As indicated by the frequent negative silver forward rates ("SIFO") reported by the London Bullion Market Association during the first quarter of 2009, silver prices were often in backwardation during this time frame. However, monthly average daily clearing turnover of silver on the LBMA for the first half of 2009 hovered around 100 million ounces/day, in line with prior months and well below past highs. The failure of backwardation to produce a noticeable bump up in turnover suggests: (1) little silver was available to be sold at spot and repurchased in the forward market; and/or (2) most holders of real metal viewed the trade as too risky, i.e., questioned the ability of potential counterparties to make good on future physical deliveries.

Drunk on Liquidity; Starved for Metal. The weight of gold and silver represented by derivatives on the precious metals has grown so large relative to all reasonable measures of physical supply that more and more questions and doubts are being raised about not only the integrity of the price discovery mechanisms for these metals, primarily among LBMA members and on the COMEX, but also the reliability of many paper claims to the physical delivery of them.

Among the numerous commentaries in this regard, two are notable for raising the specter of massive injections of clandestine physical gold into the market.

In an otherwise sober and informative analysis of gold turnover on the LBMA, one respected analyst has resurrected the story of Yamashita's gold because, as he puts it, "the gold market doesn’t make sense...the numbers don’t add up." P. Mylchreest, Goldmarket - accident waiting to happen or crime scene? Don't shoot the messenger, Thunder Road Report (Oct. 15, 2009).

He argues that figures on the volumes of gold traded on the LBMA cannot be reconciled with his estimates of the amount of gold held in "London Good Delivery" form, concluding that: (1) the massive OTC gold trade, which operates on a fractional reserve basis, is so overextended as to be "an accident waiting to happen" such that "the gold price could SOAR at any time;" or (2) if the story of Yamashita's gold is true, "particularly heavy volumes of this gold may have been laundered into the London market during 1986-90 and the mid/late 1990s," in which case "the continued evolution of the gold bull market could be more protracted."

Trying to solve the same puzzle, another analyst has looked not to General Yamashita ("The Tiger of Malaya") but to the alleged manufacture and distribution of over 16,000 metric tonnes of high quality counterfeit 400-ounce bank bars made of tungsten with a heavy gold plating. R. Kirby, On Doing God's Work, Financial Sense (Nov. 12, 2009). Half of these bars were allegedly shipped to Fort Knox "and remain there to this day." The remainder were "allegedly 'sold' into the international market," where some 60 metric tonnes are said to have recently surfaced in a scam uncovered by Chinese authorities.

This story is easy to dismiss for lack of verifiable evidence or any other independent confirmation, but like the story of Yamashita's gold, is not inconsistent with other known facts and observations about the gold market in recent years. See, e.g., FOFOA, Is the Dollar "Good as Tungsten"?, The Silver Bear Cafe (Nov. 2009). And in at least one respect, Mr. Kirby is correct: the best fake gold bars are made largely from tungsten, which has a similar density to gold. See, e.g., M. Hewitt, Tungsten as a Gold Substitute, DollarDaze (Nov. 11, 2009); Tungsten Alloy for Gold Substitution, China Tungsten Online (Xiamen) Manu. & Sales Corp.

Of course, speculation about the amount and quality U.S. gold reserves is only possible because of the complete lack of any independent third party audit, not to mention the novel accounting classification -- "Deep Storage Gold" -- adopted by the U.S. Mint in 2001 for the vast bulk of this hoard. See Status Report of U.S. Treasury-Owned Gold, which states: "Deep-Storage gold is the portion of the U.S. government-owned Gold Bullion Reserve that the U.S. Mint secures in sealed vaults, which are examined annually by the Department of Treasury's Office of the Inspector General."

A Canada Mint. Fresh from the country that produced the Bre-X scandal comes another reminder of the need for effective controls and independent audits in the gold space, this time straight from the Royal Canadian Mint in Ottawa where 17,500 ounces of gold went missing in 2008.

While not a large amount, the discrepancy produced a major investigation, including: a criminal investigation by the RCMP, which found no evidence of fraud or theft; comprehensive security reviews by The Banks Group and Microsoft Services -- Premier Support; a technical/engineering review by IBI Group/Giffels Associates Limited; and further accounting reviews by Deloitte & Touche, LLP, which had discovered the problem in the first place. See Precious Metals Reconciliation Report, Royal Canadian Mint (Dec. 14, 2009).

As it turned out, a combination of operating and accounting errors accounted for the shortfall, and the lessons learned from "the comprehensive reviews conducted by external third parties" resulted in a number of improvements to the Mint's practices and procedures, including appointment of a new Precious Metals Controller.

As a commercial Crown Corporation, the Royal Canadian Mint -- one of the largest in the world -- operates gold and silver refineries, stores precious metals for Canadian and international customers, and produces precious metals products for the investment community. Its prompt, comprehensive and open response, including online publication of the several reports from external third parties, served not only to blunt political criticism but also, and more importantly, to maintain the trust and confidence of its customers.

Trust but Verify. Questions taking the "A is to B as C is to D" format are reportedly falling out of favor in academia. But here's one anyway: the Royal Canadian Mint is to the U.S. Treasury as Central Fund of Canada (CEF) is to (pick one): (a) Newmont Mining (NEM), (b) GoldMoney, or (c) SPDR Gold Shares (GLD), which currently claims to hold over 1100 metric tonnes of gold in trust. See RKL, Musings on the Realms of GLD (10/15/2007). If you picked (c) the chances are that your gold investments are reasonably sound unless, perhaps, you place unwarranted confidence in official pronouncements from Washington.

Judges, particularly in the Supreme Court and on other appellate benches, regularly pose hypothetical questions to lawyers appearing before them to test the validity of their arguments when extended to future cases. So here's one: If credible evidence were forthcoming to support Mr. Kirby's tale of fake gold bars, what would be the likely effects on the gold market, not to mention on the credibility of the U.S. government?

Resort to Yamashita's gold or fake gold bars is not necessary to explain why the gold and silver markets do not appear to make sense; OTC derivatives by themselves can do that. But the very volume of these derivatives in comparison to annual new production and known physical supplies is precisely why now more than ever investors must pay close attention to the accounts of entities holding their gold and silver investments, including where possible periodic physical inspections and testing. See, e.g., J. Crawshaw, Einhorn Sells Gold ETF, Buys Physical Gold, Moneynews (July 29, 2009); Morgan Stanley to settle class-action lawsuit, Reuters (June 12, 2007), and comments thereon by T. Butler, Money for Nothing, SilverSeek.com (Oct. 23, 2007).

There's no run like a bank run and no rush like a gold rush, but both together on a worldwide scale would be as unprecedented as the current global fiat monetary system. We have the latter, and the figures on OTC gold and silver derivatives warn that its denouement may well arrive with the former. In that event, when the smoke clears, the financial crisis of 2008 will be seen as a premonitory tremor and Watergate as a mere bagatelle.

Reginald H. Howe, partner in Golden Sextant Advisors and litigator in the first gold price-fixing case, Howe vs. Bank for International Settlements, has just analyzed the latest precious metals derivatives report from the BIS and finds that they exploded in the six months ending last June 30. The gold and silver derivatives, Howe remarks, have lost any relation to possible gold production and again raise the question of whether real metal can be delivered against the claims that have been sold.

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