Move Over Fisk & Gould


August 16, 1999 – In 1869, Jim Fisk and Jay Gould tried to corner the gold market, and for a time, this notorious duo succeeded. It is a fascinating story that is relevant to what is happening in the gold market today.

At the time, the dollar was on the Gold Standard and still defined in terms of gold at the rate of $20.67 per ounce. However, President Lincoln had suspended convertibility during the War Between the States, and in 1869 the ability to redeem dollar paper money for gold had not yet been re-established.  Gold was actively quoted and traded on the New York Gold Exchange (NYGE), in terms of ‘greenbacks’, the irredeemable, fiat currency created during the war. Though denominated in terms of dollars, fiat currency greenback dollars traded at a discount to sound money gold dollars (hereafter, $’s). Prices were quoted at the NYGE in terms of how many greenback dollars (hereafter, GB$’s) were needed to purchase $100, i.e., five Double Eagle gold coins, which together weighed 4.838 ounces.  During the height of the war, with the prospects for the Union army and the outcome of the war still uncertain, over GB$250 were needed to purchase $100. With the war over, and the federal government’s creditworthiness rising, the greenback discount began dropping. When Fisk and Gould started their manipulations, gold hovered around GB$130.

Jay Gould was the mastermind of the two. He understood markets, and he understood human psychology. Having initiated and participated in many stock squeezes, he also knew how to drive markets to a state of frenzy, and by September 1869, his plan was well underway.

In those pre-air conditioned days, trading often languished in the doldrums of New York City’s hot and muggy summer. Those uncomfortable conditions often put markets into a sleepy state, giving many a false sense of security, and the summer of 1869 was no exception. Even though greenbacks still traded at a big discount to gold dollars, complacency reigned supreme, and Gould knew that the gold market was ripe for a squeeze. All he had to do was crack the whip. And crack it he did.

Gold began rising in mid-September, and the price rise quickened the week of September 20th. Gould got some newspapers to help him in his task by printing stories that a gold squeeze had begun. By Thursday, gold had risen to the low GB$140’s, but the real fireworks began the next day, September 24th, what has become known as Black Friday.

Brokers acting for Fisk and Gould began the day by wildly bidding up gold from its GB$145 opening price, and those creating the corner stood to make a fortune. Using derivatives to maximize their leverage, Fisk and Gould controlled calls on 5.5 million ounces of gold with a face value of $110 million, an amount equal to the US Treasury’s entire gold reserve at the time. It was without any doubt an enormous leveraged position, and Fisk and Gould stood to make GB$5.5 million on every GB$1 rise, and rise it did.

Panic was spreading throughout Wall Street, as the price rose relentlessly that fateful day. These manipulations affected every part of banking and finance. Many faced ruin as gold began to soar, and the margin calls began to mount.

The gold price had risen to GB$162, when James Brown (who with his brother took over the firm started by their father, which exists to this day as Brown Brothers Harriman) stepped up to the plate. He sold 250,000 ounces to a Fisk and Gould broker at GB$160. Others alertly sensing a change in momentum also stepped in on the sell side. The gold price began dropping.

Shortly thereafter, the US Treasury announced that it was selling gold in exchange for greenbacks. When this news hit the floor of the NYGE, the rout began. Gold closed that day at GB$132.  Its rocket-like jump and subsequent collapse left a trail of carnage and chaos. How well did Fisk and Gould fare?

Gould never told his partner Fisk the whole plan. To make the corner more credible, Gould let Fisk keep buying on the way up and the way down through their regular brokers, thereby convincing everyone on the NYGE floor that the corner was for real and would not collapse. But without telling Fisk, Gould acting secretly through his own private broker, sold out their entire position above GB$150 on average and kept selling more than Fisk was buying as the price tumbled down.

Only after the end of trading that day did Gould share with his partner his entire plan for the corner. Instead of facing ruin as he expected, Fisk learned the total net gain from their combined trading was GB$12 million.

Then to protect this hoard, Gould paid GB$2 million to two shameless attorneys to lock up in litigation the assets of the NYGE and countless brokers, as well as to defend the pair from the 300-plus law suits subsequently filed against them. Some of this money also went to Boss Tweed, who through the Tammany Society controlled New York City’s finances and politicians.

So Fisk and Gould were left with GB$10 million to split between them - not bad for a couple of week’s work. But why have I related this long story?

I believe that within two weeks, another gold squeeze will start from the depths of a typically hot and humid New York summer. Like the squeeze of 1869, the market now is far too complacent about both gold and the fiat currency of our day, the Federal Reserve Dollar (which differs from a Greenback Dollar in name only). And conditions are ripe for a successful squeeze, most notably in the low gold price and high gold interest rates.

At $260, the price of gold is abnormally low, while at the same time, gold interest rates at 3% plus are abnormally high. In contrast to the Dollar and other fiat currencies which can be manipulated to any artificial end determined by the central banks that create them, gold is money that depends upon the free-market process. The reason? Unlike fiat currencies, gold cannot be created by bookkeeping sleight of hand out of thin air.

Therefore, central banks do not have an unlimited supply of gold, which is the necessary ingredient for any ongoing successful central bank intervention. Consequently, central bank manipulation of the gold market has limits.

In order for gold’s interest rates to return to normal, i.e., under 1%, the gold price must return to normal, i.e., some price over $400 per ounce. This high gold price is needed to bring metal back into the market, thereby increasing liquidity, which in turn will cause gold interest rates to drop toward normal levels.

The abnormal conditions now prevailing in the gold market provide the opportunity for the spike. And the spark is being provided by Goldman Sachs.

This past Thursday, Goldman Sachs responded publicly to its actions taken over the past few days behind the scenes on the Comex.  Goldman announced that it had given notice to the Comex that it was standing ready to take delivery of about 473,500 ounces of gold, about one-half of the total weight in Comex vaults. It was according to a Goldman spokeswoman “all within the normal course of business.”

While taking delivery from time to time is of course entirely normal, the weight of this delivery is far from normal. Further, Goldman is said to control most of the 3,537 August contracts still outstanding, meaning that it could take delivery of even more metal, possibly nearly depleting Comex stocks.

What are the reasons behind this move by Goldman? Well, let’s see if we can put two-and-two together.

There have been rumors and some press reports that the big Tiger hedge fund is in trouble. Apparently, even though this hedge fund reportedly has a sterling long-term track record, their performance this year has been poor. Importantly, in the continuing aftermath of last October’s Long Term Capital Management debacle, investors in hedge funds these days are not very patient – they are withdrawing their investment quickly at the first hint of poor performance. Thus, Tiger has been suffering withdrawals of capital, which has required Tiger to liquidate investments to provide the funds needed to meet these withdrawals. Now here is where it gets interesting.

Australia’s largest gold mining company is Normandy Mining (NDY). According to NDY’s fourth quarter report dated June 30th, Tiger owned 11.68% of NDY. At present prices, the face value of that position is about US$156 million, surely not one of multi-billion Tiger’s biggest positions, but nevertheless, it still is a big chunk of change.

Tiger acquired this stake from another Australian company a couple of years ago around A$1.75. NDY is now trading at A$1.20, and before the latest run-up in the gold stocks was around A$1. But don’t shed any tears for Tiger. 

As I understand it, Tiger did what most hedge funds do; they hedged this position. How? Tiger had sold short gold bullion, and its gains from this short position as the price of gold slid lower have more than offset the losses on the drop in the NDY stock price. But these are paper profits, and now the hard part for Tiger begins.

How do you unwind this huge position without eroding your paper profits?   Taking profits becomes exceptionally important when you need the cash to meet investor withdrawals, as Tiger apparently now does.

The first thing to do is buy the gold needed to cover the short gold position, and here, Goldman once again enters the picture. The metal now being accumulated by Goldman on Comex will I understand be delivered to Tiger, to enable Tiger to cover its short gold position. What I hear is that Tiger will then unwind its long NDY/short gold trade. In other words, Tiger has already purchased this metal on a forward basis.

Goldman is Tiger’s broker on this trade, and Goldman will deliver to Tiger the metal Goldman will obtain from the delivery it is taking on Comex. Here’s where it gets really interesting.

During the delivery of any month, it is the shorts that choose the time to deliver on their short position. The longs have no option but to wait for the shorts to decide when to deliver, and normally the shorts wait until the end of the month.

This slowness to deliver is understandable because it enables the shorts to earn interest as long as possible. This month the shorts must deliver by August 27th, which in Comex terms is the end of the month. Somehow and from somewhere, the shorts must come up with 473,500 ounces of gold bullion, and possibly more if Goldman takes delivery this month on even more gold.

No problem, you say, because there is 948,973 ounces of gold in Comex vaults? Well, that is true. But who owns that gold? What if none or few of those ounces are owned by those who are short the gold that must be delivered to Goldman?  In that case, where will the shorts get the gold they need to deliver to Goldman?

Therefore, on or before August 27th, which is the last delivery day, one of three things will happen, and it all depends on whether or not the shorts own the 948,973 ounces of metal in Comex stocks.

1) If the shorts own this metal, they deliver metal to Goldman, and the Comex stocks will drop by 500,000-700,000 ounces (which is the weight that I expect Goldman to wait for delivery). The upward pressure on the gold price in this case may be muted, and the squeeze in all likelihood averted for the time being. If so, all the shorts who have driven down the gold price to its abnormally low level can continue for now to wring out every penny from their short position.

2) Or, if the shorts are not the owners of the metal in the Comex warehouse, we will get a huge short squeeze as the shorts try to find metal to meet their commitment. And I do mean HUGE, because there is no metal in the pipeline not already committed. The high gold interest rate is a stark warning to the shorts that metal is not available.

3) Or finally, the market goes berserk because of the short squeeze and the Comex announces a repeat of what they did to Bunker Hunt, i.e., horrendous cash margins and only trading for delivery into Comex stocks is allowed. This alternative will probably prevent the short squeeze from reaching its full potential, but the Comex cannot be expected to act until the short squeeze has already begun. So there is still plenty of opportunity to make a lot of money on the spike that I expect in the gold price.

The potential now exists to make the 1869 short squeeze engineered by Fisk and Gould look like child’s play compared to what is coming up, if we get alternative #2 above. And my own guess is that we will get #2, but this is just my guess.

One other bit of info. Apparently, Goldman did not want to take delivery of this Comex stock (which they obviously knew would bring a lot of public attention to this move), but Goldman had to tap Comex. The reason? Goldman could not get their hands on this metal from any other source! There’s nothing in the pipeline of this size not already committed, so this shortage of metal will add fuel to the fire of any short squeeze.  This shortage of metal also explains why gold interest rates are so high because as I have been saying in recent letters, there is no lender of last resort to the bullion banks.

Without any doubt, it should be an interesting couple of weeks! In nearly 30 years of commodity trading, I’ve never seen anything like this before, so the upside could be spectacular, even bigger and better than it was for Fisk and Gould.

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