The Beer Economy

 Posted by at 5:01 pm  Gold Standard
Nov 272015
 

Proponents of a Gold Standard look forward to the day when people use gold and silver coins as money but it seems that beer and spirits have a head start. This article sheds light on hundreds of secret Facebook groups in Australia where people barter goods and services for alcohol in various forms, with one group claiming 50,000 members.

Australia had an early history with an alcohol based barter economy, with rum as the medium of exchange from 1793 onwards due to a shortage of coins in the colony. The New South Wales Corps established a monopoly on the importation of rum and profited from its trade. The appointment of William Bligh (known for the mutiny on the Bounty) as governor of the colony and his outlawing of the rum trade resulted in the Rum Rebellion of 1808, “the only successful armed takeover of government in Australian history”.

While gold has been coined and used as money for over 2,500 years, with the World Gold Council noting that “gold coins were first struck on the order of King Croesus of Lydia … around 550 BC”, it appears that beer pre-dates that by thousands of years, with historians speculating “that prehistoric nomads may have made beer from grain & water before learning to make bread”.

Gold’s advantage is the uniformity in the unit of measure whereas with alcohol based units one would have difficultly converting between a 6-pack of light beer, full strength, or spirits of various proof/percentage.

With tax authorities considering barter transactions as assessable for income tax purposes, for the less honest beer does offer the advantage that the evidence of one’s tax avoidance is easily (and pleasurably) disposed of. However you may get caught out when audited if you have zero credit card expenditures on alcohol while still showing sizable beer belly.

Another strike against the precious metals is the case of Holland and Belgium, who it seems, “won their independence from the Spanish because of beer. They financed their armies from beer tax, while the Spanish relied on tax on silver. The beer won.”

The problem with beer based bartering is that one may never end up saving one’s profit given the temptation to consume one’s hoard after a hard day’s work. Maybe beer based money is the solution to the perceived problem of a lack of inflation and falling monetary velocity where people seem to be hoarding cash and not spending it?

Maybe there is a role for gold and silver after all – for saving – leaving with beer for bartering and spirits for spending.

Nov 262015
 

Today the Perth Mint and Australian Securities Exchange (ASX), one of the world’s top-10 listed exchange groups measured by market capitalisation, announced that they would be collaborating on developing new exchange traded precious metals products.

The first product is mostly likely to be a gold futures contract deliverable in Perth. Given the focus the gold community has on futures markets, and Comex in particular, I’m sure there will be a lot of interest is this Aussie gold contract. As we are in the process of talking to the market about what features they would like, it is not possible to get into contract specifications at this time but I can make some general comments about the approach ASX and Perth Mint will be taking.

Firstly, the Perth Mint’s role will be solely on supporting the physical delivery part of the contract – we are not issuing the contract or market making on it. ASX will list the contract and market it to their customers in Australia and Asia and traders worldwide.

While this contract will trade 24 hours a day on ASX’s globally connected network, given Australia is the second largest gold producer in the world and that the Perth Mint refines between 300 to 400 tonnes per year, we are sure that there will be a lot of interest in this contract from the physical traders in the Asian region.

The integrated nature of the Mint’s operations also means that unlike other futures contracts, which only offer warehousing, we will be able to offer shorts and longs flexible physical delivery choices that take advantage of the Mint’s refining and manufacturing capabilities.

The Perth Mint’s Western Australian government guarantee will also give comfort to longs who want to stand for physical delivery and store gold with us. In addition, the fact that ASX backs its clearing with its own capital (which is not something all exchanges offer) will reduce counterparty and systemic risk.

The combination of the Perth Mint’s strength in the physical market and ASX’s vertical integration of trading, clearing and settlement will introduce some real competition into the gold futures space. For more information see the official media release here.

Nov 252015
 

The idea that the US Mint has a legal obligation to mint and issue bullion coins in quantities sufficient to meet public demand is one that I have seen mentioned every time the US Mint puts its bullion coins on allocation. While originally true, it is no longer the case.

Until recently I had accepted the US Mint had this legal requirement, as when I was discussing Ted Butler’s theory that JP Morgan “is exploiting a loophole in the law that requires the Mint to produce to whatever the demand might be”. However, I was prompted to have a closer look at the law when reading the recent open letter by Bix Weir to the US Mint, available at SilverSeek.com Another Smoking Gun: US Silver Eagle Allocation Conspiracy (Pro Tip: it helps your credibility if you address a letter to the right person – Edmond Moy resigned as Director of the US Mint in 2011, as a quick Wikipedia check would have confirmed).

United States Code Title 31 Chapter 51 Sec. 5112 says in Subsec. (e) and (i) that “the Secretary shall mint and issue … in qualities and quantities that the Secretary determines are sufficient to meet public demand” (my emphasis). It appears that these subsections were amended by the Coin Modernization, Oversight, and Continuity Act of 2010 in December 2010 replacing the non-discretionary word “quantities” with “qualities and quantities that the Secretary of the Treasury determines are”, which in my opinion gives the Secretary discretion on how many coins to make to meet demand. As it is difficult to forecast demand for a product driven by volatile precious metal prices this would mean that shortages would occur when demand spikes.

While Bix argues that the revised wording has no ambiguity and “there are no provisions in the law for the Treasury Secretary to stop sales or ration silver coins. The ONLY determinate of the Secretary in the law is that he MUST supply sufficient coins to meet public demand”, it would seem that the amendment was specifically made in response to the cancellation of the 2009 Proof Silver Eagle to give the US Mint the ability to strike proof versions of bullion coins “even if full demand for the bullion version of the coin remained unmet” (see this article for more details).

Additionally, the concept of “demand” only makes sense in respect of a time period. The fact that there is no time period mentioned in the law would mean that those proposing that the US Mint must never stop sales or ration are saying that the US Mint has to supply as and when demanded, that is, on a day to day basis. This leads to the absurd position that the US Mint would have to hold tens of millions of coins in stock, as it is possible that on any day there could be such an amount of orders placed. Indeed, this probably wouldn’t even be enough as it is impossible to know what may be demand on any day thus there is no level of stock would guarantee to protect the US Mint from breaking the law.

I would argue that the fact that the law makes no reference to a time period would mean that any court asked to rule on this wording would apply the standard that would apply to a privately run business. Privately run business do not spend massive amounts of money on building production capacity to meet temporary spikes that would otherwise sit idle, as that is uneconomic and would lead to the eventual bankruptcy of the business (see here for an explanation of these issues). Therefore I think it is likely that a court would come up with the more commercially sensible interpretation that the US Mint is required to make coins to meet the Secretary’s (and thus their) reasonable forecasts of demand.

The fact that the US Mint did ration coin sales prior to the amendment would imply that it had legal advice along these lines that it was not obligated to stockpile massive quantities of coin blanks or finished coins to cover any possible level of demand. With the amended wording it would seem that position is probably even safer.


As a side note, I noticed the following clause in Sec. 5116 (my emphasis) “With the approval of the President, the Secretary of the Treasury may — buy and sell gold in the way, in amounts, at rates, and on conditions the Secretary considers most advantageous to the public interest. How to determine what is in the “public interest”? Possibly Federal Reserve International Finance Discussion Paper #582 from 1997 will be (has been?) considered, which determined that “there is a gain in total welfare” if the US Government sold all of its gold immediately with the following winners and losers (in billions of 1997 dollars):

  • Government Revenue +$342b
  • Depletion Users +$49b
  • Service Users +$149b
  • Private Aboveground Stock Owners -$102b
  • Mine Owners -$70

Oh well, if it is for the greater good …

Nov 142015
 

The Perth Mint recently released its 2015 Annual Report. This article discusses the Mint’s financial results with a focus on those areas where conventional financial analysis would fail due to the unique aspects of a the Mint’s business model. Below is a summary of the Perth Mint’s financial results (figures in thousands of Australian dollars) – the full report can be downloaded from our Annual Report webpage.

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Some general comments on the figures:

  • Financial Year – Australia works on a 30 June financial year end.
  • Sales Revenue – this figure excludes loco swaps and other payments for metal by way of metal account credits, that is, it only includes transactions involving cash (the volume of metal we process inclusive of loco swaps is around $15 billion). It includes metal purchased back – for example, if we sold $100 worth of metal and bought back $50 worth, we would record the $150 worth of transactions as “sales”.
  • Trading Profit – Sale Revenue less cost good sold.
  • Tax – this is calculated at the Federal corporate tax rate of 30% that would apply if the Mint was a company. As a Statutory Authority, the Mint does not pay Federal tax and instead the tax equivalent is paid to the West Australian government.
  • Current Assets – the majority of this is the Mint’s precious metal that backs its Depository client holdings. Note that Allocated holdings are not recorded on the Mint’s balance sheet
  • Current Liabilities – the majority of this is the unallocated and pool allocated liabilities to Depository clients.
  • Shares – this represents the paid in capital of the Mint’s owner – the West Australian government.
  • Cash – this includes money held with the Mint by Perth Mint Depository customers, which is usually much higher than the Mint’s own cash balances.
  • Financing Activities – the Government requires the Mint to be self-funding, so this only represents tax equivalent and dividends paid to the Government.

The Perth Mint’s profit before tax for the year ended 30 June 2015 was just under $20 million, down from a high of $40 million achieved three years ago. The chart below shows that, unsurprisingly, the Mint’s profits are related to precious metal prices.

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In 1999-2000 profits were boosted by sales of Sydney 2000 Olympic Coin Program numismatic coins and physical coin sales driven by Y2K fears of computer malfunctions. The 2009 financial year saw unprecedented investment volumes during the height of the global financial crisis.

To capitalise on the interest in precious metals as the bull market developed, the Mint invested in capital equipment (increasing annual expenditure from $4 million to $12 million post financial crisis) and expanded its Depository business and associated working inventory levels to allow its factories to operate more efficiently.

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As the the Mint is required to be self-funding while at the same time paying tax equivalent at the rate of 30% and then 75% of remaining profits as a dividend, its ability to expand capacity is restricted. The chart below shows how much of its profit the Mint retains (the payout policy was not in place in the 1990s). Theoretically the Mint should be paying out 30% + (70% x 75%) = 82.5% but it varies depending on the application of arcane tax law.

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This chart also demonstrates the difference a bull markets makes – the first eight years covers a somewhat stable precious metal price period during which the Perth Mint was being rejuvenated. The 1997-2005 covers a bear market and tentative bull market but the post 2005 period demonstrates the Mint’s potential envisaged by the architects of the Mint’s late-1980s modernisation.

Analysis of the Mint’s margins is made difficult by the fact that the products the Mint sells differ in gross margins dramatically in addition to the mix of products sold varying depending on precious metal prices. The chart below shows the Mint’s gross margin (trading profit / sales revenue) and profit margin (profit before tax / sales revenue) over time.

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Normally such declining margins would be a cause for concern but this merely reflects increasing volumes of low margin bullion coin and bar and Depository sales relative to high margin numismatic coin sales as the bull market developed from 2001 onwards. The Mint has actually increased numismatic coin volumes and profits but these figures get overwhelmed by high value bullion sales when working out aggregate margins.

The increased capital expenditures and precious metal inventory levels would normally raise concerns about the profitability or capital efficiency of a business. The chart below shows the Mint’s return on equity (profit before tax / equity) over the last couple of decades.

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Even after $90 million worth of capital expenditures over the past 10 years and holding $3 billion worth of working inventories, the Mint has exceeded a 15% return on equity. A key contributor to the Mint’s profitability comes from the unallocated balances of Perth Mint Depository clients, which is the major source of funding for the Mint’s working inventory. While the value of Perth Mint’s precious metal assets can be easily found in note 11 on page 27, the liability to Depository clients is note so clearly identified, merely being called “Current liabilities – precious metal borrowings” in note 21 on page 34 but the giveaway to its nature is the note that “These do not attract interest and are utilised in the consolidated entity’s operations”. Leasing from external parties in note 18 on page 33, which is clearly identified as interest bearing.

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As explained here, the Perth Mint’s unallocated is a win-win situation where the Mint has free funding for the precious metal it uses in its business while clients get 100% backed safe storage of their precious metal for free. The Mint also leases in precious metal from bullion banks to cover fluctuating operational requirements. The very small amount of metal the Mint owns is mostly related to pre-purchases of metal for numismatic coin programs where the selling price is fixed, otherwise the Mint has no exposure to changes in precious metal prices – this being borne by Depository clients or the lenders from whom the bullion banks have sourced metal.

The existence of this large funding source from Depository clients at zero interest rates does complicate traditional solvency risk assessment. For example, a classic Debt to Equity ratio for the Mint would result in a figure of over 25:1, as shown in the chart below.

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It is not coincidental that the Debt to Equity ratio above increases along with the increase in Depository client metal – as Depository clients buy unallocated gold the Mint buys physical gold and willingly increases its inventory as this gives its operational flexibility. The purpose of such a ratio is to highlight the risk to a company’s profits due to excessive interest expenses. However, with unallocated metal incurring no cost to the Mint, including such metal in the calculation hides the true risk. If one backs out the unallocated liability then the ratio averages 0.90.

Solvency metrics like the Current Ratio also get tripped up by the large value of unallocated metal, and particularly so for more aggressive ratios like the Acid Test, which ignore inventory on the assumption that it is not easily converted to cash without some loss of value. The chart below shows the conventional current ratio in blue and a revised ratio in green, which excludes the Mint’s precious metal assets and liabilities.

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The point of solvency ratios is to assess the ability of a company to meet its current obligations. However, as precious metal inventories are as good as cash in that they can be readily sold, one needs to remove the precious metal value (not cost of manufacture, which would be lost in a forced liquidation) from assets and the corresponding precious metal liability as these dominate the calculation – otherwise the ratio has no information value as it is basically 1, as the blue line shows. The green line thus gives a better representation of the Mint’s short term solvency.

While the Perth Mint is a profitable and financially conservative business on a standalone basis, ultimately our clients take comfort from the explicit Guarantee of the performance of the Mint’s obligations by the West Australian Government as enshrined in the Gold Corporation Act 1987.

Nov 092015
 

While FT Alphaville’s coverage of the Indian gold monetisation schemes started off with “why gold investing in and of itself is stoopid” they did note that

“people, especially in fledgling economies, are distrustful of sharing because they’re worried about payback. That kills trust, which consequently ensures capital isn’t put to productive use … there is also a real (and dare we say warranted) distrust of government and an historically deep-rooted inflation fear to take into account”

As Jayant Bhandari observed in his Precious Metals Investment Symposium presentation, India is a negative-yielding economy, with nominal yields on property and stocks below the 10 year government bond (even cows return -6% assuming zero labour costs). In such an environment, a zero-yielding asset like gold is better than a negative yielding asset.

The Indian government’s gold monetisation schemes, however, are more about addressing the symptom rather than the disease, which is the lack of trust in “payback”. Jayant says that high levels of corruption, superstition and irrationality in India “discourages accumulation of financial and intellectual capital”. But dealing with that, I guess, is a lot harder than trying to hoodwink “its population to take a leap of faith on the trust front”.

Why do I say hoodwink? Firstly, as I discussed in this post, the lending of any physical gold deposited in the schemes will have a one-off impact on throttling Indian gold imports. Secondly, as discussed in this post, the other uses the Government of India says it will make of the gold and the way it will run its Sovereign Gold Bonds Scheme mean that the government is simply going naked short gold in Rupees, as they themselves acknowledge in this press release:

“the risk of increase in gold price that will be borne by the government” and they “will not be hedged and all risks associated with gold price and currency will be borne by GoI”.

With that sort of risky behaviour from their own government, who really is stoopid – those holding physical gold or those trusting the government schemes?

Nov 052015
 

Last week I was in Sydney for the Precious Metals Investment Symposium. While the turnout was down on last year (surprising as the Australian gold price has been performing but I suppose people just look at the US price) the speaker turnout was excellent. For me the standouts were opening speaker John Butler, Keith Weiner and Jayant Bhandari. The presentations by Keith and Jayant were complimentary, with Keith covering his idea of yield purchasing power and how low interest rates were resulting in people eating their seed corn, and Jayant explaining why countries like India are so interested in gold (zero yield is better than negative yield), forecasting that the West is headed in the direction of negative yields/capital destruction.

On Monday night Mark from Gold Stackers roped me into helping him with the launch of the Back to the Future coins, which involved me putting on white coveralls and a wig to “act” as Doc Brown in a skit (emphasis on the double quotes around the word act). It was all good fun but thankfully I have not seen any pics of our attempt at acting circulating on the internet.

Tuesday night saw the Precious Metal Award Gala Dinner at which I was humbled to win the ‘Maggie’ Bullion Award, which is named in honour of an Australian coin dealer known for her exceptional focus on customers, who died unexpectedly last year.

Last night I recorded an interview with Dale Pinkert at FXStreet, covering a wide range of topics including:

  • bitcoin
  • personal vs third party storage
  • banning of gold in safety deposit boxes
  • manipulation
  • German repatriation
  • Chinese gold accumulation
  • price expectations for gold and silver

Towards the end I also discussed why gold has not responded to recent geopolitical and economic events, which is based on my view that everyone has a different level of trust in the politicians and central bankers to keep things under control.