August 27.2001 – In the last two letters I have written about the earmarked gold stored in the vault of the Federal Reserve Bank of New York. Foreign governments and institutions such as the International Monetary Fund own this gold, and it is ‘earmarked’ in order to specially set this gold apart from the US Gold Reserve, some of which is also stored in the NY Fed.
In Letter No. 288 I began to call attention to this gold, and noted that it was being dishoarded since September 2000 at a rate of at least 40 tonnes in each month. I suggested that this unusually rapid rate of “dishoarding from the NY Fed smacks of desperation” to get metal into the market because “the shorts need physical metal to keep the gold price from exploding upwards.” I also noted that this rate of dishoarding means that more gold is now coming out of the NY Fed each month than is being mined in South Africa, the world’s largest producer, which each month sells about 37 tonnes into the market.
Then in Letter No. 289 I noted how this extraordinary rate of dishoarding from the NY Fed began more or less at the same time that the SDR Certificates issued by the Exchange Stabilization Fund stopped declining. It thus appears that having nearly exhausted the supply of gold made available by swaps using the SDR Certificates, the shorts needed to get their hands on a new supply of gold.
Therefore, my conclusion was that it was more than just coincidental that earmarked gold began flowing out of the NY Fed at an unusually high rate just when the SDR Certificates stopped declining. This substantial supply of dishoarded earmarked gold provided the metal necessary to keep a cap on the gold price.
This is to let you know that the extraordinary dishoarding from the Fed continues. In fact, it has even increased.
In May the total jumped to 60 tonnes of earmarked gold shipped out of the Fed in that one month alone, 50% more than in previous months. What is the reason for this extra weight of dishoarding?
This question is not difficult to answer. The gold price was beginning to rally in May, so more physical metal was needed to cap the gold price. As we all know now, the rally that began in May was stopped dead in its tracks.
Then in June, after the gold price fell back into its recent trading range, the dishoarding resumed its previous pace. In June 40 tonnes was dishoarded from the NY Fed.
In total, this dishoarding for the ten months through June 2001 now stands at 423 tonnes. Therefore, if 40 tonnes are dishoarded in July and then also in August, 503 tonnes will have been dishoarded during the twelve months ending August 2001, a weight of gold exceeded only by the 583 tonnes dishoarded in calendar 1993, which as most of you will surely recall, was a year in which the gold price was rallying. So this recurring pattern of accelerated dishoarding suggests that efforts have been made to put a ceiling on gold price rallies since as early as 1993.
To analyze this dishoarding of the earmarked gold further, the 583 tonnes dishoarded in 1993 was 4.4% of the total hoard of earmarked gold. Because the total weight of earmarked gold has fallen since then because of ongoing annual shipments, at the present rate – if it continues unchanged – dishoarding for calendar 2001 will equal 518 tonnes, or 5.5% of the total hoard at the beginning of the year.
Here’s the big picture as I see it. It is by itself a telling statement that since September 2000, more gold has come out of the NY Fed than has come out of South Africa. But this dishoarding of the earmarked gold is even more significant when considering that more gold is coming out of the NY Fed than is needed for central banks to remain within their commitments established by the Washington Agreement, which leads to some fundamental questions.
Who is dishoarding? Why are they dishoarding? More importantly, given the low price of gold presently, one has to ask who in their right mind would want to borrow metal here and take the risk of a rising price?
I am referring here of course to the so-called ‘carry-trade’. By this technique, a triple-A borrower of gold may only be paying 50 basis points at present for his gold liability. He then sells the gold he is borrowing for dollars, which are then used to acquire higher yielding dollar assets, say, 5%. Thus the borrower has the potential to earn the 4.5% differential between his interest expense and interest income. But of course, if the gold price rises by more than that 4.5%, the profit from the ‘carry-trade’ vanishes and turns into losses as the gold price rises above that 4.5% threshold.
My sense of the present situation is that metal is coming into the market for extraordinary reasons, not logical ones. We’ve seen this pattern before.
For example, consider the Bank of England auctions. It is obvious that the BoE is not attempting to get the best possible price for its gold. After all, who would be silly enough to expect to receive the highest possible price after announcing in advance the sale of a major asset? Does Warren Buffett announce his stock sales in advance? Thus, the BoE sale was undertaken for some other reason than maximizing the price that it will receive from the sale.
Supposedly central bankers, as guardian of the gold reserves in their country, are ‘logical people’. If they sell metal for an objective other than to get the best possible price, it does not take a lot of imagination to conclude that these central bankers are either very stupid people (and central bankers are not that) or they are selling the metal to keep the price from going higher.
Similarly, why are central bankers willing to keep lending gold in this current environment, when the risks of lending seem so lop-sided compared to their 50 basis point return? And why are borrowers willing to keep borrowing in this environment with a lop-sided risk relative to the potential return?
Clearly, it’s not to maximize profits. There has to be some other reason. I believe that reason to be to avoid taking losses on their existing gold shorts, an objective that can only be achieved by keeping a cap on the gold price.
Thus, the evidence continues to build that governments are trying to put a cap on the gold price. But the extraordinary level of dishoarding of earmarked gold is important not so much just because it is additional evidence of government manipulation, but rather, the timing that it implies.
In the big 1993 rally, 583 tonnes were needed to turn back the price. Now 500 tonnes are needed just to keep the price from rising. In a rally, demand accelerates. If gold rallies now, how many tonnes will be needed to fill this demand? 1000 tonnes? 2000 tonnes? No one knows, but we do know that governments have ‘circled the wagons’ and are now running out of bullets.
For the past few years governments have been successful in achieving their objective to keep a lid on the gold price. But over time, circumstances change, which will in turn force governments to change as well. I think that moment is near.