January 29, 2001 - My lead article in Letter No. 276, "The Smoking Gun", has received a tremendous, positive response. I would like to thank all of you who wrote or emailed to me your kind comments. I would also like to thank those of you - and there were many - who had questions because it provides me with the opportunity to clarify and perhaps emphasize some important points in that article that may not have been given enough attention. And I'd like to share these questions, and my answers, with all of you.
Q. Does not the increase in US reserve assets from $11,048 million to $11,089 million between November and December 1999 mean that the Exchange Stabilization Fund was buying Gold?
Not necessarily. The increase only establishes that there has been a flow of Gold through the ESF's metal storage account at the Federal Reserve, increasing the amount at month-end. That metal could have been purchased, but it could have also been borrowed. We just don't know.
Q. If the increases in the ESF custody account were the result of purchases, wouldn't these purchases RAISE the price of Gold, not lower it?
In theory, yes, but unfortunately, there is not enough disclosure by the ESF to enable us to evaluate the whole picture. This change is the movement of physical Gold only, and we are unable to determine the size and scope of the ESF's derivative activity, which probably in reality dwarfs the ESF's activity in the physical market. Therefore, it is likely that the ESF's derivative trading more than offsets any positive impact on the Gold price that would arise if the above increase in the US Reserves actually represents a purchase. In fact, one could argue that the ESF is dabbling in the physical market only to provide it with sufficient metal to enable it to carry its derivative positions.
Q. Any idea how big the ESF's derivative position is?
To put some numbers to this position, it is not unreasonable to assume that the derivative position could be more than 100-times the size of a physical position. If we look at the various markets around the world, the trading in 'paper Gold' (futures, options, and other derivatives) is more than 100-times that actually trading in the physical market, i.e., where physical metal is used instead of cash in order to close out a contract or to meet an obligation to a counter-party.
Q. The size of the weights of Gold appear small, so why is this activity by the ESF significant?
There is one important point regarding this physical Gold moving in and out of the ESF's accounts. It establishes that the ESF has indeed been intervening in the Gold market, contrary to their assertions that they do not intervene in the Gold market. Therefore, the ESF and the Treasury Department spokesmen supposedly speaking for the ESF, have no credibility and cannot be believed. This conclusion leads to a corollary question, the implications of which are frightening: Why haven't these spokesmen been telling us the truth? What else is the ESF really trying to hide by not disclosing their activity in the Gold market?
Q. If the ESF didn't buy this Gold and actually borrowed it, from whom was it borrowed?
There is no way to know the answer to this question, but we can make a couple of observations. If the ESF is borrowing from actual market participants, it is a very well kept secret. Over the years I've heard a lot of rumors about what is going on in the Gold market, but never did I hear any rumor that the ESF is in the market borrowing Gold. Either the ESF is borrowing from a source who really knows how to keep a secret (possible but unlikely), or the ESF is borrowing from a secret source. Maybe the ESF is borrowing Gold from the US Gold Reserve at Fort Knox. It would be a lot easier for the ESF to be secretive about its Gold interventions if it is using the US's own Gold Reserves.
Q. Why did the level fall back down again to $11,048 soon after that increase? Does it therefore indicate some temporary fluctuation rather than deliberate manipulation?
Unfortunately, there are more questions than answers here. The actual size and nature of the movement of metal is not as important as the fact that metal is indeed moving in and out of the ESF's account, thereby confirming that the ESF is indeed intervening. Also, in addition to not knowing the size and scope of the derivative activity, it must be emphasized that the ESF's account referred to above is for one day only. Therefore, it must be assumed that there is a flow of physical activity in and out of the ESF account, and this flow could be huge. Unfortunately, we just don't know the size of this flow because the ESF does not disclose its activity. It truly is a 'slush' fund, which explains why so many leading economists and other influential people have called for its quick dissolution. The common view is that there is no room in a democracy for a secret government agency operating in a way unaccountable to the American people.
Q You only showed the ESF account on one day. What happened to it during the other 364 days?
Unfortunately, we don't know. The ESF account is reported by the Federal Reserve only at the end of each quarter, thus we only get a one day snapshot four times a year. The activity in the ESF's custody account during the rest of the year is not reported. But by looking at the quarterly numbers, we know that the weight of Gold in the custody account, or conversely the amount of Gold owed by the custody account, has become progressively larger over the four years beginning in 1996. Thus, we can assume that the ESF's activity in the Gold market has been increasing as the size of the quarter-end position in its custody account at the Federal reserve has been increasing.
Q. If the flow of Gold through the ESF's account is Gold borrowed from Fort Knox, how much of the US Gold Reserve has been tapped by the ESF in this way?
If we accept the www.GATA.org numbers of the cumulative deficit in the Gold market, no one has yet completely explained where all the metal has come from to fill the deficit. I reckon an unaccounted shortfall of at least 1500-2000 tonnes. Has this 1500-2000 tonnes been 'borrowed' from Fort Knox, passed through the ESF account at the Federal Reserve (for which we only see activity on one day), and then sold into the market? We just don't know. The bottom line is that we have established that contrary to their assertions, the ESF has been intervening in the Gold market. Now we only have to determine to what extent.
Q. Given all relevant data, how much longer can current trends continue before a major rally begins in the Gold market?
It is impossible to predict when the market will turn. All we do know is that the Gold price is being held down by unnatural forces, namely, government intervention and ongoing anti-Gold propaganda by governments, central banks, some bullion banks and their apologists. When the Gold price finally breaks upward, it should be an explosive event because Gold has been manipulated for so long and to such a great extent that its price is so unbelievably cheap.
Q. Can you try to put some guess-timates on what could happen to the Gold price when the manipulators finally lose control?
It is impossible to predict what could happen to the Gold price, but the experience of the late 1960's and early 1970's may be useful to show what could happen. The Gold price was also being manipulated back then, but it was being done in a way so everyone knew about it. The US dishoarded 300 million ounces of Gold in a vain and futile attempt to maintain the $35 per ounce price. When the price manipulators finally threw in the towel in August 1971, the price of Gold began rising and hardly looked back for the next 18 months, rising nearly three-fold during that period. Gold today is even cheaper than it was in 1971, so it is not unreasonable to expect another three-fold increase, which would put Gold around $800. However, I doubt if it will take 18 months for Gold to get there. The price rise will be much quicker this time because in contrast to thirty years ago, the price manipulation underway now has been conducted in secret. As a result, a lot of people have been lulled into a perilous complacency about Gold. When these people finally learn along with the general public about the secretive price manipulations, there will probably be a rush out of national currencies into the metal. Adding fuel to the fire will be the imbalance that now exists in the Gold market. This imbalance arises from the huge short position that now exists, so it is logical to assume that it won't take a lot of buying power to send the Gold price soaring.
Q. Do we know how much metal the central banks have loaned?
All we have are guesses because only the Swiss National Bank accurately and promptly reports the weight of metal it loaned. However, the estimates are anywhere from 5,500 tonnes as reported by Gold Fields Mineral Services to 12,000 tonnes as estimated by www.GATA.org. The importance of this 5,500 to 12,000 tonnes figure means that central banks retain in their vaults only 27,500 tonnes at most, and it could actually be as little as 21,000 tonnes, or perhaps even less. These weights are a lot less than is generally recognized because most everyone accepts the central banks statements of their Gold holdings without even giving consideration to how much of it has been loaned out. What is even more disturbing is the fact that this weight of Gold has been used to pyramid an enormity of derivative positions the size of which we can only guess at.
Q. Does the derivative legislation winding its way through Congress have anything to do with the short Gold positions in the banks?
I think the banks recognize that the end is near, which explains the pressure being put on Congress to change the derivative laws. I must admit I haven't read these proposed changes, but I have assumed all along that the changes will make it easier for the banks to default. Surely the banks are not pushing this legislation in order to make it harder for themselves. My guess is that the banks will make it easier for them to pay the cash equivalent of metal, instead of the metal itself. For example, if the banks can't deliver Gold, maybe the legislation being proposed (or some future legislation thrown together in a crisis) will enable the banks to pay Dollars instead of Gold to settle their obligations. Who knows, but you can bet that the banks will be all over Congress to try wriggling their way out of what is surely to be a massive default by them - i.e., their inability to pay metal to meet their obligations to pay metal.
Q. How will this whole thing play out in the real world? We know that the market cannot sustain this price manipulation indefinitely, and we also know that those caught short when the price explodes will face enormous solvency challenges. Therefore the question arises, how will the Gold price manipulators react?
We know from past experience in times of crisis that the 'too big to fail' justification is used for all sorts of taxpayer bail-outs. And it is in my view the big banks who are short the most Gold, and they are therefore the most vulnerable. So expect a taxpayer financed bail-out of these big banks (i.e., Morgan-Chase and Citibank in particular). There are basically two options to implement this bail-out. First, because the US government cannot create Gold 'out of thin air' to give to the banks to cover their shorts, they may instead get the Federal Reserve to monetize the losses, i.e. print fiat money in an amount equal to the Dollar value of the bank's losses in order to try wiping the slate clean. In other words, the US government will bail-out the banks by giving them enough Dollars to pay back to those from whom they borrowed the Gold the Dollar-equivalent of what they owe. Is is likely that this alternative may really clobber the Dollar, so the US government may instead take the other option. This second option is that the US government will tap the US Gold Reserves at Fort Knox. In other words, the US government will take what Gold it needs out of Fort Knox and give this bullion to the banks to enable them to repay their Gold debts. This alternative will also clobber the Dollar, but probably not as badly as the first alternative.
Q. Will President Bush come clean with the American people and reveal the ESF price manipulation, in the process pinning the blame on the Clinton administration?
I very much doubt it. In my view Washington D.C. is not run by the different political parties. Rather, both political parties - and therefore Washington D.C.- are run by the banks. My guess is that the new President Bush has his orders, which is to keep a banking crisis from happening during his watch. The best way to do that is to keep manipulating the price of Gold.
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Grist for the Consipiracy Theorists
The Smoking Gun
What Is Happening to America's Gold?
Some Answers to Doug Casey’s Questions
How Governments Manipulate the Gold Market - A Primer