Reprinted with Permission

Here is what seems clear about the Bank of England's gold sales: (1) the stated reason -- to adjust the composition of the BOE's forex reserves -- makes no sense; and (2) the decision was made at the highest political levels, apparently against the wishes of the bank's senior officers. What can possibly explain and reconcile these two facts?

There are some who say that the bullion bankers got to the politicians. Plausible, perhaps, though I for one consider this degree of venality at these levels to be unlikely. What is more, if the bullion banks themselves were in real trouble, I would expect to find the BOE both more prepared and more supportive than it appeared.

Several people with serious credentials in the gold business have suggested the possibility that although the Federal Reserve claims not to lease gold, it may write (sell) call options which are then used by bullion banks to hedge their gold leasing activities. If this assertion is correct (something I have no way of knowing), it is possible last May that not only was the Fed surprised by the strength of the gold price, but also that it was caught short with a lot of call options outstanding at around US$ 300/oz. Were this the case, it is something that would only have been known at the very highest levels of the Fed and the U.S. Treasury. And under these circumstances, it is not hard to imagine a call going out directly to the British Prime Minister for help. In particular, depending on the maturity schedule of the options, holding gold in check for just another few months could make a huge difference.

Of course, if the Fed were writing call options, one effect -- intentional or not -- would be to stimulate gold leasing. Turning off the option spigot, therefore, would also cause the bullion banks to rein in their activities, driving gold lease rates sharply higher. Indeed, at this point it would be in the interest of the Fed, the BOE, the other central banks and the bullion banks all to cooperate to keep a lid on the gold price for sufficient time to permit an orderly reduction in net gold derivatives.

Reg Howe
row@ix.netcom.com
http://www.goldensextant.com

23 September 1999