JP Morgan's Fractional Gold Scheme Is Working

The real reason JP Morgan recently decided to open and operate a Comex gold vault is now in full view. A close friend of mine in the NYC hedge fund community informed me today that hedge funds are now buying gold from JP Morgan, who turns around and "safekeeps" it for them for 15 basis points (that's .15%) on the market value of the gold being stored. My friend referred to this as "allocated" gold. On the surface it looks like the smart money "gold rush" is on.

But, in the wisdom of Shakespeare via Macbeth: "nothing is but what is not." The "what is not" part of the above business transaction is the full, 100% allocation of the gold being purchased. In other words, just as those of us who understand how the game is being played - and have pointed this out explicitly with proof from the GLD prospectus and other examples - JP Morgan is employing the traditional Wall Street/banking business model of fractional gold ownership. This is not new, as Morgan Stanley was successfully prosecuted for this same scheme several years ago when the firm was exposed for selling physical silver to high net worth clients - and "safekeeping" it for a fee.  The scheme was exposed when a few of them demanded delivery and Morgan Stanley was unable to deliver the actual silver on a timely basis.  Please use google to find the case if you are curious about the details. Only those of us intimately involved in the precious metals market at the time even bothered to care about this case.

Here's how it works. JP Morgan sells Comex gold to hedge funds, who then opt to safekeep it at JP Morgan's Comex depository for a 15 basis point fee. It makes the purchase very simple, the "storage" inexpensive and enables the hedge fund to seemingly have possession of physical gold. But in reality all the hedge fund gains is a "security interest" - or paper documentation - in the gold rather than the actual gold. Here's why:  how many of those hedge funds will actually ever ask for delivery of the gold into a private depository or go visit the vault to make sure that the gold it purchased is physically sitting in a separate, allocated bin?  JP Morgan is "banking" on the fact that none of them will. This enables JP Morgan to make an electronic ledger entry and create an account statement showing the market value of the gold purchased, but it never has to actually produce the physical bars and deliver them. This dynamic permits JP Morgan to sell gold that the bank is never held accountable for. This is exactly the scheme Morgan Stanley used with their silver fraud on a much smaller scale, that GLD and SLV use and that the Comex and the LBMA bullion banks use for their futures/forwards business.

The best part of this is that JP Morgan is "storing" the gold for substantially less than the rate charged by the private depositories in Delaware, which generically charge 50 basis points (that's .5%) for the same service. On millions of dollars of market value, this 35 basis point differential is heavy incentive for these hedge funds to take JP Morgan up on this generous storage offer. I say "storing" the gold because really what JP Morgan is doing is creating a 15 basis point income stream for itself and the only risk the bank is taking is the risk that all of the customers don't ask to have the gold delivered off-Comex at the same time.  This is something that has never occurred since the Comex started trading gold futures in the mid-1970's.  But we'll see how "generous" this offer really is when the shit hits the fan and the real scramble to take possession of the physical metal begins.  JP Morgan also gets to use the money that these funds put up to "buy" the gold.

The real beauty of what JP Morgan is doing - from a market manipulation standpoint - is the removal of tens of millions of dollars of demand for real physical metal and diverting it into this fractional gold banking scheme in order to prevent/delay an inevitable market squeeze for physical gold.  GLD serves the same manipulative purpose. It also shields the Comex, and banks like JP Morgan, from facing the potential of defaulting on contract performance, which would likely happen if even less than half of the long side of the gold and silver market demanded the delivery of their gold/silver away from the Comex and into private, independent depositories like the ones in Delaware.  It's a good bet from this perspective because very little gold has actually been demanded to be delivered off-Comex since gold futures started trading in the mid-1970's.

Back when I first started doing this sector in 2001, it was only the hardest of the hard core goldbugs who preached that the only way to truly invest in gold is to buy the actual physical metal and keep it yourself (with all the necessary safeguards, of course). They won't even invest in mining stocks. As I've watched the landscape evolve over the last 10 years with developments like I describe above, I fully understand the significance of keeping your own metal.

Most of you probably don't remember, or even know at all, that David Einhorn, the proprietor of one of the bigger NYC hedge funds, had announced in July 2009 that his fund had sold all of its GLD stock and replaced it with physical gold that the fund was taking delivery of and was safekeeping in a private storage facility. At the time Einhorn's fund was the largest holder of GLD. It was clear to me at the time that Einhorn had finally read the GLD prospectus from front to back and probably nearly shit his pants when he realized the Ponzi scheme potential created by the SEC-approved document. I doubt any of the funds buying gold from JP Morgan will be as diligent...

My fund partner actually travelled to Delaware a couple of months ago to take inventory of the gold and silver owned by our fund and safekept with a private depository in Delaware. We know where our gold is - how about you?