22 January 2014

Where We Are At In the Global Precious Metals Markets - A Framework

"We looked into the abyss if the gold price rose further. A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake.

Therefore at any price, at any cost, the central banks had to quell the gold price, manage it. It was very difficult to get the gold price under control but we have now succeeded. The US Fed was very active in getting the gold price down. So was the U.K."

Edward 'Steady Eddie' George, Governor Bank of England 1993-2003

The general hypothesis I have put forward over a period of time at this café is that with the spike in the price of gold up to $1900, the central banks of the West became greatly concerned, and opted for a lower price, and a more orderly rise.  And so the price of gold was smacked down into a trading range between $1540 and $1780 through the various price and market operations of some central and bullion banks in what we can think of as a gold pool.

As you may recall, the great sea change was that central banks turned from being net sellers to net buyers of gold, slowly over a ten year period from 2000-2010 approximately.  This change of policy was not uniform, but driven largely from the emerging and re-emerging nations. It ought not to surprise us. No fiat currency has survived for long in historical terms, and even fewer as the world's reserve currency, unless backed by an unassailable empire. They will fall to Triffin's Dilemma, and the decay of power to self-serving and short-sighted corruption. 

Forces similar to those that are working against the EU monetary union, without a comprehensive political union, are working against the dollar global reserve currency, on a much larger and slower paced scale.  This is why a global currency issued and controlled by one central entity tends to presume a one world governance, or at least a cohesive governance of a rather large piece of it.  It is not incidental to their financial goals.

In late 2012 the Deutsche Bundesbank requested, albeit under some domestic political duress and after a polite request to audit the gold was deferred, to have the return of some portion of their nation's gold from its wartime home in New York and Paris.

The NY Fed responded with a rather surprising timeline of seven years for the return of what ought otherwise be a fairly doable amount of gold, despite what the Lord Haw Haw's of the Western gold pool might otherwise have you believe.  The gold pool is a consortium of central banks, bullion banks, and purveyors of paper gold in various unallocated forms who are beholden to a vested interest in a very powerful status quo.

In their desire to control the price of gold, the gold pool has leased out a fair amount of their national bullion holdings to the bullion banks, who in turn sold it into the markets to hold down the price.  A rising price was risky for the confidence of their paper money, and rising demand placed a strain on their ability to supply additional gold to supplement what the miners could produce.   And so it appears that Germany's gold was unavailable.

With the unfortunate circumstance of the gold of the German people threatening their deal to maintain confidence in their currency arrangements,  the central/bullion banks of the West were once again 'staring into the abyss.'   

How could anyone even imagine that government sources, who traffic in public confidence, could allow such a thing to happen, to blatantly abuse their powers, and prevaricate to the public?  It would be a tremendous loss of face, and personal career risk.  And so absent a whistleblower, the goal is to keep the game going at all costs.

So starting in late 2012, a major push began to manage physical gold away from the West's ETFs,  to relieve the short term supply constraints, which involved driving the price lower, and once again mobilizing the troops to talk the metal down.  Please notice the difference in the inventory of silver and gold, both of which had comparable price declines.

This gambit worked to some extent in the West, but overall it failed, miserably.  Demand for physical bullion skyrocketed in the East, as Asia took advantage of the lower bullion prices to increase their official/private offtake of bullion.  The West rehypothecates, but Asia takes.  And that taking presents a heavy toll to a highly leveraged trade.

Apparently the people of Asia for the most part did not agree with the Western economists and brokers that gold was undesirable, for whatever reasons they hold, with a strong basis in human history I should add.  Let's call it a difference of opinion amongst 'peers.'

In a very real sense we should remember that gold is gold, and the price of gold is more like a currency exchange rate than the price of a commodity.  And so one can think of this entire scenario as a major defense of the dollar at some ideal exchange rate to gold, in much the same manner that the Bank of England sought to defend a particular valuation of the pound.

So here we are today, with gold at a level somewhat below $1250 and silver at $20.  And the Comex deliverable gold is at record lows, and indications, albeit somewhat difficult to obtain, of continuing strains for producers (e.g. miners) to continue adding to supply, in the face of a shrinking discretionary market for physical gold (scrap, ETFs, exchanges).  And those who are managing the floats in the market, the unallocated, forward sold, and rehypothecated, are fundamentally shitting their pants, and seek to sit in it with smiling faces lest they give their vulnerable positions away.

The gold pool can rehypothecate and leverage physical gold by multiples into paper, and outright create it with naked short selling.  And they can sell this paper in bulk at whatever they wish in the markets which they control. And they can use positional advantage and their media to bully boy anyone who dares to question this into silence.  But they cannot print gold bullion and deliver it to Asia, which quite frankly does not care what they say. 

In general this is what is referred to at the divergence between the paper and physical gold markets.  It is what happens when 'semi-official' forces endeavor to set an artificially low price in a market that involves some physical commodity which is in a somewhat limited supply.  It tends to become more limited as a result. 

But the supply of paper gold is not limited, especially where things like position limits and leverage are given the wink and a nod behind a wall of opaque obfuscation. And like the reckless fools that they are, they decided late in 2012 to press their advantage hard, with shock and awe, and they are failing.

So this is why I think things will unravel in a manner similar to the London Gold Pool's operation which sought to set an artificially low price.  How exactly this will unravel is a matter of much conjecture.  I doubt it will break at the source of the paper gold, given the power the insiders have over the rules and information there.  Rather, there is more likely to be a strain at some physical delivery source that will cause the current pool to back up the price higher to some more sustainable level.  What that will be I cannot say.

What is driving this current dynamic is what is called the 'currency war,' which is shorthand for a difference of opinion amongst the world powers over the existing global currency trade regime, and the trustworthiness of the financial system that supports it.

China, Russia, Brazil, Venezuela et al. have lined up their interests against the Anglo-American banking cartel which rides the wave of dollar hegemony.  

If you think about this a bit, how would you feel if China's yuan was the world's currency, in which your country held its savings, and with which it paid for important and useful things like oil.  And what if China decided it could print as many yuan as it liked for its own purposes, thank you very much, and distributed them as they wished to its favorite banks and friends.  You would not like it one bit, it would make you rather uneasy, especially if the Chinese mouthpieces in academia started talking about trillion yuan platinum coins to resolve their own internal political corruption.

So, the most likely outcome is a compromise, in which a basket of currencies and a commodity or two like gold, are bundled together into an artificial currency for world trade.  This way no one country, or group of countries, held the 'exorbitant privilege' of owning the world's currency. 

Quite to the point, I think much of what we are seeing now is the 'negotiation stage' of this process.  It is not so much a question of outcome, but rather, of price.  What is to be included and at what valuation to the various world currencies.  I would be stunned if there was a return to an actual gold standard.  I would prefer to see the price of gold float freely without an official government valuation or the thinly disguised monkey shines of the Comex.  But such antics seem to be de rigueur in most financial markets as we have recently learned.

As you might imagine, the existing power structure might choose to continue to fight this rather aggressively, since there are no such enjoyable privileges as exorbitant ones.  Especially if there is a partnership between the political and financial class to maintain their privilege for themselves and their favorite one percent of their constituents.  But they must also contend with their waning power, and significantly low approval and discontent at home.  Pushing questions of one's authority are ill-advised when you cannot be sure of the answer.

And perhaps the biggest unspoken risk-that-must-not-be-named is the credibility trap.  What will the people say if they discover that the Bankers have taken their gold in order to give it to their banking cronies for short term profits?  Yes they will wrap it in rationalizations, excuses, jingoism, and personal immunities, but when the cards fall on the table, the thefts will be uncovered.

So here we are.  Those who think they know what will happen next probably have not given it sufficient thought.  I have a range of ten scenarios, in four major groupings, that are all fairly plausible.  There are some very large exogenous variables involved that no one can predict with much accuracy.

Perhaps some day I will categorize them more cleanly and attempt to lay them out. But for now it is enough work to know what to look for. Watch the UK as I have said, as it may be a bellwether for various reasons of size and composition, and continental Europe, to see if they will accept the role of a 'patsy' for the Gold Pool.   And of course watch China and Russia, and the areas of tensions around them.

What happens next is that one way or the other change will come. Of that I am sure.