Gold Shorts DOOMED (Part 1)
Adam Hamilton August 11, 2000 3315 Words
As this essay has grown almost as bloated as the United States M3 money supply, it has been rent asunder and split in two for your own protection. The thrilling finale will be published next week.
“Abandon all hope ye who enter here.” – Dante Alighieri, The Inferno, Canto III, ca 1300 AD.
As Dante and Virgil approached the Gate of Hell on their epic journey into the underworld, this ominous inscription was carved directly into the great stony gate itself. The hideous gate marked the boundary between the land of the living and the land of the dead, it could only be crossed with great peril, and few could return once they made that fateful first step into Hell. As the rest of the tale of The Inferno unfolds, the reader is led through nine increasingly horrific circles of hell, until the heroes of the story confront old Satan himself in the final circle. The warning inscription seen by Dante before he entered the realms of the dead was very appropriate, as hope, that most valuable of human emotions, became nonexistent and was remembered no more as Virgil lead Dante through the labyrinth of the lost.
As the evidence becomes unassailable that there is a massive and concerted effort to cap the price of gold, the inscription on the gate of hell is very appropriate for those striving to repeal the immutable laws of supply and demand and artificially manipulate the price of the most important commodity in the history of the world. They have truly embarked on an endeavor which they have no conceivable chance or hope of executing successfully. In this essay we will explore some basic macroeconomics principles that demonstrate why all hope is lost for those who wish control the global gold market that is inherently uncontrollable.
Before we begin, it must be stated that this essay takes for granted that strange things have happened in the gold market in the last six years. Applying the excellent Occam’s Razor logical principle, after exhaustive research by a myriad of organizations, it soon becomes apparent that the only explanation for gold’s inexplicable behavior since 1995 is a concerted effort aimed at suppressing the price of gold. There is simply no other conceivable fundamental explanation that can explain the anomalous trading patterns the metal has witnessed. William of Occam, an English philosopher who was a contemporary of Dante, stated that logically, all possible explanations must be sliced away with the razor, until only the simplest theory that fits the facts of a particular puzzle remains. The historical average monthly closing price of gold since 1980 has been $382, a level not seen since 1996. The fundamentals for gold have been phenomenal over the last six years, with global demand dramatically outstripping global supply. In the last twelve months, the fundamentals for gold have probably become the most favorable in modern history … inflation is rearing its ugly head, interest rates are rising, world equity markets have reached extremely dangerous bubble-type valuation levels, oil has more than doubled in the last year, several regions on the planet could erupt into nuclear war at any moment, etc. Given all these stellar fundamentals, and also considering the all important factor of global demand for gold dwarfing global supply of the yellow metal for many years, why has the price consistently and relentlessly plummeted since 1995? All the possible fundamental reasons for the price slump have been investigated and discounted by analysts from around the world. The only explanation that cannot satisfactorily be sliced away by Occam’s Razor and discounted, even though many have tried, is outright manipulation and suppression of the global gold markets.
In our ostensibly free market capitalist societies of the west, it is very difficult for many to even consider the possibility that market manipulation exists. Why would someone want to suppress gold? Without a motive, a crime becomes more difficult to investigate and prosecute. Fortunately, for the global gold suppression hypothesis, the two primary motives are quite obvious. First, gold is the mortal enemy and arch-nemesis of the fiat currencies used by every country in the world today. As fiat paper currencies are recklessly expanded at ever-increasing rates, gold should rise in value to cast its veto on the fatally flawed concept that value can be created out of nothing. Gold is the ultimate inflation barometer. If it could be disabled, governments would be able to create fiat out of thin air at a much faster pace than if gold was allowed to respond to fiat intemperance. This would enable governments to print enough inherently worthless fiat paper currency to spend on any social or military programs they wanted, not have to make any hard (and potentially politically lethal) decisions on the allocation of scarce resources, and not worry about the market easily discerning the eroding of the national currency through monetary inflation. The government motivation for suppressing gold is very obvious and simple to grasp. Second, private entities were allowed to reap vast profits from the gold suppression scheme. Untold profits for agents of the gold suppression scheme make for a very potent motive. Certain key money center and bullion banks were allowed to borrow gold from central banks at absurdly low interest rates (<1% per annum), sell the gold in the open market, and invest the proceeds in the stock market bubbles around the world. The banks could make 25%+ on their capital deployed in the inflating equity markets, while their cost of that same capital was only 1%, netting incredible profits. As a further bonus for governments, in addition to suppressing the gold price through the sale of leased physical gold on the open markets, this burgeoning gold carry trade had the welcome side effect of channeling more capital into the voracious bubbles. A bubble, like a crack addict, can only stay in a euphorious state with ever-increasing injections of all-important capital. As soon as the crack addict or bubble can’t find “just one more fix”, they plummet from their highs and hit bitter new depths with blinding speed. Governments know that their economies (and hence their tax revenues) are very highly correlated with the state of their particular national stock market. If the stock markets could be levitated indefinitely, and gold can be held under water until it drowns, maybe the speculative excesses of government fiat spending binges would not come home to roost. Maybe Adam Smith was wrong … maybe something valuable CAN be created out of nothing, and there are no scarce resources to allocate … maybe the political/economic/monetary equivalent of Santa Claus really exists…
These gold shorts, organizations that owe physical gold but do not possess the physical metal, have been estimated to owe over 10,000 tons of gold, worth an astonishing US$90b at today’s depressed gold price levels. In general, shorting a market is a perfectly legitimate strategy for speculation. In a normal long transaction, one buys an investment low, and sells the investment high, netting a profit... buy low sell high. In a short transaction, the same thing happens, with a slight temporal distortion. A speculator borrows an investment, sells it immediately, and then buys it back later for a lower price and returns it to its original owner… sell high buy low. When normal capitalist interests are short a market, it provides valuable price stability to the market. For instance, in a free falling stock market, often the only folks buying are shorts covering their positions for a profit. On many particularly ugly days when equity longs where standing on windowsills ready to empirically learn the terminal velocity of a human carcass, shorts have saved the day by buying when no one else was interested. In the current gold market, however, these are not normal speculative short interests. They are governments and large money center banks. Apparently explicit assurances were provided to large banks by governments that the gold price would be kept stable, at all costs. Alan Greenspan made a cryptic statement before the US Congress recently, “Central banks stand ready to supply ever-increasing quantities of gold to the market should the price begin to rise.” Dumb and careless statements like this create an economics moral hazard. Even though gold is at a major cyclical low, banks were given assurances that the price of gold would be artificially capped by central banks. With nothing to fear, banks stepped up the gold carry trade, netting tens (maybe hundreds) of billions of dollars in profits, and ending up with massive IOUs to central banks to repay the borrowed gold. Since they were told that gold would not be allowed to rise, that the free market would be short-circuited, all normal market safeguards and controls were effectively removed. Now, six years later, these large institutional gold shorts are absolutely terrified of a sharp rally in the price of gold. They have sown the wind, and they know they will reap the whirlwind when gold breaks free. If gold ramps up in price, they will have to spend a lot more money buying back the gold in the open markets that they owe to the central banks. Several banks of immense international and domestic importance have a notional value of gold derivatives exceeding their entire capital bases, all the money they have earned and retained in their entire histories. There is an extremely high probability that virtually all their gold derivatives, which must be reported quarterly to the US Comptroller of the Currency, are on the short side of the gold market. If gold rallies, many of these banks are teetering on the slippery edge of a deep dark pit full of punji stakes, whose nasty festering wounds inflicted when gold rises may prove lethal.
The more one studies markets, the more evident it becomes that ALL investments are cyclical. Sometimes stocks rally, sometimes they crater. Sometimes real estate is up, sometimes it is down. Sometimes bonds do well, sometimes they do not. Gold (and every other commodity) works exactly the same way. As gold is trading at 20+ year nominal and real lows, it would seem that maybe the gold cycle is due for an upturn, even IF one disregards all the stellar fundamental positives for the yellow metal. Shorting is a strategy that works best at the top of valuation cycles, when the overwhelming probability of a major downtrend exists. (NASDAQ anyone?) Logically, it makes zero sense that gold shorts are at record high levels at the rock bottom current gold price levels. Why on earth would anyone sell an asset when it is at its lowest price in 20+ years, and expect to be able to buy it back lower in the future to repay the gold liability? As we slice away all the possible answers to this critical question with Occam’s Razor, the only remaining possibility is a concerted effort to suppress the price of gold.
The best single document available to understand what has happened in the gold market since 1995, and why the market action has been so suspicious, is without a doubt GATA’s incredible Gold Derivative Banking Crisis report. The Gold Anti-Trust Action Committee hand delivered this document to every member of the US Congress a few months ago, and it describes what is coming down the financial and political turnpike unless the incredible problem of massive gold short positions and credit excesses are not addressed immediately. Although the document is long (~100 pages), it is the finest summary available on the recent activities in the gold market, how the gold price has been suppressed, why it has been suppressed, and what bitter harvest it will bring forth if not addressed immediately. The report is available for free at www.gata.org in Adobe PDF format, and it may prove to be the most important financial document produced in modern market history. It is extremely highly recommended, and will likely have profound implications for the future net worth of every private investor on the planet.
Initially, all these thoughts seem negative for contrarians patiently awaiting gold’s long anticipated thrust for the heavens. Upon close examination, however, the artificial price ceiling created for gold is a TREMENDOUS positive omen for the metal’s future. Before you think I have been hit on the head by one too many gold bricks (actually I wish I had the “problem” of people throwing gold bricks at me!), we need to take a look at simple college Economics 101, and demonstrate why price ceilings are unsustainable, have ALWAYS failed in history, and why this current effort is futile and destined for disaster for the gold shorts. They have truly abandoned all hope by proceeding down this path that will predictably lead to their doom.
The wonderful science of economics has developed great graphical tools for simplifying the almost infinitely complex aggregate supply and demand in a particular market. In the real world, supply and demand curves are built on millions of independent decisions made by unrelated individuals, all seeking to maximize their personal profits. To facilitate practical analysis, economics has developed the ubiquitous supply and demand graphs. Supply and demand graphs look like an “X”, with the vertical axis representing the price of a particular good and the horizontal axis representing the quantity supplied and demanded of the good. The normal demand “curve” slopes down from the upper left quadrant of the graph to the lower right. It indicates that, everything else being equal, the lower the price of a good, the higher the quantity demanded. This is easy to mentally grasp. Imagine an alternate reality where a brand new Porsche 911 only costs $1000… there would be many more Porsche 911’s sold at that bargain price than at $85k. The quantity demanded normally increases as price decreases. The other half of the graph, the supply curve, generally slopes up from the lower left quadrant of the graph to the upper right quadrant. This indicates, everything else being equal, the higher the market price of a good, the more companies want to get in the business of manufacturing and supplying it. For example, if toilet paper cost $100 per roll, there would be a lot more businesses clamoring to produce toilet paper! Higher prices and resulting larger profits draw in competitors, increasing the total quantity supplied to a market. The exact point where the demand curve and supply curve intersect is known as the market clearing equilibrium price. At this price, consumers demand exactly the quantity that is produced by the suppliers. The price is called “market clearing” because no surplus is built up (all goods produced are demanded) and no deficit exists (demand does not exceed supply). This is how free markets work, as no one sets the price of anything, but the aggregate actions of millions of individuals determine the proper market clearing equilibrium price. The concept is elegant and beautiful, and it is a travesty to see humans continue to attempt to muck around with the very core of capitalism. The graph below is a classic free market supply and demand graph for the global gold market.
In the graph, US$600 is depicted as the market clearing equilibrium price of physical gold. This number is from the legendary Frank Veneroso. Mr. Veneroso and his associates performed a long-running and exhaustive study on global gold demand in countries all over the world. After completing the research, they concluded that the true market-clearing price of gold is around $600 per ounce, sans manipulation and price suppression efforts. Some of Mr. Veneroso’s research and excellent reports may be read at http://www.venerosogold.com/library.htm, and are highly recommended. The equilibrium market clearing quantity of gold used in the graph above is arbitrary, although it is likely in the general neighborhood of true global gold demand. As discussed above, the intersection point of the blue supply curve and the red demand curve determines how much gold is sold/bought in the market, and at what price. Enter the current gold suppression scheme…
Generally, the easiest way to artificially create a price ceiling is by regulatory fiat, simply declaring by law what the price of an item will be. Since the usual suspects who have a vested interest in the low gold price do not have complete military and financial hegemony over the entire planet, this is not an option. In order for a fiat price declaration to work, the government attempting to manipulate the market must exercise total authority over the region where the goods are traded. In the case of gold, it is the entire world, and there is thankfully not yet a world government. The second easiest way to suppress a market is to manipulate the supply curve. In general, in most markets, there are relatively few suppliers and a vast number of consumers. It is much easier and more cost effective to concentrate efforts on the fewer entities on the supply side than threatening to kneecap the billions of people around the world who demand gold. This concept, that supply side manipulation is more cost effective and easier than demand side manipulation, is evident in the United States “war” on drugs. Rather than focusing on the internal moral decay in the United States that breeds drug addicts, the US has chosen the easier route of financing attacks on drug suppliers and distributors. The US government hopes they can reduce supply, thus raising the price of illicit substances, in order to stave off the devastating effects of drug use in America.
The global gold suppression effort has the exact opposite goal in mind. Governments and banks are urgently trying to artificially increase the supply of physical gold available to the market, in order to keep the price of gold low. They are not concerned with how much gold they sell, only with the market price of gold at the end of the day. Through gold leasing to gold carry trade participants (which results in sales of gold on the open market), or outright central bank sales, the anti-gold forces have succeeded in artificially boosting the supply of gold available to the market for a short period of time. The graph below shows the economic effects of the increased supply of gold, as evidenced by the supply curve shifting down and to the right.
The artificially engineered supply glut, only possible because national treasuries have been liquidating thousands of tons of their citizens’ hard-earned gold, has had the rather impressive effect of cutting the true market price of gold in half. The suppressed “equilibrium” market-clearing price of gold is now sub-$300, and the quantity of gold available on the market has also increased dramatically to enable the lower price to hold. Interestingly, the new suppressed equilibrium point is not a true market clearing equilibrium point. The day the artificially increased gold supply deluge ceases to flow into the open market, the price of gold will begin rising rapidly as the supply curve shifts back to the left. It is only a matter of time, as the supply of physical gold that the suppressing entities can draw on to dump on the market is finite and rapidly dwindling.
Just as Dante and Virgil were warned before they crossed the threshold to Hell, these large entities foolish enough to short gold in the current environment truly have no hope of emerging successfully from their foul scheme! The forces of free markets are immutable, relentless, and unstoppable. Real world supply and demand fundamentals will grind the gold shorts to a pulp, and their blood will flow red in the gold trading pits. There have been many epic battles fought in history between governments and big business and the free market, and the free market has won every single contest without even breaking a sweat. The current scheme to artificially suppress a global market in the ultimate commodity exudes folly, and the players on the dark side are attempting the patently impossible and downright absurd.
It is amazing the gold shorts can sleep at night, as they are beginning to perceive in abject terror the mounting free-market forces marshalling against them…
Part 2 of this essay will outline the aftermath of an artificial price ceiling created by supply side manipulation, attempt to plot the real-world gold supply and demand curves, provide evidence that the suppressing entities are growing afraid and losing hope, and will be chock full of action, drama, and romance. (and the good guys win!)
Adam Hamilton, CPA August 11, 2000