
.
The volume of bullion coming to market today is more than sixteen hundred times what it was in the sixteenth century, when Spanish treasure fleets were jostling up the river to Seville. Not only are people buying all this fresh gold, they are buying it and selling it and buying it again.

In 2011, the total value of mined gold was about $143 billion, yet the value traded was much larger.
In one three-month period alone, 11 billion ounces of gold worth $15 trillion changed hands in London. The true size of this market only came to light that year. Gold movements are secretive.
Most of the trade is in the hands of a cabal of banks in London. Those very banks led the way in exposing the size of the market. Their reason for uncovering the volume of the bullion trade was to provide it with a whole new class of customer—
banks. As part of a campaign to promote the standing of gold as a “liquidity buffer,” a type of capital asset that European commercial banks were required to hold, the bullion market wanted to show European banking regulators how big the gold market was. First they had to find out themselves.

The London Bullion Market Association polled its members about the size of daily trading. Most bullion trades in London, the world's oldest and most important market, are on a principal-to-principal basis. The transactions are private to the parties involved, and leave no public footprint. When the size of this trading emerged, it was astonishing. In the first three months of 2011, the value of gold traded was $15,200,000,000,000. In volume terms, the figure represented 125 times what the world produced in a year, or twice as much gold as had been mined in all of history.

These trading volumes helped cause rapid movements in the gold price. New investment vehicles make it easier to trade bullion. No longer does the speculator have to buy gold bars from a dealer. He can pick up a phone and buy shares in a bullion fund. The biggest of these funds appeared in 2004, only seven years before the London bullion market discovered its own size. The people who created the fund opened a crack in a dike that had been holding back an ocean of demand, and the money poured in. In a few years they had more gold in their vault than China's central bank. Bullion analysts began to watch the gold flows in and out of the fund with as much attention as they watched such crucial market indicators as jewelry demand. In the gold world they call the fund the Spider.

The Spider is an exchange-traded fund, or ETF, an investment composed of a basket of assets that trades with the ease of trading stock. In this case the asset is a single one: gold bullion. The nickname “Spider” comes from the fund's full name, SPDR Gold Shares. (The first-ever ETF was called Standard & Poor's Depositary Receipts, or
SPDR.) The nickname fits. The Spider's customers could react with arachnid speed to the slightest tremor of investor sentiment. By removing the headaches of picking up physical gold and finding and renting vault space, the fund advanced gold ownership more than any measure since the creation of gold money in the seventh century BC. It democratized bullion. Anyone with a few hundred dollars could take a gold position. More importantly, and what gave the Spider fangs, so could anyone with a hundred million.

The Spider was a creature of the World Gold Council. The gold miners who ran it wanted a better way to sell gold, as they were producing so much more of it. From 1975 to 1985, world gold production ran between 40 million and 50 million ounces a year. New technologies, such as heap leaching, brought more reserves into the production stream. By 1995 world production had leapt almost 50 percent to about 72 million ounces, and ten years after that, to 80 million ounces. In thirty years the amount of gold coming to market had doubled.

As the gold supply ballooned, the WGC's New York office looked for ways to expand the customer base beyond the jewelry market. They took a simple approach: they canvassed American investors who did not own gold, and asked them why they didn't. “The very strong message we got back,” said the executive who ran the survey, “was that gold investment was cumbersome, costly, and complicated.” The investors wanted something that would be easy to trade, did not have to be vault-stored by the buyer, yet represented exposure to the spot price of gold. In short, they wanted to be able to bet on gold the way they could bet on stock. In 2000, the WGC set about inventing a product that wrestled the complexities of the bullion market into a simple form, yet one that would satisfy the strictures of the Securities and Exchange Commission.

“They hadn't a clue how the gold market worked,” a WGC manager
said of the commission. “I would go down to Washington with a lawyer and a gold trader and someone who had dealt in ETFs, about five of us all together, and we'd be ushered into a cavernous conference room and we'd sit around an enormous table. We'd start to talk about how the gold market worked, and you'd notice that people were filtering into the room, and at the end I'd be addressing forty or fifty people. There was a tremendous interest in how this exotic product worked.”

To license the ETF for sale, regulators had to be convinced that every share would represent real gold bullion in a vault. In 2004, the SEC licensed the Spider. For the gold believer, that warm feeling was now a phone call away. The Spider went on sale in November 2004. In four days it took in $1 billion. Eight years later the Spider owned about 1,300 tons of gold worth almost $70 billion.
There was more gold in the Spider's stash than in the central bank of China.

The Spider ETF made bullion ownership available to ordinary investors, who apparently wanted to own gold once the difficulties of doing so were removed. But ease of ownership added more to the gold market than additional owners. It added instability.

T
HE
S
PIDER DESTABILIZED THE GOLD
price in two ways. One way was by making it so easy for people to buy and sell large amounts of bullion, and the other was a structural consequence of how the fund worked.

In analyzing the Spider's effect, it would be useful to know who its investors are, so as to understand the relative sophistication behind the trading. But there are no data to show who owns the Spider.
Some of the owners' positions show up in 13F filings—mandated
quarterly declarations by American institutional investors that report their trading. For instance, 13Fs revealed that billionaire George Soros sold $650 million worth of Spider shares in the last quarter of 2010, while another billionaire, John Paulson, whose managed funds had $4.5 billion in the Spider, stayed put. But 13Fs document only those funds under institutional management, products sold to the public. If Paulson or Soros had a billion dollars of his own in the Spider it would not show up in a 13F. Jason Toussaint, a WGC executive, told me that 13Fs were his only window into ownership. He could not even say how many owners had the shares, and therefore could not estimate the average size of holdings. This means that there is no way to gauge investor sophistication. We can assume that some of them are not as sophisticated as Soros or Paulson.

The Spider (and the other gold ETFs that sprang up in the wake of its success) contribute to volatility by supplying a larger public with the means to make quick bullion trades. Presumably the moves of the more sophisticated practitioners influence some of this trading. In this view, the less sophisticated investors pile on, hurling themselves into the action in an imitative frenzy. ETF trading did not drive price action as a primary mover, said bullion analyst Sterling Smith, but made its movement “more intense.”

The structural effect of ETFs on price instability arises from the requirement that ETFs “rebalance” themselves at the end of the trading day, buying or selling their underlying assets to match up with the day's buying or selling of the fund. As rebalancing occurs, a flood of trading orders hits the market at the same time. The market reacts as it does to any large order, moving up if the order is to buy, down if to sell. Since ETF shareholders may have acted in response to a market movement in the first place, their actions intensify that movement.

In a DealBook column in the
New York Times
, Steven Davidoff, a law professor with expertise in financial regulation, saw in the general buzz about gold the elements of a pricing bubble in which “speculation is aided by the financial revolution. Previously gold could be bought by retail investors only through dealers and street shops. Now anyone can go on the Internet, click and buy gold in the market through exchange traded funds.” In a bubble, wrote Davidoff, television and the Internet would play a large role in spreading the hype. And that is what they were doing. In such an atmosphere, he said, “the marketing of gold to the masses is an ominous sign.”

You can order gold as easily as groceries. Some sellers will deliver to your door. One such company is Goldline International, Inc., of Santa Monica, California.
Goldline's most famous pitchman is Glenn Beck, a popular right-wing talk show host. In 2011 he had a show on the Fox television network. Beck stirred up his pitch with forecasts of ruinous inflation. He advised his viewers to put their faith in “God, gold, and guns.” In a broadcast I listened to online, Beck predicted the collapse of the European Union, and European war.

The fortunes of Goldline soared as the gold price rose. In late August 2011 gold hit $1,917.90 an ounce. The WGC reported that demand for a single category of gold investment—bars—had doubled in the previous two years to 850 metric tons a year.
Television business commentators predicted a gold price of $2,500 an ounce, and gold bug websites vibrated with reports that John Paulson, with billions of dollars worth of bullion in his funds, was prophesying $4,000 gold.
Leaving aside the holdings of gold coin speculators and private bullion owners, and the uncountable lumps belonging to those who'd melted down their jewelry in home smelters, the amount of investor gold in ETFs alone stood at 2,250 metric tons. Then in September 2011 the gold price reached the end of a ten-year bull run, and fell off a cliff.

In a month gold tumbled $300, landing with a thud at $1,600 an ounce in October 2011. Some investors saw their gains evaporate.
On November 3 the Santa Monica, California, city attorney filed a nineteen-count criminal fraud complaint against Goldline, alleging the sale of overpriced gold coins to people who thought they were buying bullion.
Goldline agreed to refund as much as $4.5 million to buyers, according to reports, and to pay $800,000 into a fund to settle future claims. ABC News reported that Goldline also had to stop telling customers that the government wanted to confiscate its gold.

As the gold price fell, hedge funds started “unwinding” gold positions to raise cash to cover the increased collateral required by the funds' bankers when other assets, such as stocks, started falling too. This overall decline of asset values challenged the rule that the gold price rises when equities fall. This time the whole ship was sinking. Analysts call it a “risk-off,” in which investors jettison any risk at all, and head for cash. “Cash” meant only one thing: the U.S. dollar.

You could take the view that selling gold to raise collateral for wilting stock positions demonstrated gold's utility as a hedge. If, for example, gold had withstood the risk-off better than some other asset, the prudent investor would choose to take a loss on gold in order to escape the greater loss of selling that more depleted asset, an asset that, if held, might recover later. Moreover, the ready market for gold, even as its price declined, showcased one of the metal's undoubted qualities—liquidity: the ease with which it was turned into money.

As it happened, this quality was crucial to a coup the World Gold Council was attempting to pull off. They were asking European banking regulators to include gold in a special class of top-flight assets. If gold were included in this class, the banks would need to own it. It seemed a strange time to be making the pitch, with the gold price tanking and the markets feeling faint. But they have sturdy
hearts at the WGC, and just the metal, they would say, to stabilize the teetering banks of the European Union.

A
FTER THE BANKING CRISIS THAT
followed the collapse of Lehman Brothers in 2008, the Basel Committee on Banking Supervision, an obscure but powerful caucus of G20 finance ministers, issued new capital requirements for banks. These requirements included bigger liquidity buffers. Such buffers were to be highly liquid assets that could provide cash in an emergency, when normal sources of cash, such as other banks, dry up. Top-quality government debt—German bonds or U.S. Treasury bills, for example—would qualify as highly liquid assets. In the submission of the World Gold Council, so would gold, and on a bright day that heralded a spell of Indian summer for London, where I was living then, I went down to the old financial quarter, known as the City, to hear why.

It was just after noon, and the steps of St. Paul's Cathedral were crowded with people sitting in the sunshine eating sandwiches and tilting their faces to the sun. I strolled through the gate into Paternoster Square. A well-dressed crowd was flowing out of the London Stock Exchange and into the restaurants around the square. If anguish about sagging markets was troubling the financial heart of London, they had decided to forget it while they ate.

I made my way into Newgate Street. Lawyers wearing wigs smoked on the sidewalk outside the Old Bailey, London's main criminal court. Down the street from the dark old court stood the entrance to a modern, glass-walled office building, and in a third-floor conference room I sat down with Natalie Dempster.

Dempster, a brisk Scottish economist, worked for the Royal
Bank of Scotland and JPMorgan Chase before joining the WGC, where she heads government affairs. When we met, she had just returned from Brussels, where she'd been pitching European banking regulators on gold's inclusion as a liquidity buffer. She slapped a wad of lobbying material onto the table and began to enumerate the reasons European regulators should like gold, picking her way through the criteria with practiced skill, and explaining how gold met them: