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Citigroup Report Reignites Gold Manipulation Debate

Commodities | Oct 03 2007

By Greg Peel

“Central banks have been forced to choose between global recession or sacrificing control of gold, and have chosen the perceived lesser of two evils. We believe that the policy resolution to the credit crunch will take the form of a massive, extended ‘Reflationary Rescue,’ in a new cycle of global credit creation and competitive currency devaluations. This could take gold to $1,000 an ounce or higher.”

This paragraph comes from a recent Citigroup report from US analysts John Hill and Graham Wark. The report has sparked a flurry of debate around the world, but not because of the US$1000/oz call. Indeed, such a call is not uncommon now. What did spark controversy was this paragraph:

“Official sales ran hot in 2007, offset by rapid de-hedging. Gold undoubtedly faced headwinds this year from resurgent central bank selling, which was clearly timed to cap the gold price. Our sense is that central banks have been forced to choose between global recession or sacrificing control of gold, and have chosen the perceived lesser of two evils. This reflationary dynamic also seems to be playing out in oil markets.” [FNArena underline]

This was an off-handed comment, unsubstantiated, but one the London Daily Telegraph’s Ambrose Evans-Pritchard has described as “explosive”. It is explosive because it corroborates the supposedly taboo accusation, made most stridently by the Gold Anti-Trust Action (GATA) Committee, that global central banks have long been manipulating the price of gold in order to support the US dollar and the Western financial system.

You would have to be Blind Freddy not to have noticed that ever since gold burst through US$700/oz back in early 2006, and then corrected, any subsequent rally attempts towards the US$700/oz level have been unceremoniously smacked down – until now. The accusation is that central banks in agreement with the US Federal Reserve sell down gold whenever it threatens to break up in price, thus providing support for the US dollar. The US Treasury and its European counterparts do not like the idea of a collapsing US dollar.

That is, they didn’t up until last month when the Fed slashed the cash rate by 50 basis points and sent the dollar into a spiral. As the Citigroup report suggests, a decision has been made to re-inflate the US economy, and thus ward off recession, by allowing the US dollar to fall to a lower level. This means the gold price can no longer be suppressed. Had it never been suppressed, critics of manipulation suggest the price of gold would already be in excess of US$1,000/oz today.

But just because central banks sell their stocks of gold into the market does not, by definition, make them manipulative. This is no more manipulation than pumping liquidity into the cash market or selling foreign currency reserves. The manipulation accusation derives not from official sales of central bank gold, but from unofficial sales.

Unofficial sales occur when a central bank “lends” gold to the so-called “bullion banks” (which are those banks active in gold trading and include most of the world’s largest investment houses) and their counterparties which in turn is sold into the market. Most of this gold ends up as jewellery and hence cannot be delivered back to settle the loan. If the gold price falls, the bullion banks pick up a profit, but if it rallies they are compensated for their losses in cash – printed by the central banks. So goes the theory.

The same can be achieved by bullion banks selling into the vast futures market, or through using other gold derivatives. Either way, there are two significant results: (1) central bank official gold is replaced with fiat cash, and (2) stocks of central bank gold do not register with the IMF as having been diminished.

And this is the crux of the matter. GATA, and others, maintain that global central banks are holding a lot less gold bullion than they claim to still own. If that’s the case, then the price of gold should be much, much higher. Indeed, the gold uber-bulls are waiting for the day when some central banks actually run out.

There was another analyst report released earlier this year which this time caused a lot of red faces at France’s largest bank, Credit Agricole. In a report entitled “The Remonetization of Gold”, analyst Paul Mylchreest also opened the Pandora’s Box of the activity of which one should never speak. This excerpt was highlighted this week by BullionVault’s Adrian Ash:

“Central banks have 10-15,000 tonnes of gold less than their officially reported reserves of 31,000. This gold has been lent to bullion banks and their counterparties and has already been sold for jewellery, etc. Non-gold producers account for most [of the borrowing] and may be unable to cover shorts without causing a spike in the gold price.”

“Covert selling (via central bank lending) has artificially depressed the gold price for a decade [and a] strongly rising gold price could have severe consequences for US monetary policy and the US Dollar.”

Which it now has.

There are still those in the market who try to dismiss the concept of gold manipulation as a load of trumped up conspiracy theory nonsense, while others simply pretend it doesn’t exist or go to great lengths to quash any mention. That is why, in certain circles, the subject is taboo. However, there have been plenty of confirmations over the years, all of which GATA has documented.

Adrian Ash, similarly, notes 1993 comments by then Federal Reserve governor Wayne Angell:

“The price of gold is pretty well determined by us…But the major impact on the price of gold is the opportunity cost of holding the US dollar…We can hold the price of gold very easily; all we have to do is to cause the opportunity cost in terms of interest rates and US Treasury bills to make it unprofitable to own gold.”

There have been a lot of comparisons between the US economic situation of today, and that of the 1970s, which was the last time the oil price was at uncomfortable highs and the gold price was higher than where it is today. Inflation was again the concern, although back in the 70s inflation was running at double digits, not the 2-3% we’re looking at today. However, a recession eventuated, and then Fed chairman Paul Volcker reminisced in his memoirs published in 2004 that “letting gold go to [US]$850/oz was a mistake”.

That mistake has supposedly not occurred again since, and probably the greatest example has been the Bank of England’s sale of half its gold reserves at the bottom of the gold market in 1998, following the collapse of LTCM. Only recently has the then Chancellor of the Exchequer (and now Prime Minister) Gordon Brown been asked to “please explain”.

So here we are faced, in theory, with another possible US recession, and another potentially devastating collapse of financial markets if the credit freeze had been allowed to continue. To avoid recession the Fed has been forced to cut rates, which requires printing US dollars. Suppressing gold also requires printing US dollars, so one or the other had to be chosen, as the Citigroup report suggests. On that basis there should be nothing holding back the gold price. So the theory goes.

If there was anything to be particularly concerned about it’s not being expressed in the US stock market, which has returned to set new highs. On that subject, Ambrose Evans-Pritchard notes:

“Even so, I am not sure that the Bernanke Fed will move fast enough, given fears of moral hazard, or, indeed, whether the rate cuts on offer are enough to head off an insolvency crisis. The chart of S&P 500 looks eerily similar to October 1987, the last time a tumbling US dollar set off a crash.”

As for the gold price, last night saw a tumble of close to US$20/oz which most in the market consider part of a pull back “we have to have”. If the US dollar continues to consolidate at current levels (and a cut from the ECB could assist that) then a further pullback to US$700/oz is on the cards. Beyond that, well, it all depends on what happens next.

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