05 February 2009

Blame yourself before blaming others

I liked this reply by Tom Szabo to some comments on his Today in Silver blog:

Market making should be temporarily and is not the same as manipulation in the sense of trend change.

“Should” is your own totally arbitrary qualifier. Market making is an activity that provides liquidity to the market, period. Since the trend in gold has been up for the past 6 years but it was sideways to down before then, can we conclude that manipulation is actually responsible for the “trend change” being up? In other words, maybe the central banks have been trying to manipulate the price of gold higher. Certainly the ECB gold agreement first put in place in 1999 seems to coincide rather well with the current bull market in gold.

Prof. Fekete wrote some time ago an article about Barrick’s forward selling of future mining output pointing out that this hedge is forcing gold prices down and might bankrupt Barrick in the long run.

I would have agreed (and did in fact agree) up to about a year ago but it is now clear the Professor was obviously wrong about the long run. I’m willing to make such a conclusion at this point even if we go instantaneously on the gold standard because Barrick has amassed a very large near-production gold resource that swamps the remaining hedge position even though it might represents more than 1 year of production. While it is very likely that Barrick’s forward selling was a business decision facilitated by the desire of central banks to “lease” gold, there was never any secret about this relationship. I’ll grant even that Barrick may have hedged in part to purposefully put other gold miners out of business. That, however, still does not constitute a trust or make its actions illegal. Note that gold miners who hedged were actually more likely to go out of business because their hedges, unlike Barrick’s, were FIXED MATURITY. Meanwhile, Barrick was able to roll its hedges forward indefinitely as well as to contractually allocate them to specific projects.

In late October 2008 gold traded at a low around 700$ but no metal was available (possibly except 400 oz bars.) Low prices and shortage do not go together in normal supply/demand situations.

The vast majority of the gold market by QUANTITY consists of 400 oz. bars. Your parenthetical admission of “possibly except 400 oz. bars” is quite relevant in that there was in fact no shortage in gold. In fact, the price tells us that there was more than adequate supply of gold. And I’m not talking about paper. Your point is only that there was a shortage in some gold coins. BIG difference.

A shortage in minting capacity is not the explanation either since the US mint was able to produce 2 million oz in 2000 and only some 700,000 in 2008.

So what? Annual mine and recycling supply is in the 80 million ounce range. Total world stockpiles are in the 5 billion ounce range. That makes U.S. mint production, whether it is 2 million or 700,000 ounces, completely irrelevant as far as the gold market.

Lundeen’s argument of CB’s leasing gold can be supported by a statement from Greenspan from 1998 that the central bank(s) are ready lo lease gold in increasing quantities if the price of gold increases.

He and you have taken Greenspan’s comment TOTALLY out of context, as all good conspiracy theorists and others who like to contort basic logic and common sense for personal gain have done. Greenspan was addressing the role of derivatives regulation and specifically the idea that derivatives can be used to extort market players by squeezing the physical markets. In respect of this, what Greenspan said was that worries about a short squeeze in gold, a finite market, are misplaced because central banks would be willing to lease gold to the market so as to make a short squeeze impossible. While central banks actually being able to do that (especially today) is debatable, the fact is that Greenspan was arguing for central bank action in gold being used to support a FREE MARKET (free of manipulators trying to create a short squeeze). This is exactly the opposite of how this quote has been used, that central banks stand ready to co-opt the free market by leasing gold in an uneconomic manner.

Starting around 2000 the balance sheet of the German Bundesbank shows instead of gold “gold and gold receivables” without assigning an amount to either position. This is at least a highly unusual accounting practice that in normal business life would be unacceptable.

“Normal business life” is full of millions of examples where things are described in specific ways meant to limit disclosure. For example, Central Fund of Canada, a private company in “normal business life”, currently trading at several % premium to spot prices which presumably means that investors find it a very attractive way to hold gold and silver, discloses as physical gold and silver holdings even the bullion that is a receivable from refineries. Is this unacceptable? Clearly not to CEF holders, many of whom I’m sure would nonetheless have a problem with the Bundesbank practice. In any case, the Bundesbank actually made an improvement in its disclosure (which is also arguably better than the current disclosure of the CEF) by moving from a title of “gold” to “gold and gold receivables”. Yes, a further improvement would be to actually break out the two numbers but the improvement itself cannot be used as “proof” that a conspiracy exists.

There might be stockpiles of silver around, but if the owner is insensitive to the price and does not want to sell the metal, why sell it short on paper?

You are kidding right? The owner is insensitive to price but like most people in this world, he/she/it/they are sensitive to profits.

There is the risk that the buyer of the contract wants delivery.

At least on a historical basis, this is a tiny, tiny risk. Other than the Hunt Brothers’ threat of wanting delivery in 1980, there has never been anything for shorts in COMEX silver to worry about. Even Warren B. was able to acquire over 100 million ounces of silver mostly over the COMEX and I doubt any of that came from these “secret stockpiles”. If a lot of deliveries were constantly taking place, that would be different, but at it stands only a small percentage of contracts are ever delivered each month. This is NOT the “fault” of the shorts, but the “fault” of the longs; there is simply not that much physical demand for COMEX silver. Besides, no specific contracts can be forced into delivery and the short position, in the worst case, can be offloaded for cash, even if it is at a really high price. At least that has been the case in 100% of the months (with the possible exception of January 1980) so far since the 1960’s when COMEX silver started to trade, and that is quite a good track record.

Moreover, the owner of the stockpile and the short seller are not necessary the same body.

Clearly, Sherlock! The owner of the stockpile uses a bullion bank as an intermediary, which makes it look like the bullion bank is “naked” short (since it does not itself hold a large stockpile of silver) to those who have no concept of how the bullion markets work.

That leaves the bullion dealer (or fabricator) as legitimate short seller. By selling the equivalent of his inventory short he takes a market-neutral position. But this assumes the dealer has no concept of market trends. Why sell short as long as an uptrend lasts? This is throwing money away. Only in a downtrend short selling makes sense.

You must clearly be a communist or socialist because you don’t appear to grasp even the most rudimentary aspect of capitalism. A dealer makes money by intermediating the spread between the buy and sell. In the case of gold and silver, the dealer is typically long paper and short the COMEX. That is the main intermediary play. In commodities like oil or grains, the intermediate trade is different. But in all cases the dealer makes money on the spread between the two markets (physical and futures). Of course the other side of the paper is held by the owner of the physical stockpile. In effect, the dealer makes a deal to hedge the physical position using the COMEX. That is why the dealer is called a “dealer”.

A dealer who can call trend changes correctly should be way more profitable then shorting gains in an uptrend away.

This is not a dealer, it is a trader. Many bullion banks have both dealer desks and trading desks. The two are separate although there are “leaks” between the two, primarily of information that gives the trader an upper hand in the market. Even without this leak, however, it is obvious why “sell short as long as an uptrend lasts” — BECAUSE it won’t last forever. Typically the short selling will increase during price spikes of a magnitude that have not been historically sustainable. A subset of longs ALWAYS hopes “this time might be different” while the shorts simply play the averages. These longs then make up crazy stories about why they are wrong EVERY SINGLE TIME. I prefer the credo “blame yourself before blaming others” but that’s just me.

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