Everything about the Alleged Gold Manipulation

December 9 2014

Stock market manipulation goes back many centuries. Over the years, a lot has been said and written about the (alleged) manipulation of gold. Let’s examine the arguments on possible gold manipulation: what is true, and what is false? And what are the implications for your investment in gold?

Everything about the Alleged Gold Manipulation

Stock market manipulation goes back many centuries. Over the years, a lot has been said and written about the (alleged) manipulation of gold. Let’s examine the arguments on possible gold manipulation: what is true, and what is false? And what are the implications for your investment in gold?

David Ricardo: Master Manipulator

June 18, 1815 was a memorable day. David Ricardo — ironically a renowned economist — spread false rumors on the London Stock Exchange on the outcome of the battle of Waterloo.

“Napoleon defeated the British,” he whispered. When he reinforced the rumors by placing a large number of sell orders, a full-blown panic arose on the stock exchange.

Ricardo’s plan succeeded. After a sharp drop, the clever Englishmen bought British government bonds at fire sale prices. When the rumors proved to be false, bond prices recovered and Ricardo amassed a fortune. He was able to retire at age 41.

By telling this story, I want to emphasize that manipulation is not a new concept. Equally, I want to make clear that I am aware of the fact that market manipulation happens.

Is the “Paper Market” Unrelated to the “Physical Market?”

Since 2011, the price of gold has collapsed. Prices dropped by a third. Many investors blame the “paper gold market.”

Their reasoning is that the world price of gold is determined on the COMEX. “Futures” are traded on this exchange. However, these are merely paper assets — a promise of future delivery. In fact, very few deliveries actually take place. The outstanding futures are not backed by “physical gold” in the \ vaults of the COMEX. This enables malevolent parties to bring unlimited quantities of “paper gold” to the market, in line with their major interest to keep gold prices low.

Gold prices have been manipulated this way since 2011, despite the fact that the physical demand for, for instance, gold coins is stronger than ever.

What Can We Say about Gold Manipulation?

For the sake of simplicity, let’s substitute a different commodity for gold: wheat. According to the above theory, it is possible to manipulate the price of wheat continually downwards and to make bread practically free of charge — regardless of its physical supply. However, we all know what kind of disaster this would cause: long waiting lines in supermarkets, huge shortages of wheat, and not one farmer who wants to rise at dawn to put in a day’s work.

Moreover, the assertion that a party can sell “unlimited quantities” of paper gold is verifiably incorrect. First of all, every futures contract needs a counterparty. An unlimited number of counterparties is not possible. If there is no counterparty, no “sale” can take place. That is why you read about “open interest,” the number of outstanding contracts. The number of outstanding contracts can either be high or low.

Second, futures contracts always require collateral. Gold prices only have to rise slightly for the value of the collateral to be fully offset by the incurred losses. In such a scenario, someone who owns an enormous quantity of gold futures has to pledge additional collateral or have his position liquidated automatically. The paper loss is then irreversible.

On a side note, the value of this collateral has increased strongly over the past years. This allowed an enormous credit expansion in financial markets. For example, margin debt has reached record levels. Investors can use this credit to buy securities. This credit expansion creates the perfect conditions for a series of uncontrolled price declines in financial markets in the future.

Can someone influence prices to a significant extent by placing large buy or sell orders? Absolutely, but the futures markets for gold are liquid to such a degree that nobody can exert a permanent downward pressure. In addition, a futures contract expires at a certain point in time.

Finally, we have to mention that if indeed a large discrepancy between the paper price and the physical price were to exist, it would be strange if nobody were to profit from this discrepancy by arbitrage. The alleged “decoupling” of paper gold and physical gold would provide an enormous incentive to buy futures contracts and convert them into gold. If I can buy gold in London at a certain price, and resell at a price that is, say, 20% higher, then this discrepancy will disappear while I become rich (almost) effortlessly.

The simple fact that nobody is prepared to pay more than the London price, demonstrates that no such discrepancy exists. (India is not taken into consideration given its import restrictions.)

396 Pages on Commodity Manipulation Ignored

Nobody mentions the 396-page bipartisan report on the alleged manipulation by major banks in physical commodity trading that appeared last month.

Why? The conclusions are completely at odds with all assertions on market manipulation. Goldman Sachs is actually accused of keeping commodity prices artificially high, instead of low.

It is ironic that this very case was being used to prove that the price of gold was kept intentionally low, i.e., to prove the alleged gold manipulation. But what Goldman did was actually the very opposite. Goldman Sachs is accused of keeping aluminum artificially scarce by, among other things, extending the waiting time for withdrawing metal from 40 to over 600 days. They were able to do so after acquiring storage provider Metro Trade Services, and they profit mostly from the higher storage costs they could now charge.

Also notice that Goldman Sachs can increase the price of aluminum by restricting its supply. That is, by hoarding aluminum and keeping it off the market. Doing the opposite is very difficult. The classic scheme is to sell back the acquired position before prices have dropped. This is also known as a “pump-and-dump” scheme, akin to what Jordan Belfort did in the Wolf of Wall Street. The Hunt brothers became famous by applying this scheme to the silver market. Their scheme failed though, resulting in “Silver Thursday”, and the brothers lost all their money.

Central Banks Are the Biggest Manipulators

The biggest manipulation of today has its origin in the carte blanche that was given to central banks in 1971, by breaking the ties between money and gold. The biggest manipulation of our time is the manipulation of the yield curve by the central planning agency called the central bank.

Last week, a chief economist of the Dutch Statistics Agency (Centraal Bureau voor de Statistiek, CBS) even stated that “that the low interest rates [on Dutch government bonds] could be considered as a compliment from international investors.” An absurd statement, if we recall that interest rates are only low because the ECB has de facto nationalized interest rates. In addition, what counts is the interest differential. And those interest differentials show that international relations have remained mostly unchanged.

Central banks can increase the quantity of money as they see fit and — as long as the people don’t lose trust in their currency — nationalize bad loans. Central banks are providing major bailouts to banks, although it is presented as such in the headlines. The zero interest rates of worldwide central banks have disastrous economic consequences and, as a result, create an undesirable redistribution of wealth.

Central bankers try to counterbalance any price decline; relative prices are not allowed to adjust to fundamentals. Therefore the biggest manipulation originates from the actions of central banks.

What Christmas Has in Store for Gold

Last week, I said the price of gold had some trouble breaking through the $1,200 barrier. After initially declining due to the Swiss gold referendum, gold and silver made a serious comeback.

In a single day, the gold price increased from $1,140/oz to $1,210; a staggering 6% increase within 24 hours. However, the trend did not continue and on Friday the price dropped below the $1,200 barrier again.

It is plausible that the price of gold will close below $1,200 dollars at year-end.

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