Posted on 12/04/2008 11:44:24 AM PST by Vince Ferrer
There is no other leveraged commodity market where short sellers increase their positions, materially, as the price rises, and increase them even more when prices are exploding, except gold and silver. The reason traders don’t normally do that is that it exposes short sellers to unlimited liability and risk. Yet, in both March and July 2008, and on countless occasions over the past 21 years, vast numbers of new gold and silver short positions were temporarily opened up, with the position holders seemingly unconcerned about the fact that precious metals had just risen exponentially, and that there was a very real potential they would bankrupt themselves with unlimited upside potential. Normal traders would not expose themselves to such unlimited risks.
I conclude, therefore, that over the last 21 years or so, “fake” precious metals supply in the form of promises of future delivery have habitually been increased when prices increase until increased “supply” managed to overwhelm increased demand, leading to a temporary price collapse. This is compounded by the fact that the futures prices on COMEX tend to dictate the “officially” report price for the precious metals elsewhere.
After the market is broken, shell-shocked leveraged long market participants have always been thrown out of their positions by margin calls, and/or have been happy to sell contracts back to the short sellers at much lower prices. This process has always allowed short sellers to cover short positions at a profit. If for some reason naked shorts needed to deliver, they could always count on various European central banks (and some say the Fed basement repository) to backstop them, releasing tons of physical gold into the market. It seemed that there were always another 34 tons or so of gold dumped at strategic times to bring down fast rising prices. Meanwhile, huge physical market demand in Asia and severe shortages buffered the downside. Because of the physical demand, prices steadily increased but, perhaps, at a much slower pace than would have been the case in the absence of market manipulation.
Rarely was there ever a serious short-squeeze. Rarely, that is, until Friday of last week when the deliveries demanded by non-leveraged long buyers reached record levels. In spite of an avalanche of complaints from gold and silver investors, the CFTC (Commodity Futures Trading Commission) has never bothered to audit even one vault to see if the short sellers really have the alleged gold and silver they claim to have. There is a legal requirement that, in every futures contract that promises to deliver a physical commodity, the short seller must be 90% covered by either a stockpile of the commodity or appropriate forward contracts with primary producers (such as miners). Inaction by CFTC, in the face of obvious market manipulation, implies a historical government endorsed price management.
Things, however, are changing fast. As previously stated, the first major mini-panic among COMEX gold short sellers happened last Friday. As of Wednesday morning, about 11,500 delivery demands for 100 ounce ingots were made at COMEX, which represents about 5% of the previous open interest. Another 2,000 contracts are still open, and a large percentage of those will probably demand delivery. These demands compare to the usual ½ to 1% of all contracts.
The U.S. economy is in shambles. Both commercial and investment banks are insolvent. European central banks no longer want to sell gold. China wants to buy 360 tons of it as soon as humanly possible, and as soon as it can be done without sending the price into the stratosphere. A close look at the Federal Reserve balance sheet tells us that Ben Bernanke eventually intends to devalue the U.S. dollar against gold. There has been a vast expansion of Fed credit, which has risen from $932 billion to $2.25 trillion in the last two and a half months. The Fed has bought nearly all toxic bank assets that were supposed to be purchased pursuant by the $700 billion Congressional bank bailout.
Official bailout funds have been used to buy equity interests in the various banks instead. By avoiding the use of monitored Congressional funds, the Fed has embarked on a secretive campaign to buy toxic assets. They have refused to give any accounting of their activities, even though they are using taxpayer money to do this. The Fed has refused, for example, to comply with a “freedom of information act” request from Bloomberg News. That refusal is now the subject of a major lawsuit.
The Federal Reserve has embarked on the biggest money printing surge in history, though the world economy has yet to feel its effect. To prevent newly printed dollars from causing immediate hyperinflation, these newly printed dollars have been temporarily sequestered into the banking industry’s reserves, rather than being released for general use. This was done in a number of creative ways.
First, the number of “reverse repurchase agreements” has been increased to $97 billion. A “repurchase agreement” is a non-recourse method by which the Fed increases the money supply by paying dollars for collateral. The collateral, in this case, are toxic defaulting mortgage bonds that banks want to be rid of. The cash enters the system and theoretically stimulates the economy because it supplies banks with money to make loans with.
A “reverse repurchase agreement” is the exact opposite. It is a method of reducing the money supply by selling bonds to the banks, and taking the cash back out of the system. In this case, the Fed gave banks cash for toxic defaulting mortgage bonds. Then, it took the same cash back by selling the banks new treasury bills just received from the U.S. Treasury. The Fed, in turn, bought these T-bills with the newly printed dollars. The banks, having gotten rid of toxic assets, were allowed to transfer private risk to the taxpayers. This process bolsters bank balance sheets by privatizing bank profits, and socializing bank losses.
At the same time, the U.S. Treasury has been very busy selling newly printed Treasury bills to anyone foolish enough to buy them. To a large extent, the fools reside overseas, but some reside inside this country, and the sale of these U.S. bonds has resulted in a substantial inflow of foreign reserves to the Treasury. Banks have also been offered favorable interest rates on both reserve and non-reserve deposits held at the Fed.
This was combined with what is probably a tacit agreement by which the banks were given the money and led to redeposit most newly printed cash back into the Fed, in a category known as “Reserve balances with Federal Reserve Banks”. This category has ballooned from $8 billion in September to $578 billion on November 28th.
On October 9, 2008, the Federal Reserve began paying interest on deposits at Federal Reserve Banks. The overnight rate happens to have dropped way below the “official” federal funds rate. Meanwhile, rates paid by the Fed on required deposits are only .1% less than the federal funds rate, and on voluntary deposits only .35% less than the federal funds rate. Accordingly, U.S. banks can engage in a dollar based one-nation carry trade, which further sequesters the newly printed dollars.
Banks are borrowing from the Fed, then taking the same money, redepositing it, and earning a spread on the interest rate differential. Banks can also deposit newly printed dollars into a category known as “Deposits with Federal Reserve Banks, other than reserve balances.” This category also earns interest in a similar way, and has risen from $12 billion to $554 billion in the same time period. The funds will eventually be used for direct lending from the Fed to open market borrowers, at huge levels of risk that even the free-wheeling cowboys who run things at America’s private banks are not willing to accept.
That being said, most money center banks in America are certainly NOT risk averse, even now. People who are bailed out of foolish decisions never become risk averse. They are, however, very insolvent, and, aside from the non-recourse provisions of Fed repurchase agreements, they would prefer, for bad publicity reasons, not to default on their obligations to the Fed. Aside from the newly printed dollars given to them by the Fed and the recent transfer of all risk to the taxpayers, they have no liquidity of their own with which to make new loans. That is why they aren’t making any. The Fed will eventually make the loans itself and take all the risk, while using the private banking system as merely a means for delivery.
Right now, however, the Fed wants to sequester the new dollars, until the U.S. Treasury has finished the major part of its funding activities. That will allow the Treasury to borrow money at very low rates. The Fed intends to feed money into the system, but at the minimum rate needed to prevent the DOW index from staying under 8,000 for any significant period of time. Right now, most measures are designed simply to stop U.S. banking laws from automatically requiring the closure of most big banks.
The extent of manipulations engaged in by this Federal Reserve is mind numbing. The total number of sequestered dollars has now reached well in excess of $1.2 trillion dollars. That means that Fed credit, so far, has been effectively increased only by about 10%, over the last 2.5 months, rather than 150% that appears on the surface of the Fed balance sheet. The rest is temporarily sequestered.
Back in July, the U.S. Treasury, through the ESF (Exchange Stabilization Fund), sold billions of euros and, I believe, established a dollar sequestering “derivative” by paying interest, perhaps in Euros, to foreign money center banks. This was designed to keep dollars out of circulation, overseas. It was the beginning of the dollar bull back on July 15th.
I had thought, at the time, with good reason, that the U.S. would run out of foreign exchange and would be forced to close down the operation within a few months. I underestimated Ben Bernanke.
Instead, the Fed managed to establish currency swap lines with various foreign nations, under the guise of supplying them with dollars. This need for dollars arose partly as a result of the actions of the Fed, in sequestering Eurodollars in July, and partly as a result of the multiple credit default events which triggered over $2.5 trillion worth of selling in the stock and commodities markets, as 50 to 1 leveraged players were forced to cover about $50 billion worth of credit default insurance obligations.
In truth, the Fed needs the foreign currency more than the foreign central banks need dollars. The Fed is using its new foreign currency resources, in part, to control the value of the dollar, and to insure that U.S. bailout bonds are sold for the highest possible prices at the lowest possible long term costs. Anyone who buys long term Treasury bills is going to lose a fortune of money in the long term.
The Fed has also taken a number of steps beyond those already discussed to restrict aspects of the normal money supply which most strongly affect exchange rates. For example, they only allowed “currency in circulation” to rise by $33 billion in aggregate, while at the same time increasing foreign reverse repurchase agreements to reduce foreign availability of dollars by $30 billion, and reducing the “other liabilities” category dollar availability by another $7 billion. Since it is likely that “other liabilities” involve foreign held dollars, this resulted in a net deficit of $4 billion on foreign exchange markets, as compared to September, 2008.
All these actions, taken together, have supported the dollar overseas, and led to a breakdown of the commodities markets. The adverse effect of a paradoxically rising dollar has been especially severe in dollar dependent commodity producing nations, such as Ukraine.
The net effect is that the U.S. dollar, in spite of terrible fundamentals, is now King of the Currencies once again, at least temporarily. The rising value of the dollar happens also to support naked short sellers of gold and silver, on COMEX, and these are old friends of the Federal Reserve. Supply and demand ultimately determine the price of gold but, in the shorter term, it is inversely tethered to the dollar. When the dollar is artificially high, gold prices will often plunge artificially low.
But, in short, the Fed currently has gained complete control over the value of the dollar. It can now adjust and micromange the dollar on a day-to-day basis. All it needs to do is open and close the “dollar spigot.” When they want the dollar to rise, the Fed can reduce the number of sequestered dollars. When they want it to fall, they simply ease up, releasing dollars into the financial markets. There is only one problem. Real investors are fleeing the stock market, and stock indexes are becoming more and more dependent upon government cash in order to avoid collapse.
People are liquidating holdings in mutual funds, and redeeming against hedge funds at a fantastic rate. This has created heavy downward pressure on stock prices. If the DOW falls below 8,000 for any significant amount of time, most big American insurance companies will be forced to recognize huge losses on their portfolios, and will become insolvent. Insolvent insurers, like insolvent banks, must be closed by their regulators as a matter of law. Obviously, mass insurer bankruptcies would be yet another major destabilizing slap in the face to an increasingly unstable economy.
The Fed now has only two ways to stop this. One is by brute force. It can buy securities directly, through its primary dealers, thereby supporting and pumping up stock prices. It has done a lot of that in the past few weeks, but this method is highly inefficient and costly. It is better to catalyze upward market movement rather than force it. Catalysis of markets involves opening up the money spigot a bit, allowing some of the sequestered funds to bleed back into the system. This allows the stock market to rise or stabilize naturally, as the equivalent of inflation is created mostly in the stock market without substantial bleed through. At the same time, however, opening the money spigot reduces the value of the dollar and causes gold prices to rise. Rising gold price adversely affects COMEX short sellers who are, as previously stated, old friends of the Federal Reserve.
Gold buying enthusiasm, everywhere but at the COMEX, is at record levels, whereas stock market investing appetite is low. For this reason, when the Fed tried to constrict the money supply on Monday, it caused more damage to the stock market than to the price of gold. Gold declined by over 5%, but the S&P 500 collapsed by over 9%. The next day, the Fed eased up on the money supply spigot, allowing the dollar to fall and the stock market to reflate. If the Fed repeats this performance over and over again, stock investor psychology will be seriously harmed. Withdrawals from mutual and hedge funds will accelerate. The stock market will sink at an uncontrollable rate, and the world will surge onward toward Great Depression II, much worse than the first. At some point, there will be nothing the Fed can do about it, no matter what manipulations it attempts. Hopefully Ben Bernanke is aware of the dangerous nature of the game he is playing.
The Federal Reserve must now make a tough choice. In the past, Federal Reserve Chairmen may have felt it necessary to support regular attacks on gold prices to dissuade conservative people from putting a majority of their capital into gold. Now, however, the world economy needs much higher gold prices in order to devalue paper money, not against other currencies in a "begger thy neighbor" policy, but against itself. This can jump start the system. If the Fed continued to support gold price suppression, that would collapse the stock market far deeper than they can afford, most insurers will end up bankrupt, and there will be no hope of avoiding Great Depression II.
I think Ben Bernanke is aware of this. Gold shorts will be abandoned, to avoid financial catastrophe. In commenting, I take a practical view, accepting what appears to be so, without passing judgment on the acts and omissions of the last 21 years.
Anyone who reads the written works of our Fed Chairman knows that Bernanke’s long term plan involves devaluing the dollar against gold. This is the exact opposite of most prior Fed Chairmen. He has overtly stated his intentions toward gold, many times, in various articles, speeches and treatises written before he became Fed Chairman. He often extols the virtues of former President Franklin Roosevelt’s gold revaluation/dollar devaluation, back in 1934, and credits it with saving the nation from the Great Depression. According to Bernanke, devaluation of the dollar against gold was so effective in stimulating economic activity that the stock market rose sharply in 1934, immediately thereafter. That is something that the Fed wants to see happen again.
It is only a matter of time before gold is allowed to rise to its natural level. Assuming that about half of the current increase in Fed credit is eventually neutralized, the monetized value of gold should be allowed to rise to between $7,500 and $9,000 per ounce as the world goes back to some type of gold standard. In the nearer term, gold will rise to about $2,000 per ounce, as the Fed abandons a hopeless campaign to support COMEX short sellers, in favor of saving the other, more productive, functions of the various banks and insurers.
Revaluation of gold, and a return to the gold standard, is the only way that hyperinflation can be avoided while large numbers of paper currency units are released into the economy. This is because most of the rise in prices can be filtered into gold. As the asset value of gold rises, it will soak up excess dollars, euros, pounds, etc., while the appearance of an increased number of currency units will stimulate investor psychology, and lending and economic output will increase, all over the world. Ben Bernanke and the other members of the FOMC Committee must know this, because it is basic economics.
Many venerable names in banking agree, although none have gone so far as to take their thoughts to the natural conclusion. Both JP Morgan Chase's and Citibank’s analysts, for example, are predicting a huge rise in the price of gold. That is interesting because GATA has come up with fairly compelling evidence that JP Morgan Chase (JPM) and HSBC (HBC) may have been big COMEX naked short sellers in the past.
Goldman Sachs (GS) is also a huge bullion bank, which allegedly is heavily involved in downward gold price manipulation. However, this month, both HSBC and GS took lots of deliveries of gold from COMEX. Given the size and bureaucracy at such firms, it is certainly possible for the majority of traders to be entirely honest, while others, at the same firm, may be totally corrupt.
More important, however, than dwelling on the accuracy of conspiracy theories is the fact that huge international banking firms normally do not take metal deliveries from futures markets. They normally buy on the London spot market. The fact that they are demanding delivery from COMEX means one of two things. Either the London bullion exchanges have run out of gold, or these firms are finding it cheaper to buy gold as a “future” than as a spot exchange.
Smart traders at big firms may be buying on COMEX to sell into the spot market, for a profit. This pricing condition is known as “backwardation”. Backwardation is always the first sign that a huge price rise is about to happen. In the absence of backwardation, there is no rational explanation as to why HSBC, Bank of Nova Scotia (BNS), Goldman Sachs, and others are forcing COMEX to make large deliveries.
The fact that this backwardation is hidden from the public eye is not surprising. In spite of the ostensible existence of a so-called “London fix”, 96% of all OTC transactions are secret and unreported. The transactions happen solely between two parties, and are done opaquely, in complete darkness. The current London fix may well be just as fake as the bank interest rate reports that comprised LIBOR proved to be, just a few months ago.
It won’t matter much if you purchase gold at $750, $800, $850, $900 per ounce, or even much higher. All of these prices will be looking extraordinarily cheap in a few months. The price of our pretty yellow metal is about to explode, and it is probably going to soar, eventually, to levels that not even most gold bugs imagine. COMEX gold shorts will be playing the price a bit longer, in an attempt shake out some remaining independent leveraged longs. Once that is finished, however, and it will be finished soon, the price will start to rise very quickly.
Disclosure: The author holds physical gold and is long positions in GLD and gold futures.
Russia.... thats really the trick part of the question.... Because of their natural resources (LOTS of gold in Siberia) they could have many tons of it squirreled away.... But given the way Putin has been playing his own games for the last 9 years I wouldn't be surprised if he had less than ten pounds or more than ten thousand tons of it stashed in his central bank.
They are both prime gold producers so naturally they are good candidates to back their currency with gold or create a new gold backed currency. Even 40% gold backed will be in demand
But I suspect nether government hold's much. In Russia case everything valuable was stolen and sold to KGB and Communist bosses back in the 1990s. I would bet the Central Governments gold was stolen too
Plus I doubt there was much to steal but that most was spent during the crisis years (Yeltsin Gorbachov) before and after the fall of communism
So what we left with is possible coalition of governmanets and large corporations (such as Toyota and Walmart) who would start up a gold backed currency. I'm sure there would be demand for it. But then you get to the question of where would this gold be kept. What nation would this "Fort Knox" sit in? Would it be safe?
If our gold is really in Fort Know maybe the US will start a gold backed currency. There is no reason we couldn't have a green dollar and a gold dollar
I personally was part of a group that moved around 10% of that amount during an audit in 1977. There were plenty of sealed vaults we didn’t move, to make up the rest. You could peer into them and see the gold there. So it was there, then.
I need to find my picture of Michael Blumenthal, Carter’s Treasury Secretary, standing in a vault, gold stacked to the ceiling, holding an ingot, with my name scrawled in chalk on the masonite on the wall behind him, among the other chalk graffiti we put there.
Legend Has It ;-) that most of the Ft. Knox gold has been transferred to the Federal Reserve vaults during the last 30 years... And no telling where it has gone since then.
Even if it hasn’t been moved, even if there are 400+ tons of gold there at Ft. Knox, it doesn’t belong to the Government (the people) any more. The Federal Reserve has a 100% lien on that gold for all the paper they have put green ink on over the last 55 years.
The practices can be curbed by electronic means. It’s not as if nobody knows what is going on it’s just that not everybody knows what is going on. That is why some “unnamed hedge fund” could short AIG stock with impunity — such that 125% of its entire issue was short (which obviously means that the market was forced to absorb 125% more shares than the company issued). The broker didn’t stop his client from shorting when it hit 100% and to this day nobody asked who pushed it over the brink. All that needs to occur is that all the brokerages report the short volume in real time into a central database. Make shares short transparent and in real time just like everyone can see volume and price and bid and ask, and force a pre-borrow before a short sale can be executed. Computers can control it to make sure that 1) shares are available to borrow and 2) that the same share isn’t borrowed twice.
In addition, the SEC should force reporting of short interest if it should exceed a small % of the issue, just like they force reporting of long shareholders who exceed 4%. What we have today are money pools (hedge funds) that control billions in capital and have leverage that exceeds 5:1. They can literally control the price movements of scores of mid-cap stocks simultaneously. If 2 or more Hedge Funds talk to each other about their actions it is a conspiracy. Technically if you and I talk about it it’s a conspiracy but the likelihood of you and I moving the market is absurd. But look on youtube for the video of Jim Cramer talking about how he would “foment” by taking a large put position then hitting the bid with shorts then calling journalists to “foment” the idea that the sell-off they are seeing is due to a “rumor” that product X is broken or delayed or whatever.
And in no circumstances should anyone be allowed to short more than they can borrow. If they fail to deliver their shorts they should be required to buy them back.
As to derivatives, again it is the lack of transparency. The Credit Default Swaps specifically is another matter altogether. CDS’s are basically an insurance bet. When you buy a mortgage backed security you are betting that the mortgage payments will flow in your direction. The CDS is insurance in case of default that causes the payments to stop. What was to stop anyone from rigging that game? I could buy properties with 10% down via one fund, and short those properties through CDS’s in another fund, then stop paying the mortgages. AIG would have to pay off my 2nd fund the full 100% face amount, while my first fund which only put up 10% would renegotiate with the bank or simply surrender the properties who cares it cost 10% to make 100%. IMHO that whole class of securitization was an easy scam waiting to happen.
There may be nothing wrong per-se with derivatives as hedging instruments - but certainly they shouldn’t be secrets. They need to be public information if they are traded in markets. Otherwise, if they are private agreements unregulated by the agencies then they should not get a bailout.
Chris Cox simply didn’t want to do his job. He is, imho, corrupted or lazy. He isn’t incompetent and he isn’t overworked. He has been bombarded with calls and letters about the naked short selling problem. Patrick Byrne has led a crusade against it, and all Cox has done is ask for 3 comment periods. He just delayed and delayed and delayed action and here we are today with the DOW down 6000 points, and the Treasury printing over $2 trillion in cash and still the economy is shrinking and unemployment is rising.
Sorry for the rant but the lack of action by this administration has been atrocious and these problems were forseeable by people a lot smarter than me. My only saving grace is that I didn’t have much money in the markets. I blame Bush for his inaction and for letting Paulson take the lead here. We needed a leader and Bush abdicated control to Goldman Sachs with Congressional support. Well I’m sure Goldman Sachs knew quite well where the problems were within the market itself but plugging the holes with cash isn’t enough to fix these problems for the future.
For currencies, I have started to follow the Russian ruble. They will be devaluing it quickly against the dollar. But if the dollar crashes, oil will rise, and the Russian economy can recover quickly.
I have not bought anything yet, and don't recommend anything to anyone.
Do you have an ycomment on the 75 to 1 ratio of gold to silver?
YOuwwrote your commenttstinDec 4.
What are now?
Buy gold?
Buy silver?
Buy both?
I really don’t have any advice to give in that respect at this time. Both are at prices that make me glad that I’m not buying either one right now.
If they dip below $850Au and $11Ag again I’d consider buying either or both.
And as far as ratios... I never even put any thought into that... To my way of thinking Au & Ag should analyzed mostly independently.
I’ve always preferred silver to gold, since more of silver’s value is based on utility rather than psychological which is the primary thing that makes gold so costly.
Thanks for your comment.
I just finished reading again the manipulation of gold prices.
I’m been following currencies, money supply, and commodities for years. I’m not an expert in fact consider myself just a beginner in understanding the manipulation of commodity markets.
But I do know this, having in my lifetime invested hundred million dollars and $1 billion with a retail businesses:
many of the comments, listed in the manipulation article will come true. It’s not a question of if but when.
I also subscribe to the thinking of Chris Martinson philosophy that their three controlling factors on this third rock from the Sun. First population control, second petroleum, third finally, financial paper money. Chris, states several hundred paper economies have failed in the past two centuries, as politicians and financial managers inflate away their past that. This places the burden of inflation on the back of those who save paper money.
http://www.chrismartenson.com/crashcourse/chapter-1-three-beliefs
checked Chris out and see what you think.
Chicago farmer
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