PeakOil is You
The Carry Trade
Re: The Carry Trade
by MrBill » Tue 06 Mar 2007, 05:19:10
$this->bbcode_second_pass_quote('Zentric', 'M')y apologies for the intrusion, Mr. Bill. But I've heard so much talk of the central banks lending their gold to the wall street firms for the purpose that I've just described in my post above. Is this a myth or the 'conspiracy' of which you speak? I always want to make sure I have my facts straight.
Micki is the one to ask. He is the expert on gold lending from the central banks to commercial banks. We do not agree on the facts, although he has more supply of them than I do.
Although this is not depletion economics related, my point of view is that gold lending comes down to a misunderstanding of how 'loans' are treated on a bank's book to 'avoid' (not aid) the so-called double counting.
Gold on a central bank's balance sheet is treated as part of its equity or its capital. Liabilities and equity are on the same side of the balance sheet. But gold is a non-income earning asset, so the only way to generate a return is to lend it out. When the CB lends gold out it creates an asset.
However, the CB's asset is the commercial bank's liability. So there is no double counting. The commercial bank lends the central bank money against the gold loan.* Or in other words it uses cash as collateral against the gold loan and it pay interest on the gold loan. The cash loan to the CB is an asset on the commercial bank's balance sheet to offset the liability of the gold loan. The interest on the gold loan has to be paid out of the bank's interest income or from its own capital. So that gold loan also has a cost of money. It is not a free loan.
If the commercial bank then turns around and lends out the gold to someone else. Perhaps a gold trader that is short. Then again the bank creates an asset in the loan of gold. That asset is offset by the gold trader's liability to repay that loan. So there is no double counting of assets or reserves as each time it creates a liability as well.
And here is where Micki and I disagree. If the price of gold has risen from under $300 in 1998 to almost $650 today (it was higher of course). And if the commercial banks were manipulating the price of gold by short selling it. With enough leverage to make a serious difference. Then how did they make money? They would have lost money on the way up everytime gold went up in price multiplied by that leverage. Call it 10X or 100X.
In my opinion the gold longs, not the gold shorts made money. But Micki feels they traded in and out to maintain a core short position and to take advantage of market timing. I just do not see it, but as I have no facts to support my argument it is just my opinion. Others disagree and that is their right. So long as we agree on the mechanics of the loans and their accounting treatment.
Now, of course, there are outstanding cash loans against those gold loans and that interest and principle needs to be re-paid. Keeping in mind that Fed funds has risen from 1% to 5.25% starting in April 2004. And someday that gold has to be returned to the CB who is its rightful owner. Some have also argued that gold has been lent out and will never come back. However, just like I have no facts to support my opinion, they also have no facts to support theirs either. So we just have to agree to disagree?
But I do not see many similarities between gold lending and the yen carry trade. Different fundamentals and the yen carry trade was not manipulation of the physical market, but used to finance the leverage on credit, interest rate and currency risks to earn a profit from low, stable rates in Japan used to make profits elsewhere. It is a pure funding play that is blowing-up in many player's faces at the moment due to a sudden jump in the value of the yen against the US dollar, euro and other currencies.
However, against the reality of post peak oil resource depletion you can make a case for borrowing cheaply to benefit from a rise in commodity, metals and energy prices. If your cheapest source of funding is yen thanks to Japan's ZIRP then great. But you still have to take the price risk and the currency risk. It is not a risk free trade as some would have you believe.
*it depends on whether it is a gold loan or a repurchase agreement (repo). A loan is a loan. No change of ownership. A repo or reverse repo is a buy/sell arrangement. There is a change in ownership. But you enter into both side of the transaction simultaneously, so you still create an asset and a liability. And just to make it a little more complicated repos can go on 'special' which means you may lend money AND pay interest for the privilege depending on the demand for gold (or stock/equity for that matter). So when the market is really short gold/equities it is quite expensive to stay short because you have to pay double for the privilege.
Last edited by MrBill on Tue 06 Mar 2007, 05:47:14, edited 1 time in total.
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Re: The Carry Trade
by Zentric » Tue 06 Mar 2007, 05:36:37
Thank you, Mr. Bill. I'll read your post a few times more over the next few days to better absorb the details of what you're saying. But you've made your point. There surely is more complexity to the gold-leasing business than how I attempted to sum it up in my earlier post.
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Re: The Carry Trade
by MrBill » Tue 06 Mar 2007, 05:44:11
$this->bbcode_second_pass_quote('Zentric', 'T')hank you, Mr. Bill. I'll read your post a few times more over the next few days to better absorb the details of what you're saying. But you've made your point. There surely is more complexity to the gold-leasing business than how I attempted to sum it up in my earlier post.
And Micki is also upset (in another post) about US investment banks like Goldman Sachs beating the drum of higher gold and commodity prices in their research, while their trading desks may be shorting the heck out of it. But that is because of Chinese Walls that Elliot Spitzer and the SEC insisted on to separate Sales & Trading from Research.
So their 'independent' researcher may be advocating one strategy for all the right reasons at the time, but Trading may be seeing something completely different. As was the case when the gold market was predicting higher inflation and/or a falling US dollar, while the bond market was pricing in lower yields from falling economic activity.
It turns out they might be both right in the form of stagnation in the US economy against a backdrop of higher commodity demand in the rest of the developing world. Maybe? So the stock market gets trounced instead! ; - )
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Re: The Carry Trade
by mmasters » Tue 06 Mar 2007, 11:10:59
$this->bbcode_second_pass_quote('Zentric', 'T')hank you, Mr. Bill. I'll read your post a few times more over the next few days to better absorb the details of what you're saying. But you've made your point. There surely is more complexity to the gold-leasing business than how I attempted to sum it up in my earlier post.
Be careful on his "analysis" - it doesn't include a working knowledge of "fractional reserve banking".
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Re: The Carry Trade
by MrBill » Tue 06 Mar 2007, 11:23:22
$this->bbcode_second_pass_quote('mmasters', '')$this->bbcode_second_pass_quote('Zentric', 'T')hank you, Mr. Bill. I'll read your post a few times more over the next few days to better absorb the details of what you're saying. But you've made your point. There surely is more complexity to the gold-leasing business than how I attempted to sum it up in my earlier post.
Be careful on his "analysis" - it doesn't include a working knowledge of "fractional reserve banking".
We have already clarified that issue and my explanation was found perfect in both theory and practice!
MonteQuest even was so kind as to send me the link to the Fed that confirmed my analysis right down to the last debit, credit, asset & liability. There is no more discussion. There will be no further attempt to explain it again for those that just don't get it?
The link is here. A Workbook on Bank Reserves and Deposit Expansion. But of course you have to be able to understand what you read as well.
Modern Money Mechanics
So go back to writing software and installing printers or whatever it is you do? thanks.
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