• John Adams

Beware of Synthetic Gold and Silver Products

Updated: Jun 10

Owners or prospective owners of gold and silver bullion need to become aware of the intention and risks associated with non-physical gold and silver bullion products (or what I like to call ‘synthetic gold and silver products’).

In recent years, a series of synthetic gold and silver products have flooded both the Australian and international market which give the illusion of monetary exposure to gold and silver, but in fact do not.


Synthetic gold and silver products carry significant implications at the micro level for individuals as well as other legal entities (trusts, corporations, etc) who wish to have exposure to gold and silver, but also carry significant implications for both the:

  • global gold and silver bullion market; and

  • global economy and international monetary system.

These implications carry such global significance that deliberately little attention or scrutiny is given to synthetic gold and silver products by market participants and observers, thus market knowledge and understanding, especially that of retail gold and silver bullion customers, remains grossly immature and underdeveloped.

Forms of Gold and Silver Exposure

Prior to the advent of modern day synthetic gold and silver products, historical forms of exposure to either gold and silver (gold or silver certificates will be discussed further below) was achieved either through direct ownership of:

  • gold and silver jewellery (including rings, bracelets, necklaces, watches, etc);

  • gold and silver heirlooms (including gold and silver kitchenware, antiques and collectables);

  • physical investment grade gold and silver bullion products (such as gold and silver coins, bars, etc)[1]; or

  • lower grade physical gold or silver such as ‘junk silver’.


In many instances, such possession of gold and silver by individuals or legal entities represents direct legal ownership which requires physical handling and storage either directly or through a third party which in both instances incurs particular risks and costs.

However, as noted above, in recent years, both wholesale and retail market participants including:

  • government owned gold and silver mints;

  • private sector precious metals refiners and retailers;

  • financial institutions – i.e. banks;

have brought to market a range of new non-physical gold and silver bullion products or so‑called innovations which seek to overcome traditional issues and challenges associated with gold and silver ownership such as security, storage, portability and convertibility.

These new non-physical gold and silver bullion products (i.e. synthetic gold and silver) typically provide market participants with a greater degree of flexibility in how these synthetic gold and silver holdings can be:

  • stored;

  • transferred (either to a domestic counterparty or internationally cross-border);

  • used to facilitate commercial transactions; or

  • converted to tangible physical gold and silver bullion.

Moreover, these synthetic products typically incur lower transaction and storage fees, thus making them financially more lucrative for gold and silver market participants.

These synthetic products, typically include the following range:

  • unallocated gold and silver accounts;

  • pool allocated gold and silver accounts;

  • gold and silver Exchange Traded Funds (or ETFs);

  • gold and silver futures contract (e.g. as traded in the COMEX); and

  • gold and silver backed crypto currencies.

In all of these instances, owners or investors of these synthetic products typically do not have direct legal ownership (i.e. title) or control of physical gold and silver bullion, but rather have a promise from an intermediate counterparty that they will either:

  • deliver physical gold and silver bullion upon request; or

  • pay funds into a nominated currency equivalent to the current market value of the gold or silver bullion holding assumed in the synthetic product.

The Intention of Synthetic Gold and Silver Products

While synthetic gold and silver products can, according to their promoters, deliver benefits to gold and silver bullion owners, these products do perform other market functions, especially in the context of gold and silver market price manipulation.

Importantly, as outlined in my recent articles about the gold and silver market including:

  • The undeniable manipulation of the silver market[2];

  • COVID-19 exposes gold and silver price manipulation[3]; and

  • Will COVID-19 collapse gold and silver price manipulation[4]


the internationally recognised price of gold and silver are heavily manipulated and supressed via the actions of the New York based COMEX futures market which is part of the CME Group as well as the London Bullion Market Association (LBMA) and its member organisations (in particular the bullion banks and bullion refiners).


These actions include:

  • flooding the futures market with unbacked gold and silver short futures contracts (commonly known as ‘naked shorts’); as well as

  • using Exchange for Physical (EFP) contracts in order to settle naked shorts where actual physical gold or silver is not exchanged.


As noted by Craig Hemke from TF Metals Report and Sprott Money[5], the ability of bullion banks to successfully manipulate and suppress the price of gold and silver relies on:


  • increasing the total size of the gold and silver market through the issuance of unbacked futures contracts; and

  • financial institutions and gold and silver refiners supressing the demand for physical gold and silver bullion through the offering of synthetic gold and silver products which give the illusion of ownership.

Thus, synthetic gold and silver products have played and continue to play an important role in extending the life of LBMA/COMEX gold and silver manipulation complex.

Without these products, severe physical shortages would occur in both the London OTC market and the COMEX futures exchange with more frequency and severity which would result in bullion banks being placed under severe financial pressure to keep the price of gold and silver tightly controlled, similar to the episode which took place on 23 and 24 March 2020.


Thus, in the absence of synthetic gold and silver products, the current price of gold and silver would mostly likely be substantially higher than contemporary levels.

Risks associated with Synthetic Gold and Silver Products

Given the importance of these products in facilitating the manipulation complex, it is little wonder that the benefits of these synthetic products are heavily promoted by product creators and product issuers, with little discussion of the potential risks and pitfalls.

While there are obvious security risks associated with owning physical gold and silver, there are significant risks associated with owning synthetic gold and silver products which many market participants have either not considered or mitigated for.


These risks include:

  • over issuance risk - the involved counterparty (bullion dealer, bullion bank, ETFs) does not, either deliberately or by accident, have the requisite gold or silver consistent with the funds invested in the synthetic product;


  • convertibility risk - the involved counterparty is not able or is unwilling to convert the synthetic product into physical gold and silver upon request (where convertibility is a feature of the synthetic product);

  • rehypothecation risk - meaning that multiple synthetic gold and silver products are sold to multiple individuals which are tied to the same underlying physical gold or silver bar or coin;

  • counterfeit risk - the involved counterparty uses ‘salted’ gold and silver (i.e. bars and coins which actually are counterfeit gold and silver) or gold and silver which is not up to the requisite purity.


These risks may appear to be theoretical or academic, but recent media reports and market commentary suggest otherwise.

For example, as noted in my recent article: Will COVID-19 collapse gold and silver price manipulation, it was documented how HSBC lost $US 200 million in a single day of trading in late March 2020 via market participants standing for delivery using COMEX EFP futures contracts given that HSBC did not possess the requisite physical gold to meet contractual delivery demands.


Moreover, significant concerns abound throughout both the gold and silver markets regarding the risk of rehypothecation, whether it be:

  • via market leading ETFs such as GLD and SLV (as discussed in a recent interview[6] between Chris Marcus of Arcadia Economics and Dave Kranzler of Investment Research Dynamics); or

  • gold leasing as recently noted by independent market analyst Ted Butler[7] of Butler Research.

English Goldsmiths and Synthetic Gold

Synthetic versions of gold and silver are, from a historical perspective, nothing new given that they have been prevalent since the rise of the English goldsmiths of the 17th century.


During this period, English goldsmiths would routinely issue ‘gold certificates’ which were tradable certificates redeemable in physical gold. These certificates were effectively warehouse receipts acknowledging rights to a certain number of gold coins, collectable on demand by the bearer of the note.


These certificates were a convenient instrument because they eliminated the need for individuals to visit the goldsmiths every time anything was purchased.


Over time, as the volume of gold certificates increased in circulation and usage, the number of deposits and withdrawals with the goldsmiths began to decrease. This, as a consequence, led to goldsmiths lending a significant portion of their gold reserves, coupled with gold certificates, at a market rate of interest which resulted in goldsmiths:


  • generating a lucrative source of income given that no income streams can be generated from idle gold;


  • only holding a fraction of the gold relative to the total volume of redeemable gold via gold certificates (i.e. a system of fractional reserve lending);


  • increasing the total supply of ‘certificate gold’ (or paper gold) thus causing England’s total money supply to increase (i.e. inflation); and

  • offering gold depositors reduced service charges for safeguarding their physical gold[8].

Some historical estimates[9] suggest that English goldsmiths held only 20% of their physical gold holdings as redeemable reserves to back-up issued gold certificates (i.e. 80% of the physical gold was lent out), thus the total money supply was 1.8 times larger than the amount of gold deposited with the goldsmiths.

This early version of factional reserve lending was only possible if public confidence could be maintained in the gold certificates being redeemable. Confidence in this system was routinely tested throughout modern English history via a series of common problems which plagued gold and silver certificates such as:

  • the double printing of certificates;

  • purposeful over-issuance;

  • forgeries;

  • bad administration; and

  • failure to destroy replaced certificates.

As noted throughout this article, some of these problems have continued to manifest themselves throughout global gold and silver markets up to the current day.

Conclusion

For individuals and other legal entities who wish to obtain exposure to gold or silver, a multitude of domestic and international options are available through either:

  • direct ownership of physical gold and silver;

  • share equity ownership of gold or silver mining companies; or

  • ownership of synthetic gold and silver products.

For unsophisticated market participants, synthetic gold and silver products appear, at least on the surface, to be an attractive option given that these products:

  • typically incur lower transactions fees;

  • avoid the logistical and security challenges as well as cost burdens from directly owning and storing physical gold and silver;

  • appear to carry an equivalent or even lower risk profile than direct ownership of physical gold and silver bullion.

However, for those market participants who:

  • are aware that the internationally recognised price of gold and silver is heavily manipulated; and

  • have exposure to gold or silver through synthetic products

are performing a significant disservice to their own financial interests and to the broader gold and silver market by extending the life of the current LBMA/COMEX manipulation complex.


If all owners of synthetic gold and silver products around the world were to:

  • liquidate their positions in these products; and

  • directly acquire physical gold and silver bullion,

extreme shortages would immediately manifest in both the global wholesale and retail bullion markets which, if the 1968 collapse of the London Gold Pool is any experience, would place uncontrollable pressure that would likely result in the collapse of the LBMA/COMEX manipulation complex.


In such a circumstance, those who have obtained an exposure to gold and silver in order to protect their purchasing power would instantly benefit from one of the largest transfers of wealth in human history.


John Adams is the Chief Economist for As Good As Gold Australia


(John Adams does not own any synthetic gold and silver products. Moreover, As Good As Gold Australia (AGAGA) does not promote or trade in synthetic gold and silver products. Rather, it does trade in real physical gold and silver bullion).

[1] Share equity ownership into gold and silver mining companies is excluded from this list given that share equity ownership is ownership of a business, not actual ownership of physical gold and silver. [2] https://www.adamseconomics.com/post/the-undeniable-manipulation-of-the-silver-market [3] https://www.adamseconomics.com/post/covid-19-exposes-gold-and-silver-price-manipulation [4] https://www.adamseconomics.com/post/will-covid-19-collapse-gold-and-silver-price-manipulation [5] https://www.sprottmoney.com/Blog/real-gold-vs-pretend-gold-craig-hemke-14-012020.html [6] https://www.youtube.com/watch?time_continue=1&v=xypLFprs9FQ&feature=emb_logo [7] See Butler’s article of 4 June 2020 entitled ‘The return of precious metals leasing’ https://silverseek.com/article/return-precious-metals-leasing [8] Thomas, L., (2006), ‘Money, Banking and Financial Markets’, South Western, Thomson, USA [9] Gwartney, J., Stroup, R., Sobel, R., and Macpherson, D., (2015), “Economics: Private and Public Choice”, (15th Edition), Cengage Learning, Connecticut, USA

2,090 views1 comment

© John Adams Economics 2020. All Rights Reserved.