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"Ah! tenez, vous êtes de la merde dans un bas de soie."
With this much quoted insult Napoleon concluded his famous
tirade against Talleyrand in 1809, an outburst of anger that
most expected would end with the grand chamberlain hanging from
a gate of the Tuileries. Instead, he was merely dismissed. Talleyrand
himself would later suggest that Napoleon's clemency signified
weakness, "le commencement de la fin," an end that
Talleyrand in his enforced leisure secretly worked to hasten.
More than once at the FT World Gold Conference in Paris, I
found myself thinking how well Napoleon's coarse description
of Talleyrand fit certain bullion bankers, and wondering whether
they would prove as adept as the great French diplomat at retaining
money and power through changing governments and international
alliances.
The new "consensus" figure on the net short physical
gold position seems to be about 5000 tonnes, although where this
figure comes from or how it is derived is far from clear. No
matter, it is a figure that everyone can live with, giving the
longs hope but not scaring too much the shorts. However, no one
knows what the actual figure is, and most seem to prefer this
state of uncertainty, along with an absence of discussion about
the possibility that gold prices are being manipulated by a cabal
of bullion bankers acting in league with certain government officials.
The bear case for gold of a year ago has been replaced by predictions
of stable to modestly rising prices, just the right climate for
the shorts slowly to wind down their positions. Under the surface,
the great fear in the bullion bank camp is another upward spike
like that witnessed last fall in the wake of the Washington Agreement.
Much anecdotal evidence continues to support the hypothesis of
severe tightness in the physical market.
Summed up briefly, my principal impressions from the conference
were: (1) the ECB and its 11 member central banks do not have
a common policy on gold, which remains almost entirely subject
to national control by the individual member states; (2) while
a few central banks are making noises about a greater monetary
role for gold in the future, there is as yet little real movement
in this direction, either with respect to gold support for the
euro or as regards the monetary use of gold by less developed
countries; (3) the gold policy of Germany and the Bundesbank
is a mystery with potentially explosive ramifications; (4) no
one wants to talk publicly about the recent increases in the
notional amounts of gold derivatives on the books of the bullion
banks, but at least some bullion bankers evince concern that
these numbers, despite acknowledged difficulties of interpretation,
may indicate rising systemic risk; (5) some large gold mining
companies are beginning to show more sensitivity to investors'
concerns, including the dangers of hedging, the often misleading
use of "cash cost" figures, and the importance of the
"option value" of their shares on rising gold prices,
thereby creating a widening chasm between companies that do not
hedge (or hedge only minimally) and those that do; and (6) outside
of investors, but especially among bullion bankers, there is
great reluctance to credit or even to discuss seriously the mounting
circumstantial evidence of an international conspiracy to control
gold prices.
No Common Gold Policy in the Euro Area. Perhaps the
most striking fact to emerge on the first day of the conference
was the lack not only of a common gold policy within the Euro
Area but also of any officially reported information on gold
lending or gold derivatives activities by EA central banks. Speakers
from the Banque de France and the Oesterreichische Nationalbank
("OeNB" or Austrian National Bank), both of which are
EA member banks, described the gold policies of their banks without
once mentioning any constraint imposed by EA membership or the
ECB other than the Washington Agreement. While both hailed the
agreement as an example of cooperation among European central
banks, the substance of their remarks made clear that it was
in large part necessary precisely because the EA central banks
do not have a coordinated gold policy administered by the ECB.
For the French, Hervé Ferhani suggested: (1) gold lending
is risky because gold lent out is not the same thing as gold
in the vault; (2) the return on gold lending is low; (3) gold
lending tends to push gold prices lower, adversely affecting
the balance sheets of central banks that regularly mark their
gold reserves to market, which the ECB and all EA central banks
do; (4) central banks with large gold holdings tend to lose more
due to revaluations at lower gold prices than they gain from
returns on gold lending; and (5) in light of these considerations,
the Banque de France, which has gold reserves in excess of 3000
tonnes, does little or no gold lending.
Mr. Ferhani also noted the possibility that if major reserve
currency governments continue to reduce debt, a shortage of "risk-free"
assets might cause central banks to add more gold to their portfolios
to offset rising credit risk in other assets. Although he did
not say so, it is also possible that if these governments revert
to their former ways, their additional debt might not be viewed
as still so risk-free and more gold in central bank portfolios
in that case would make sense as well.
Dr. Peter Zoellner for the Austrians gave quite a different
view, emphasizing: (1) the lesser role of gold as a safe haven
in light of the central banks' success in controlling inflation;
and (2) the ability of central banks through gold lending and
other gold derivatives activities to earn a modest return on
an otherwise sterile asset. Austria has reduced its gold reserves
from over 650 tonnes in 1988 to under 400 tonnes today, with
a target of 320 tonnes in 2004. Much of this reduction represents
sales to the Austrian Mint for its popular "Philharmonic"
gold bullion coins.
During the question period, Mr. Ferhani tried to explain the
difference in the French and Austrian positions on gold lending
with reference to the difference in the size of their respective
gold reserves. But admitting that the right gold policy for a
nation with 3000 tonnes might not be the same as that for a nation
with only 400 tonnes, no effort was made to explain why two countries
which are members of a common currency area having combined total
gold reserves of over 12,000 tonnes should not follow a common
gold policy based on their combined reserves.
In conversation after his talk, Dr. Zoellner told me that
the OeNB limited its gold lending and derivatives activities
to not more than 5% of any particular market or market segment.
I asked if that meant, assuming total gold loans were 5000 tonnes,
the OeNB would be prepared to lend up to 250 tonnes. He answered
in the affirmative, and when I expressed surprise at the idea
of a central bank lending up to 62.5% of its total gold reserves,
he reconfirmed his answer. In any event, the policy of the OeNB
is not that of a central bank which expects gold to return to
the center of the international payments system at much higher
prices anytime soon.
After that same session of the conference, I had two other
revealing conversations. In one, a representative from the Banca
d'Italia told me that Italy takes very much the same position
as France with respect to gold lending, and then added that the
Bundesbank holds a similar view. Since there are well-founded
reports that the Bundesbank may have loaned out as much as 10%
of its gold reserves, I pressed him on this point, but he insisted
that his contacts at the Bundesbank report that Germany does
little or no gold lending.
In the other conversation, a representative from the ECB confirmed
that it does not publish any figures on gold lending or other
gold derivatives activities by EA central banks. He also confirmed
that unlike Swiss National Bank, none of the EA central banks
issues an annual (or other) report detailing its gold lending.
Indeed, it appears that the ECB itself does not have these figures,
which continue to be guarded at the national level much as they
were before the euro was launched. Accordingly, it appears that
there is absolutely no way to police the Washington Agreement,
particularly as it relates to the signatories' commitment not
to increase gold lending or gold derivatives from the levels
that existed on the date of the agreement.
The German Mystery. The gold policy of the Bundesbank
is rapidly emerging as a major issue with potentially huge ramifications.
Many believe that if the Bundesbank is in the gold market,
the bulk of its business is being channeled through Deutsche
Bank, Germany's biggest bank. In an earlier commentary,
I detailed the extraordinary increases in the notional amounts
of Deutsche Bank's gold derivatives during the last half of 1999,
all as shown in its most recent annual report. At the conference
I learned from a reliable source that its former chief gold trader
left the bank a couple of years ago, apparently forced out in
a dispute over new and more aggressive trading strategies.
At the conference, Jonathan Spall, Head of Central Bank Marketing
at Deutsche Bank, gave -- as did others -- a current estimate
of 5000 tonnes of central bank lending, attributing 1700 tonnes
to the European signatories to the Washington Agreement and noting
that both the Bundesbank and the Swiss National Bank had confirmed
lending "a small proportion of their gold." In the
Swiss case, officially reported
figures show leased gold at the end of 1999 amounting to
almost 320 tonnes, or over 12% of total reserves. If the Germans
lend in the same proportion, total gold lending by the Bundesbank
would amount to around 420 tonnes of its nearly 3500 tonnes of
reserves.
However, excluding the gold reserves of France and Italy since
these countries do little or no gold lending, and even without
adjustments for recent gold sales, total gold reserves available
for lending by the signatories to the Washington Agreement are
less than 10,400 tonnes, which multiplied by 12% yields about
1250 tonnes of gold lending. Thus to arrive at a figure of 1700
tonnes of total gold lending by this group, both more aggressive
lending by some of the smaller central banks and German lending
at least equal to Switzerland's as a percentage of reserves appears
required. In other words, if Mr. Spall is close to correct, the
Italian view of the Bundesbank's gold lending activity is almost
certainly mistaken.
Other interesting figures in Mr. Spall's talk: (1) his estimate
that "realistically the available balance for expansion"
of central bank gold lending worldwide is not more than 1000
to 1500 tonnes; (2) of the some 70 central banks that are involved
in the gold market, the great majority lend gold via deposits
of maturities under one year; and (3) only 10 to 15 central banks
trade in options and perhaps no more than 5 or 6 engage in lease
rate swaps. Although there have been rumors that the Bundesbank
is among the central banks writing call options, Mr. Spall unfortunately
provided no information on this point.
The day before announcement of the British gold sales, GATA's
Bill Murphy reported online that Deutsche Bank had notified its
clients that "the gold market is stopping at $290."
Deutsche Bank was notable but not alone in reporting exploding
notional amounts of gold derivatives in the last half of 1999.
The same phenomenon
occurred at Morgan Guaranty Trust and Citibank, but not at UBS,
the market leader, or Credit Suisse. Indeed, at the big Swiss
banks during this time period, the total notional amounts of
gold derivatives were flat to down. What is more, Morgan by all
accounts is the bank that sold Barrick its calls, a strange
transaction smelling of manipulation.
Deutsche Bank, which acquired Banker's Trust in mid-1999,
clearly aspires to be a major force in the dollar area as well
as in the EA, where it now faces greater competition from large
banks outside Germany. The transition to the euro has deprived
the big German commercial banks of the home currency advantage
they enjoyed when the mark was the dominant currency of Europe.
Financings in euros can as easily be done by French, Italian
and other EA banks as by German banks.
An even bigger loser to the euro is the Bundesbank, which
has yielded its former position as the pre-eminent financial
institution in Europe to the ECB. There are many who think that
former French President Mitterand and the Italians outsmarted
Helmut Kohl in negotiating the Maastricht Treaty. In any event,
the French and Italians who used to have to follow the Bundesbank's
lead on monetary policy and interest rates now have some significant
input through the ECB, while the Bundesbank is reduced to just
another EA central bank, albeit one with memories of glory and
a surfeit of formerly important officials.
Under these circumstances, it is not inconceivable that the
German bankers might cooperate at some level with an Anglo-American
scheme to control gold prices. For the Americans, the goal would
be to protect and extend the international dominance of the dollar,
rebuffing any challenge from gold or a gold-backed euro. For
the British, the purpose would more likely focus on undermining
the euro. Its success will almost guarantee the demise of the
pound as a major international currency, forcing the British
to choose between the euro or the dollar. It is a choice that
the British do not want to make and upon which they cannot agree.
If the euro fails, the British can muddle on with their own currency
and monetary policy.
For the Germans, if the euro fails, there is hope for the
restoration of their beloved deutschemark, and the privileges,
advantages, power and prestige that go with managing Europe's
leading currency. All these considerations hint at possible hidden
motives for the Anglo-American push for military action in Kosovo
during the euro's first year, as well as Germany's willingness
to support that action by sending its forces to fight on foreign
European soil for the first time since World War II.
Notional Amounts of Gold Derivatives. Since these numbers
first surfaced publicly, there has been surprisingly little public
discussion or even acknowledgement of them. The bullion banks
with the largest increases have refused to discuss or explain
them. Others have sought to play down the significance of notional
values. At the conference, in response to a question from GATA's
Bill Murphy, Kevin Crisp, formerly at Morgan and now at Credit
Suisse, refused to discuss the increases in Morgan's gold derivatives
on the ground that he was no longer there, and asserted wrongly
that his new employer did not have to report similar figures,
a mistake that was caught by his competitors at UBS. Another
speaker mistakenly tried to compare notional amounts of gold
derivatives to turnover figures for the LBMA.
However, several bullion bankers approached Bill Murphy and
me specifically to discuss the figures on gold derivatives. Although
they made some good points particularly about the difficulties
of interpreting notional amounts, none could explain why certain
large bullion banks had huge increases in the notional amounts
of their gold derivatives during the last half of 1999 while
others experienced no growth or even slight declines. A couple
of the bankers also confessed to having difficulties reconciling
total gold borrowing with total gold deposits, i.e., their
inside observations suggest a lot more borrowing by the bullion
banks than there are readily identifiable gold deposits by central
banks (and others) to support.
Within a single large bullion bank, there are often multiple
trading operations frequently located in different countries.
A couple of bankers said that even they did not know their own
bank's total gold deposits. Since the conference, another analyst
has told me that this problem is further complicated by the fact
that bullion banks not only accept gold deposits from central
banks but also borrow gold from them. The deposits typically
fund trading operations, but the gold loans are more often part
of the bank's general funding under the supervision of its treasury
department. In any event, it appears that some bullion bankers
are beginning to reach the same conclusion as Frank Veneroso,
GATA and others: there is a large, undisclosed source of physical
gold entering the market.
Synthesizing the bullion bankers' comments on gold derivatives,
several points merit mention. Both the sharp price collapse that
followed the British announcement of gold sales and the even
sharper rally triggered by the Washington Agreement naturally
stirred up a lot of hedging and derivatives activity. Basically,
the third quarter was characterized by heavy demand from miners
and others to put on new short positions, and the fourth quarter
brought equally heavy demand to cover these short positions or
go long. Had the fourth quarter demand been satisfied mostly
in the physical market, notional amounts logically would have
come down from end of third quarter levels. However if this demand
were met mostly by derivatives, and particularly by derivatives
of different types which are not as susceptible to netting, they
would likely be cumulative and add to the third quarter notional
amounts.
For example, suppose a mining company entered into forward
sales contracts with bullion banks in the third quarter for delivery
of a million ounces two years out. In the fourth quarter, it
covered part of this position. If it did so by buying back some
of its forward contracts or buying offsetting forward contracts,
the bullion banks would show lower notional amounts. If it covered
by purchasing physical bullion, the notional amounts reported
by the bullion banks would not rise but probably would not fall
either. But if it covered by purchasing calls, both the forward
contracts and the offsetting calls would be reported in the bullion
banks' notional totals at the end of the fourth quarter. Being
different types of instruments, they likely would not qualify
for netting, particularly if the precise terms of the calls did
not exactly match the forward contracts.
This example is hardly farfetched. Recent information suggests
that Barrick's calls are European style, cash settlement only,
with maturity dates of December 31, 2000, and December 31, 2001.
Most of Barrick's forward contracts are spot-deferreds. Thus
the obligation to deliver physical gold at a specified date (or
another date further out) is being covered by a cash obligation
that comes due on one of two specified dates at the prices prevailing
on those dates, which almost certainly do not coincide with the
delivery dates of more than a few, if any, of the forward contracts.
Clearly these different sets of obligations are not appropriate
for netting.
However, while this example shows how notional amounts could
grow even as the size of a short position is reduced, it also
points at two other risks: (1) a real or threatened shortage
of physical gold; and (2) ever longer daisy chains of derivatives
with increasingly complex links. Indeed, as previously discussed
in my commentary on Barrick's calls, this kind of transaction
seems almost purposely designed to avoid triggering a sharp covering
rally in a market short of physical gold, but of course it does
nothing to deal with the underlying problems of too little supply
and too low prices.
Changes in Hedging Strategies. Another important point
about the increases in notional amounts of gold derivatives reported
by bullion banks relates to changes in hedging strategies by
many mining companies, particularly in Australia where hedging
has not fallen into as much disfavor as elsewhere. However, there
are now many reports of Australian companies changing the mix
of their hedging to reduce the role of forward contracts and
increase that of purchased puts, still typically financed by
written calls. Logically this practice should tend to inflate
the notional amounts of gold derivatives reported by the bullion
banks while leaving replacement values more or less flat, and
thus is consistent with the most recent BIS statistics on the
gold derivatives of the major bullion banks and dealers in the
G-10 countries.
But again, this explanation also points to another area of
increased risk. To bullion banks, forward contracts with mining
companies represent a call on gold at favorable prices in a gold
bull market. So do any purchased calls. But while written puts
may provide gold to bullion banks in a bear market, in a bull
market they merely permit the bank earn its premium without engaging
in much delta hedging. Thus a significant move away from forward
contracts toward options tends to reduce the amount of physical
gold available to bullion banks at favorable prices in a bull
market. Again, some examples may help.
Prior to the Washington Agreement, a mining company wanting
to hedge a million ounces of future production might typically
have sold forward 800,000 ounces and bought reasonably close
to the money puts on 200,000 ounces, financed by writing calls
further out of the money on 400,000 ounces. This activity would
have resulted in a total notional amount of derivatives covering
1,400,000 ounces. In a big bull market, the company's maximum
exposure would be to deliver 1,200,000 ounces to its bullion
banks at below market prices.
Today a company wanting to hedge a million ounces might typically
sell 200,000 ounces forward and buy puts on 800,000 ounces financed
by written calls on an equal or lesser number of ounces. These
transactions would create a total notional amount of derivatives
covering up to 1,800,000 ounces. But the maximum delivery exposure
to the company's bullion banks in a bull market would not exceed
1,000,000 ounces, and could be considerably less depending on
the company's choice of strike prices and the premiums it could
obtain for its written calls in the much more favorable climate
for selling them since the Washington Agreement.
Alternatively, the company might reduce its hedge position
to 800,000 ounces, with 200,000 ounces sold forward, and purchased
puts on 600,000 ounces financed by written calls on another 600,000
ounces. The total notional amount of these derivatives would
cover 1,400,000 ounces, the same as in the first example, but
the company's maximum delivery exposure in a bull market would
now be down to 800,000 ounces, or a one-third reduction from
the 1,200,000 ounces in the first example.
Admittedly all these examples are a bit arbitrary, but the
point is that the notional amounts of gold derivatives reported
by the bullion banks can remain level or even increase while
the maximum delivery exposures of mining companies to bullion
banks in a strongly rising gold market actually decline.
More Evidence of Manipulation by the ESF. The June
2000 U.S. Treasury Bulletin (www.fms.treas.gov/bulletin/b20esf.pdf)
contains the financial statements of the Exchange Stabilization
Fund for the period ending December 31, 1999. It had a trading
loss of $1.627 billion in the the last calendar quarter of 1999,
or its first quarter of fiscal year 2000. This loss wiped out
virtually its entire profit of $1.637 billion in fiscal 1999,
of which $1.257 billion was earned in the last (July-September)
fiscal quarter. An earlier commentary
traces in detail a pattern over the past several years under
the Clinton administration of ESF losses in quarters marked by
strong gold prices and gains in quarters with weak gold prices.
This pattern could not be more unequivocal than in the last
half of 1999, with large gains in the third calendar quarter
during the price collapse caused by the May 7 announcement of
British gold sales, and large losses in the last calendar quarter
dominated by the sharp rally and complete reversal of sentiment
brought about by the Washington Agreement of September 26. What
is more, since the administration denies making any interventions
in the currency markets during either quarter, and since there
were no other crises appropriate for ESF intervention, nothing
other than gold trading appears available to explain these odd
results.
Another interesting aspect of the most recent ESF profit and
loss statement is another mysterious entry for commission income
of $39 million, the second time in the last three quarters that
this new line item has appeared. The closest historical analogue
in prior ESF statements to these "commissions" are
"handling charges on gold" that appeared prior to 1978.
I didn't hear it, but Bill Murphy reports that James Riley
of Goldman Sachs told a delegate to the Paris conference that
Goldman would offer unlimited amounts of paper to keep buyers
from pushing gold prices above $310 to $320. This remark does
not make much sense unless Goldman Sachs, former Treasury Secretary
Robert Rubin's old firm, has unlimited backing from some government
entity. None is a more likely suspect than the secretive ESF,
as to which Treasury Secretary Summers still has not responded
to GATA's questions. Last I heard, he was reportedly "looking
into" the matter.
"Talleyrand - Entre l'aigle et le lys."
Under this title in Son et lumière, the series
of summer evening spectacles in the Loire Valley, a cast dressed
in period costumes at Valençay, Talleyrand's castle, celebrates
his astonishing career. Because members of his family still live
in the château, only a few rooms are open to the public,
but there is an interesting automobile museum in the park. Talleyrand
is buried at Valençay. He died in 1838 at his Paris townhouse
on the rue de Rivoli. Today two plaques, one in English and the
other in French, remind passers-by that his former home, now
the Hôtel de Saint-Florentin, is where the Marshall Plan
for Europe was signed into effect.
As Bishop of Autun under Louis XVI, Talleyrand anticipated
the French Revolution. After moving to Paris, he helped draft
the Declaration of the Rights of Man and became president of
the National Assembly. Fleeing France for England and America
during the worst excesses of the Revolution, he returned after
the fall of Robespierre. Talleyrand both assisted in Napoleon's
accession to power and managed his departure. At the Congress
of Vienna in 1815, Talleyrand negotiated a favorable settlement
for France under the restoration of Louis XVIII, whom he served
as prime minister at the insistence of the European allies. With
their departure from France, he was sacked, but later returned
as advisor to Louis Philippe in the July Monarchy. Talleyrand
ended his official career as ambassador to London in 1834 at
the age of 80, having worked with equal success for France's
advantage and his own through the most tumultuous half century
in French history.
In 1800 as Napoleon's foreign minister, Talleyrand signed
a commercial treaty with the U.S., and in the process forced
the American minister, Robert Livingston, to pay a substantial
bribe. In April 1803, Talleyrand arranged Napoleon's sale of
Louisiana to the U.S. for $15 million. In his definitive and
entertaining biography Talleyrand - ou le sphinix incompris
(Flammarion, 1970), p. 397 (English translation, Talleryrand
- The Art of Survival (Knopf, 1974), p. 281), Jean Orieux
notes that France paid an unexplained 10% negotiating charge
on the gross sales price, and hints that this "fee"
may have facilitated Talleyrand's acquisition of Valençay
the following month. Purchased at Napoleon's urging as a place
to receive princes and foreign diplomats, Valençay, once
under contract to John Law and among the last remaining great
feudal estates of the Ancien Régime, fell by serendipity
into Talleyrand's hands. Thus, as Orieux wryly observes (p. 298),
"the shipwreck's most illustrious victim claimed the best
of the wreckage."
A malicious rumor that Talleyrand counterfeited notes somewhere
in the cellars at Valençay never gained traction. His
preference for real money was too well-known. Acts of official
thievery are one thing. Undermining the monetary system is quite
another. With nothing but contempt for real money, today's manipulators
of the gold price share Talleyrand's thirst for wealth and power,
but they lack his ability to discern and effect the broadest
national and international interests. His public legacy was relative
stability merely tarnished by greed. Theirs will be chaos as
the product of greed -- not the simple greed of individuals but
that of great commercial nations seeking to capture much of the
world's physical wealth by foisting their unlimited fiat currencies
upon lesser states.
Reg Howe
row@ix.netcom.com
http://www.goldensextant.com
14 July 2000
