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How Can the State Bank of India Pay Interest in Gold?

Monetary Metals's picture




 

by Keith Weiner

 

An article caught my eye this week. The Tirumala Tirupati Temple in India has deposited gold at the State Bank of India, and is getting paid interest on their deposit. There is something unique about this. The interest is paid in gold.

To understand why no one else is paying interest in gold, let’s first look at how one can use any asset class to make a dollar income: speculation. Buy something. Wait. Sell it at a higher price. You can use bonds, stocks, real estate, artwork, or classic Ferraris. By the way, no matter what you use, you are converting what had been someone else’s capital into your own income. This is capital destruction on a massive scale.

Using gold to produce a dollar income is simple. Just sell a covered call with a strike price a little higher than the current market price. You get paid a premium immediately. If the gold price does not rise, then you can repeat the trick and sell another call. If it does rise, you must sell the gold at the strike price. This earns you a profit, as it is above what you paid. Then just buy more gold and do it again.

If you keep your books in dollars, and trade for dollar gains, you don’t really care how much gold you have. You only care about how many dollars. If the gold price doubles, you may end up with about half the gold. But who cares, at least you’re making a steady stream of dollars that you can consume.

Making a gold income is something else.

You can’t just sell calls, or sell the gold itself. If you do, and the gold price rises, you will have to buy the gold back. However, the same dollars you have will get you less gold at the higher price. For example, you start with 100oz gold. Today the price is about $1,300 per ounce, and you sell a December call option. It has a strike price of $1,325 and you get paid immediately $25 per ounce or $2,500 for the contract.

Unfortunately—yes this is unfortunate as we shall see in a moment—the gold price jumps in September. It goes to $1,500 and holds steady there. In December, you deliver the gold and per your contract you are paid $1,325 per ounce. Now you have $1,325 × 100oz = $132,500 + the option premium of $2,500 = $135,000.

When you go to buy your gold back, you discover the catch. At the new price, you can only get $135,000 ÷ $1,500 = 90oz. Even after picking up almost two ounces worth of pennies in front of the steamroller, it still squeezed 10 ounces out of you. Your 100oz shrunk to 90oz.

Would you like to play again?

This is why the headline in the International Business Times caught my eye. The bank is paying 1% on the temple’s gold, in gold! It may not sound like a lot, but that means for every 100oz the temple deposits, it gets back 101oz next year. It does not face the risk of having its gold called away at the next crisis flare-up.

I wondered how the bank could pay this interest in gold. After all, if you can’t make a yield on your gold and the temple can’t make a yield on its gold, how can the State Bank of India make a yield on gold?

I asked some of my friends from India this question. I got two basic answers. One way they could do this is by selling the gold and investing the proceeds in a dollar denominated instrument that pays interest. The bank makes, say 4%, and pays the temple 1%. It sounds feasible, but there is a very basic catch. As we saw above, if the gold price rises, there is a loss in gold.

The temple’s account is denominated in gold. If the books are kept using gold as the unit of account—as they should be—then the dollars must be marked to market. This is a profoundly important but subtle point.

On gold books, if you hold gold, then there are no profits or losses. Only when you buy an asset such as the dollar (i.e. sell gold), do you start marking gains and losses on your books, whenever the dollar price changes.

Going back to our example, you begin with 100oz of gold. You buy 130,000USD, at the price of 23.93mg (a dollar price of 23.93mg gold is equivalent to a gold price of $1,300 per ounce). Now you have 100oz worth of dollars (it’s awkward, at first, to say that, but it’s perfectly valid).

Then the dollar price falls 13.3% to 20.74mg (i.e. the gold price rises to $1,500). You still own 130,000USD. Now it’s worth only 86.68oz. You have lost 13.32oz. This is bad enough for the investor, but it’s a much more serious problem for a bank.

A bank balance sheet has assets matched to liabilities. The liability is the gold deposit owed to the depositor, in this case 100oz. The asset is whatever the bank bought, in this case 130,000USD. Now, this sum of USD is only worth about 86oz. The bank has a very big problem. If this happened in enough accounts, it would be bankrupt.

I am not satisfied with the first answer. Several people told me that it’s just the risk the bank takes to do business. I disagree.

Lending money incurs risk. You hope the borrower will repay it. You do all of your diligence to verify that the borrower has the means and intent to repay. There is a chance that, despite this, he defaults. An analogy is that you have car insurance because no matter how carefully you drive, you may crash.

The falling dollar price is not a mere “risk”. It is a certainty. Just look at a graph over the past 100 years. In the analogy of driving a car, this is like driving over the cliff edge into the Grand Canyon. A collision is certain.

The second answer I got was less complicated and more sinister. The bank could be planning fraud, and not intending to ever repay the gold. They might get the government to declare that all gold deposits are redenominated in paper money.

I don’t know which of these two answers is correct. I hope they are both wrong, and there is something real backing their gold deposits. If you know something about this, I would love to hear from you.

The gold interest rate is a very important topic. The world is not yet prepared to grasp it. However, with each insolvency, quantitative easing, falling currency, bail-in, and the inevitable rise of the gold price, the tide is turning.

 

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Wed, 08/13/2014 - 12:42 | 5087760 Bluntly Put
Bluntly Put's picture

The gold interest rate is a very important topic. The world is not yet prepared to grasp it. However, with each insolvency, quantitative easing, falling currency, bail-in, and the inevitable rise of the gold price, the tide is turning.

Seems simple to me, with contango holders of large physical can lease their gold to the warehouses and the cost of storage is paid by contango. Once gold enters permanent backwardation, storage costs cannot be paid by the markets. At that point if you allow your gold to be leased, then you must pay for the re-hypothecation AND risk losing your metal in a run on the bank.

Or am I just confused?

Wed, 08/13/2014 - 12:13 | 5087611 SmittyinLA
SmittyinLA's picture

Works like this: the Temple "loans" the gold to the bank who uses it to get dollars to buy lead, lead secures oil, oil is then traded for dollars or gold.

Gold is a function of human labor plus o

 

 

 

 

Wed, 08/13/2014 - 12:24 | 5087657 strannick
strannick's picture

More obfuscating nonsense from the most assinine Monetary Metals.

It works like this.

1. Western bullion Banks need gold to suppress the price of gold.

2. By strong arming their lackey RBI to strong arm the temple into giving up its gold, they then use the Temple gold to pay out gold deliveries incurred by bullion banks.

3. The RBI then pays out the incremental ''interest'' gold to the temple from the temple's own gold.

4. When the shit storm ultimately does hit the fan, and there's no gold, well, thats the problem for another day.

Wed, 08/13/2014 - 13:23 | 5087909 Bastiat
Bastiat's picture

Maybe the Indian government gets some nice weapons or intel access.  The temples can be very nationalistic, so maybe they tell the temple it helps India vs the Paks.

Wed, 08/13/2014 - 11:58 | 5087529 lasvegaspersona
lasvegaspersona's picture

The real question here is WHY??? does the Bank of India need gold?

The Central Bank can print the curency of India. That is usually all that is needed. Buying gold is ALWAYS a currency manipulation.

In doing so the bank is essentially adding an asset to it's books and sending out more currency into the world. It should weaken the currency.

In our current system gold is usually a minor asset of a central bank, the Euro being the key exception where gold is it's #1 asset.

BORROWING gold is even more confusing. Central banks DO NOT NEED INCOME!!. They can print currency. Whatever theBank of India is doing it is not doing it to 'make more dollars'. One must wonder if it is trying to help the USA keep the dollar alive a few more tons.

Wed, 08/13/2014 - 17:30 | 5089243 PT
PT's picture

They couldn't stop gold from coming in the front door so now they just ship it all out the back door.  But why didn't they want it to come in the front door?

Wed, 08/13/2014 - 11:46 | 5087460 Jano
Jano's picture

Is IFM coing to get their cut?

COuld it be connected to the BRICS bank?

Wed, 08/13/2014 - 11:36 | 5087399 Seize Mars
Seize Mars's picture

Call option in one numeraire is the put option in its reciprocal

Wed, 08/13/2014 - 11:24 | 5087336 KansasCrude
KansasCrude's picture

My guess is the Temple has been central bank gold raped and the gold is already gone.  Anybody notice as soon as this "Deposit" was made the GOFO rates went positive....uh like the banksters have more hypothicated gold to deliver to the Chinese and suppress the market.  The Indian government has been the Cartels bitch for the last year + as please remember the import restrictions were put on after much arm twisting by the Western Central Banks.  Now this....what a surprise to learn they already have another +4700 tons on deposit. Anybody have an physical audit trail to follow here? 

This announcement has all the hallmarks of Central Bank theft and I would love to be shut up by a credible source saying the gold is there....uh the same gold that has been deposited. I am deeply suspicious.

Wed, 08/13/2014 - 11:21 | 5087314 eishund
eishund's picture

Sri Venkateswara Swamy is one very rich deity with some very stupid temple managers.

Wed, 08/13/2014 - 10:46 | 5087147 armageddon addahere
armageddon addahere's picture

Before 1913, every bank on the gold standard did this. They took in gold from depositors, and paid them interest. They lent the money to people or invested in productive businesses. The people paid the interest out of the money they earned from their work or business. The businesses paid out of the profits they made.

Interest rates were low (British Consols, a perpetual government bond at 2%, were considered a terrific investment, if you could get them) and productive businesses flourished.

Wed, 08/13/2014 - 10:20 | 5086991 laomei
laomei's picture

Simple shit here... if you want to do profits in gold, you take the bullion, craft it into anything that sells for a premium (jewelry, coins, etc) and bank the profits immediately to buy more gold.

Wed, 08/13/2014 - 10:15 | 5086867 fel.temp.reparatio
fel.temp.reparatio's picture

From the source article...

http://www.ibtimes.co.in/tirumala-tirupati-temple-deposits-1800-kg-gold-...

"Tirumala Tirupati Devasthanams (TTD) already has pure gold deposits of 4,335 kgs in State Bank of India (SBI), Corporation Bank and Indian Overseas Bank...TTD earns a collective annual interest of 70 kgs of gold on gold deposits in the aforementioned banks. In 2010, the TTD converted its interest on deposits into gold form and deposited in banks again."

This implies that the interest component (at approx. 1.6%) was paid as local currency... the principle is no different to having a foreign currency account, which is common in Asia/ME/Europe.

Wed, 08/13/2014 - 09:51 | 5086831 zenon
zenon's picture

The bank lends the gold out earning 1 year interest on gold loans (currently around 0.35%). So it is paying a 0.65% premium to that (not that high) plus whatever appreciation this 1% per annum gold actualy achieves. Say in a bad secanrio gold appreciates by 20% p.a. Then each year the bank is paying the 0.65% surcharge plus 20% of 1% or 0.2%. So all-in it looses 0.85% p.a.

Wed, 08/13/2014 - 09:51 | 5086826 slightlyskeptical
slightlyskeptical's picture

Or they could take whatever the interest is in currency terms and then buy the gold to pay the interest.

Wed, 08/13/2014 - 09:35 | 5086759 TweedleDeeDooDah
TweedleDeeDooDah's picture

I think that one has to consider Vedic prescriptions/writings/teachigs on what exactly is allowed, as a matter of religious law in terms of compound interest, principal of debt, and how much interest is allowed to collect on a debt, or in this case deposit.

A long time ago when I studied sanskrit, I remember reading some ancient holy scripture, quite incredulously, that said once the interest paid is twice the principle, the debt must be forgiven, or something along those lines. How a church deposit works, religious law, and ancient laws of India all work together in this case are certainly beyond me.

Wed, 08/13/2014 - 09:30 | 5086738 Fix-ItSilly
Fix-ItSilly's picture

The untold story is how do the Temple's followers feel about this?

Gold brings gold luck, is a sign of wealth and power, a holy item, The followers accumulated gold and gifted it to the Temple.

Misplacing gold brings misfortune.

The real issue here is what is going on at the Temple!

Wed, 08/13/2014 - 08:59 | 5086571 Badabing
Badabing's picture

Let me think...................
Deposit my gold in a bank...................
I think not!

Wed, 08/13/2014 - 08:45 | 5086506 PT
PT's picture

If smart people are running something at a loss then there is a good chance that it is a small part of something bigger.

Wed, 08/13/2014 - 08:34 | 5086465 PT
PT's picture

Aaaahh, now I get it.  Remember that the people working the gold mines are paid in fiat!  Free gold!  (For some.)

Wed, 08/13/2014 - 08:33 | 5086464 Fix-ItSilly
Fix-ItSilly's picture

Misguided column.  Mountain out of a molehill.  Bigger issue is the deposit of gold.  It is a liability to the bank that on its return dwarfs the payment of 1% interest (no matter the species of payment).

Since the Bank of India can print fiat money, the purchase of "gold" is costless to bank, but possibly not to society.

Wed, 08/13/2014 - 08:30 | 5086447 PT
PT's picture

Have any new freighter flights been scheduled from India to Germany?

Wed, 08/13/2014 - 08:28 | 5086439 PT
PT's picture

Can anyone get in on this deal or just The Tirumala Tirupati Temple?  How big is the Tirumala Tirupati Temple and how large is its gold holdings?  The less gold, the longer the scam can last, but this really does sound like a case of, "Well how else can we get our mitts on that gold?  Let's give them a reason to give it to us".  Or "Once we get the temple suckered in, the sheep will follow."  Remember, the early entrants to the Ponzi get rich!  It's the later entrants that cop it in the nuts.

Wed, 08/13/2014 - 12:05 | 5086805 Bastiat
Bastiat's picture

1% won't get you rich.  Fact is the temple is already rich.  1% does not justify the counter party  risk-the trade marks no sense on the face of it. There are side deals behind this.

 

Wed, 08/13/2014 - 17:25 | 5089182 PT
PT's picture

Okay, okay, I'll fix it for you:  "The first entrants to the Ponzi get a little bit of their money / gold back.  They have to, in order to encourage new entrants to join.  And there is a new depositor born every minute."

http://www.dilbert.com/1994-09-18/

 

Wed, 08/13/2014 - 08:00 | 5086371 dontgoforit
dontgoforit's picture

Interesting concept.  I wonder if BoA could swing it?  How much gold would they have to have on hand - and more importantly, how much would they have to have to cover their leveraged exposure?  Is there that much gold in the world?

Wed, 08/13/2014 - 08:15 | 5086408 Ban KKiller
Ban KKiller's picture

BofA couldn't find their crack whores without fifty pimps. The good news is they have fifty pimps per floor in San Francisco and NYC.

Wed, 08/13/2014 - 07:45 | 5086341 Rory_Breaker
Rory_Breaker's picture

If it sounds too good to be true, it most often is.

Wed, 08/13/2014 - 08:10 | 5086389 PT
PT's picture

That statement is 99% accurate and 99% useless.  It'll save you a bucketload and it will also guarantee that you miss 100% of all good opportunities.

Wed, 08/13/2014 - 10:49 | 5087168 armageddon addahere
armageddon addahere's picture

These days it should read, if it's too good to be true, the government and big financial interests want in on it.

Wed, 08/13/2014 - 07:34 | 5086316 Kina
Kina's picture

If somebody is paying interest in gold on a gold deposit....take your gold out and run.

Wed, 08/13/2014 - 07:21 | 5086280 SoDamnMad
SoDamnMad's picture

The bank won't lose on this. We just haven't figured out what fraud they will pull off.

This might be a test of their (GS) scam.

Wed, 08/13/2014 - 12:36 | 5087726 Anasteus
Anasteus's picture

Indian government desperate of traditional Indian's addiction wants to at least attract the people to get their beloved gold deposited in the banking system. They perhaps assume 1% interest in gold is attractive enough to lure the people into the scheme. The scheme itself is quite smart, if I'm getting interest in gold I have no incentives to withdraw my gold; after all, where else could I earn interest in gold and thus enlarge my real wealth? And that's the point... even if all gold suddenly disappeared.

The scheme would only work if the price of gold was steady/declining or, at worst, it's progress remained (remarkably) lower than profit from equivalent fiat amount from ordinary investment. In such a case buying additional gold to settle the 1% would be relatively easily covered from the profit. However, this assumption has a little to do with reality, so the Indian government/banks most likely rely on expected credulousness that allows to prolong the gold Ponzi for a while... until it's all seized or settled in fiat.

Hope Indian people are smart enough to dismiss this ’gold’ Ponzi idea immediately.

Wed, 08/13/2014 - 07:37 | 5086305 Cognitive Dissonance
Cognitive Dissonance's picture

The fraud is simple. The 'interest' paid is book entry 'Gold' interest, not physical Gold shipped to the depositor. But even if the depositor insists on receiving their 'interest' in physical Gold, all the bank needs to do is to send them some of their 'principal' and call it 'interest'.

At the extremely low rate of 'interest' the depositor is receiving, the bank only needs to set aside 10% of the 'deposit' for payment of 8+ years of 'interest'. The scam is as old as the hills.

This is after all a central bank. They have no intention of honoring their agreement if things go wrong. Force majeure bitches.

Wed, 08/13/2014 - 10:29 | 5087070 Sambo
Sambo's picture

State Bank of India is not the central bank, RBI - Reserve Bank of India- is....

of which Raghuram Rajan is the Governor...the same guy who told Alan Greenspan

that the Wall Street crooks are being paid to take more risks (aka gamble). The result

was the sub prime crisis. In India such crooks do not stay out of jail for too long.

Wed, 08/13/2014 - 08:12 | 5086383 PT
PT's picture

Just imagine that the Bank has no interest in making sure its depositors are made whole.  Let's say that all they care about is increasing demand for physical gold.

As long as the price of gold goes down, they can sell calls and buy more phyz.  Maybe the idea is simply to increase demand for phyz up to the point where the gold manipulators get caught with their pants down.

Same motive but a bit more sophisticated than "Crash JPM, Buy Silver"?

Wed, 08/13/2014 - 08:21 | 5086421 PT
PT's picture

In 70 years the temple can double its gold holdings.

Actually, coming to think of it, I'd say the gold won't be there five minutes after it has been deposited.  Desperate times, desperate measures, first they ban gold imports, now this.  If you can't stop the inflow, redirect the inflow to yourself.

Hotel India Bank California?  You can check it out but it can never leave?

Wed, 08/13/2014 - 12:28 | 5087685 Davalicious
Davalicious's picture
"How Can the State Bank of India Pay Interest in Gold?"

By robbing Gupta to pay Sanjid.

Wed, 08/13/2014 - 12:26 | 5087679 Citxmech
Citxmech's picture

That's what is sounds like to me.  Basically it would be a leasing scam designed to tie-up as much physical as possible.

If you don't hold it. . . 

Wed, 08/13/2014 - 12:55 | 5087802 Herd Redirectio...
Herd Redirection Committee's picture

Basically, you give up your principal, so that you can receive it back as interest.

Will the principal ever be seen again?  Unlikely.

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