Will China ‘Amnesty’ Birth the Black Swan?

For those who have been unsettled by gold's corrective weakness in recent days, I've reprinted a reassuring letter below from a friend and longtime subscriber who also happens to be a U.K.-based gold-dealer and metals trader. Andy, as he is known in the Rick’s Picks chat room, is bullish as ever on gold and sees a potential "black swan" bearing down on the financial system in the form of a Chinese derivatives-default. This is a looming catastrophe that we've written about here before, as some of you may recall. The threat surfaced with an announcement by China a couple of months ago that the government would take no legal action against its own banks if they walked away from derivatives deals gone bad.

Imagine what this would mean if you were running one of those banks yourself. In effect, it would allow you to build extremely risky derivatives positions, but with no exposure if they didn't work out. Here's an analogy: Picture yourself being allowed to use counterfeit money in a casino. You make huge bets in roulette, blackjack and baccarat, and although most of these bets lose, the casino pays your winners in real money. You bank the winnings -- buy gold bars with it, perhaps -- and continue to gamble with funny money until you've used it up.

This, in effect, is undoubtedly what some Chinese banks are doing right now: laying highly leveraged bets all over town, knowing they won't have to cover them if the derivatives market starts to implode again. Moreover, the mere fact that the Chinese government has promised legal amnesty to those who lose big at this game is probably causing the volume of such bets to explode. We'll find out for sure when reality comes calling once again on the banking system, which, with the help of regulators and the central banks, has done little more than sweep a $600 trillion derivatives problem under the rug.

Make no mistake, when the festering creature under the rug emerges one day breathing fire, we're likely to see a panic into gold that will make bullion's ascent so far from $260 to $1227 look relatively tame. What will be the catalyst for this Day of Reckoning? Nick Guarino, a well-known seer, thinks Dubai's troubles are about to take the global financial system down. But he also believes the resulting panic will be into U.S. dollars rather than gold, which he says is in a bubble along with oil and stocks. (Click here for a scary read, in Guarino’s own words.)

Andy disagrees, and we have reprinted his letter below so that you can understand why. Here it is:

"[Guarino] has a lot of things right. However I think his take on gold is wrong. I have a completely different take on it. There are several reasons --for example, why would the producers buy back their hedges at these levels? It is because they know higher prices are coming down the pipe. What kind of business-sense would it make, if you have Gold hedged from the $300's through the $900's on the books, to consider locking in such a massive loss if you could average down the price by selling forward production above 1000?

"As far as Wall Street creating a bubble in the price of gold, you only have to look at the massive concentrated short positions to see the opposite is true. There are all the usual reasons why JP Morgan, HSBC et al. act for the Fed in keeping a leash on Gold's rise in an attempt to prop up the U.S. dollar. But there are several cracks in the dam. Gold is having ‘up’ days when the dollar is rising, and HSBC is covering while JPM is taking the load. Physical supply is VERY tight. We were offered 125% premium not to take delivery of our September contracts because unallocated LBMA gold runs on a fractional-reserve basis and they simply didn't have the metal to deliver. We are now demanding delivery of December early and are hearing the same song.

“My client refused, and will refuse again, to take a cash settlement and insists on physical. They are looking longer-term and don't care if gold is as $1000 or $1300. My orders are to keep buying all the dips. We will take advantage of rollovers, option expiries, fix takedowns, NFP today etc. and keep this up until further notice. Something big is going down here, and I am hearing China will default on their OTC obligations and Gold will become very tight.

“Personally, as a trader I will take the cash premium again if it comes up and immediately buy spot, which I will quietly convert to physical.) I hope we do get a dip over the next few days but I am just one of many looking to convert paper to gold. As an aside, the new futures position-limits kick in before month's end, and it is not the long side that will be affected. JPM has over 40 % of the silver shorts and the CFTC is under pressure to deal with it and the Gold position.

“Here is a link to my last letter to Chilton that I see popped up all over the net. Historicals no longer apply -- there has been a major shift in the dynamics. I look forward to coming back 'home' to the chat board in the New Year. Thanks for all your good work.”

Interesting post. Yes, these days, gold is still going up even when the dollar goes up, and even when the stock market goes up. The oil-dollar exchange link is functioning but gold seems disconnected now from the dollar value. The correction in play is a consolidation and adjusting of basis. I believe the next run will be soon, through Christmas and New Years, as traders look for a safe place to put proceeds from equities they want to exit by year end. Copper and silver generally track gold lately too.

Black Swan Theory

The Black Swan Theory is used by Nassim Nicholas Taleb to explain the existence and occurrence of high-impact, hard-to-predict, and rare events that are beyond the realm of normal expectations. Unlike the philosophical "black swan problem", the "Black Swan Theory" (capitalized) refers only to unexpected events of large magnitude and consequence and their dominant role in history. Such events are considered extreme outliers

If China defaulted it would certainly qualify as a Black Swan event. Remember they just said the banks stuck them with junk.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aYH5edxx8gvc&pos=5

Who is to say they would not decide to write it off in this manner.

Oh and you might want to take a look at these

http://johngaltfla.com/blog3/2009/12/08/death-of-the-gold-bull-nah-hes-hiding-with-tiger/

http://commoditytradealert.com/blog/

Tell me what has changed to avert the coming financial collapse? Nothing. The admin has actually taken measures to make it worse...

so why would I expect anything other then the inevitible?

(gold is set... I’m working on supplies)

"(gold is set... I’m working on supplies)"

Good move.

(morning bump)

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