GOLD REPORT MYSTERIOUSLY “LEAKED”
You didn’t
hear about this on the national news, CNBC, or in your local newspaper. After all, most of these controlled/scripted
sources of “news” are still trying to keep us all believing that all is well
with the world. In particular--though the
stock market’s recent meltdown has often been made even more dramatic by the ways it’s
being covered--the Establishment media nevertheless goes out of its way to, generally,
support our fractional reserve banking system. As
part of this process, it will usually go out of its way as well to dismiss gold and gold
bugs as wackos, and to--as much as possible--discredit gold as either an investment or
monetary alternative.
Thus, our press
saw fit NOT to cover a news story that broke last month which should have made the front
pages of at least every financial publication.
From time to
time, I have commented on the ongoing efforts of GATA (the Gold Antitrust Action Group) to
bring to the light of day their contention that gold prices have been artificially
controlled by a cabal which includes our own Federal Reserve. This has been done through a variety of means
which has resulted in the future financial health of large mining companies and certain
financial institutions being called into question, as these outfits have used various
short-selling and derivative-related devices in the past to profit while gold’s price
was declining. Now, these parties are
arguably at risk from a spike in the price of gold, which would cause their “bets”
to plunge under water. A spike higher in gold’s
price would decimate some of these players; thus, GATA’s claims go, the
powers-that-be must keep gold relatively contained at all costs; even though it means that
there really is not a true “market” price for the yellow metal being realized,
and even if it means that all this chicanery constitutes a serious, unreported threat to
the entire financial system.
GATA’s
claims have received short shrift from almost everyone, however. And, as you already know, their law suit was
dismissed earlier this year.
However, the
publication of a March, 2002 report somehow obtained by GATA has given significantly new
credibility to the group’s claims. It
has also made some people in the financial world extremely nervous.
It seems that
well-regarded mutual fund manager John Embry of Royal Bank of Canada (among other things,
he manages the bank’s very successful precious metals mutual fund, which happens to
own a significant piece of Claude Resources) authored a report on the gold market for his
peers at the bank. In it, he offered his
viewpoint that--among other things--there has indeed been a “conspiracy” to
suppress the gold price, the suppression has been engineered chiefly by the U.S. Federal
Reserve, and that the Fed is scared to death that it could lose control and have all those
billions of dollars worth of derivatives to clean up.
The ingredients, according to Embry’s report, could lead to a far more
dramatic price rise at some point than most expect.
Somehow, this
report made its way outside the four walls of RBC, and ended up in the hands of Bill
Murphy at GATA. Needless to say, Murphy has
spread Embry’s report far and wide. I
would too, if I were him; after all, Embry is one of the most highly regarded money
managers in Canada. His firm is not some
local coin shop where local militia members come to talk conspiracy over coffee all day
long; it’s one of the biggest financial companies in North America.
For their part,
embarrassed (and quite angry) Royal Bank officials were quick to claim that Embry’s
report does not represent the bank’s views. Instead,
this was a report meant for other managers and big shots at RBC, and was not intended for
public consumption, they say. Bottom line,
the bank is hopping mad that of all the people who got their hands on this, it was Bill
Murphy. (NOTE: Murphy claims that this report
also went to some of the “biggest and best” clients of the bank, one of whom
forwarded it to him.)
Embry cannot be dismissed, however--and he is respected
enough that this report is turning some heads. As
Matthew Ingram of Toronto’s Globe and Mail
put it in one article on this crazy story, getting such a well-regarded money manager from
a major bank to essentially agree with what GATA has been saying for a few years now is,
“. . .a bit like the U.S. government admitting that yes, there was a top-level CIA
plot to assassinate former president John F. Kennedy, and the whole lone-gunman theory was
just a crock.”
THE REPORT
Following is a
copy of Embry’s report, generously forwarded to me by Murphy:
RBC INVESTMENT MANAGEMENT, LTD.
Report
on Gold
Clearly, with
gold stocks on a tear as the gold price moves laboriously forward battling the fervent
attempts to suppress it, one must be comfortable with the notion that the gold price
is going to
overcome the forces that are aligned against it. What
is happening today is no different than what was happening in the late '60s and the very
early '70s, when the Gold Pool was in existence and the gold price was contained at $35
per oz. by a consortium of central banks that dumped a considerable amount of gold to keep
prices down. Today, instead of the overt action of yesteryear, it is covert because the
market is allegedly free, and it has entailed a
So the question
obviously is: “Will the gold rally ever begin?” The following arguments
emphatically suggest that it will more than rally; it will explode to the upside.
1.Unsustainable Supply/Demand Imbalance
Mine production
has flattened out at 2,600 tonnes and is beginning to fall due to a lack of exploration,
falling grade at many mines due to previous high-grading, and the closing of older mines
as they run out of ore. It has been estimated by Beacon & Associates in an exhaustive
study that if gold prices were to remain under $300/oz., production will fall in the
neighborhood
of 25% over
the next 5 to 7 years. Scrap supply tends to average about 600 tonnes annually. Demand is
currently estimated to be roughly 4800 tons (primarily jewelry) without any investment
demand from the Western world. The present deficit has been met by direct central bank
sales (roughly 400 tonnes per year) and central bank leasing for mining hedges and
financial speculation.
2. Unsustainable Short Position
Central banks
have ostensibly lent increasing amounts of gold to earn interest on their reserves.
However, when one lends at any rate (less than 1% generally), the question arises as to
whether there may be another motivation. As a rising gold price stands as a direct
repudiation of their alleged responsible monetary policy, perhaps this is the real reason
they have been so aggressive in this area. Bullion banks have borrowed gold from the
central banks for their own accounts and those of various speculators, such as hedge funds
and financial institutions (the carry trade) and for producers (mine hedging) and have
used derivatives to limit their risks and generate additional income. The loaned gold has
been sold into the physical market and is now in jewelry, primarily in the Middle East,
India, and other parts of the Far East. The size of the short position, officially
acknowledged to be more than 5,000 tonnes by the bullion bank apologists, is thought to be
well over 10,000 tonnes and may exceed 15,000 tonnes. To put this in context, this
constitutes between one-third and one-half of all central bank gold, and the vast majority
of it is no longer accessible.
3. Unsustainable Low Inflation
The gold price
has a tendency to rise at the first whiff of accelerating inflation. CPI inflation has
been unrealistically low due to the very strong dollar, which has underwritten vicious
foreign competition and removed pricing power in many sectors. However, in the final
analysis, inflation is a monetary phenomenon and the aggressive interest rate cuts and
monetary
expansion to
avoid recession/deflation is expected to result in re-inflation. Year-to-date, the liquidity injection is more than $1 trillion and
MZM has grown by 16.5% in the past year. To avoid debt default, the Fed must err on the
side of ease, virtually ensuring upside pressure on the CPI. In addition, the “war on
terror” superimposed on Bush's mammoth tax cuts and a four-year government real rate
of spending increases that is the greatest since the '60s portends large U.S.
4. Unsustainable U.S. Dollar
The U.S. dollar
has been levitating for a long time, but the underlying fundamentals continue to erode.
The U.S. current account deficit exceeds $400 billion annually, and the continuation of
this chronic deficit turned the U.S. into the world's largest debtor as most of these deficits are being
recycled into U.S. debt instruments. However, foreign appetite for U.S.
securities
appears to be ebbing and the chart on the U.S. dollar looks very toppy . Gold is already
in a bull market in U.S. dollars, and an
established bull market in every other currency. If the reserve currency, the U.S. dollar,
falters, gold could well be launched on the upside as people recognize its status as the
only “true currency.”
5. Unsustainable Prices for Financial
Assets
Western world
investment demand will be the true fundamental that drives gold much higher. Gold tends to
be counter-cyclical and investors buy it when financial assets begin to lose credibility.
Ownership and pricing (P/E) of financial assets are at historic highs and if inflation
accelerates, the U.S. stock market is extremely vulnerable. The ratio of the S & P 500
Index to the price of gold reached an all-time high, by a considerable margin, in 2000,
but this parabola have been broken and a downward trend is in effect. At the margin, if a
small amount of money is moved from financial assets into gold, the price effect on gold
will be dramatic and the ratio will continue to move in gold's favor.
6. Increasing Evidence of Unsustainable
Gold Price Manipulation
a. Aggressive
gold lending, which from an economic perspective is indefensible, has filled the
supply/demand gap.
b. NY Fed gold
has been mobilized when the gold price is rising.
c. Timing of
Exchange Stabilization Fund gains/losses corresponds to gold price movements.
d. Audited
reports of U.S. gold reserves show unexplained variances.
e. Minutes of
Fed meetings confirm officially denied gold swaps.
f. Rules on gold swaps revised but subsequently
denied. However, individual central banks have repudiated the denial.
g. U.S. gold
reserves have recently been re-designated twice, initially to “custodial gold”
and latterly to “deep storage gold.”
h. Statistical
analysis of unusual gold price movements since 1994 indicate high probability of price
suppression. The invalidation since 1995 of Gibson's Paradox -- that gold prices rise when
real interest rates fall -- suggests that the real manipulation began then.
i. NY gold price
movements versus London trading defy odds.
j. Timing of
huge increases in bullion bank gold derivatives is consistent with gold price declines.
k. Rapid decline
in U.S. Treasury holdings of gold-backed SDR certificates is not explained.
One or two of
these factors could be viewed as random, but the full body of evidence is overwhelming.
It would appear
that gold is beginning to be viewed as money again. Gold is the only monetary asset that
doesn't represent somebody else's liability, and with U.S. real short-term interest rates
now in negative territory, there is no disadvantage in holding gold. Those with a vested
interest in containing the price of gold -- central banks, bullion banks, heavily hedged
gold companies -- will not die easily, but the tide is moving strongly against them and
the embedded short positions could catapult the gold price higher while imperiling the
future of those holding the short positions.
The great
rallying cry of the bears is the mobilization of even more central bank gold to the tide.
Recently, Ernst Welteke of the Bundesbank has spoken publicly of the Germans selling gold
after the initial Washington Agreement limiting European central bank gold sales to 400
tonnes per year expires in late 2004 with the intention of redeploying into stocks and
bonds. Formerly, commentary and action of this sort by central banks (the announcement of
Swiss sales, the initiation of English gold auctions, etc.) devastated the gold market but
this elicited
little more
than a yawn. An astute gold analyst in South Africa postulated the reason why, perhaps.
There are strong rumors that Deutschebank has borrowed an enormous amount of gold (more
than $10 billion worth) from the Bundesbank over the years to facilitate the carry trade,
producer hedging, etc. and it is becoming apparent that there is no way they will be able
to pay it
back.
Perhaps, to make good on their gold loans, they will reimburse the Bundesbank with stocks
and bonds and Mr. Welteke is readying the German public for this with his statements.
In addition,
there are enormous dollar reserves building up in the Far East, particularly in China, and
the Far East has acknowledged being significant buyers of gold. So the flow of central
bank gold is not only one-way. Even the Russian Central Bank is on the buy side. The
shibboleth of central bank sales will undoubtedly be trotted out again, but it is losing
its sting, particularly if the possibility that as much as half of all the central bank
gold may already be in the market starts to become more widely recognized.
In addition, in
the '70s, when gold was rising sharply in price, central banks, after having been heavy
sellers at $35/oz., sold little or none at higher prices. Central bankers are no different
than the momentum players; if the price is rising, they are more likely to be buyers than
sellers.
One last
observation concerns the gold share price action prior to the explosion of gold prices in
the '70s. Then, as now, gold stocks rose to prices that made no sense to observers who had
a static view on gold prices, but the stock buyers knew that sharply higher gold prices
were
7. Gold Stocks
Gold stocks are
perceived by many to be expensive, but, in fact, they are considerably cheaper than they
were in the late '90s. The central banks' overt attempts to bring the gold price down
(Swiss sales, British auctions, etc.) at that time removed the premium in gold shares and
it is now gradually being restored as confidence returns to the sector. In fact, if the
gold prices were to rise sharply, I would not be surprised if the price to NAV continued
to rise due to a shortage of viable gold stocks.
-END-
There are at
least some in the press who have been picking up on this story since it broke, and have
provided some additional insights. Recently,
I came across an article by Ian Williams, head of fixed income and commodity research at
European investment house Durlacher, Ltd. Following
are his thoughts penned on July 9:
LONDON
(ShareCast) - There may be trouble brewing in the gold market. But for a change, this trouble will be good for
gold bugs as an unusual confluence of events pushes gold, currently trading around $310 an
ounce, to $400 and above. And it will prove very bad for any
The phenomenon
revolves around a highly unusual form of gold derivatives, a market in which Citibank,
Goldman Sachs and JP Morgan are the major players. The particular form of derivative is a
type of hedging pioneered by Barrick, one of the world's largest gold producers
Ordinarily, a
hedge protects a producer or investor from the downside, but, other things being equal, it
does so by limiting their upside. Barrick, however, has managed to construct a hedge that
allows it considerable upside if gold rises. And one big bank could be caught very short.
Barrick has been
a very good hedger, making use of all sorts of instruments and investment strategies. In
fact, at the end of 2001, its hedge book had assets of $5.5bn, which was more than the
gold-mining part of the company.
It appears that
part of this success comes from what is known as a spot deferred forward sale contract,
which it started using in 1990.
Barrick makes a
forward contract with a bank to deliver (unmined) gold at a certain price at a certain
date. But - and this is what makes these contracts different and, indeed, dangerous for
counter-parties - Barrick also had the right to defer the delivery of the gold for periods
ranging from five to 10 years. Recently
Barrick has entered into contracts that allow it to defer
While deferring
or rolling over a contract is not unusual in the financial world, it can usually be done
for only a short period and both parties have to agree. But Barrick appears to have pulled
off a coup by writing extended-length contracts that allow it to take the decision
This can be very
lucrative for Barrick. Say gold is trading at $300 an ounce and Barrick agrees to sell
Bank X 1m oz of gold at $320 an ounce in 12 months. If gold then trades at $310 an ounce
one year later, Barrick will sell the gold to the bank and receive a better price than it
would get elsewhere. But if gold has shot up to $350, Barrick can choose to defer the sale
to the bank, and sell its gold in the market. This gives it the best of both worlds -
little risk and the highest price available.
If you are Bank
X holding the obligation to buy the 1m oz at $320 per ounce, then you need to hedge this
position in the market. Standard gold futures contracts have no deferral clauses, so you
sell forward the gold that you don't have, which means you are now relying on Barrick to
deliver the gold so you can fulfil your end of the bargain.
If Barrick
decides to defer the sale, though, there could be trouble - which is what we hear could
happen.
Apparently, one
sizeable bank active in this market has a gold derivatives book of $41bn, a significant
part of which is attributable to its dealings with Barrick. Barrick's contract apparently
has the option to defer any sale. If the gold price starts to accelerate, Barrick could
How will it do
that? It will have to buy the gold - potentially hundreds of millions of dollars worth -
in the market. A forced buyer of that size would send gold rocketing to $400
You may have a
question: How could a bank do something so risky? Eight words give a clue to that: Enron, Savings & Loans, Long-Term Capital
Management.
Finally, one
more perspective on a story we will undoubtedly hear more about in the months to come;
this one from Thom Calandra, a regular writer for CBS’ MarketWatch.com, and co-author
of the upcoming book, “How America Made a Fortune and Lost Its Shirt: The CBS
MarketWatch Stories Behind the Numbers.” This is his column of June 7:
Hedge edge may spark mad scramble:
Wall Street banks' gold derivatives in danger zone
SAN FRANCISCO
(CBS.MW) - As gold's polar opposite, Nasdaq, gets blasted, bullion investors expect
miners' risky hedge books to further boost the metal.
By some
estimates, gold mining companies are hedging, or selling forward, about 4,000 tons of
gold. Some analysts say it's far more. As gold prices continue to rise in the face of a
weak stock market and a declining dollar, most of the world's largest hedgers are looking
for ways to reduce the hedge risk from their books.
Earlier this
week, South Africa's AngloGold Ltd., the second largest gold miner as measured by
production, indicated it would continue to slim its hedge book. The company took 105 tons
of gold off its forward-sale program in the six months ended March 31.
Other highly
hedged companies, including Canada's Barrick Gold, say they will keep slimming their use
of derivatives and the bullion leasing market to hedge gold production. In bad times, when
gold prices were below $300, such practices created extra revenue for gold companies.
Hedged instruments harvested a higher gold price than was available in the spot market for
bullion.
Yet critics of
the practice long have pointed out how hedging by gold miners battered the gold price,
mostly by encouraging the lending of central banks' gold reserves to investment banks,
which then design hedge programs. Essentially, hedging of any type is a short-sale against
the price of gold. Now that gold is flirting with $330 an ounce in the spot market, gold's
most outspoken investors see the hedge-rush adding speed to the gold rush.
“I see $340
and $360 an ounce as the danger zone for banks, that is where hedging and the hedge book
problems start to have an impact,” said Ian McAvity, editor of Toronto newsletter Deliberations on World Markets and a director of
gold and silver closed-end fund Central Fund of Canada.
“I expect to see a $25 up day for gold one day, largely due to someone
getting skewered by their hedge book, either the bank that extended it or the mining
company.”
A rapidly rising
gold price is the worst enemy of hedged miners and the banks that designed their
derivative strategies. A powerful gold rally could force some miners, or the banks behind
the hedge books, to engage in a mad scramble to locate gold and deliver it to the original
lenders. McAvity points to the largest investment banks, among them JP Morgan Chase, as
facing the most risk from the continuing gold rally. Gold's spot price is up about 20
percent since Jan. 2. Figures from the Office of the Comptroller of the Currency show JP
Morgan Chase having the largest exposure to gold derivatives among U.S. banks and trusts,
as of Dec. 31.
JP Morgan Chase
held $41.04 billion of gold derivatives of all maturities as of Dec. 31, according to the
Comptroller of the Currency. The total amount of gold derivatives for U.S. commercial
banks and trusts last year was $63.3 billion.
McAvity sees the
declining dollar and the move away from Nasdaq and other expensive company shares as
positives for the gold price. The euro is zeroing in on 95 cents vs. the dollar for the
first time since January 2001. The dollar has lost about 7 percent against the currencies
of its major trading partners thus far this year.
“The
financial asset mania of 1982 to 2000 is now giving way to a return to tangibles, and a
precious metals trend that should run for many years,” McAvity says.
The gold fund
manager most outspoken about the evils of hedging, John Hathaway, sees fiscal distress for
many parties as gold prices rally. Hathaway's Tocqueville Gold Fund has gained 81 percent
since Jan. 2, holding largely unhedged mining companies such as Gold Fields Ltd. and
Harmony Mining, both from South Africa.
“There is a
huge outcry against hedging among investors,” says Hathaway. “Mine company
managements have received a loud message from the investment world to cover their hedge
books, and all but the most obtuse will be doing so.”
Hathaway sees
gold mining companies issuing new shares to buy physical gold that they use to ameliorate,
or cover their forward sales of bullion. “Durban Deep was the first to do it, and I
believe there will be other, bigger players,” he said.
Durban is a South African company whose shares have gained 290 percent since
Jan. 2.
Hathaway
estimates each $10 rise in the gold price “means the collective bullion dealers have
extended another $1.4 billion to the gold mining industry, based on a 4,000-ton position.”
Hathaway
warns, “A $50 move, which is certainly in the cards, would be $7 billion. What does
this mean? It means a serious squeeze on the bullion dealers, not the mining companies for
the most part. Central bankers who have lent the gold to JP Morgan, Morgan Stanley,
Goldman Sachs and others would not be happy with this situation.”
What can the
bullion dealers do about it? “Not a whole lot, other than buying gold to cover their
short, which is what they are starting to do,” says Hathaway from his Tocqueville
offices in New York City. “Most mining companies, especially the big ones, have
margin-free trading agreements with their various dealers. This means they do not have to
advance cash when the gold price rises. It is too late for the bullion dealers to go back
to the mining companies to change the deal, so they have no choice.”
Hathaway sees
Wall Street clean-up crews at work, frantic in their efforts to erase the gold
derivatives. “There are all kinds of crazy, exotic deals made in the past that will
come to light -- exploding puts, knock-in calls, etc., which had high fees originally but
are now viewed as toxic waste by the dealers who sold them.”
The fund manager
points out that actual gold supplies do not move around as freely as those who need to
cover their hedging strategies would like. “Physical gold is illiquid relative to
short covering demand. This will take gold a lot higher, unless the central banks step in,
which I expect them to do when the gold market gets really disorderly, like gapping $10-$20
a day or more.”
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