Money Stuff: Leave the Gold in the Ground

Gold is shiny and can be made into jewelry. For this and other reasons it is valuable and has been used as money for millennia. First there were gold coins, and later there was paper money backed by gold. Even now, gold is an important reserve asset, and people hold it in their financial portfolios in the form of gold futures, gold exchange-traded funds, etc.

A lot of gold sits in vaults underground. If you buy gold reserves or futures or ETFs, you get entries in a database entitling you to some of that gold underground. [1] There is a whole financial system built on moving gold around in which the gold doesn’t actually move. The gold is heavy. Just the electronic database entries move. The gold sits there. Its shininess is abstract and potential; it is dark in the vaults.

Milton Friedman has a famous paper about this, comparing the gold in the vaults at the Federal Reserve Bank of New York to Yap money stones. On the island of Yap, in Micronesia, residents used large stone wheels as money. “A noteworthy feature of this stone currency,” wrote an anthropologist quoted by Friedman, “is that it is not necessary for its owner to reduce it to possession”: If I buy something for you for a big money stone, we don’t move the stone from my house to your house; we just agree that now it belongs to you. Same with the Fed, notes Friedman. There is an anecdote about a Yapese man who acquired a “remarkably large and exceedingly valuable stone, which was placed on a raft to be towed homeward.” The raft sank at sea, but everyone agreed that this did not affect the value or ownership of the stone: “The purchasing power of that stone remains, therefore, as valid as if it were leaning visibly against the side of the owner’s house.” 

We talk a lot around here about what I call “abstract commodity space,” the network of global warehouses that hold commodities to support futures trades. Financial market participants trade warehouse receipts — electronic records entitling them to some of the stuff in the warehouses — without necessarily moving anything inside the warehouses, or putting anything in or taking anything out. [2]  We talked once about some nickel that JPMorgan Chase & Co. owned in one of those warehouses, nickel that turned out, when kicked, to be bags of rocks. Until someone kicked it, it functioned perfectly well as (abstract) nickel: JPMorgan’s commodities trades were just as good as everyone else’s, even though the underlying nickel was actually rocks. 

There is a lot of gold in vaults underground, but there is also a lot of gold in gold mines underground. There are places on Earth with a lot of rocks that have gold in them, and with modern science you can make reasonably confident estimates of how much gold there is under your particular parcel. If gold is valuable, why is this gold still underground? Sometimes the answer is that no one knows it’s there; sometimes the answer is that it is under an active gold mine and they’re getting to it. But often the answer is that mining it is uneconomical: The gold is mixed with a lot of rock, and the cost of digging up all the rock and refining out the gold would be more than you’d get from selling the gold.

If you have a certain type of mind, or if you own a marginal gold mine, you might get to thinking that it is a bit wasteful — and environmentally destructive — to dig gold ore out of the ground, refine the ore into gold, form it into shiny bars of pure gold, and then stick it back underground so that people can trade electronic database entries entitling them to the gold. Why not leave it underground, skip all the other steps and just trade the database entries? If you own a gold mine, you can with reasonable confidence certify how much gold you have underground. That gold is there, in, uh, almost the same sense that the gold at the New York Fed is there. You could just go ahead and sell entitlements to it, without digging it up. 

NatBridge Resources Ltd. is a gold mining company listed on the Canadian Securities Exchange. From its public filings, it seems that NatBridge has acquired various rights to parcels of land that contain gold, but it has never mined any gold. NatBridge has a better idea:

NatBridge Resources Ltd. (“NatBridge” or the “Company”) (CSE: NATB | OTCID: NATBF | FSE: GI80) [last week] announced that it has reached an agreement with NatGold Digital Ltd. (“NatGold Digital”) to tokenize the subsurface mineral rights for Land Parcels 45 and 46 within the Cahuilla Gold Project in Imperial County, California, subject to successful completion of NatGold Digital’s due diligence, internal certification and title transfer. The transaction enables NatGold Digital to initiate its patent-pending digital mining process — the critical first step toward converting the project’s mineral resources into NatGold Tokens.

“Having spent decades in the global mining industry, including my work as Chief Innovation Officer at Barrick Gold, I’ve focused on how digital mining can offer a complementary alternative to traditional extraction—one that strengthens the industry while easing pressure on the environment. In this context, NatBridge’s work with NatGold Digital represents an important early step in applying these concepts, contributing to the natural evolution of how the sector may recognize and realize gold’s value,” said Michelle Ash, Executive Chair. …

“This agreement marks the first project we present to NatGold Digital for tokenization,” said Stephen Moses, Chief Executive Officer of NatBridge Resources Ltd. “It’s a key milestone toward our goal of transforming our technically compliant gold resources into tradable digital assets as a Premier NatGold Miner and creating liquidity and long-term value for shareholders.”

The theory seems to be that you get a technical report saying that your parcel contains gold — “Parcels 45 and 46 comprise approximately 12,290,139 tonnes containing an aggregate of 122,211 ounces of indicated gold resources, and 6,650 ounces of inferred gold resources at a 0.005 oz/ton cutoff grade” — and then you mint digital tokens representing that amount of gold.

And then you sell those tokens to, uh. To people who want digital tokens representing a certain amount of gold. Who are those people? I assume the answer is “crypto people.” We have talked a bunch about the funniest guy in crypto, James Howells, whose partner threw away a hard drive containing his private key to 8,000 Bitcoins. Howells is convinced that he knows the Welsh garbage dump where the hard drive ended up, and he wants to dig up the dump to find it, but the dump won’t let him. So he announced this summer that he was “planning to tokenize his legal ownership of the lost 8,000 BTC into a new Bitcoin Layer 2 smart token named Ceiniog Coin.” Of course he was! I wrote: “You could imagine people saying ‘well, Bitcoins at the bottom of a garbage dump aren’t worth as much as Bitcoins on the blockchain, but they are still Bitcoins, and if I can get them at 30 cents on the dollar that’s a good deal.’” The same analysis might apply to gold at the bottom of a gold mine.

That said, though, “people who want digital tokens representing a certain amount of gold” is, in the abstract, a huge market. Central banks that keep gold reserves at the Fed or the Bank of England, gold futures traders, investors in gold ETFs: They all spend many billions of dollars on digital tokens representing a certain amount of gold underground. The NatBridge tokens are just, you know, gold in a slightly different part of underground. [3]

A theme that I think a lot about these days is that modern finance creates layers of abstraction on top of real-world activity, and sometimes those abstractions become unmoored from the reality. [4]  A share of Apple Inc. stock encapsulates all of the labor and creativity that went into inventing the iPhone and manufacturing it and selling it and building app stores and everything else; all the factories and offices and decades of decisions are all reflected in the tradeable electronic token that is a share of stock. And you can just buy Apple shares on your phone without knowing about any of that stuff. The abstractions are so successful that you might lose sight of the underlying activity. The complex apparatus that links a share of Apple stock to all of its underlying reality is largely invisible, and sometimes people forget about it.

Similarly, gold is valuable in part because humans have valued shiny yellow jewelry for millennia, and in part because it is difficult and laborious to turn a parcel of rock into gold. [5]  When you trade an electronic token entitling you to some gold in a vault, the token encapsulates all of that labor and history. But maybe you don’t care; maybe you just want the token. Here’s a token.

If you borrow money at 8% interest, that’s fine. That’s a normal interest rate, maybe a little high but normal enough. SoftBank Group Corp. did an 8.25% subordinated bond last month. The average interest rate for US BB-rated bonds hit 8% in 2023. Eight percent is fine.

If you borrow money at 16% interest, that’s kind of alarming. If you borrow money at 16% people will think that you are in distress.

If you are in distress, though, nobody will lend you money at 8%. Maybe they will lend you money at 16%. You might be willing to pay 16% — you need the money — but you will not want everyone to know about it. If everyone knows that you are borrowing at 16%, then that might set off a bad spiral of lost confidence.

The obvious trade is: 

• You borrow $100 at 8% interest.
• You pay the lender $8 per year of interest (8%).
• You also give the lender a Christmas present of $8 each year. [6]
• The lender gets $16 per year (16%), but you get to say you only pay 8% of interest. The other $8 is a Christmas present. What?

Does this work? Short answer no, long answer eh maybe sometimes. Bloomberg’s Jackie Cai and Jin Wu report:

China’s cash-strapped local governments are caught in a bind.

The financing vehicles they’ve used for decades need to roll over a mountain of debt. Investors are demanding high interest rates, but openly offering them risks making future borrowings far more expensive.

To get around the dilemma, some of the local government financing vehicles, commonly known as LGFVs, are making extra undocumented payments to investors when selling bonds.

There is an example in which an issuer sells a one-year bond with a face amount of 100 yuan and an interest rate of 8%. The issuer sells the bond to a bank for 100 yuan, the bank sells the bond to a customer for 93 yuan (a 16% yield to maturity), and the issuer “reimburses” the bank 7 yuan “as a consultation fee,” perhaps “months after the sale.” Net, the bank has intermediated a trade at 93 yuan, the customer has bought a bond with a 16% yield, the issuer has paid 16% for money, but it gets to say that it is paying 8%.

This is frowned upon — it “would breach conduct rules governing debt pricing and sales incentives as laid down by [Hong Kong’s] Securities and Futures Commission” — but, you know. Sometimes banks do buy bonds at par and then resell them at a loss; bond underwriting can be a risky business. And sometimes banks do get consulting fees for, uh, consulting. It all sort of works separately; the question is whether it’s a coincidence that the bank is losing money on the bond trade and making the same amount of money on consulting.

The basic business of a big investment bank is that you have a collection of money services that you sell to clients, you get clients in the door by giving them some money service they desperately need right now, and once you have your hooks in them you start gently but firmly selling them all of your other money services. A startup is desperate for cash, you lend it money, you become its best friend, and years later you lead its lucrative initial public offering. A sleepy public company needs to refinance its bank debt, you lead the loan at tight margins, and years later you help sell the company in a lucrative merger mandate. You help a startup founder manage her personal finances, which gives you the inside track for the IPO, and then after the IPO there are a whole bunch of suddenly rich startup employees who are also looking for wealth management advice.

So we talk periodically about various banks launching or re-launching “One Bank” initiatives, telling bankers that they’ll be rewarded for cross-selling, etc.: This is the business, but bankers often resist it, because usually they get paid for selling their product, not their colleague’s products. A mergers-and-acquisitions banker might bring a corporate derivatives banker along to a client meeting, but she’ll roll her eyes during the derivatives pitch. But the bank wants the cross-selling.

Traditionally this is a matter of cross-selling: Banks use one sale to a client to open the door to other sales. In theory the trades could go in opposite directions: The bank could go to a bakery and say “need a loan?” and the bakery could say “sure, do you need cookies for your corporate cafeteria?” and there could be a mutually beneficial arrangement. Or the bank could go to the bakery first for the cookies, and once it has been onboarded to supply the cafeteria, the bank could go back and say “hey do you want financing to expand?” You hear less about this because:

1. Traditionally investment banks do not have a ton of inputs in their production process — just some bankers with phones and computers — so they are not dealing with that many suppliers, and
2. The people at the banks who are dealing with suppliers are not bankers: The person buying the cookies is the cafeteria manager, she is not a banker, and she is definitely not incentivized to cross-sell banking services.

But those things are just often true; they’re not laws of physics. A bank could ask its procurement teams to look out for M&A opportunities, and give them bonuses if they find any. Bloomberg’s Hannah Levitt reported last week:

At Morgan Stanley, which has grabbed the lead for tech IPOs so far this year but ranks third in overall investment-banking fees, executives have been leaning on its innovation team to make inroads that could ultimately lead to a revenue boost across its business. On its face, the group is charged with finding up-and-comers to sign on as vendors. But behind the scenes, the team has been giving the firm’s investment bankers and wealth advisers a foot in the door.

“We establish an initial relationship and then we try to expand it as much as possible,” Jed Finn, Morgan Stanley’s head of wealth management, said in an interview. “At some point there will be a need to access capital markets and advice. If we’ve been good partners for five, 10, 15 years, we’re going to get the benefit of that.”

In particular, the innovation team signed Morgan Stanley up as an OpenAI customer in 2022, before ChatGPT launched, which gave Morgan Stanley an inside line on, you know, the $10 trillion of financing that OpenAI has planned over the next few years. Plus it got to use the chatbot.

It is plausible that the stocks of Fannie Mae and Freddie Mac would be pretty uncorrelated to everything else. Most stocks go up on economic growth, good news, lower interest rates, etc., and Fannie and Freddie’s business — guaranteeing US mortgages — is obviously correlated to the economy, but their stocks are a different proposition. As we have discussed a few times around here, Fannie and Freddie are in receivership, and all of their profits for the foreseeable future belong to the US government, not to their shareholders. It is widely believe that this situation will change: At some point the government will return them to private hands, probably in a way that makes their existing common stock valuable again. In particular, the current director of the Federal Housing Finance Agency, Bill Pulte, seems interested in moving quickly to re-privatize Fannie and Freddie, and Bill Ackman, the Trump-friendly hedge fund manager, is a Fannie and Freddie shareholder who has been pushing for a resolution.

And so Fannie and Freddie’s stocks trade on factors like “has Donald Trump posted about them recently” or “is Bill Pulte falling out of favor with Trump” or “what do you think of Bill Ackman’s pickup lines,” weird politics-and-policy stuff that is unrelated to traditional economic factors and even other policy stuff. “Investors have occasionally been drawn to trades that involve government policy,” Bloomberg News wrote this month, citing the Fannie/Freddie trade, “in part because their outcome is independent of broader market movements.”

On the other hand, if you are the sort of investor who is drawn to a trade like “see what Bill Pulte is up to on social media,” you might be the sort of investor who is drawn to other trades that are, you know, particularly online. If you get a margin call on one of them, you might sell the others. It is possible that a trade driven by online social sentiment will be correlated with other trades driven by online social sentiment, even if they are otherwise unrelated. [7]

Or something like that seems to be Ackman’s theory. Bloomberg’s Georgie McKay reports:

[Last] Thursday’s wild selloffs [in Fannie and Freddie], and further losses Friday, were a reminder that the fervor of retail traders — whipped up in part by Federal Housing Finance Agency head Pulte — can quickly turn sour. Ackman, a billionaire hedge fund manager, sent out a social media post this week blaming forced liquidations and margin calls in the cryptocurrency market for the sagging prices on the mortgage giants.

“I underestimated how much exposure Fannie and Freddie (‘F2’) have to crypto, not on balance sheet, but in their shareholder bases,” Ackman said on X.

Ackman’s theory for the pullback — that leveraged cryptocurrency investors facing margin calls had to sell other assets to raise cash — was echoed by some on Wall Street who saw the stocks drop by more than 10% on Thursday. It happened as Bitcoin was on track for its worst monthly performance since a string of corporate collapses rocked the sector in 2022.

As crypto has gotten bigger and more integrated into the real financial system, people sometimes wonder: If there is a crypto crash, will that lead to contagion in the broader financial system? Will leveraged crypto players collapse, leading to forced selling of stocks or Treasury bonds? Will crypto collapses bring down banks or other traditional financial institutions, leading to restrictions in real-world credit? So far — even in 2022 — the answer has been “absolutely not”: The ties between crypto and traditional finance have been too small and too carefully managed to cause much contagion. And I think that an important but unstated goal of crypto advocates is to change that, to integrate crypto into traditional finance so thoroughly that it becomes too-big-to-fail and backed by an implicit government support.

For now, though, not much contagion. But it would be funny if the vector of contagion from crypto to traditional finance was the shares of Fannie and Freddie. On the one hand, they are idiosyncratic quasi-meme stocks. On the other hand they are multi-trillion-dollar institutions and the backbone of US mortgage financing. If crypto prices fall, will that make it harder to get a mortgage? Probably not, no, but there is a link.

But only for tax avoidance, don’t worry. Last week Rusty Foster wrote that “there is a ton of random junk included in the 20,000 pages of Epstein files released by the House in November,” and helpfully linked to a searchable archive. Naturally I searched. In 2014, before Money Stuff existed in its present form, I wrote a Bloomberg Opinion column titled “Texas Billionaire's Heirs Save Some Money on Taxes.” The gist was that a billionaire left an estate consisting in part of a 94% stake in an illiquid public company that he controlled, and, after his death but before the valuation date of the stock for estate tax purposes, his heirs’ charitable foundation sold chunk of stock that represented (1) a small fraction of their holdings but (2) a large multiple of the stock’s daily trading volume. This had the effect of pushing down the price and potentially saving the heirs billions of dollars taxes. I was amused and impressed, as I sometimes am by tax shenanigans.

Also amused and impressed, apparently, was a trusts and estates lawyer at Paul, Weiss, Rifkind, Wharton & Garrison LLP, who emailed my column to Jeffrey Epstein with the note “I thought of you when I read this article. Was this your idea?” I could not find any response from Epstein, so I don’t know if this was actually his scheme. But apparently it was his type of scheme; it was a scheme in which a top estate-tax lawyer recognized his style. 

In the early days of the Epstein scandal, one mystery that bothered me and a lot of other people was: Where did his money come from? A small collection of billionaires seemed happy to pay him hundreds of millions of dollars, but for what? Given the context, there were various wild theories, but as far as I can tell the answer was just that he was really good at saving them taxes. I once wrote, somewhat jokingly, that Epstein would find tax schemes and then “the fancy lawyers in the Paul Weiss tax department would say ‘wow ... this is amazing, why didn’t we think of this, this guy is a Michelangelo of tax minimization?’” Apparently that really happened!

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