Gold Shorts DOOMED (Part 2)
Adam Hamilton August 18, 2000 3612 Words
Part 1 of this essay outlined evidence indicating there appears to be a concerted effort to suppress the price of gold, offered motives for the guilty parties, discussed logically why the current gold short position is absurd, explained how the gold price has been suppressed, and graphed the current suppression efforts on classical economics supply and demand graphs…
“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 most 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 continue to 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.
The ancient Hebrew sage, King Solomon, wisely expounded, “There is nothing new under the sun.” His God-given wisdom still rings true today, three millennia later. Unfortunately for the gold shorts, price suppression schemes have been attempted many times in the past, and the same dismal result always ensued … utter failure. Economic textbooks are chock full of examples of artificially manipulated prices all throughout history. From the biblical times, to Rome, to our modern era, people have imprudently tried to wage war against Adam Smith’s invisible hand. Every single time a free market has been burdened with an artificial price ceiling, the irresistible and overwhelming forces of supply and demand eventually violently shattered the wall in which men tried to imprison them. While the artificial price ceiling is temporarily held in place, free market forces continue to build behind the obstruction. The futility of the endeavor is comparable to trying to dam the Amazon River. The flow of water is so vast, and so irresistible, that any effort to stop or drastically reduce the water flow is doomed to failure. The financial imbalances that build behind the price ceiling are not instantly eliminated when the manipulation efforts cease, boding great ill for the gold shorts. The graph below outlines the economic consequences for the gold market after the price ceiling inevitably fails…
Rather than simply returning to true free-market equilibrium levels, in the aftermath of a price suppression scheme the supply curve retracts far to the left. Instead of re-establishing a pre-gold dumping equilibrium level, the supply pendulum swings violently in the opposite direction. This radically compounds the problems for the gold shorts. After demonstrably mucking around in the gold market since at least 1995, incredible imbalances have been built up which will have to be blown off before a true equilibrium price is again reached. One of the primary reasons for this great over-correction is the mechanics of gold mining. The artificially low prices in the last six years have been devastating for the gold mining industry. Many mines have been shut down, sold, or abandoned, as they are simply uneconomical at these anomalously low gold price levels. (The monthly average closing gold price since 1980 has been US$382, for comparison.) The artificially increased supply of physical gold, through the engineered collapse of the gold price, has dramatically lowered near future global gold production capacity. Unlike the flavor de jure dot com company, gold mining has mammoth barriers to entry, and requires a great deal of capital and lead time to get a mine into production. In addition, there are only a finite number of locations on the earth where gold may be mined. As soon as the central bank originated gold flood abates, there simply won’t be enough gold productive capacity left to meet market demand, and prices will ascend far above the normal expected equilibrium levels. The free-market mechanism to correct this gutting of the gold mining industry is simple and elegant. A much lower supply with a constant demand yields a much higher price for gold. At higher gold levels (US$1000+), new mining companies will be enticed to enter the industry, and prices will gradually trend down and stabilize near a long-term supply/demand equilibrium price over a decade or so. It is impossible to predict how high gold will rise in order to rectify at least six years of an artificial price ceiling, but it is safe to say the levels reached will probably astound 99% of the investing world.
Thus far, our analysis has been significantly over simplified, as only the supply curve has been shifted. In the real world, the supply and demand curves move (and shape shift) simultaneously. Unfortunately for the foolish gold shorts who decided to fight a 20+ year low in a cyclical market, the biggest short covering rally in the history of the world is just around the corner in gold. As the gold price begins to rise, a few shorts will get nervous, and will aggressively buy physical gold to cover their gold debt. Their purchases will ignite further price increases, which will cause more shorts to cover. Soon, the shorts will be stalked like vultures chasing a dying man through the desert, as global investors will begin rapidly buying physical gold, creating critical mass and igniting an enormous explosion in the price of gold. An unstoppable vicious circle (or virtuous if one is long gold!) will be initiated, catapulting the demand curve up and to the right as the supply curve shrivels rapidly to the left. The net result could be large jumps in the price of physical gold for months on end. The gold price may touch the stratosphere, and the shorts will be utterly slaughtered. Blood will run red in the gold trading pits beginning that fateful day the first few shorts get really scared and begin to cover. Decreasing supply coupled with increasing demand is a recipe for a gold rally of legend, and the gold shorts’ most terrifying nightmare.
In another over simplification to this point in our journey, the real-world gold supply and demand curves for the global gold market are definitely not simple lines like the textbook examples. The real shape of the supply and demand curves will greatly exacerbate the strength and magnitude of the unavoidable monster short-covering rally in physical gold. The following graph shows hypothetical real world supply and demand curves for gold. As this is all conceptual, the shape of the curves is important, not the specific prices and quantities which comprise the curves…
Although the graph above is not as attractive as the textbook “X” supply demand graph (this resembles a faulty chromosome), it should be much more accurate. The blue supply curve and red demand curve above are cut into regions, marked by letters (supply curve) and numbers (demand curve). Beginning with the supply curve, we will briefly examine each region of these hypothetical real world gold curves.
On the blue supply curve, Region “A” represents the fact that only a few mines in the world can profitably mine gold at very low prices (<US$100), hence global supply will be very low at these price levels. As the price rises to $150, a few more mines are able to produce gold, and the quantity supplied begins to rise slightly more rapidly. There are only a handful of producers in the world who could supply gold over the long run at the price levels in this whole region of the supply curve, thus the low quantity of gold supplied to global markets. Region “B” is the normal upward sloping portion of the gold supply curve, and is easily recognizable as a classical economics supply curve. As the gold price increases, mines kick up production and produce more of the yellow metal to take advantage of higher prices. Most of the surviving mines today can scrape by at $300 gold, but none are making blockbuster profits and very few or no new mines are attracted to the depressed industry. As the price of gold begins to take off from around $400 or so, region “C” represents the fact that it takes time to bring new gold mines into production, so the price of gold can rise dramatically before new supplies can be added to the market. The supply of gold produced lags price by years, as it takes time to drill shafts, build infrastructure, or re-open mothballed mines. This part of the curve is particularly ominous for gold shorts, because as soon as their central bank cronies turn off the gold leasing spigots, there will be a massive increase in the price of gold, but no commensurate increase in the mining supply available for at least several years. Finally, Region “D” indicates the new mined supply of gold that will come online in several years in response to a major increase in the price of gold. This portion of the curve is also normally sloped from a classical perspective. Region “C” is the critical part of the global gold supply curve, and ought to scare the heck out of the gold shorts, because when the citizens of the world figure out that their respective central banks have been giving away their hard-earned national wealth like party favors (or the banks can’t find any more physical gold to dump), central bank sales will come to a screeching halt and gold prices will skyrocket, and it will take years for additional supply to arrive on the market to bring gold prices back down to quasi-normalcy.
Incredibly, the hypothetical red demand curve is even more bullish than the supply curve for gold’s near future. Once again, the region by region dissection of the theoretical beast… Region “1” represents virtually unlimited demand for cheap gold. Even if gold was $50 per ounce, it would still be in great demand from the jewelry industry and various other industrial users. The metal is incredibly beautiful and versatile, and buildings would be covered with it if it was cheap enough. As gold prices drop still lower, demand becomes asymptotic and rapidly approaches infinity. New industrial uses for the ancient metal would no doubt be discovered if the price of gold sunk to these low levels. Region “2” represents the normal textbook downward sloping demand curve portion of world gold demand. As gold becomes cheaper, a higher quantity is demanded, which the central banks are now generously supplying to world gold markets. Region “3” is where gold demand becomes REALLY interesting. Somewhere between $300 to $450, global investment demand for gold overtakes industrial demand. At this point, the price of gold can rise dramatically, but demand stays relatively stable as investors clamor to purchase gold with their risk capital. In region “4”, the gold demand curve actually inverts, and gold becomes an economic luxury good. An economic luxury good is defined as an item where demand INCREASES as price increases, which is counter to normal market behavior. Real world examples of this include certain types of yachts. Amongst the ultra-rich, the yacht is a status symbol. The more a yacht costs, the more desirable it becomes. There have been many documented cases of sales actually increasing markedly as the price on luxury goods is raised. As gold moves north of $600, investment demand increases spectacularly, and investors can’t get enough of the rapidly appreciating yellow metal of legend. An insatiable gold lust begins to burn in hearts around the world, and no one wants to sell gold but everyone wants to buy the mystical metal of legend. In region “5”, gold becomes the most talked about investment on the planet. Cabbies give tips on gold stocks, newsmagazines trumpet the new golden era, and a full blown speculative mania is born. The higher the price goes from here, the more people want a piece of the action, and the more money chases physical gold. Presumably demand would taper off at some point as risk capital available to chase gold dwindles, but once the gold mania point is reached, it is impossible to predict how high gold will have to gallop for the mania to run its course. There is no rush like a gold rush!
Using this hypothetical model of true gold supply and demand curves, it rapidly becomes quite apparent the gold shorts are in a world of hurt. When the supply curve shown above shifts left as central banks become unable to feed the stitched together gold suppression Frankenstein’s monster they have created, the dangerous (from a gold short perspective) regions “3” and “4” of the demand curve will be crossed, and the gold price will jump dramatically even if the new lower quantity of physical gold supplied to the market is relatively constant. When the central banks cease and desist giving away their citizens’ gold, the combination of the available supply of physical gold shifting to the left, the price of gold rising, and the demand curve shifting to the right as investors salivate at the prospects for vast profits, will whip up an uncontainable firestorm that will immolate the gold shorts and catapult the price of gold through the stratosphere. From a macroeconomics perspective, it is simply amazing that anyone short gold can actually sleep at night! By its very nature, a short position has UNLIMITED loss potential. (If you are a gold shortie, you better re-read that last sentence a few times and reflect on it!) The writing is on the wall, the gold shorts are doomed, and they truly have no hope…
And evidence continues to accrue that the gold shorts are quite aware of these fundamental principles and are rightfully terrified…
As we have demonstrated from a macroeconomics perspective in this essay, the only way the charade of artificially low gold prices can be perpetuated is with an ever-increasing supply of fresh gold delivered from various central banks around the world to dump into global physical gold markets. In what is becoming increasingly comical, western bankers are really scraping the bottom of the barrel to find ever more gold to chuck! Last autumn, in response to the phenomenal run of gold from around $250 to $330, the tiny nation of Kuwait surprisingly announced that it was shipping its ENTIRE national supply of gold to London to be leased, and hence sold on the open market. Anyone who understands the Arab culture and its strong, deep, and ingrained love for physical gold was simply awestruck by this mysterious decision. Why would the Kuwaitis do this, especially when the price of gold was so low in historical context? Suspiciously, only a few days later, the United States announced the sale of prime high-tech US weapons to Kuwait on unbelievably favorable terms… a quid pro quo? The plot continues to thicken… Lately, it appears the artificially augmented supply of physical gold is running out. After the gold loving Swiss were somehow convinced (coerced?) to sell 1300 tons of gold (50% of their large national reserves), increasingly second tier banana republic central banks are being hit up for small table scraps of gold. Countries in the Middle East and South America have suddenly and puzzlingly agreed to sell or lease 100% of their national gold reserves, with the latest being Chile. The amounts of gold these countries have is very trivial, sometimes as low as a few dozen tons. This is a trifling amount of gold, worth a paltry few hundred million dollars at current depressed price levels. There are probably dentist offices that have more gold on hand to use for high-class tooth fillings than these third world central banks! The fact that smaller and smaller central banks are being hit up for a little scarce physical gold implies the gold shorts are very desperate, and are truly scraping the bottom of the world gold barrel in their frantic rush for fresh gold to supply the market to keep the price down. The gold shorts intuitively sense the reaper is marching, and they have almost lost all hope…
As mentioned above, in the real world, supply and demand curves shift simultaneously. In addition to horse-trading for shrinking supplies of back alley physical gold, the gold suppression camp is also trying to mitigate potential investment demand, as they are deathly afraid of the vertical investment demand portion of the demand curve intersecting with the supply curve as the depressed gold price shatters the shorts’ shackles. Another piece of evidence that the gold shorts are indeed terrified is the recent shuffling of the Philadelphia Stock Exchange Gold and Silver Index (XAU). The XAU was specifically designed to track gold and silver stocks, providing the general stock market with a fair indication of how gold and silver stocks are performing. In a move that defies all logic, the XAU was recently reshuffled a couple times, first a massive COPPER miner was added, and then one of the best and biggest gold mining companies in the world was cast out of the index. The net effect was to emasculate the XAU as a true indicator of gold and silver mine performance.
The addition of Phelps Dodge, a huge copper miner, to the XAU left a baffled gold investor community. Phelps Dodge itself claims that less than 1% of its revenue is from gold and silver, which is simply a small, immaterial byproduct of its copper mining operations. Phelps Dodge’s investor relations liaison has stated that the company was not consulted by the Philadelphia Stock Exchange on the decision, and Phelps Dodge itself has no idea why it is included in the XAU as a “gold mine”. The mysterious addition of Phelps Dodge to the XAU made the copper miner the third most important company in the index, accounting for over 14% of its weight. Shortly after this very strange occurrence, one of the biggest and best gold mining operations in the world, Goldfields, was removed from the XAU. Many speculated the reason the stock was kicked out of the index was for Goldfields CEO Chris Thompson’s strong and courageous public comments against forward selling and leasing of gold, which have been virtually proven to severely depress the price of gold. These cryptic occurrences have left a shell of an XAU that is only very loosely correlated with the performance and profitability of unhedged gold mining operations. When gold begins to rise, many casual investors will look at the now sham XAU, see it remain flat, and assume that gold mining shares are not rising in price. It really is a very clever stratagem by the gold shorting crowd, to break the most common instrument used to measure gold share performance in order to attempt to retard future investment demand as the physical metal itself begins to rise. Looking past the smoke and mirrors, this recent move to destroy the validity of the XAU is a key indicator of the levels of visceral fear and outright terror building in those who owe physical gold to others. The economics of the gold market, coupled with the increasing evidence that the gold suppression scheme is reaching vital sink or swim time, indicates all hope is virtually lost for those who foolishly decided to declare war on a critically important global free market.
As the global gold shorts desperately scramble to launch feeble and last minute campaigns to protect their ill-acquired spoils, Adam Smith’s invisible hand of free market economics is rapidly approaching like a mammoth juggernaut. When the gold monster rears on its hind legs and lets out a mighty bellow, the endgame will have arrived and few on the short side will escape the great carnage. Governments and central banks, as in the past, will try their bureaucratic best to protect the large commercial money center banks that made bad bets on gold, but their efforts will be overwhelmed by the irresistible fury of a free market long suppressed. The economic forces of free markets are swift and merciless when they stampede, and they will punish those who tried to break and suppress them. Once these days of destiny for the gold market arrive, they will probably be remembered in financial history right beside the infamous 1929 stock market crash. They will indeed be awesome to behold.
As the gold shorts are being slaughtered for their lack of due diligence and anti-free market manipulation, the quiet legions of gold bulls will have stadium seats to watch the spectacle. The fortunes to be made on the long side of gold are simply staggering, and many of the new financial masters of the universe in 2010 will have reaped their king’s ransoms while riding the coming gold bull from today’s rock bottom lows to moonshot heights.
While they count their spoils from the great gold wars, they will chuckle to themselves and marvel that mere mortals had foolishly tried to overthrow the global free gold market…
The warning on the path to the abyss of Dante’s Hell is SO appropriate for the gold suppression camp… “Abandon all hope ye who enter here.”
Gold shorts are DOOMED!
Adam Hamilton, CPA August 18, 2000