Ready…
Set… Go…
Personally, I have been bullish on gold prices ever since
the Bank of England announced that it would sell most
of its remaining gold, in the spring of 1999. One reason
is that while the announcement sent gold prices down to
the $250 handle, the sell off wasn't panicky, in nature.
There was volume, but it wasn't a long liquidation. There
weren't enough (gold) bulls around even then for the announcement
to set off a panic.
It
was more like the very last gasp of air that a dead bull
might snort, just before he keeled over at the hands of
his bullfighter…
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| 10
year gold prices:BOE announcement |
2
year gold prices:Nine month wedge? |
Within
five months, in any case, we were ready to discover why
the Bank of England chose to slam the gold market… the
major European banks had already sold or leased too much
of their gold, and had finally agreed to stop the risky
practice by signing the now historic Washington Agreement
at month end, September 1999. Though the agreement was
downplayed for its significance, perhaps it was necessary
if only because the banks did not trust each other to
keep to a verbal agreement (maybe even having already
failed at that). Is that an idle thought?
Anyhow,
with the benefit of hindsight, may we propose that it
was helpful to the European banks (the signatories) for
the Bank of England to stand on top of the corpse and
squeeze every last ounce of life out of it (the market)
first? This way, the reversal could take place from a
lower price level, allowing two obvious advantages: first
it would soften the net financial punishment that the
market was ready to deliver in October - upon hearing
of the agreement - and second, not unrelated, it would
allow the European banks some time to prepare and cull
their portfolios a little. In our opinion, this basic
scenario is far too plausible to dismiss.
Consequently,
maybe it is "not" all that ironic that lurking
in the background recently has been the rumor of news
that the Bank of England is short physical gold supply
with which to settle on its post auction delivery notices...
The
view has been offered (by many blue chip analysts…) that
the psychological impact of the news that a prestigious
central bank cared nothing for its gold holdings, at the
time, vastly outweighed the potential market impact of
the relatively small amount of gold it held and planned
to sell, were it done quietly. But the Bank dismisses
this key point as misguided criticism, proposing rather
that they broadcast their intentions precisely because
they did not want to scare the market. Huh?
You
can say that again…
Anyhow, nothing ever happens unless there is a reason
for it, right? Of course, we have no proof. We haven't
the resources to obtain it. But we can assure you that
there are very few speculators or investors who have any
more than half the truth at any given point in time… maybe
even less than that today.
The
reality is that the Bank of England's move was out of
place and out of character. It did not reconcile with
the view that the European banks shared about gold officially,
and it stood entirely against the American position on
gold. Folks, this is not conspiracy, it is strategy. We
cannot expect that if there exists a potential systemic
risk in capital markets large enough that it could crush
the global banking system, were it to crystallize, that
politicians would tell us all about it. It just does not
stand to reason.
More
to the point here, adopting our view, it suddenly becomes
easy to explain the rise in lease rates prior to the signing
of the Washington Agreement, which seemed to puzzle the
esteemed Dr. Jessica Cross in her report on the gold derivatives
crisis, one year later.
Right,
here we go then… those bankers in the know spent the summer
unwinding some of their more perilously speculative positions.
Who wouldn't? Perhaps, some of the smarter ones had also
decided to hoard some physical gold supply, without detection,
and maybe even bid for it at the Bank of England's own
gold auctions throughout that summer. Ok, if not, how
else does one explain the rise in lease rates?
Traders
have been trained to anticipate large bullion sales on
the rising lease rates. One reason is that it has been
traditionally customary for a borrower to sell the gold
right away if it was borrowed as a source of financing.
The other reason is that when a central bank would sell
its gold, it would draw it from the leasing pool to do
it.
Yet
neither occurred. Rather, there was a nearly obvious accumulation
on the charts, at the $250 handle. Well then, somebody
must have been accumulating physical gold supply. I suppose
it could have been anyone, but consider that such a move
might enable the said bankers to contain the post Washington
Agreement gold market by supplying the lending pool in
order to hold lease rates down and persuade us that there
is plenty of supply. Sound familiar?
Yet
that conclusion is way too controversial to make about
her own clients and business associates, and evidently
further removed from reality than the idea, proposed by
Cross, that the higher lease rates were deliberated by
said bankers to generate a little more profit for themselves.
Hah! No kidding, that kind of guessing is allowed because
it pleases the Queen that her bankers seek to profit in
the name of capitalism. The greater insidious truth is
that they do it at the expense of capitalism. The critic
of our argument might suggest that the lending pool is
far too large to lend itself (no pun intended there) to
manipulation with such a small quantity of physical gold
as could be bought without detection in five months. This
critic should read on…
Contango-i-tis
How important are lease rates anyway? According to Dr.
Cross, writing for the World Gold Council on the subject
of gold derivatives and lending, "the widespread
use of derivatives has generated a growing need for
lent gold and the concept of participating in the
leasing market has been actively marketed (?) to the official
sector by the commercial banks."
Since
the widespread use of derivatives has grown ever wider
since the Washington Agreement was signed, lending markets
must have become ever more crucial to the life blood of
the contemporary banking system, and lease rates ever
more indicative, of something.
But
what lending market? According to Jessica Cross, again,
"The extent to which the Washington Agreement
has effectively sterilized a very large proportion of
potential new lending is all too apparent… Should this
be the case, the total potential liquidity, post the Washington
Agreement, now stands at between 560 and 1000 tons. This
compares with figures of over 6000 to over 9000 tons prior
to the announcement."
In
other words, the regular flow of gold into the lending
pool has withered by almost 90%, as a result of the agreement.
Well… if this tap has been all but shut off, shouldn't
lease rates have risen after the Washington Agreement?
Maybe that is what is happening right now. The delayed
reaction may be the consequence of two things: First,
demand from traditional gold borrowers undoubtedly declined
by roughly the same quantity as the new supply, after
witnessing what could happen to entire companies who owed
the volatile metal. Second, whatever borrowers remained,
largely rolled their borrowings right up the maturity
contango… meaning that they extended their maturities
beyond one year, for a little temporary safety. Another
observation made by the Doctor (PhD) in her own report…
quoting anonymous banking sources of course.
So
if borrowers are borrowing longer term now than one year,
that alone probably imparts a slight net drain on the
availability of short-term physical gold supply. Moreover,
if the currency volatility continues, duh, as if the international
currency regime would all of a sudden become stable, then
it is increasingly unlikely that the smaller players,
like Turkey or India, will be all too willing to join
loyal Kuwait in lending their official gold reserves to
the hungry tentacles of a giant Fiat Octopus. And if the
commercial banks continue to increase their net derivatives
exposures then they will be, according to Ms. Cross, generating
a growing "need" for lent gold.
So
unless Japan or the United Sates enter the picture, there
really isn't much of a lease market… and therefore, the
published lease rates, especially under one year, have
been largely containable, until now perhaps. Since Japan
has the lowest proportion of their foreign exchange reserves,
among its senior economic peers, vested in gold and since
China is planning to become an influential gold trader
in the nearby future, it is unlikely to expect Japan on
the offer any time soon. If it does, it will be at its
own monetary peril, but we believe that the Japanese are
increasingly uninterested in supporting dollar policy
as an international standard.
Finally,
I cannot imagine anything quite so bullish as the American
government approving the sale or lease of its own gold.
What would be bearish for gold in the short run is for
US bullion banks to successfully market the concept
of leasing gold to influential Japanese authorities…
an unlikely monetary coup for our dollar governors.
But
let's consider the bullish case. Maybe there is some truth
to this rumor about the Bank of England's supply shortfall.
Even as far as a month ago, we began to hear questions
like, what if the BOE were to repeal its gold auctions?
Well, if that is true, then combined with the other pressure
cookers in the lease contango and dollar-denominated capital
markets, we are perhaps only seeing the beginning of an
enormous supply shortfall in the gold business… especially
if investment demand comes back!
And
maybe the idea that the Washington Agreement effectively
shut down the leasing pool in the same way and maybe for
the same reason that the London Gold Pool was shut down
in 1969 will be valid. If so, its symbolic significance
cannot be understated.
Edmond J. Bugos
Editor - The Goldenbar Report
March 8, 2001
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