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The How And Why Of Gold Price Manipulation

Feature Stories | Aug 30 2006

By Greg Peel

There are none more passionate than those the world calls “gold bugs”. Sid Reynolds is an FN Arena reader and states emphatically “I am not a gold guru”. However, Sid has followed the accusations put forward by the US-based Gold Anti-Trust Action Committee (GATA). From various sources, Sid has collected evidence from experts supporting the GATA theory. He was keen to share his summary with FN Arena.

FN Arena introduced GATA’s theories in the article “Did the US Government Manipulate The Gold Price Down?” (Commodities, 01/08/06). Further questions were raised in the more recent “Gold Sales Continue To Confuse” (Commodities, 25/08/06).

Sid suggests that in order to explain the how and why of gold price manipulation, and why it’s “covert, illegal and unfair”, one needs to consider six aspects – motive, means, proof, opportunity, track record, and impact.

The finger of blame for gold price suppression is most often pointed at the US government, although the central banks of the UK and Germany, amongst others, are also said to have been in on the act.

The US government’s motive for covert gold sales is firstly to keep interest rates low by deceiving bond markets about actual inflation levels. This sets in track the effect of lower gold price = lower inflation = lower bond price = higher stock market. It is also a means of supporting the US dollar, such that lower gold price = higher US dollar.

Sid adds that higher stock market = better re-election chances. (In terms of propping up the US dollar, this is more than just a case of = higher stock market etc. As the benchmark and safe haven currency of the world, US dollar assets are held extensively by central banks all over the globe. A falling US dollar is bad news for all economies, but it is particularly frustrating for bounteous America. It undermines America’s capacity to be the wealthiest, most powerful nation on earth.)

The US government prefers to maintain a strong dollar relative to other currencies, by whatever means.

There is also a motive for gold price suppression from the world’s so-called “bullion banks”, being large global investment banks carrying a surplus of bullion (Goldman Sachs, JP Morgan, Morgan Stanley, Deutsche Bank for example). By using gold they can access a huge source of capital for spectacular gain, provided the gold price does not rise. More on that later.

Before moving on to Sid’s summary of the means of gold manipulation, let’s take in some history.

The Great Depression of the 1930s came as a bit of a shock to a world previously enjoying the abundant fruits of a post-Industrial Revolution world. Leaders of the developed world agreed that a mechanism needed to put in place amongst them in to keep currency movements within an orderly range and to head off any further shocks. Thus towards the end of WWII an agreement was signed which pegged currencies against the value of gold. This was known as the Bretton Woods agreement. A keeper of the rule book was established in the form of the International Monetary Fund (IMF).

To facilitate the arrangement, it was agreed the world’s official gold reserves would be stored in the US – at Fort Knox. By the early 1970s, Bretton Woods had broken down. By default, the US dollar became the pseudo-benchmark for world currencies anyway, as the “peg” system related to the dollar-denominated gold price.

The US was the economic superpower in the first half of the twentieth century, but after the war Japan and Germany started catching up. Artificial overvaluation of the US dollar, and the US refusal to “pay” for the Vietnam War, led to Bretton Woods being “floated”. While the US dollar remained the benchmark, the control now lay with the IMF.

In 1974 there were 12,500 tonnes of official gold in earmarked accounts at the Federal Reserve. At the end of 2005 this figure was 8,967 tonnes. It must be appreciated that gold is not a consumable, and that the total amount of gold existing in the world can be calculated to within about 98% accuracy.

There have been various crises that have sparked official gold sales leading up to 1998, and these are largely accountable as official Fed outflows and not manipulations, but when hedge fund LTCM collapsed in 1998, threatening to bring down the world’s largest banks, something strange happened.

Fed outflows all but dried up, yet official US gold exports continued to spike as the gold price rose in response to LTCM. If large amounts of gold weren’t coming from the earmarked accounts, where was it coming from?

There exists, as Sid points out, a “secret” branch of the US Treasury called the Exchange Stabilization Fund. The name says it all. The ESF is not accountable to US Congress or the courts. It reports directly to the President.

The ESF may have been behind the post-LTCM gold sales, but the question still remained as to where that gold came from. But the gold price remained suppressed, despite the fact LTCM carried with it to the grave a substantial short gold position.

In 1999, the UK equivalent of the US ESF suddenly, and for no apparent reason, sold a great deal of gold. Speculation that the ESF had passed the baton over to the UK mounted, and the remaining central banks of Europe were so incensed by this collusion that they signed the Washington Agreement, which has since limited the amount of gold each of them can sell in one year.

The Washington Agreement dealt a blow to the US Treasury’s capacity to invoke the selling of earmarked gold, and it sparked a significant gold price rally. But the theory is that this simply led the US to come up with other ways to sell gold, under the radar.

Sid notes the two major means of disguised gold sales – leasing and derivatives.

Leasing involves central banks effectively lending gold out to other parties and having them return it at some later date. The practise is adopted legitimately and extensively by gold producers. They can borrow gold, sell it forward on the market, raise capital to finance a mine, and return the borrowed gold in the form of what they have dug up in the interim. Provided producers don’t overstretch the mine’s reserve estimates, the practise is a safe one. (Some get caught out, however).

Alternatively, central banks can lend gold to bullion banks who then sell on the market and invest the funds in other financial instruments which, unlike gold, produce a return. Provided the gold price remains stable, a fortune can be made. Provided the gold price remains stable.

Gold derivatives include various complex instruments, but the simplest derivative is the gold futures contract. The turnover of gold futures each day equates to several multiples of the amount of traded gold. Gold futures can be cash settled, so while massive futures selling may imply the sale of a large amount of gold, expired contracts need not require delivery of actual gold.

The theory goes that the world’s bullion banks are “in” on gold price manipulation schemes. JP Morgan is banker to the ESF. Bullion banks were on the wrong side of LTCM’s short position default in 1998. If bullion banks “sell” gold via futures contracts, thus suppressing the price, any losses incurred at expiry through a gold price rise can be offset by freshly printed dollars provided by the banks’ ultimate guarantor – the Fed.

But more problematic is the nature of leased gold. Although the IMF is the official bookkeeper on gold reserves, its accounting system allows for leased gold not to be considered a sale of gold, even though the borrower has sold the gold. In other words, the “earmarked accounts” may show a lot more gold in reserve than is actually the case.

Despite numbers that didn’t add up, eyebrows began to be raised around 1999 in regards to the writings of Harvard Professor Lawrence Summers, who became Treasury Secretary under President Clinton. Noting the relationship between gold and interest rates, he concluded interest rates could be kept low and the dollar stable by selling gold. One of Clinton’s major policies was the “Strong Dollar Policy”.

As we approached the new century, gold derivative trading and lease arrangements were becoming more sophisticated and prevalent. By affecting the above strategies, suppression of the gold price would not be that hard. Sid points out:

“Under the Sherman Antitrust Act (US Supreme Court), a combination formed for the purpose and with the effect of raising, depressing, fixing, pegging, or stabilizing the price of a commodity in interstate or foreign commerce is illegal per se”. Put simply, while gold leasing and futures is legal, it is illegal to do so for manipulation purposes.

While there are still gold sales dating back to 1998-99 which cannot be accounted for, the ESF claims it has not been involved in any gold swaps (leasing or derivatives) in the last ten years. So is there any “proof’ that gold manipulation has indeed been going on illegally?

Over to Sid and his referenced evidence:

In a 1998 testimonial to the House Banking Committee, former Fed governor Alan Greenspan said:

“Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise.”

After the price of gold rallied strongly post the Washington Agreement, Bank of England governor Eddie George said on record:

"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 US Fed was very active in getting the gold price down. So was the U.K."

In 2003, in order to have a case thrown out of court on the basis of “central bank immunity”, mining giant Barrick Gold admitted that it, and its banker JP Morgan, had manipulated the gold price as agents of central banks.

In 2004, the chairman of the Central Bank of Russia said “major banks” are suppressing the gold price.

In an example of the numbers just not adding up, the Bank for International Settlements (BIS) recorded a 16% increase in the notional amount of gold held in derivatives in the second half of 2004, representing 2700 tonnes. At the same time Golf Fields Mineral Services (GFMS) noted gold producer hedging had fallen 11%.

The World Gold Council, and GFMS, insist all gold derivative transactions are legitimate producer hedges or hedge fund activity. Hedge funds accounted for one tenth of the increase. 2700 tonnes is more than the total supply of gold in 2004.

In March this year BIS admitted manipulation.

Sid’s list goes further, but that is enough for now.

Consider also that questions were raised about the extraordinary collapse in the price of gold in May this year. There was a lot of speculative activity leading up to May, such that gold could be considered to have been in a bubble, but the reality is that 14 million ounces of gold was sold in the period and no one has laid claim to the sales. Nor have they appeared in any official figures.

If there is gold manipulation going on, that is sinister, as it suppresses the value of other countries (particularly poorer ones). But that aside, there are potentially extraordinary ramifications for the price of gold.

At present, annual gold production falls short of demand by some 1500 tonnes. The production trend is downward. If more gold has been sold than is accounted for, and that gold has now become jewellery (as some 75% of world gold production usually does), then it’s going to be hard to buy it back.

If leased gold must be returned eventually, where will it come from?

If there was actually a lot less than 8,967 tonnes of gold in earmarked accounts last year, and a lot more has been sold since, could gold even “run out”?

If the gold price begins to rally strongly again, what will happen to the settlement of all the short derivative positions when there is not enough gold left to keep a lid on the price?

At least one pundit is tipping a gold price of US$2,000/oz as early as next year.

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