Central Bank Gold Operations And Its Ramifications Conclusions

An Enigma Wrapped In An Anomaly

November 22, 1997

Since 1993 the financial markets have displayed unprecedented "IRRATIONAL EXUBERANCE" - as the Fed Chairman aptly describes it - while the CRB and GSCI (commodity indices) show only very modest appreciation. Specifically, stock market valuations have surpassed the unbridled market mania of even 1929. Meanwhile, the agriculturally oriented CRB is up a mere 9%, while the energy weighted GSCI has done a little better, rising 15% during the same period In sharp contrast gold has been prevented from reflecting the general, across the board increase in values enjoyed by all other types of investment assets. With a short respite of rising gold prices in early 1996, the yellow metal has on-balance dwindled in value. From late-1993 the Midas metal has indeed declined by 3% from $333 to $304. In fact just recently the noble metal registered a 12 year LOW!

SOMETHING IS AMISS - SOMETHING IS CAUSING THIS ANOMALY RAPPED IN AN ENIGMA. SOME FORCE - EXTERNAL TO THE MARKET - IS CONTROLLING THE PRICE OF THE NOBLE METAL. SOMETHING IS FORCING IT TO BE RANGE BOUND! This begs the following questions: 1) By whom? and 2) Why?

WHO HAS THE MEANS TO CONTROL THE PRICE OF GOLD?

There only one entity, which has both means and motive for the job: Central Banks. And Who is the MOTHER OF ALL CENTRAL BANKS: Federal Reserve Bank of New York!

THE FEDERAL RESERVE BANK OF NEW YORK

Among its myriad functions the New York Fed also is responsible for maintaining relations with, and providing financial services for, FOREIGN CENTRAL BANKS and international organizations. One of these services is the New York Reserve Bank's unique custodial responsibility for the gold reserves of about 60 (SIXTY) countries, central banks, and international organizations.

In fact the FRB of New York stores about one-third of the world's official gold stock, about 12,000 tons - valued at approximately $125 billion at current market prices! It is imperative to appreciate that this gold stash represents almost six years of the western world's annual mine production!

Intervention In Foreign Exchange Markets

- The U.S. monetary authorities may sometimes intervene in the foreign exchange (FOREX) market to influence market conditions and/or the value of the dollar.

- The U.S. Treasury, in consultation with the Federal Reserve System, has responsibility for setting U.S. exchange rate policy, while the Federal Reserve Bank of New York is responsible for executing FOREX intervention.

- The New York Fed buys dollars on the FOREX market to increase the value of the dollar and sells dollars to decrease its value.

Although the FRB and U.S. Treasury will not admit that gold bullion is money or legal tender, it nevertheless possesses 262 million ounces of the yellow metal for payment of international debts when necessary. Throughout history and through most of the world, gold is considered money. The FRB and U.S. Treasury's stubborn refusal to recognize gold as money is as absurd as its ridiculous balance sheet value of gold at $42.22 per ounce.

GOLD IS MONEY - GOLD IS CURRENCY, otherwise why would the Fed jealously GUARD AND KEEP INTACT ITS 262 million ounces of the yellow metal for payment of international debts when necessary.

Central Bank Gold CALL Operations

It is common knowledge that banks - especially central banks - have for years been selling (i.e. writing) gold Calls against their holdings of the yellow metal. The reason for this unorthodox banking activity is obvious: it provides income on a non-producing asset.

The gold Call writing activity can also be made relatively risk free - if the gold price can be "stabilized within a tight range. Although the FRB can easily control the market price alone, price "maintenance" within a pre-determined range - through the cooperation of its financial cohorts - is much easier. Specifically, when gold's market price approaches the strike price of its Call options, the Fed or Treasury simply starts selling bullion (and/or gold futures) to bring gold's market value down, so that near-term Calls may expire unexercised - AND WORTHLESS!

This begs - NO DEMANDS - the crucial questions: SHOULD CENTRAL BANKS BE ALLOWED TO SPECULATE WITH THE PUBLIC'S MONEY IN THE COMMODITIES MARKETS? INDEED, ARE CENTRAL BANKERS EVEN QUALIFIED FOR THESE HIGHLY RISKY COMMODITY MARKET OPERATIONS? ARE THESE TRADITIONAL CONSERVATIVE BANKING OPERATIONS? WHY ARE THESE NON-BANKING TRANSACTIONS NOT REVIEWED BY CONGRESSIONAL COMMITTEE TO ENSURE AS TO THEIR PRUDENCE AND SAFETY? WHAT COULD BE THE DIRE CONSEQUENCES IF THE FED MISCALCULATES IN ITS GOLD SPECULATIONS? COULD THIS RESULT IN ANOTHER S&L DEBACLE, COSTING THE PUBLIC HUNDREDS OF BILLIONS OF TAXPAYERS' HARD EARNED MONEY? WHO IS TO BE HELD IN ACCOUNT IF ALL GOES AWRY? AND WHAT COMPENSATION IS ALLOWED THE HAPLESS INNOCENT PUBLIC WHO BUY THE CALL AND PUT OPTIONS, DESTINED TO GO UNEXERCIZED - AND WORTHLESS?"

Motives for CENTRAL BANK Gold Manipulations

1. To control the public's inflation expectations by keeping the gold price relatively flat.

2. Fed may fear the horrendous impact of a big short-squeeze in gold due to the record large speculative short posture - and possibility due to a record amount of outstanding NAKED OPTIONS. A short-squeeze would give explosive impetus to the gold price - consequently, the Fed would most probably lose control of its price "maintenance" activities.

IS IT NOT STRANGE AND UNFATHOMABLE THAT THE FED EARNS $9.4 BILLION IN BOOK-KEEPING INTEREST PAID ON ITS U.S. TREASURY BONDS INVESTMENT, THEN BY THE END OF THE YEAR THE FED MAKES BOOK-KEEPING PAYMENTS OF EXACTLY $9.4 BILLION "BACK" TO THE U.S. TREASURY????? Maybe this is why the Fed is not audited by independents.

THE REAL DANGER -- GOLD CALL SHORT-SQUEEZE

In my mind there is no doubt the Fed as executor of the U.S. Treasury monetary policy is engaging in the suppression of gold prices, and selling gold Call options in order to produce a constant income flow from the government's non-producing bullion. And although the Fed's Annual Report does not show evidence of these unorthodox banking operations, there are many ways the U.S. Treasury may camouflage the tracks of these activities. Whereas increased income for a government drowning in its mounting debt may be rationalized by politicians, the growing risk to the international currency markets seriously questions the prudence of these operations.

A number of months ago the Financial Times Annual Gold Conference was held in Venice, Italy. The very well-attended conference displayed a characteristic heretofore unknown to this august gathering. In the past the majority of the attendees were - logically - Gold Producers and Gold Users. However, on the this occasion the place was over-crowded with brokers and bankers. There were three times as many brokers and bankers as other attendees. Obviously, it has become universal knowledge that the most lucrative and RISKLESS speculations in the last four years have been to write covered gold Call options. There were several speeches and much informal discussion on how to "maximize" value from gold holdings. Moreover, the lesser important and third world central banks were very interested in "learning more" about the riskless venture. NOW EVERYBODY wants to pile on and get into the profitable act. Precisely herein lies the explosive problem!

If the Fed Can Do It - Why Not All Central Banks?

Financial institutions and large speculators have become understandably oblivious to the real risk of the gold options market. Was it not well-known that the central bank "controlled" gold prices within a well-defined tight range? Was it not well-known the central bank is in the business of writing gold Call options in order to generate a constant flow of real income on their idle gold? Was it not well-known the Fed is authorized to execute such orders (selling gold Call options on bullion deposited in FRB in New York) on behalf of foreign banks? What could be easier and more discreet? And all perceived at seemingly no risk!

The REAL DANGER is that gold Call option growth will eventually exceed the amount of gold existing and available in the event the Fed loses control of the market price of the yellow metal. Consequently, there will be the ugly likelihood of a violent short-squeeze causing gold prices to orbit - and conceivably precipitating chaos in the currencies market. The current state of gold's open interest is testament to the growing (indeed explosive) instability of this market. Large commercial hedgers - who are traditionally net short - have been for many months carrying a historically high net long position. On the other side of the gold futures market are the large Specs, who are in an all-time high net short posture. The dynamics of this situation are mind-boggling.

As the Internet's Resident Economist, George S. Cole, so aptly puts it: "LOOKS LIKE THE GOLD CALL OWNERS WILL GET SCREWED AS USUAL.

Banking Dominos in South East Asia

South East Asian banks are falling like a toppling row of dominos. Currencies are being trashed... and Stock Markets are in turmoil and suffering a cascade of falling prices. The contagion effect is spilling over into Japan, China, Europe and some Latin-American countries. Soon it will be hitting US shores...

Menaced by this growing dark financial shadow spreading throughout the world:

How Can Central Bankers Justify Continuing to Speculate in the Gold Market with the Publics' Money and Assets?

Gold's special properties mean that it has a greater variety of uses than almost any metal.

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