From the May 01, 2010 issue of Futures Magazine • Subscribe!

McGhee on the gold currency

Frank McGhee is head precious metals dealer for Alliance Financial and has more than 30 years of experience in all aspects of the futures and physical precious metals market. Frank McGhee is also the director of risk management and operations manager for Integrated Brokerage Services, LLC. McGhee has been a precious metals trader/dealer since 1976. He is chief system designer of TheOTCDesk.com, Alliance’s proprietary browser-based, Internet physical dealing environment.

Alliance is involved in making markets in more than 400 physical metals products and operates a large proprietary trading operation. McGhee is a recognized precious metals expert and has provided expert analysis on the markets for various media outlets. We spoke with Frank to discuss gold.

Futures Magazine: Before we go into your outlook on the metals markets why don’t you talk a little bit about your background and what you do for Alliance Financial?

Frank McGhee: I am the head precious metals dealer for Alliance Financial. I have been involved in the markets for most of my adult career and I am in my mid 50s. We make markets in over 400 different physical metals products from investment-grade coins to exchange deliverable warrants to industrial products such as the casting grade for making rings.

We are very active in both the cash and futures markets involved in deliveries in any U.S. market. We launched and developed one of the first Internet precious metal dealing systems in 2002 called the OTC desk.com. It is a system fully automated as to the pricing availability of product. It provides a unique quote for each client based on the specifics of the orders, current market conditions, available prevailing interest rates, shipping costs etc. Two different clients can be on with similar orders but going to different places and seeing individual prices. We have two sister companies: Integrated Brokerage Services, which is an FCM and there is IBS Securities. We provide a specialty metals environment for both our wholesale counterparties as well as for retail investors where you can deal in just about every component of the metals complex whether it be physicals futures, exchange-traded funds, across the board.

FM: Gold is perhaps the most interesting commodity, if you can call it that. Do you view gold as a commodity, currency, bellwether of global stability or something else entirely?

McGhee: Gold is a currency. It is one of the oldest forms of money. It has provided a store of value and a settlement vehicle for various governments throughout the years. The unique nature of gold is that it is not issuer specific. Gold is unbiased, that is the reason that it developed the exchange process and was the original form of currency. There actually was a euro before the euro. That was the 20-franc piece. For 200-300 years, major European governments all issued a [gold] coin within a fraction of each other and if you were doing a transaction inside of Europe you might get back a French 20, a Swiss 20, a Belgium 20 and two German 20 marks. It really was a unifying currency across differing issuing mints.

FM: How should investors view gold?

McGhee: You have to look at the history of gold over the last 25 or 30 years. After the inflation bubbles of the late 1970s, the central banks tried to do just about everything they could to demonetize the metal and to that end it helped to create a fairly protracted bear market. At the same time, you had the rise and development of the lease market for precious metals with extensive multi-year forward hedging operations and this continued to keep pressure on the price of gold. Ultimately though it failed with the accords in 2002 when the central banks agreed to limit both their forward and spot sales of gold, as well as their leasing activities. As soon as that accord came into place, you had the beginnings of the current rally that is going on its eighth year. Gold has done, in the past several years, what it should normally do. It has been helped along significantly by the advent of the exchange-traded funds (ETFs). That probably has added $400-$500 an ounce to the price of gold that would not normally be there if it was just an industrial commodity. There are almost 1,100 tons of gold that have come off of the marketplace that are in long-term hands that generally do not tend to get rid of it. When gold goes into to GLD, because it has to be backed by gold, it doesn’t tend to come out. Even in the most sever breaks, you only see a modest redemption. That has changed the overall face of the market. The [ETF funds] have distorted the historical [fundamentals] of the jewelry business and the Christmas buying season. [These things] have become less important than the accumulation of investment grade metals. And the ETFs have replaced or consumed the metal that the Central banks have sold over the years. Absent the ETF, we would be probably in the $600 to $700 range, as opposed the $1100 range. It has gotten to a point that because GLD has to have physical bullion that there are shortages in depository locations in the city of London that meet the requirement of the trust. It is difficult to get storage for a new bullion account.

FM: What is your opinion on the current obsession with gold?

McGhee: It is certainly reflecting a distrust or fear of the current conditions both domestically and internationally. At the height of the financial meltdown in 2008-09, the cash and carry markets almost tripled their normal premiums with people physically taking possession of gold and that directly showed the anxiety of a growing number of people. Prior to that meltdown, we would routinely get calls saying I have $50,000 I want to put into the gold market. In the midst of that, we were getting calls from investors saying ‘I have $1 million I want to put in the gold market. The concept here is not only has gold maintained valued but gold has gained value relative to the other currencies and you have to view gold as a currency.

FM: Do you subscribe to the notion that gold is an essential hedge against inflation?

McGhee: Gold is absolutely a hedge against inflation, but in many cases inflation is something that is occurring after the fact in the change in the currency rate rather than before the fact. I am a major supporter of having a significant portion of an investment portfolio in precious metals. I am also a supporter of most people doing a dollar cost averaging purchase. You take a certain amount and routinely and mechanically acquire metals. You buy gold on the 15th of the month each month. You acquire more gold in breaking markets and you acquire less gold in a rallying market. It acts virtually as a savings account. Six months, a year, two years into it you’ve got this nice piece of your portfolio in something that is counter cyclical to most of the rest of the markets.

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