Credibility of the U.S. Bullion Depositary and Gold PricingCommodities / Gold and Silver 2013 Jan 02, 2013 - 10:12 AM GMT
In the classic 1964 movie Goldfinger, James Bond tries to prevent the main villain, Auric Goldfinger, from detonating a dirty nuclear bomb inside Fort Knox. While in Fort Knox, Bond says:
Well, if you explode it [the bomb] in Fort Knox, the... the entire gold supply of the United States would be radioactive for... fifty-seven years.
Goldfinger is only a work of fiction. Fort Knox wasn't under the threat of a nuclear explosion (then again, who knows?). Nonetheless, it has been argued that it wouldn't really make difference if the gold in the fort were radioactive - nobody has seen much of it since the 1950s. On December 4 and December 12, 2012 in our two-part story on gold and the U.S. dollar, we highlighted two possibilities: the dollar collapses, gold goes up like crazy or the dollar doesn't collapse, gold still appreciates. In those commentaries, we analyzed the possibilities of gold appreciating and tied possible price levels with a number of factors, for instance with U.S. gold reserves as presented on the chart below.
On December 4, 2012, we wrote the following:
This chart presents the (...)relation of U.S. debt to Treasury gold reserves - the amount of debt per one ounce of gold - up to 2012. The red line represents U.S. Treasury gold reserves in metric tonnes, while the yellow line denotes the amount of U.S. debt in dollars per ounce of gold. The debt per ounce has visibly increased since 1971, accelerating around 2000 and even more around 2008. In 2012, there were $61,796.11 of debt per one ounce of gold owned by the U.S. government.
Now, if a new gold standard is introduced and the agreement works like the Bretton Woods system, the dollar (or whatever other currency) would be tied to gold. As noted earlier in this essay, at the introduction of the Bretton Woods agreement in 1944 the debt coverage for the U.S. stood at 10.9% (or $319.90 of debt per one troy ounce of gold). If the new system were based on similar assumptions with debt coverage at 10%, this would imply a fixed price of $6,179.61 per ounce of gold ($6,179.61 per ounce of gold divided by $61,796.11 of debt per one ounce of gold gives us coverage of 10%).
Since the publication of this essay, we have received a particularly interesting question about the assumptions we used:
Dear Mr. Radomski
Your December 4, 2012 article (...) is exceeding well-written and researched, and I gained a lot of knowledge from reading it. However there is one potential problem I see in all the logic you are applying to the current situation. It seems to me you are assuming the USA actually has gold at Fort Knox and West Point. But there is mounting, but unproven evidence, both places have no gold in them at all, and are rather storage places for nerve gas. (...)An audit of the US gold holdings has been demanded by some for years, but the government will not allow it. The gold belongs to the American people, so why won't they let us see it? Many think it is because it is no longer there. If that is indeed the case, do we not face a "financial Armageddon?" Thanks for reading this and any response you might have. (I am not a conspiracy freak!) (...)
We always appreciate our readers' feedback and would like to thank for it here. We also appreciate spot-on questions and see this particular one as intriguing, to say the least. Which brings us back to Fort Knox.
At first it may sound shocking, but the last audit of gold stored in Fort Knox took place in 1953. No typo here, 1953, just after U.S. President Dwight Eisenhower took office. Even though it is the last audit up to date, it can't be described as satisfying. No outside experts were allowed and the audit team tested only about 5% of gold hoarded in the fort. So, there hasn't been a comprehensive audit of Fort Knox in at least 60 (!!!) years. This is at least surprising, given the fact that large entities listed on stock exchanges are usually required to undergo an outside audit at least once a year. Of course, the U.S. Bullion Depository is no conventional company. Nonetheless, not auditing it independently for more than half of the century raises questions such as the one posted above.
This is no new topic. One of the first written accounts questioning the amount of gold really stored in Fort Knox appeared in 1974 in a tabloid, the National Tattler. An unnamed informant claimed that there was no gold left in Fort Knox. The sensational nature of the story, and of the newspaper, wouldn't perhaps contribute to the credibility of the account but it was later revealed that the informant, Louise Auchincloss Boyer, secretary to Nelson Rockefeller, had fallen out of the window of her New York apartment and died three days after the publication in the Tattler. The tragic incident resulted in controversies over the possibility that the U.S. Bullion Depositary may have misstated the actual amount of gold held in Fort Knox. Congressman John R. Rarick demanded a Congressional investigation and, on September 23, 1974 six Congressmen, one Senator and the press were allowed to enter Fort Knox to see for themselves if the gold was there or not.
The tour showed that there was gold in Fort Knox but, all the same, it sparked even more controversies. Only a fraction of the gold reserves were available to see. A photo of one Congressman published by Associated Press suggested that gold bars held in the fort may have been less heavy than would be usually expected.
Quite obviously, this has resulted in even more doubt about the fineness of gold in Fort Knox. None of these doubts have been put aside by any of the audits carried out since 1974. When the reserves were audited, the amount of the gold examined was fractional and there has been no comprehensive bar count and weighting. The same goes for assaying - if a fraction of gold bars were examined at all, then a fraction of this fraction were assayed. The methods used in the assaying process were not conventional. Usually, during an assay, gold bars are examined by means of drilling, which is called the core boring method. But the bars in Fort Knox were examined merely by cutting of small chips of the metal from their surface. This method only proved that the outer layer of the bars examined was made of gold.
This difference in assaying methods is important if you consider that counterfeit "gold bars" have been showing up in New York recently and that fake gold bars turned up in LBMA Approved Vaults in Hong Kong. All these bars had one common characteristic: they were made of tungsten, which has similar density as gold, and covered with a gold veneer. The problem here is that such bars can go undetected if they are examined with X-ray fluorescence scans or by means of simply scraping of a bit of the metal from the surface. So, to properly assess the fineness of gold bars in Fort Knox, a full core boring method should be employed.
In 2012, the German federal court ordered that the German central bank, Bundesbank, conduct an audit of German gold reserves stored abroad, particularly in the U.S., U.K. and in France. The German authorities have never before conducted a comprehensive audit of their foreign gold reserves and the last time they were able to see their gold stored in the New York Federal Reserve vaults was supposedly in 1979/80. The Bundesbank has expressed that it doesn't doubt the trustworthiness of the U.S. authorities but demands stricter control over its gold reserves. Because of that 150 tons of gold will be shipped from the U.S. to Germany to assess the fineness of the bars.
All of this shows that the measures applied by the U.S. government to gold storage in Fort Knox and the Federal Reserve Bank of New York's vaults are questionable and that this fact may have been recognized by German authorities. It's hardly conceivable that there is no gold left in Fort Knox or the New York vaults. On the other hand, the lack of a comprehensive audit of either facility is unnerving. So are other irregularities associated with Fort Knox: missing shipments, audits acknowledging the existence of gold based on seals that were not broken, not on the actual count and examination of bars and so on.
Of course, a full audit of Fort Knox wouldn't be an easy task because of the sheer amount of gold to be examined. But it's feasible. The U.S. Mint estimated the cost of such an audit to stand at $60 million. The Treasury came up with a lower estimate - $15 million. Even if we take the higher value, and compare it to the value of gold stored in Fort Knox (as of December 31, 2012, $240.8 billion) it adds up to about 0.02% of these reserves. In this light the Treasury cannot really claim that this is too expensive.
So, what does all of this mean for the analysis we presented in our essay on gold and the dollar collapse? In short words, not much. Our price target for gold is to be treated as a general indication of where gold might go if the dollar collapses. If the value of the greenback is reduced to paper, we would expect gold to appreciate, but not exactly to $6,179.61. It could appreciate to $5,000 or to $10,000 (in today's dollars). Nobody really knows that. The point is that if doubts about the amount of gold stored in Fort Knox are just that - unproven doubts - gold could be a lot more expensive (in dollar terms) than it is today. If, however, there's any substance in these doubts and gold reserves in Fort Knox are lower than officially reported, gold could go even higher, and the price of $6,000 per ounce of gold could be viewed as the lower bound of where it might go.
The bottom line is that if the dollar collapses and the gold reported to be in Fort Knox is really there, gold could appreciate very strongly. If the dollar crashes and Fort Knox is (partially) empty, gold could go sky-high (in dollar terms).
For more information on how to structure your gold and silver portfolio to deal with both the possibility of the dollar collapsing and the possibility that it will endure in spite of the current U.S. debt levels, please consult our essay on gold and silver portfolio. For information on why we use past gold tops as reference points, check our essay on the 1980 top in gold.
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Thank you for reading.
Przemyslaw Radomski, CFA
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