Submitted by cpowell on 01:36PM ET Monday, May 10, 2010. Section: >http://www.cpmgroup.com/free_library1/HEDGING/Bullion_Banking_Explained_...

The document is titled "Bullion Banking Explained" from which I derived the title of this article. While explaining what bullion bankers do, this document makes it clear why owners of unallocated metal accounts are being cheated and why the price of gold and silver have been suppressed for so long.

A critical comment from the document is the following:

"The way in which banks monetize their gold and silver positions, using them as collateral for subsequent trades, is integral to understanding what has been driving gold and silver prices over the past several years."

That is absolutely correct, and it drove prices down from 1980 to 2001 and has suppressed their price rise since then, and we will shortly see why.

The CPM document goes on to state:

"With the start of the London Bullion Market Association's release of monthly trading data, the market has become aware that 100 times more gold and silver trade hands each year, just in the major markets, than is produced or used. Some market participants have wondered aloud how 10 billion ounces of gold could trade via the major markets each year, compared to 120 million ounces of total supply and demand, while roughly 100 billion ounces of silver change hands, compared to around 628 million ounces of new supply."

I am one of those market participants who have been "wondering aloud." In fact I "wondered aloud" on March 25 this year, when I made comments at the U.S. Commodity Futures Trading Commission that the London Bullion Market Association's OTC gold market operates on a fractional-reserve basis and that the major bullion banks that operate in that market have sold more gold and silver than they could possibly deliver. I called it a Ponzi scheme. I pointed out to the hearing the significance with respect to position limits on the New York Commodities Exchange that the large shorts were not hedging real metal in London but just paper bullion.

Testifying after I made my comments, Christian agreed with me and added information that it is a misnomer to refer to the London market as a "physical" market because it is largely a paper market where the bullion banks sell 100 times more bullion than they actually have.

You can read more about this here:

This means that the bullion banks operate a fractional-reserve scam. The CPM Group document describes this as follows:

"This article may help to clarify the complex world of commodity banking, in which gold, silver, and other commodities are treated as assets, collateralized, and traded against. When we explain these processes to clients, we often refer to the same mechanics as they are applied to deposits, loans, and assets by commercial banks in U.S. dollars and other currencies. Banks treat their metal deposits in much the same way as they do deposits denominated in money, as the reserve asset against which they lend additional money to borrowers."

I think it will come as a surprise to many investors who hold unallocated accounts in bullion that their investments are no safer than the fiat currency system against which they are seeking to protect themselves.

The CPM Group document explains on a rudimentary basis how bullion banks use investors' bullion to conduct business for their own account and revealing the scam in more detail:

"Imagine, if you will, that the bank can line up three or more producers and others who want to borrow this gold. All of a sudden, that 1 ounce of gold is now involved in half a dozen transactions. The physical volume involved has not changed, but the turnover has multiplied. This is the basic building block of bullion banking. This admittedly rudimentary outline of bullion banking holds the key to understanding how bullion banking allows for a multiple of trades to be based on one lot of metal. Many banks use factor loadings of five to 10 for their gold and silver, meaning that they will loan or sell five to 10 times as much metal as they have either purchased or committed to buy. One dealer we know uses a leverage factor of 40. (Long-Term Capital Management had a leverage factor of 100 when it nearly collapsed in 1998.)"

It is interesting that the CPM Group document cites Long-Term Capital Management. This was something that helped prompt the foundation of the Gold Anti-Trust Action Committee, because it was speculated that LTCM was short around 400 tonnes of gold and that this short position was the main reason the Federal Reserve orchestrated the LTCM bailout. Soon after that the Bank of England announced that it was selling approximately 400 tonnes of gold. This was a surreptitious bullion bank bailout and demonstrates clearly what a dangerous game the bullion banks are playing.

"A bank does not even have to be buying gold at a particular time to be able to use it as collateral against which it can trade, sell forward, and lend gold. If a bank has gold held in an unallocated account, or a forward purchase on its books committing a producer to sell it gold later, it can use these gold assets as collateral for additional gold trades."

As an investor in an unallocated account, that is all you need to know to understand that your investment is not safe. CPM Group has warned you that your investment is put at risk for the gain of the bullion bank. If an investor takes a risk he at least should be eligible for the gains won by that risk. Instead the bullion banks give the impression that the investor in unallocated gold is "holding metal" while the banks are selling it or loaning it many times over.

The CPM Group document then climaxes with a real peach:

"In the second quarter of 1998, one of our mining clients had a forward sale on its books which was coming due at an unattractive price. This was a silver trade, with a forward sale locked in at $5 coming due when silver was trading at $6 per ounce. In fairness to the producer, its bank had forced it to sell forward, forcing it to use forwards instead of more efficient options positions, as part of the terms of a revolving credit facility the bank had extended the producer. On our advice the producer rolled the position forward and sold that month's silver output at the higher $6 spot price. The chief financial officer of the mining company asked us why the bank, which had a $1-per-ounce profit on the position, would allow them to roll the position forward. The explanation is that having a silver position on its books at $6 per ounce provides the bank silver assets that it can collateralize many times over, which is worth a lot more to a bank than $1 per ounce in one-time profits."

I don't think it could be much clearer. Creation and selling metal that does not exist is a phony supply, but when the market treats it as indistinguishable from metal in the vault, the effect is to suppress prices.

The CPM Group document concludes:

"A major bullion dealer at one of the most active bullion banks in the world made a comment to me in early 1998 that succinctly put in context what one's approach should be toward those comments about how bullion banks and monetary authorities were colluding to drive the price down. The banker said, 'Do these people have any idea whatsoever how gold is traded?' The answer is no."

Of course I would disagree. At GATA we understand very well how gold is traded and how paper gold is sold to those who will accept it and physical bullion is sold only to those who will not.

In a recent essay Christian defended "fractional reserve" operations in the bullion market by saying of GATA:

"They then went on to rail against fractional-reserve banking, implying that it was the root of all evil. They seemed to ignore that fractional reserve banking has made modern life possible, and has been around since at least the time of Christ."

Fractional reserve banking has made modern life possible?

Mr. Christian, you have to be kidding me. What fractional-reserve banking has made possible is all modern financial crises, including the current one.

Fractional-reserve operations, and particularly ones where the customer is not fully aware that he is invested in one, are accidents waiting to happen. The following account of the collapse of Johnson Matthey bullion bank in 1984, written by Randy Strauss of Centennial Precious Metals in Denver, helps to bring this into focus: