Gold manipulation:
Central banks are now in deep trouble
Central banks have
routinely manipulated the gold market since the
beginning of fractional reserve banking, but they have
always eventually failed in their quest. This time there
is circumstantial evidence that we could be on the verge
of the most spectacular failure so far.
Physical bullion differs
from other investment media because today there is no
secondary market. Buyers of bullion are not speculators,
or even investors: they take delivery, hoarding it from
the market, and are not tempted to resupply it at any
price. To some degree this loss from the market has been
replaced by newly mined gold and scrap, but the size of
the market is such that gold from these sources is now
insufficient for hoarding demand. So when the bullion
banks try to shake out the bulls, as they have recently,
they may manage to reduce their short position in the
paper markets; but the lower prices for bullion simply
generates extra physical demand. The result is that the
size of the paper market has become increasingly
dangerous relative to the physical gold actually
available.
A fascinating insight
into this process is recorded in an interview of one of
the leading American coin dealers, who described how the
fall in the gold price in 2008 from $1,000 to $700 was
the opportunity for hoarders to clean out the market. I
quote:
“…all product worldwide
disappeared. Within weeks the U.S. Mint was shut down.
The Canadian, Austrian, and Australian Mints were all
eight to 12 weeks back-ordered or shut down. The
Australian Mint stopped taking any new orders in July or
August for the rest of the year. The Rand Mint, for the
first time ever, sold out of all its product. One
wealthy Swiss businessman flew his own 747 there and
cleaned them out.”
The interview, which is
well worth reading in its entirety, can be found
here.
It is particularly apposite given the recent shake-out
in the futures market, raising the question, how much
physical disappeared in the process? Not surprisingly,
the interviewee is also worried that rising prices will
merely generate yet more demand; so the absence of a
secondary market is crucial to understanding the problem
facing central and bullion banks today.
For the last fifteen
years the European central banks have led attempts to
keep the price down. In the last ten years alone, this
cartel has officially sold about 3,800 tonnes, all of
which is now effectively hoarded. On top of this, they
have leased unrecorded amounts of their gold, all sold
into the market and now irrecoverable - and still the
hoarding continues.
Leasing has had one
over-riding purpose, to swamp demand. Thirty years of
leasing has fed the hoarders, and provided the feedstock
for the futures market, where the bullion banks are also
short on their trading books a net 718 tonnes today.
This has been going on so long, everyone has become
complacent. The result must be the accumulations of the
largest short position ever on the bullion banks’
unallocated accounts and on Comex, where logic suggests
they should hedge, rather than compound their short
positions.
Some
interesting research by
Adrian Douglas
suggests that the operational gearing on unallocated
accounts is as much as forty five times: in other words
the bullion banks only have one ounce of gold for 45
ounces of customer liabilities. If this is even half
correct, the implications are frightening. In the
absence of a secondary market for physical, just a small
rise in prices leaves the bullion banks dangerously
exposed.
These conditions are
obviously explosive; but why does it matter, other than
for reasons of hoarders’ self-protection? Well, central
banks are going to have to rescue bullion banks or let
them go to the wall. So far, they have always managed to
conjure up a rescue, but now that their ammunition has
almost run out a covert rescue is very difficult. The
task is made more acute by growing instability in both
general banking and the global economy. Worse still, the
increasing possibility of unrelated systemic failure is
fuelling the incentive to hoard.
So here is a major
banking crisis in the making, mainly as a result of the
central banks’ continual attempts to rig the market
finally coming to a head. It is a time when the whole
idea of a world monopolised by fiat currencies is losing
credibility. Fears of deflation currently dominate
central bankers thinking. They dare not address the risk
of inflation and nothing would suit central bankers more
than the ability to print money without inflationary
consequences.
But talk of deflation is
intellectually sloppy. It is based on the Irving Fisher
theory that falling asset prices lead to a price
collapse. This is certainly true of collateralised
assets, but that is as far as it goes. The argument does
not extend to the means of production, being raw
materials and labour. It is true that an asset implosion
will affect demand for raw materials and labour but this
is a secondary effect and not an even one at that.
The risk of an asset
implosion is tied to economic performance. If the recent
global trend of failing demand and credit contraction
persists, government finances everywhere will rapidly
deteriorate. A renewed slump also brings systemic risks.
This cannot be permitted, so the monetary imperative is
to print, print, print. The effect is simply to
undermine the value of fiat currencies, which will be
dumped by foreign creditors; and with no reasonable
amounts of bullion available, they have no alternative
but to stockpile commodities and raw materials instead.
To illustrate the point,
China is reducing her exposure to dollars by selling
them to buy commodities. The common assumption is that
this is only because she is stockpiling to satisfy her
own future demand. There is some truth in this, but any
asset allocation has to take account of the
alternatives: in this case the unattractiveness of
holding dollars. Furthermore, selling dollars and buying
other paper currencies generates little enthusiasm.
Through currency intervention, China is able to acquire
depreciating dollars and turn them into metal and oil.
She does this because no one will sell her enough gold
to replace her dollars. Looked at this way it becomes
apparent that a rise in the dollar price of gold becomes
a threat to the dollar itself, since gold is the leading
proxy for a general basket of commodities.
The threat extends to
all fiat currencies. It becomes only a short step for
creditor nations such as the Chinese to look upon all
their forex dealings in commodity terms. It is thinking
like this that the Western central banks are desperate
to play down, since it completely undermines their
position.
But what can they do? We
can rule out a deliberate sharp rise in interest rates.
Other than cover up the problem, there is now virtually
no solution. Quite simply, there is so little ammunition
left that further expenditure of what bullion is still
available merely exposes the underlying weakness of the
central banks’ position. The central banks’ banker, the
Bank for International Settlements, recently made
available 346 tonnes to the market, all of which smartly
disappeared into the hoarders’ hands. It stank of a
last-ditch attempt, and achieved little more than the
temporary concealment of yet more hoarding.
The bullion banks can
only have become so uncovered on their unallocated
accounts with the encouragement of the central banks,
since their exposure appears to exceed the maximum
fractional reserve basis of ordinary lending by a factor
of four. So from a regulatory point of view, no one is
looking. The result of a combination of excessive
gold-related credit and lack of regulatory oversight has
much in common with the events that led to the credit
crunch in 2007. The result can be expected to be
similarly violent.
What we don’t know today
is whether a broader systemic crisis will tip the gold
price towards infinity, or whether a gold bullion crisis
comes first, triggering a wider systemic collapse. It is
too close to call. Either way, it should be spectacular.
18 August 2010
