Commodities | Aug 01 2006
By Greg Peel
Patrick A. Heller is coin collector. A lot of us have collected coins in the past, particularly as children, but Heller has turned it into a living, and a prosperous one at that.
Heller is the owner of the Liberty Coin Service in Michigan, and editor of "Liberty’s Outlook", a newsletter concerned with all things gold. Heller believes the price of gold will reach US$2,000/oz by the end of 2007.
To understand why Heller provides such as seemingly over-optimistic forecast, let’s consider the events of the last few months in the world of gold.
On May 11, 2006, the gold price hit a 26 year high of US$719.75/oz. This represented a 50% increase from only November. Clearly gold had reached a point of being overstretched, driven as it was by many factors including a newfound popularity amongst novice investors. A lot of this was put down to the recent availability of listed gold trading instruments. No one was particularly surprised that a correction occurred.
They were, however, somewhat taken aback by the sheer ferocity of the correction. Gold dropped 22% in five weeks. Heller noticed that, profit-taking aside, there was no change in the fundamentals that suggested gold should be in a long term boom market.
Those fundamentals have been well documented: the US deficit problem, increasing money supply, falling housing market and teetering economy; slowing growth in foreign investment in US dollar assets, and the potential switch to gold reserves; global geopolitical tension; global inflation.
In this climate the gold price collapsed. While there was a certain amount of stimulus from the world’s largest paper gold market – Comex – in altering trading limitations and margin requirements, observers were also puzzled by a large influx of physical gold onto the market.
The amount of gold sold during this period appears to be in the order of 14 million ounces. Heller notes that no party has come forth to claim such significant sales. The reality is, however, that there are very few sources that could actually hold that amount of gold. (If you took, say, an average price of US$625/oz that would equate to US$8.75 billion.)
Undeterred by the anonymity, Heller suggested the seller could be narrowed down by considering who may have been the biggest beneficiary of the sale. That, he decided, was the US Treasury. The US dollar strengthened as the gold price fell. The US Treasury is one of few contenders who would have that much gold.
The US Treasury is supposed to declare its gold sales. But if the gold came from elsewhere, says Heller, it would still have to be from a different anonymous central bank or international government body "on the sly". There is a possibility that more than one central bank was in on the deal, as a collapse in the US dollar has serious ramifications for the entire global economy.
If it was the US Treasury, then the gold likely came from a drawdown from the US share of the International Monetary Fund (IMF), says Heller. Just how feasible is this theory?
For starters, Heller relates that when the gold price entered the US$700s he heard rumours that "federal officials at high levels were issuing orders to force the price of gold way down". Whether or not one is prepared to pay heed to such hearsay, there is evidence that such gold price manipulation may have occurred in the past.
The last time the gold price hit such heady heights was back in the seventies. At the time, the US dollar was under tremendous pressure. The then Fed president, Paul Volcker, said in his memoirs:
"Joint intervention in gold sales to prevent a steep rise in the price of gold, however, was not undertaken. That was a mistake. Through March, the price of gold rose rapidly, and that knocked the psychological props out from under the dollar". (Eric Hommelberg, Gold and GATA, May 16, 2005, www.golddrivers.com
Did the US government learn from its mistake?
One increasingly powerful voice in the wilderness of gold trading is the non-profit Gold Anti-Trust Action Committee (GATA). GATA has become known as the world’s greatest exponent of gold conspiracy theories. It has many supporters. There are also many who refer to the committee as "the lunatic fringe".
One example GATA provides involves the collapse in 1998 of the world’s biggest hedge fund, LTCM. The collapse may have also brought down many of LTCM’s creditors, who included some of the world’s biggest investment banks. If this was allowed to occur, it would have caused major global financial devastation.
LTCM went down with a significant short gold derivative position. Had this position been covered in the market, the price of gold would have scaled never before seen heights. However, every time gold tried to rally after the news of LTCM broke, it was quickly stifled. GATA believes the gold price was manipulated to ensure the US dollar did not collapse.
In order to achieve this, says GATA, the world’s big bullion banks (for example, JP Morgan, Goldman Sachs, Morgan Stanley, Deutsche Bank) were "in the know" and were given the opportunity to sell gold borrowed from central banks and invest the proceeds elsewhere, such as in US treasuries. Then Treasury Secretary Robert Rubin was preaching "a stronger dollar". GATA asks "Ever wonder how he achieved this?"
If the US was artificially holding down the price of gold, their efforts hit a big hurdle. In 1999, 15 European central banks signed the "Washington Agreement" in which they agreed to limit gold sales and gold lending over a five year period. The gold price rallied strongly. The gold sellers were now caught short. Edward George, then Governor of the Bank of England, later said:
"We looked into the abyss if the gold price rose further. A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake. Therefore at any price, at any cost, the central banks had to quell the gold price, manage it. It was very difficult to get the gold price under control but we have now succeeded. The U.S. Fed was very active in getting the gold price down. So was the U.K." (Hommelberg)
Underlying the basis of GATA’s arguments is the fact that central bank gold reserves remain a mystery, and that not only does the IMF allow this to be the case, it perpetuates the mystery. Liberty’s Heller notes:
"In an issue paper released in April, the IMF effectively conceded that the accuracy of claims made by the Gold Anti-Trust Action Committee [GATA] that central banks were required to report gold as being in their vaults even if it wasn’t there."
"The central Banks can report to own 30.000 tonnes of Gold without actually have it stored in their vaults. The IMF tells the central banks not to exclude their leased/swapped gold from reserve assets. So if a central bank reports having 1000 tonnes of Gold in their vaults, no-one knows for sure how much of that gold is really there and how much of that gold is loaned/swapped. Now if a central bank doesn’t report the amount of loaned/swapped gold GFMS won’t report it either." (Hommelberg)
GFMS (Gold Fields Mineral Services) is the world’s pre-eminent gold market analyst and consultancy. GFMS dismisses everything GATA claims. GFMS claims central banks have lent 5,000 tonnes of gold into the market. GATA claims 15,000 tonnes.
Crucial to GATA’s claims is that a lot more gold has been sold than has been accounted for. Crucial to the gold price is that very little gold ever produced has been consumed. In other words, GFMS claims to know of nearly all of the gold in the world. But GATA claims a lot of that gold has now been turned into jewellery, and that the world is actually running out of central bank gold.
In other words, if central banks, including the Fed, have been manipulating the price of gold in the past, then there may not be enough around to continue any manipulation. If this is true, the gold price may soon have a very, very long way to run on the upside.
If this is true. Again, many in the market dismiss GATA as a bunch of crazies.
The gold price appears to have started on a more measured upward move from its previous lows. There is not a lot of news in the market that suggests the gold price has anywhere to go but up.
Liberty’s Heller notes the UAE central bank has announced it is preparing to convert up to 10% of its currency reserves into gold. A Chinese official has also said "It is practical for China to increase its holdings of gold by choosing an appropriate time to buy, because compared with other big trading countries the percentage of gold in China’s reserves is seriously low."
He also points to a recent talk from the US Comptroller General that the US twin deficits are getting out of control, and that by 2025 US debt will exceed GDP. "When even high-ranking accounting officials within the US government are willing to admit that the federal budget deficits are a danger to the US economy", says Heller, "everyone better start worrying".
The Fed is currently stuck between a rock and a hard place. It has raised interest rates 17 times in order to curb inflation and support the US dollar in the face of deficit fears. If it continues to raise rates it runs the risk of tipping the US economy, already under pressure, into recession. If it stops raising rates then US inflation could run hard (and the oil price does not look like falling any time soon). Either way there must be downward pressure on the US dollar.
If there is downward pressure on the US dollar then the gold price will rise (barring manipulation). Heller is sticking by his forecast that gold will reach US$2,000/oz by the end of next year.
Note: Interested readers may which to visit the GATA website at www.gata.org
. Further (non-conspiratorial) analysis is provided in the FN Arena feature "Why Gold Will Break All Records", 11 July 2006.
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