We’ve had some recent discussions with our market technician partner at Eidetic Research in order to help us gauge the current situation in precious metals and other markets with an emphasis on silver given its notable recent behavior. While our own outlook will always remain our own, we are heavily influenced by Eidetic’s technical and market observations. The reason is simple: the analysis is more useful, apt and accurate than any other technical work out there. With the above understanding out of the way, we’ll paraphrase and embellish Eidetic’s views below. Our own supplemental and dissenting thoughts will be presented in separate market updates to follow.

According to Eidetic Research, there is not a huge amount of insight that can be gleaned from near-term gold or silver at the present time that the charts don’t already make rather obvious. Tellingly, a $41 area swing target for silver didn’t contribute much to the recent price action as the moon metal powered through the low 40’s range and is now within striking distance of the January 1980 all-time spot market high of $50-something. Last Monday’s top reversal from around $41.70 could have threatened the trend but a lack of follow through and then an upside reversal into Thursday with a new bull market high on Friday revealed just how strong this market is currently. Unsurprisingly, the price action to end last week has translated into aggressive buying of silver into early this week.

Importantly, the recent exuberant performance by silver has not undermined the market. Indeed, there are presently no specific nearby price levels below which silver would need to drop for there to be lasting technical damage. Overall, silver appears to be in an accelerated third wave of an even larger wave three — what Elliott wave theorists call a “third of a third” (i.e., Wave 3 within larger Wave III of the sequence that began in 2001).

Silver should continue to outperform gold until it no longer does — in other words, there is no nearby ratio of gold to silver that has technical significance. That said, there could always be a bounce in the ratio if silver hits a meaningful downdraft in the short term. Even with the technically overextended conditions, however, silver is telling us in the macro scheme of things that eventually it will narrow its ratio to gold to the 15-17 area (around where the 1980 top was made).

On its own merits, gold still looks good as well. The gold market has put behind it a huge amount of resistance in the 1420-1440 area during the range-bound price action from last November to March and this fact should support further gains. Turning short-term neutral to negative might be warranted if spot Comex gold were to close below 1410, thus returning prices to the November to March range.

A couple of thoughts by Eidetic Research on other markets: the Japanese yen blow-off the night of March 17 to 129.57 on Globex — about 77 in the cash JPYUSD — appears to have been a “major, major” turn. How major? Possibly reversing the multi-decade yen/dollar trend that has been ongoing since a 1950 cash high at 620 yen to the dollar! U.S. Treasury bonds still deserve a bearish outlook even though that view now has a lot of company. That market has an outside chance for one last neck snapping runup to the 126 area basis spot month Chicago T-Bond futures, but longer term, bonds likely have a date with destiny down in the 85 area — the level where they traded in 1987!

Now for something a bit more specific on silver that could potentially have immediate implications even if it tells more about the past than the future. The following chart represents a method to target price levels that Eidetic has used in the past to generate very long-term, high-probability market objectives. For example see the recent work on commodities and other markets. Below we see the method applied to the long-term chart for silver. The targets appear to line up with historical price activity quite well with the final “E” target at just under $45. And here we are at this very moment with silver at $44.50!

We’ll let Eidetic explain the above chart in words dating from 2007 (the above chart has since been updated but it was unnecessary to update most of the explanation):

The majority of technical analysts will agree that uptrends consist of 3 well defined advances.  In major bull moves we have observed that those advances are often comparatively related.  Our experience is that the size of the initial advance sets the standard for the subsequent 2 advances.  We have found that typically, when the initial advance is considered as a baseline of 1 then the second advance will reach to a level approximate to 1 and the final advance will reach a level that approximates 2.

In the above silver chart, we have drawn a major uptrend line (A) below the lows of  1971 and 1993.  Subsequent intermediate term lows in 1997 and 2001 were in the general area of that trend line, thus validating it.  We subsequently paralleled a line (B) from the 1974 high to define a long-term channel.  Notice how many intermediate term price highs and lows, both backward and forward in time,  occur in proximity to that mid-channel  line.  We infer that line as corroborating the channel.

As the ongoing uptrend from the 2001 low matured, it underwent an acceleration phase as prices cleared the top of the A-B channel.  Typically an upside channel exit accompanied by increased momentum will carry to a distance equal to the vertical height of the channel.  In this case, that potential was achieved when prices traded at $15.11 in May 2006.  Our interpretation is that $15.11 marked the top of the first advance in what is a long term uptrend series.  Therefore, in our view, the distance from line A to line C determines the baseline of the series (A –> C = 1).  Observe the classic pullback to line B following the 2006 high as well as the failure of price weakness to carry back within the A – B channel.

That was written in 2007. Eidetic Research then went on to say that the next expectation for upside potential in the silver market was in the area of Line D,  which is drawn parallel to the underlying A and C lines and at a distance from C equal to the height of the A-C channel.  (C –> D = 1).  That would put upside potential for the subsequent advancing phase in the $26 area with some consolidation around the halfway distance from line C to line D, which is around $21. This in fact appears to have been very close to target as well. Indeed, the last update on silver from Eidetic Research was made in early September 2010 as silver was staging for a move past this very level.

Eidetic Research finishes by pointing out that ultimately the third advancing stage of the current cycle should reach the area of line E, presently just under $45, which is drawn parallel to line D and at a distance equal to the height of the A – D channel (D –> E = 2).  Notice how, if line E is extended backward in time it crosses near the top of the 1980 blow off phase ($50.36 on this chart which features the inactive January 1980 COMEX futures versus the actual high of $41.50 basis the active front month March 1980 silver futures).

So what does this all mean? For one, that silver has achieved this week a very significant, long-term price objective even without having taken out its all-time-record-high nominal price. Silver could hesitate here or perhaps even pull back in deference to the technical pattern although it could just as well power through on its way to a level that defies all attempts at prognostication. There is certainly nothing at this point to suggest that silver in the longer term will find it hard to achieve further gains.

Disclaimer: This commentary is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any commodity, futures contract, or option contract. Although the statements of facts in this report have been obtained from and are based upon sources that are believed to be reliable, we do not guarantee their accuracy and any such information may be incomplete or condensed. We do not assume responsibility for typographical or clerical errors in this report. All opinions included in this report are as of the date of this report and are subject to change without notice. Employees of Eidetic Research and Metal Augmentor may hold positions in futures or cash markets that are either in accordance with, or contrary to, stated conclusions within this report.

Silver Market Technical Analysis
by Eidetic Research

Note: All charts in this technical analysis can be enlarged to full size by clicking on the chart.

The foundation of our technical approach to analyzing markets rests on three principles: pattern recognition, momentum conditions and wave analysis. Although our initial monthly chart above features wave annotation, we are presenting it more for perspective than wave interpretation. In this analysis we want to concentrate on momentum conditions but we will revisit the above chart in our concluding remarks. For now, our longer term perspective on silver is that the market completed a major down price cycle in November 2001 at a Comex nearby futures low of $4.0150. Since then new up cycle trend development has encountered heavy selling pressure around $20. Prices have backed down, sometimes aggressively from highs around $20 in March and July 2008, December 2009 and May 2010. Our August 21, 2010 silver market analysis discussed the potential for a near-term move up to the $21.20 area given the upside completion of a May-August 2010 triangle pattern (pictured here). The pattern did complete to the upside so we are expecting further gains from a current price at $19.90 as we write.

Our favorite gauge of price momentum conditions is the stochastic(s) oscillator but we also rely, albeit to a much lesser degree, on Wilder’s ADX indicator. For those unfamiliar with the indicator, it may be defined thus:

ADX attempts to measure the trending quality of a market . . . The indicator measures the strength of the trend, regardless of direction; the higher the value, the stronger the trend.

The indicator itself appears as a line that may move between values of 0 and 100 (see indicator on silver chart below). In the past we did a study of the reliability of the indicator (10-period and applied to Comex gold prices) and our conclusion is that as far as its application to weekly charts goes, it is a better gauge of trending power in up markets than it is in down markets. We also adhere to the view of other technical analysts that the indicator needs to be rising and above a threshold of 20 to confirm a sustained trend condition.

Pictured next below is a weekly silver continuation chart with a 10-period ADX in the sub graph. This chart is worthy of several interpretive comments. As you can see the ongoing uptrend cycle shows pattern repetition. Recurrence of patterns in a cycle is common and that condition is often seen across time frames which can range from intraday to monthly. High level continuation patterns, bounded by red overhead resistance lines, occurred in 2004-2005 and again in 2006-2007. Arguably the resistance line that we have drawn from the 2008 high also defines the upper boundary of an even larger pattern of similar appearance.

Note that in the 2005-2006 pattern the ADX indicator bottomed in May 2005 at a value of 11.4 (cyan box on indicator that has been extended up to the price chart). It did not cross above the 20 trending level (horizontal magenta line on indicator) until October (prices circled in yellow) and the price consolidation was not completed until November 2005. During the 2006-2007 pattern, the ADX indicator bottomed at a value of 8.9 in August 2007. The indicator cross above 20 occurred in November 2007, coincident with the completion of the price consolidation. Currently the ADX indicator turned up the week ending August 20, 2010 from a value of 7.9.

Our price data dates from January 1970 and the 7.9 ADX reading is the lowest in the entire series. From the previous behavior of the index, we draw two inferences. First, there’s a long way to go before the indicator crosses above the trending threshold at 20. That could mean prices will consolidate around the overhead red resistance line at about $19.70, not ruling out a significant pullback within the pattern similar to that in mid-2007. Or prices could forge ahead toward their $21.20 area target and thus be in new uptrend high ground before the ADX crosses 20. Second, the absolute low level from which the ADX has turned up suggests that potential uptrend development could be pronounced in its trending power – i.e. surprising in upside acceleration with corrections being less deep than traders expect.

Before we conclude, we would like to show one more chart since we think that it tends to corroborate the concluding sentence in the above paragraph. Below is a gold/silver ratio monthly chart. This is obviously a long-term chart where swings in the ratio are long to develop and mostly sustained. Following the February 1991 high at 98.9 the ratio declined to a March 1998 low at 46.5. Since then the ratio has been confined to a range that is bounded by two highs at 80.4 and 80.1 in 2003 and 2008, respectively, (overhead red line) and two intermediate-term lows at 46.5 in 1998 and 2006 (underlying green line). Ratio values are now declining and at about the middle of the range (63.7). Because of software limitations, we cannot show the monthly stochastic in this illustration but we would note that the indicator will make a monthly down cross in neutral territory given September closing values at current levels (i.e. Comex active nearby futures at $19.90 plus/minus). Given a downturn in the stochastic indicator, the intermediate-term bias would be for the gold/silver ratio to move lower. In that case, we would expect an intermediate-to-long-term downside move to the 46.5 area.

To finish our chart references, let’s return to our first chart above — that with Elliott wave annotations. In our opinion, if our illustrated wave scenario is correct — we have previously presented our rationalizations for it to Metal Augmentor subscribers — then the most significant point about the chart is the nature of the corrective swings that followed the May 2006 high at $15.11 (annotated point I). The increasing amplitude of the a-b-c labeled sequence established what is called an “irregular” flat that featured extension in the c-swing. In our opinion “irregulars” of that type in the number II wave position are rare and, in this instance, we think that price behavior signaled an environment in which the market will be continually subject to unexpected and pronounced price volatility.

In summary, weekly momentum conditions in the silver market suggest that its recent advance from below $18 to a high at $19.93 basis September Comex futures on September 3 could be the start of a sustained trending phase. That scenario would likely favor trend strength well above a near term target around the $21.20 level. Deteriorating momentum conditions in the gold/silver ratio, if further corroborated at the end of September, would also suggest that silver prices could improve, especially relative to gold. Since the ADX indicator has only recently turned up, however, there is time enough for silver prices to still be vulnerable to downside pressure in the near-term as the prevailing pattern from the 2008 high is completed in a fashion similar to patterns in 2005-2006 and 2006-2007.

Eidetic Research
September 3, 2010

This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any commodity, futures contract, or option contract. Although the statements of facts in this report have been obtained from and are based upon sources that are believed to be reliable, we do not guarantee their accuracy and any such information may be incomplete or condensed. We do not assume responsibility for typographical or clerical errors in this report. All opinions included in this report are as of the date of this report and are subject to change without notice. Employees of Eidetic Research may hold positions in futures or cash markets that are either in accordance with, or contrary to, stated conclusions within this report.

“If there was no question about the gold being there, you think they would be anxious to prove gold is there,” he said of the Federal Reserve.

This is not the first time the congressman has made his pitch. “In the early 1980s when I was on the gold commission, I asked them to recommend to the Congress that they audit the gold reserves – we had 17 members of the commission and 15 voted no to the audit,” said Paul. “I think there was only one decent audit done 50 years ago,” he said.

Paging Dr. Paul! Paging Dr. Paul! The U.S. gold reserves held at Ft. Knox and elsewhere are actually under the control of the U.S. Mint, a bureau of the U.S. Treasury Department, and these gold reserves are ALREADY being audited by the independent accounting firm KPMG. In fact, an annual audit has been ongoing for a number of years, first by inspectors of the U.S. Treasury Department since the 1980s (Treasury inspectors are sworn federal law enforcement personnel) with additional audits by independent accounting firms starting in the 1990s.

When KPMG was appointed independent auditors for the 2005 fiscal year, the accounting firm insisted on a revised audit format that involved a complete audit  included accompanying Treasury inspectors on the physical count of bullion in vault facilities at the Ft. Knox and West Point bullion depositories. Prior to this and despite Dr. Paul’s claim that the last audit was conducted in the 1950s, Treasury inspectors had conducted rotating audits of bullion held at the Ft. Knox, West Point and other depositories since the 1980s as part of a comprehensive overhaul of governmental accountability by the Office of the Management and Budget. These audits include test weighing and assays that have periodically revealed minor discrepancies in bullion fineness and weight over the years. Not all the bullion is counted each year, mind you, rather it is done on a rotating basis with Treasury seals being placed on each audited vault. The inspectors check at least on an annual basis that these seals have not been tampered with. According to my reckoning, all vaults should have been initially rotated through a few years ago, which means that the vaults now being inspected are already on their second or third audit pass.

I have written on this subject extensively in the past and will not rehash it. Instead, I will simply reprint below one of the more comprehensive analyses that I have done on the subject matter. Some of the stuff I wrote in this analysis was coincidental to the question of “missing” Ft. Knox gold but it does help frame the developments taking place in late 2006 and early 2007 that provided the most satisfactory answers to date. To my knowledge this is still the only complete analysis of the “Ft. Knox gold audit” based on actual research, reference to documents and (attempted) interviews with appropriate persons. Unfortunately, we never did get confirmation of KMPG’s physical presence at Ft. Knox subsequent to the 2005 audit despite several queries to Treasury officials.

Perhaps this latest “audit the Fed” activism by Dr. Ron Paul will finally result in some explanatory statements being made by the Treasury. In the meantime,  Dr. Paul can clearly use a bit of education on this subject so if any readers are so inclined, you have my permission to forward my analysis to him. And even if Dr. Paul decides that an independent audit by KPMG is simply not enough given the importance of the gold reserves, at least he’ll be aware of the presently-known facts before drafting the legislation. For example, an audit of the Ft. Knox gold should not focus on its physical presence in the vaults but rather on encumbrances that might have been placed on it.

The issue of encumbrances is complicated by the fact that the gold reserves are pledged to the Federal Reserve to back about $11 billion of Federal Reserve notes under a gold certificate account that still values the gold at the formal statutory price of $42.22 per ounce. Come to think of it, Dr. Paul might better serve his country by introducing legislation to repeal the gold certificate account and thereby return direct unencumbered ownership to the American people for the first time since 1933. That is something everybody should be able to get behind.

*******************

Independent Audit of U.S. Gold And Silver Reserves Confirmed

April 20, 2007
Tom Szabo
www.silveraxis.com

A few months ago, I got into a verbal shoving match with one Mr. Douglas Gnazzo regarding the audit of the U.S. Government-Owned Gold and Silver Bullion Reserves, or simply gold reserves, most of which are in the custody of the U.S. Mint (custodial gold and silver). After the debate spilled and spread all over the Internet, I decided to let Mr. Gnazzo have the last word because I could find no easy way to untangle the mess that he and I had made in the course of our disagreement. Well, I am happy to report today that I have found the solution and it turns out to be rather simple. A private third party audit firm has in fact conducted an independent audit of the gold reserves since 2005. More astonishingly, history will be made in 2007 as the audit firm, KPMG, is set to participate in the physical inventory of gold stored at Fort Knox.

The Background

Mr. Gnazzo made a claim last December that has turned out to be very important in retrospect. He said something to the effect that the U.S. Department of the Treasury’s Office of Inspector General (OIG) may have conducted an audit of the gold reserves in 2005, but the U.S. Mint’s own independent auditors, KPMG LLP, took no responsibility for auditing such gold reserves at all. And at the time, Mr. Gnazzo was absolutely correct. My own research had shown that KPMG issued an opinion on the Mint’s 2005 financial statements (or “audit report”) that read, in part:

“These financial statements are the responsibility of the Mint’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the United States’ gold and silver reserves (Custodial Gold and Silver Reserves) for which this Mint serves as custodian. These reserves were audited by to United States Department of the Treasury, Office of Inspector General (OIG) whose report has been - furnished to us, and our opinion, Insofar as It relates to these reserves, Is based solely on the report of the OIG.” [Original KPMG audit opinion on U.S. Mint's 2005 financial statements; emphasis mine]

I copied the above quote directly from the original 2005 audit report as it appeared on the Mint’s website on January 13, 2007. Unfortunately the report has since been deleted and is nowhere to be found. Perhaps somebody with a bit of foresight saved a copy on his or her hard drive and is willing to share? In any case, those who are curious about what the lost 2005 KPMG audit report looked like should examine the 2004 audit report prepared by a predecessor audit firm. My recollection is that the format and content of the 2004 and 2005 audit reports were very similar, which should come as no surprise since the first instinct of auditors is to follow a concept known as SALY, same as last year. I would note, however, that the 2004 audit opinion was worded differently compared to the above quote taken directly from the lost 2005 audit report.

In any case, the Mint had a valid reason for pulling the 2005 audit report from its website. You see, sometime between this past January and today, two new audit reports have been quietly posted at the OIG’s website. One is for the Mint’s 2005 fiscal year and replaces the audit report that has mysteriously disappeared from the Mint’s website. The other is for the year 2006 with comparative numbers for 2005.

The Confirmation

To my utter surprise, both the revised 2005 and the just-released 2006 audit reports include a clean audit opinion pursuant to which KPMG, not the OIG, has taken full responsibility for the audit of the gold reserves. Now you understand why the above background was important. But wait, it gets even more shocking. The gold reserves are now listed as assets of the Mint, comprising more than 90% of the balance sheet.

Clearly, 90% is a very material number and means that KPMG must have performed significant, unprecedented audit procedures related to the gold reserves, which now constitute a critical focus of the independent audit. Unfortunately, KPMG’s audit procedures have fallen short thus far of the holy grail of gold reserve audits: observing the physical inventory of gold bullion stored at Fort Knox. But according to a Treasury Dept. source, KPMG did observe the 2006 physical inventory at West Point, where more than 50 million ounces of gold (approximately 20% of the gold reserves) are said to be stored. And there is every reason to expect that 2007 will be the year when that most-troubling of questions for many gold bugs may finally be put to rest: does Fort Knox actually hold any gold? Regardless, nobody will be able to proclaim henceforth that an independent audit of U.S. gold reserves is not being performed. In fact, such whining is already two years past its “best used by” date. Any whining now will have to be limited to the quality of KPMG’s audit, whether or not the audit firm is truly independent, the competence of the audit staff and other alleged problems that no doubt will continue to pester the conscience of a paranoid few.

The independent audit reports can be found here:

2005 Audit Report: http://www.ustreas.gov/inspector-general/audit-reports/2007/oig07006.pdf

2006 Audit Report: http://www.ustreas.gov/inspector-general/audit-reports/2007/oig07022.pdf

Three Bonuses

As if the discovery of the independent audit reports weren’t enough, a careful reading of the fine print results in at least three additional revelations that I consider to be very enlightening.

FIRST, the definition of “Deep Storage” is now officially sanctioned by a major accounting firm. Basically, Deep Storage means gold and silver stored in sealed vaults as contrasted to gold and silver that is working stock for the Mint’s coin programs. Personally, I am very appreciative of KPMG’s endorsement of this definition of Deep Storage because now I won’t have to waste so much time attempting to refute wild speculation from the gold conspiracy camp. I can simply refer them to KPMG.

SECOND, we find out that the U.S. Mint started a silver hedging program in 2006 whereby a “trading partner” acquires an interest in that portion of the Mint’s silver held as raw material for the production of American Eagles and other coins. The hedged silver is automatically repurchased from the trading partner at prevailing spot prices as minted coins are sold, protecting the Mint from losses due to falling silver prices. Since title and custody remain with the Mint at all times, however, the only possible use the Mint’s trading partner would have for this silver is to hedge a derivative short position, likely in COMEX futures.

The disclosure of the Mint’s hedging program provides a rare purview into a realm that has long been the subject of conjecture. For my own part, I have claimed in the past that the practice of lending by silver users and forward selling by mining companies has supplied the commercials with the hedging ammunition to maintain a significant short position in COMEX silver. On the other hand, Mr. Ted Butler has alleged that the commercial shorts are naked; that is, there is no silver backing their positions at all. Based on how the Mint’s hedging program is described and without the benefit of reading the actual contract, I have to admit that Mr. Butler is partially right. You see, the Mint has already earmarked the hedged silver to be sold in future apportionments to authorized coin distributors. So unless the trading partner/COMEX short was given superior rights under the hedging contract, there is neither a contractual nor external means for it to take possession of any physical silver. Put another way, a commercial short would never be able to use this type of a hedge contract to make delivery of silver, even when a futures contract could be rolled to a later date. This is unlike a forward purchase from a mining company where the commercial short is entitled to physical silver. In fact, the sole purpose of the Mint’s hedge is price protection, meaning that it would not protect a trapped COMEX short against a delivery default. To Mr. Butler’s point, there is no physical backing to this type of silver and therefore its use to obtain a commercial trader designation on the COMEX, assuming that is possible, would create a short position that is naked against forced delivery.

At the same time, we need to realize that these almost naked shorts have nothing to worry about unless and until a supply squeeze in the spot market is accompanied by a lack of buying interest in futures (preventing the shorts from rolling their contracts to future months). According to Prof. Antal Fekete, such a situation might only occur during a melt-up of gold and silver prices to universally-recognized monetary status. As an aside (i.e., shameless plug), my own work on the basis in gold and silver futures is meant to provide an early warning sign of just such an event. In every other instance, however, the commercial shorts can be secure in the knowledge that their paper silver will protect them from taking a beating, regardless of how high silver prices may reach. In fact, the shorts probably welcome increasing prices since the accompanying volatility will add to their potential profits. After all, they are long on paper and thus never fully naked. So it turns out Mr. Butler isn’t entirely right, just in the event of a delivery default. In the meantime, the only thing that really matters is that commercial shorts will continue to rake in the profits.

THIRD, the disclosure of hedging activity involving a few million ounces of silver creates a strong precedent for KPMG to seek out and report other hedging, leasing or derivative transactions that might involve or impact the Mint’s balance sheet, now consisting predominantly of the gold reserves. While not a guarantee that the gold reserves are free of all encumbrances, the oversight by KPMG should help ensure that accountability for the gold reserves is moving in the right direction.

The Pesky Details

This is probably the point where I should end this commentary on account of it being a bit too much to absorb in one sitting. In the interest, however, of discouraging the hatching of new conspiracy theories, I’m now going to address the seven most likely questions still bugging the inquisitive, suspicious and skeptical. Everyone else can probably stop here without risking sleepless nights.

NUMBER ONE. Why was there a change in the audit approach with respect to the Mint’s financial statements after KPMG had already issued an audit report for 2005? The answer is actually quite simple. The Mint’s original financial statements for 2005 (and prior years) were prepared and audited under a set of accounting standards applicable to private-sector enterprises. One could speculate why this might have been the case but a reasonable guess would be that the Mint’s activities are more consistent with a for-profit, private enterprise than a government agency. In any case, sometime after KPMG had issued its original audit report for 2005 on a private-enterprise basis, somebody high up on the decision chain (a “decider”) must have had an epiphany: the U.S. Mint may function in some ways like a private company but it is, in fact, a government entity. More than likely, this decider was some managing partner at KPMG responsible for firmwide accounting policy. In any case, what’s important is the Mint’s financial statements had to be revised to comply with its charter as a government agency. Among other things such as budgetary disclosures, this meant that custodial gold and silver would now become the primary assets (and offsetting liabilities) in the financial statements instead of just disclosure items. As a result, KPMG could no longer simply defer to OIG’s audit given that the gold reserves now represented over 90% of the Mint’s balance sheet. To do so would break the world record for auditor recklessness.

An alternate explanation is that KPMG never actually issued the 2005 audit report previously listed on the Mint’s website; instead, the report might have been a draft that somehow was mistaken as a final product and posted by Mint personnel. This theory is supported by the possibility that the OIG website never had a copy of this original 2005 audit report. Furthermore, there are obvious formatting and grammatical mistakes (see quote above), which is quite uncharacteristic of the work of a Big 4 CPA firm such as KPMG.

NUMBER TWO. Assuming it was not just a draft mistaken for the final, what happened to the original KPMG audit report for 2005? Well, the auditing standards state that as long as an audit report has not been issued for a subsequent year, all copies of a superceded audit report for the current year should be returned to the auditor so that two competing versions of the same report are not in circulation. In the present case, one should expect vigorous efforts to stamp out any and all instances of KPMG’s original 2005 audit report. Unfortunately, this occurred before I could save a copy to my hard drive, but several exchanges with Mr. Gnazzo imply that my arguments were constructed based on the now-missing 2005 audit report. For example, consider the following two statements:

“But since these are not the Mint’s assets, KPMG is not required to look at the gold and silver when auditing the Mint’s financial statements.” [from Reply to Gold Reserve Audit 2005]

and

“The custodial reserves are in fact disclosed on the face of the Mint’s financial statements. Not as assets but rather what is called parenthetical disclosures. Still, the gold does technically fall under KPMG’s audit responsibility. As a result, KPMG is unlikely to have issued any type of opinion other than a disclaimer (’we are unable to express an opinion…’) without some assurance about these gold and silver reserves that are in the Mint’s custody. It sure looks like the only solution is the audit by the Treasury Dept.” [Excerpt from e-mail to Douglas Gnazzo on January 13, 2007].

With respect to these examples, I was obviously talking about a set of financial statements that did not include gold reserves as Mint assets but rather as disclosures for which KPMG had not taken any audit responsibility.

NUMBER THREE. If the new audit report for 2005 was issued on November 11, 2006, why did it take until now for it to show up? One possible explanation is that the OIG takes its sweet time to get audit reports released. Another one is that some administrative procedure created the delay. In any case, this phenomenon is not restricted to the audit of the Mint. For example, the Office of the Comptroller of the Currency’s 2006 audit report dated December 12, 2006 was released just before the Mint’s 2006 audit report dated December 21, 2006. On the other hand, the Mint’s website is still missing both the 2005 and 2006 audit reports as of today. It seems that some bureaucrats are slow to update websites, just like the rest of us.

NUMBER FOUR. How was KPMG able to audit the custodial gold and silver as of the fiscal year ended September 30, 2005 when clearly nobody at the time had anticipated that the gold reserves would have to be reported and audited as Mint assets? The only sensible answer I come up with is that KPMG did not actually observe any physical inventories during 2005. Rather, the audit firm apparently examined the OIG seals on the gold vaults at some later date, probably on or about September 30, 2006. This begs the question, what kind of audit did KPMG perform with respect to the gold reserves in 2005? Well, it would be quite difficult, but technically not impossible, to design a set of audit procedures as a substitute for being present during a physical inventory. I suppose the trick might be accomplished using an alternate audit program that includes procedures such as interviews with Mint police and OIG personnel, a thorough examination of all existing records including inventory documents and security logs, a direct confirmation of gold assays with the U.S. Assay Office (responsible for annual re-assays of a portion of gold reserves), conversations with auditors of the U.S. General Accounting Office (GAO) and who-knows-what-else.

Of particular note is the fact that the GAO reports directly to Congress and has an independent mandate, although seldom exercised, to oversee the audit of gold reserves. So if somebody wants to write a letter to Congress about gold reserve audits, he or she should start by asking Senators or Congressmen like Ron Paul to help make sure the GAO is exercising its authority in full. This is very important because the GAO apparently obtained a full list of the bullion bars held in the gold reserves during a co-audit with OIG in 1975. At a minimum, such list can and should be compared by the GAO to the bar list prepared during KPMG’s audit of the gold reserves. That would provide an additional layer of assurance, one that I suspect has not escaped KPMG itself.

After having performed the above audit procedures and then some, KPMG must still have stretched the auditing standards almost to the breaking point in order to issue a clean audit opinion on the gold reserves for 2005. Recall that KPMG never directly observed a physical inventory during that year and typically that would necessitate a disclaimer of opinion. That, however, is clearly not what KPMG issued for 2005 the second time around. I’m only speculating here, but what probably helped convince KPMG to issue a clean opinion is the robustness of the Treasury seals placed by the OIG on the gold vaults to prevent tampering. You’re probably thinking, those sure must be some very special tamper-proof seals! And you’re probably right. You might also be thinking that the OIG inspectors came across to KPMG as incorruptible, irreproachable officers of the law. Yet it was most likely KPMG’s presence during the 2006 physical inventory of gold held at West Point that would have provided the audit firm with the required level of confidence to issue a clean audit opinion on both 2005 and 2006. Obviously, KPMG must have been very impressed with the thoroughness and precision of the OIG and Mint staff’s physical inventory procedures. Last but not least, it is inconceivable that KPMG did not request and receive assurances from the Mint and the OIG that the audit firm will be able to take part in the physical inventory at Fort Knox in 2007.

The bottom line is that KPMG has indeed conducted an independent audit of the gold reserves, but such audit has so far not included direct observation of the physical inventory of the gold held at Fort Knox, the primary gold depository where more than 50% of the reserves are held. But don’t fret, that will have to happen in 2007 since otherwise the KPMG audits of 2005 and 2006 are frauds. Now you might still be left wondering why KPMG didn’t attend the physical inventory at Fort Knox in 2006. My guess, one that is as good as any other, is that the change in reporting that required KPMG to take primary responsibility for auditing the gold reserves likely occurred after the Fort Knox physical inventory for 2006 had already taken place, but before the one at West Point.

NUMBER FIVE. Why did the OIG discontinue issuing audit reports on custodial gold and silver after 2005 (see 2005 report here)? This question has already been answered for the most part: KPMG is now officially in charge of the custodial gold and silver audit. Yet if KPMG was also responsible for 2005 as its revised audit opinion now states, why did the OIG issue a separate 2005 audit report that was no longer necessary? This brings us back to the point that KPMG became responsible for the gold reserve audit only after the OIG had already issued its 2005 audit report. Another way to state this is that KPMG did not actually participate in the 2005 physical inventory conducted by the OIG but rather performed a combination of substitute audit procedures at a later date. The inescapable implication is that KPMG continues to place a certain degree of reliance on audits previously performed by the OIG. This should become less of an issue with the passage of time as it would be unimaginable for KPMG not to materially participate in future physical inventories, particularly at Fort Knox.

NUMBER SIX. Why did KPMG’s 2005 audit report not include comparative numbers for 2004 in contrast to the 2006 audit report that includes comparative numbers for 2005?  The reason provided in KPMG’s revised audit opinion for 2005 seems genuine but insufficient:

“As a result of the lack of comparability, the fiscal year 2004 financial statements have not been presented with the fiscal year 2005 financial statements.”

The missing piece of the equation seems to be that in 2004 the predecessor audit firm did not audit the gold reserves, which now comprise more than 90% of the balance sheet due to the retroactive adoption of different reporting standards. It was probably too much of a stretch for KPMG to go all the way back to 2004 using substitute audit procedures since many of the records to be examined and personnel to be interviewed would have been much more difficult to locate. Following this somewhat convoluted logic, the exclusion of comparative 2004 gold reserves from the 2005 audit report tends to indicate that whatever audit procedures KPMG did conduct with respect to 2005, they represented a substantial improvement over the audit procedures, if any, that may have been performed by the predecessor auditor in 2004 and years prior.

Bottom line, KPMG’s independent audits have not been ideal up to this point but they are leaps and bounds ahead of anything that has been done before. More importantly, everything is now in place for 2007 to mark the start of a new era in which the gold reserves of the U.S. are independently audited on an annual basis by an external audit firm that will for the first time in history observe the physical inventory of the bullion stored at Fort Knox. The time is short, enjoy your conspiracy theories while they last!

NUMBER SEVEN. Can we really expect that KPMG will be present for the physical inventory at Fort Knox in 2007 and beyond? Well, I must admit that we won’t know the answer with absolute certainty for a few more months, but based on the fact that KPMG has already been granted historic access to the fabled Gold Vaults in 2006, possibly by presidential order, in order to examine the OIG seals at fiscal year end, the precedent has been set. In fact, it would be shocking if KPMG was willing to accept such a major limitation on its audit scope. After all, gold reserves now represent the lion’s share of the Mint’s balance sheet and KPMG could be held accountable for damages reaching into the many billions of dollars should the gold prove not to be there. Facing such unimaginable risk, do you think KPMG is going to settle for anything less than full access or full disclosure? I’m thinking KPMG must have brought a lot of firepower and pressure to bear on the Mint and the OIG so that a proper independent audit can be performed, something that the predecessor audit firm was unable to do.

THANK YOU KPMG! THE END.

Copyright © 2007 silveraxis.com - All Rights Reserved.

Among Mr. Schectman’s not-very-extraordinary claims is that the apparent shortage of gold and silver bullion and the resulting premiums that arose during the financial crisis in 2008 were caused by extremely strong demand from panicked retail buyers. Mr. Schectman then warns us that we should expect more retail shortages in the future. We can’t really argue with his logic but we believe he is only telling half the story given that many dealers were in fact rationing their existing inventories as a result of low bullion prices. Simply put, the dealers were unwilling to sell the shelves bare at prices so terribly low.

While it is true that bullion dealers are running a business like everybody else, most of them are also gold (and/or silver) bugs and consequently have much of their wealth sunk into their business in the form of bullion inventory. That way when the eventual and inevitable price spike to $5,000 gold and $500 silver comes, they can sell it all and retire as billionaires. This might not be the case for the large corporation-style dealers or the tiny numismatic coin shop mom-ann-pops but there are a lot of dealers between those two extremes. Their inventories are typically not hedged or only slightly so. More to the point, these dealers are expecting the big score along the way and would only sell out at a loss under desperate circumstances.

So, what’s our point? That retail demand is only half the story: even without it, we’d see dealer inventories disappear during severe price declines. Consequently, we won’t share Mr. Schectman’s enthusiasm unless we see widespread, sustained retail shortages while gold and silver trade at record high prices. Call us crazy if you must, but so far the shortages during high prices have been regional or of very limited duration. And while logic dictates this will not always be the case, logic is not the same thing as reality.

One instance of reality is that the bull market peak in late 1979 and early 1980 brought a veritable flood of retail selling even while buying was at record levels as well. The retail selling was significant enough at times that many bullion products didn’t command a premium but rather sold at a discount. The highest bidder was often the refinery. With the purported market price of silver near $50 per ounce, for example, junk bags of 90% U.S. silver coins exchanged hands at a price closer to $30. Not coincidentally, that $30 also happened to be the melt price the refineries were paying dealers. Many a bag of old U.S. silver coins, not to mention bona fide numismatics including rare Morgan silver dollars, thus met their end in the Great Silver Melt of 1980. In fact, the “best” form of bullion to have owned during that bull market peak was actually COMEX deliverable bars since they could be sold (by futures exchange for physicals) at the same price that COMEX futures contracts were trading. Indeed, only people holding COMEX deliverable bars had a reliable chance to cash in anywhere near $50 silver or $850 gold during the 1980 peak.

This time around the situation could prove to be radically different — sellers will probably not be lining up in droves in front of dealer shops — but it might be because of something that Mr. Schectman does not mention: the development of “P2P” exchanges such as the auction site eBay that could eventually cut dealers completely out of the secondary market. So far these retail exchanges have been a mere annoyance to the dealers although sometimes you can find dealers who will sell and even buy on eBay. Such retail exchanges could, however, eventually dominate the secondary bullion market especially if we are to believe the outrage from gold dealers about the “hidden tax” in the recently enacted health care legislation.

Indeed, we find it difficult to reconcile dealer complaints about the new transaction reporting requirements with Mr. Schectman’s suggestion that going forward there will be little if any supply available from retail sellers. If that were true, there should be little actual impact from a new “tax law” that requires virtually all bullion purchases from the public to be reported by dealers to the Internal Revenue Service. It appears to us that either the complaining dealers are right or Andy Schectman is right.

Alternatively, they could both be telling only half the story: the likely outcome is an acceleration of the secondary bullion market’s transition to P2P bullion exchanges that offer retail investors the most privacy, the widest selection and the best prices. If so, generic auction services like eBay are likely to be joined by several new offerings in the near future while recent P2P applications dedicated to the bullion market such as SeekBullion and the Nucleo Exchange at Bullion Direct are likely to expand significantly. For this to happen, however, there is a need for independent bullion escrowing and verification services that enable trusted transactions to take place between individuals while avoiding new transaction reporting requirements. Another option would be P2P exchanges being set up within member-based organizations where escrow and verification could be handled internally.

A credit union can, for example, set up a private bullion exchange for its members and even Metal Augmentor can set up a private bullion exchange for our subscribers. All it would take is a very simple software platform (even a user forum or mailing list would suffice), a basic template for the business process and some training in bullion authentication. In fact, we’ve already drafted a conceptual business plan on the back of a napkin and would be willing to work with anyone interested in developing it into a viable business  opportunity. There’s probably not much money to be made initially but it is exceedingly simple and would help ensure a healthy secondary bullion market in the U.S. (or any other country for that matter). After all, gold and silver need to be more widely owned and must also be exchanged from time to time instead of merely accumulated and hoarded as a prerequisite to their acceptance in future monetary regimes.

It’s a pipe dream to think that any kind of gold standard could reappear without the public first becoming reacclimated to gold and silver and the best way to do that is often to just let people simply hold a gold coin or silver bar. We don’t see bullion dealers, many of whom are “out there” in terms of political thought, conspiracy mongering or ethics (we’re thinking of Goldline International in particular since they specifically target their aggressive upsell to people who are unfamiliar with bullion), as being effective tour guides to introduce the public to the marvels of gold and silver. Grassroots P2P exchanges potentially can, however, be an excellent introductory mechanism, especially as long as GATA and other agenda-driven organizations can manage to keep their paws off.

The other thing we think will start happening more and more is gold and silver bullion being used in private transactions. This actually became fairly common in the late 1970s and early 1980s so there is some precedent for it. We suspect it is only a matter of time before something like this is no longer uncommon in the classifieds or Craigslist: “Boat for Sale. 1998 Sea Ray 17 footer, perfect condition with trailer. Price: 3 Gold Eagles, firm.”

In conclusion, we see a bit of a silver lining in the new transaction reporting regulations “hidden” in the new health care law and we welcome the possibility that dealer involvement in the secondary bullion market could evaporate soon.

We reach basically the same conclusion as in our initial reports — Fortuna Silver and First Majestic get top honors although there is a case to be made for Silver Standard and several of the other companies depending on what you are looking for in a silver producer other than fundamental value. I will note that yesterday Fortuna and First Majestic were top performers among the silver producers along with U.S. Silver, which our report identified as having the greatest leverage to higher silver prices. Coincidence? I think not.

Our report is unlike anything else out there since it is comparative and allows silver investors to analyze a number of different fundamental and valuation measures on a head-to-head basis. Even a venerable and respected analysis such as John Doody’s Gold Stock Analyst looks like doodling with crayons compared to our effort. Previously we published a mid-tier gold report that identified New Gold as an undervalued standout. The company’s chart over the past six months tells the story: our approach works.

Soon we are going to be adding several smaller juniors (Great Panther, Excellon, Impact, Aurcana, etc.) as well as some larger companies (Fresnillo, Silver Wheaton) in an updated silver producer report that will be available to Metal Augmentor subscribers. We are also in the process of updating the mid-tier gold producer report as well as preparing a junior gold producer report over the next few weeks. These reports alone are easily worth ten times more than the measly $107 cost of a one year subscription to Metal Augmentor.

The PDF format makes the silver producer report easy to send around, which we encourage. Once again, here is the report: Mid-Tier Silver Producer Report June 2010 PDF.