Barton Biggs: Weekend Gold WormBarton M. Biggs, Morgan Stanley's well-known global investment
strategist, put out a research note
on July 16, 2002, making an investment case for gold. See T. Wood, Morgan
Stanley "name" backs gold, The Miningweb (July 18, 2002). Under
the heading "The True Believer," Biggs admits: "[A] horse I have never
believed in is gold, for all the conventional reasons, but now I am changing
what's left of my mind." He continues: "I think there is a plausible case
that a professionally managed portfolio consisting of the metal itself and
gold shares could realize returns of 15% real per annum in the difficult
environment ahead. Here is the story."
The story, as it turns out, is that Biggs has an old friend, Peter F.
Palmedo of Sun Valley Gold, who is a
"true believer" in gold. Biggs' research note is essentially a summary of
Palmedo's recent report: "Gold 2002: Can the Investment Consensus Be Wrong?"
This report is available online from links provided at the bottom of T.
seminal gold analysis is in, The Miningweb (July 19, 2002).
Palmedo builds on the 1988 article co-authored by future U.S. treasury
secretary and then Harvard economics professor Lawrence H. Summers and
Robert B. Barsky, "Gibson's Paradox and the Gold Standard," Journal of
Political Economy (vol. 96, June 1988, pp. 528-550) (available online at
discussed at length in my prior commentary Gibson's
Paradox Revisited: Professor Summers Analyzes Gold Prices.
Palmedo is nothing if not a good salesman. Biggs, describing the
Summers-Barsky paper as "too dense a thicket for me," accepted Palmedo's
interpretation unquestioningly. The Miningweb's Tim Wood gushed:
[M]oney manager cum braniac Peter Palmedo will be lionized for making
gold the most respectable subject in daily institutional investment
We're away from retread explanations of gold as a one-dimensional safe
haven from terror, plague and famine, the more hysterical chants about
dark conspiratorial manipulation in the vaults of the NY Fed are receding,
and the deflationary-Fed drumbeat of supply-side doyen Jude Wanniski is
Written in a calm tone reflecting rock-ribbed confidence, Palmedo's
analysis starts with the famously infamous "Summers-Barsky Gold Thesis"
published in the Journal
of Political Economy (June 1988). The research by Lawrence Summers,
former Clinton Treasury Secretary and current Harvard President, attracted
a lot of attention as one of the key exhibits in Reg Howe's impudent
effort to sue Alan Greenspan and other luminaries from the
finance-treasury complex for cooking the gold price.
Where Howe and his supporters at the Gold Anti-Trust Action Committee
saw the thesis as a blueprint for a cabal to rig markets and the dollar in
a devilishly clever way, Palmedo saw fine scholarship.
In fact, Palmedo saw quite a bit that wasn't there, starting with his
basic assertion: "These two highly regarded researchers conclude, based on
two hundred years of empirical data, that the relative price of gold is
driven by (and is the reciprocal of) the real return from capital
markets" [emphasis in original]. Lord Keynes gave the name "Gibson's
paradox" to the close correlation between interest rates on British consols
and the general price level observed during the gold standard era. Studying
the period from 1973 to 1984, Summers and Barsky conclude (at 548):
The price level under the gold standard behaved in a fashion very
similar to the way the reciprocal of the relative price of gold evolves
today. Data from recent years indicate that changes in long-term real
interest rates are indeed associated with movements in the relative price
of gold in the opposite direction and that this effect is a dominant
feature of gold price fluctuations.
Thus, according to Barsky and Summers, Gibson's paradox is not solely a
gold standard phenomenon, but also manifests itself in a free market for
gold, where gold prices will move inversely to real long-term interest
rates, falling when rates rise and rising when they fall. To the extent that
Summers and Barsky looked at equities, they used "stock yield data ... [to]
argue that Gibson's paradox involved the underlying real rate of return, and
not merely the nominal yield on nominal assets" (at 530). Thus they
"examine[d] both earnings/price and dividend/price ratios [because] [b]oth
should be proxies for long-term required real returns" (at 537).
Neither Gibson's paradox nor Summers and Barsky posit any relationship
between gold prices and total returns on equities, whether real or nominal,
especially where capital gains rather than earnings or dividends are the
principal measure of return. Nevertheless, Palmedo asserts: "This
relationship [of gold prices] to the capital market real return (and
particularly to the movement of the stock market) has proven stunningly
consistent since [the Summers and Barsky] paper was written."
As the following chart by Mike Bolser demonstrates, there is no
observable long-term correlation between the annualized total return for the
S&P 500 calculated on a monthly basis and either inverted gold prices or
real long-term interest rates. For this purpose, Mike has calculated the
return on the S&P 500 each month by taking the absolute change in the
index over the prior twelve months, positive or negative, adding cumulative
dividends over the same period, then dividing by the starting value of the
index, and finally dividing by ten in order to plot on the same scale as
interest rates. Thus a 20% positive return on the S&P is plotted the
same as a 2% real interest rate. The return on the S&P 500 has not been
adjusted for inflation, which in any event would have had relatively little
impact on the rate of return given its wide swings often exceeding plus or
Of course, the "movement of the stock market" is not precisely equivalent
to the monthly annualized return on stocks. Biggs includes as Exhibit 1 in
his research note a chart headed "Gold and the Dow - A Natural Aversion"
depicting "Weekly Gold Spot vs. Inverted Dow Jones Index" from 1996 to 2002.
At my request, Mike Bolser has created essentially the same chart but
covering the period from 1966 to 2002. Because of the different time spans,
the scales for the both gold prices and the Dow cover a greater range in
Mike's chart, where the Dow starts at around 1000 versus 5500 in Biggs'
chart and gold reaches from $35 to over $700 versus a range of $240 to $420
for Biggs. Yet it is easy to see from Mike's chart that taking the period
from 1996 to 2002 and adjusting the scale would yield a pretty close
correlation between gold and the inverted Dow, just as Biggs' chart showed.
The problem is that the same cannot be said for the period prior to
Taking Mike's two charts together, the period since about 1995 is
characterized by a breakdown in the long-term correlation described by
Gibson's paradox while at the same time the Dow and gold prices are moving
in a close inverse relationship that is unusual. Gibson's paradox operates
in a free market for gold just as it did under the classical gold standard
because both regimes are free market mechanisms. What will defeat Gibson's
paradox under either regime, as Summers and Barsky point out, is government
interference, whether with the free flow of gold under the gold standard or
with its the free market price since the demise of the Bretton Woods
According to Palmedo: "Statistically speaking, the stock market explains
72% of the monthly price movement of gold over the past 14 years and 88% of
the weekly price movement over the last eight years." Even assuming that his
statistics are sound, there is nothing in Gibson's paradox to support the
causal relationship that he asserts. The argument that Gibson's paradox does
support is that beginning around 1995, government interference with free
market gold prices permitted real long-term interest rates to fall to
artificially low levels, and these low rates contributed to the stock market
boom -- or, more accurately, bubble -- that is now unwinding. Correct as his
bottom line investment advice may be, Palmedo's analysis has validity only
to the extent that it is the Dow/Gold ratio in drag. See The
Dow/Gold Ratio and the International Monetary Order.
What is more, just as The Miningweb consigns them to near
irrelevance, "the vaults of the NY Fed" have produced an interesting
development that bears close watching over the next couple of months.
Paragraphs 2 and 3 of Plaintiff's
Second Affidavit in the gold price fixing case summarize the outflows of
foreign earmarked gold from the N.Y. Fed through June 2001 as reported
monthly in table 3.13 of the Federal Reserve Bulletin. As shown in
the following chart by Don Lindley, the pattern of steady outflows in excess
of 50 tonnes per month that started in September 2000 ended in June 2001.
From then through March 2002 there was virtually no change in the amount of
foreign earmarked gold at the N.Y. Fed. However, in both April and May, the
most recent months for which there is data (Federal Reserve Bulletin,
July 2002, table 3.13), the outflow resumed at a rate of 5 tonnes each
month, barely enough to register on Don's chart. Whether these new outflows
represent a last few drops that can be squeezed from increasingly reluctant
central banks or the start of new, more significant monthly outflows to come
remains to be seen. Meanwhile, those who believe that what happens in the
vaults of the N.Y. Fed has little to with gold prices might consider why in
recent years gold prices have tended to rise whenever these outflows have
As a gold bug, Biggs never progressed beyond the larval stage. On Monday,
July 22, less than a week after issuing his panegyric to Palmedo, Biggs went
on CNBC to aver that he really knew nothing about gold and to imply that his
favorable comments about it the previous week should be disregarded. It's a
safe bet that his employer didn't like them either. Near the end of June, I
learned from a quite reliable source, later confirmed by a second, that
Morgan Stanley had emerged as "the new sheriff in town that keeps a lid on
the gold market" in New York. (Note: Because Morgan Stanley is an investment
bank, its gold and other derivatives do not appear in the OCC's reports, and
unlike Goldman Sachs, it had not previously been visibly active in
suppressing gold prices on the COMEX. Thus, although aware of information
suggesting that it was member of the cabal, I did not have sufficient
grounds to name Morgan Stanley as a defendant in the gold price fixing
Working overtime for this commentary, Mike Bolser has provided a chart of
the daily closing spot gold prices on the COMEX since Judge Lindsay's
decision dismissing the gold price fixing case, together with a related bar
chart of COMEX daily gold futures volumes over the same period. The price
chart also plots the daily closing prices of J.P. Morgan Chase (NYSE: JPM),
which as can be seen in the Gold Market Regression
Charts is the American Goliath of gold and interest rate derivatives. As
the price chart shows, gold prices climbed steadily from just under $300/oz.
on March 26, the date of the decision, to almost $330 by the beginning of
June. Since then, in both mid-June and mid-July, gold made two more runs at
the $330 barrier, only to be beaten back on heavy volume and amid reports of
Prior to this past June, the last time gold made a serious run at $330
was during the sharp rally in gold prices triggered by the Washington
Agreement in the fall of 1999, all as recounted at paragraph 55 of the Complaint
in the gold price fixing case filed in December 2000:
The fifth wave of preemptive selling in excess of two standard
deviations occurred in response to this rally as the Fed, the Bank of
England and the BIS struggled to halt and reverse it. According to
reliable reports received by the plaintiff, this effort was later
described by Edward A. J. George, Governor of the Bank of England and a
director of the BIS, to Nicholas J. Morrell, Chief Executive of Lonmin
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 U.S. Fed was very active in getting the gold price down.
So was the U.K.
What the market seems to be saying now is what Eddie George was saying
then: gold prices over $330 will collapse the heavily exposed bullion banks,
starting with J.P. Morgan Chase. See M. Goldstein, Bank
Derivatives Back on Radar, TheStreet.com (August 2, 2002).
Indeed, given their enormous absolute and relative size, the gold and
interest rate derivatives of J.P. Morgan Chase cannot be reasonably
explained except as a Fed-endorsed operation carried out through its
traditional bank. See W. Greider, Secrets of the
Temple (Simon & Schuster, 1989), p.269.
In this context, Barton Biggs' July 16 clarion call to investors to
consider the merits of gold could not have come at a worse time for the gold
price fixing cabal. Gold prices were rising again toward $330 while JPM's
stock price was falling into the mid-20's from the high 30's as recently as
late May. Royal Bank of Canada, one of that country's leading financial
institutions, was still wiping golden egg from its face after publicly
disassociating itself from an improvidently published internal report by one
its senior officials endorsing point-by-point the principal evidentiary
allegations of the gold price fixing case. See "'Conspiracy Theory' Gains
New Credibility at www.nationalinvestor.com/leaked_gold_report_reveals_troub.htm;
see also http://groups.yahoo.com/group/gata/message/1149;
Stories on this contretemps dated June 22 to 25, 2002, from The Globe
and Mail (Toronto) and South China Morning Post are reprinted at:
During the week that began with Biggs aborting his gold call, gold prices
were hammered back to near $300 even as JPM's stock price fell to around $20
before recovering slightly at week's end. Palmedo's "seminal analysis" may
give comfort to those investors in gold who crave respectability over truth;
it does little to explain the fierce battle whenever gold prices approach
$330. Real gold bugs can handle the truth and will sting for it. "Impudent"
is among the milder adjectives typically applied to them, as any member of
the GATA army can readily attest. Pseudo gold bugs might bite a little, but
not enough seriously to offend the powers that be. And gold worms, well,
they just roll over.
August 13, 2002
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