Gold as Theater

CFA, Senior Managing Director, Co-Portfolio Manager
August 26, 2001

At precisely 1:57pm on June 27th, 2001, a seller dumped 100 contracts (10,000 ounces) of gold on the Comex market. The transaction was noteworthy as to the amount and timing. It was the largest transaction by far that day and for several weeks on the Comex where trading activity has dwindled to the lowest levels in two decades. More important, it took place 15 minutes in advance of the announcement by the Federal Reserve that the discount rate would be reduced by only 25 basis points instead of the 50 that had been widely speculated. (see chart) Gold, which had been rallying strongly since the stock market lows at the end of the first quarter on the view that the Federal Reserve’s concern over the economy’s slide was reaching panic proportions, slumped during the remainder of the day. In a few more days, it settled at $265/oz, down sharply from the intra day peak of nearly $300 reached on May 21st.

The above chart is a minute by minute account of Comex gold trading going into the Fed announcement at 2:15 (14:15). On the lower part of the chart, volume for each trade is graphed. The trade in question took place just before 2:00 pm (14:00), and initiated the breakdown of gold.

The seller, whoever it was, seemed to be acting on the conviction of advance knowledge. For anyone willing to spend the time, more about the identity of the seller could be learned by examining the public records of the Comex for that day’s trading. I’d love to know, but don’t have the time to go to the warehouse and pore through trade records. Whether it was the Exchange Stabilization Fund (ESF) of the Treasury or a bullion dealer with a hot line to the Fed Conference room is of secondary importance. If it were a bullion dealer for its own account, the profits on the trade would hardly pay the rent. If it were a bullion dealer for the account of a third party such as the ESF, we may never know. What is more interesting is the apparent use of gold to convey a message to the markets: Gold tanks!… The Fed has everything under control…concerns reflected in the previous gold rally have been allayed. Gold remains a highly visible barometer of the well being of financial markets, despite concerted efforts by central banks to demote its standing as a financial asset.

In a private meeting in June 1993, the late Sir Jimmy Goldsmith asked me whether I thought his bullish stance on gold at the time was correct. Yes, I answered. We agreed that paper currencies were suspect and that the rising gold price signaled legitimate concerns. He responded with a question: "But what happens if the authorities try to squash the signal?" In retrospect, this was not only an excellent question, but quite possibly foreshadowed what has been going on in the gold market since then.

The trade on June 27st illustrates how a well-timed minor action in a very thin market, can turn the tide. It is only a skirmish in a very big picture. By itself, it proves nothing, but it does suggest something. Government intervention in financial markets is neither surprising nor new. Gold is a financial asset. Official denials notwithstanding, respected and knowledgeable observers including Jack Kemp and Professor Robert Mundell appear to regard it as a matter of fact.

On August 21st, the date of the most recent Fed rate cut, a similar pattern could be observed. This time, Goldman Sachs appeared as a featured seller in the midday hours prior to the announcement. Of the 24,000 contracts traded that day, Goldman accounted for 10,000. A Comex floor trader told me, the following day, that there had been a very large drawdown of Comex warehouse stocks of 45,000+ ounces, the same day as the Fed announcement. The drawdown amounted to more than 5% and left the ratio of warehouse stocks to open interest at a dangerously low 6% (ratio of physical to outstanding contracts), normally a good precursor for a short squeeze. However, the trader continued, in recent years it has not been profitable to anticipate a short squeeze under these circumstances. "Metal just comes back into the market mysteriously", he said. On the day of this particular conversation (8/22), "every dealer is selling, including Republic, Goldman Sachs, AIG, and JP Morgan-Chase. Action like today is what scares people away from the gold market. The dollar is getting crushed, a short squeeze should be happening, and gold does nothing."

The price of gold in perpetual checkmate became a central motif in the mythology of the new economic paradigm. The imagery played a role in facilitating the investment bubble that ended over a year ago. The evolution of the financial markets has diminished the role and effectiveness of traditional monetary policy. The Fed no longer controls the monetary aggregates and now only has a direct influence on interest rates. Tinkering with the gold price would be a very tempting way to reinforce the strong dollar rhetoric. It would be simply shocking, even inconceivable if no high level official had ever considered the idea. A low or declining gold price would soothe financial markets and, conversely, a rapidly rising price would roil them. The price behavior of gold is a simple sound byte able to penetrate the increasingly confusing overload of electronic inputs and media circus confronting traders and investors. It is a much more efficient way to communicate a state of being than the inscrutable or indecipherable pronouncements of various economic policy spokesmen, especially for grass roots consumption. The behavior of gold, notwithstanding repeated attempts to write it out of the script, still affects market and consumer psychology.

Legions comforted by the somnolence of the gold price assume that such behavior is the result of a free market process. The history of government intervention in currency markets alone would strongly suggest otherwise. The precedent of the London Gold Pool, a scheme orchestrated by the US and Britain to rig the gold price in the 1960’s, exemplifies the keen interest of our government in the matter. For these reasons alone, believers in whatever low gold prices are signaling should suspect a fairy tale.

Given the long history of official sector antipathy to gold, especially in the US and the UK, one would be hard pressed to explain why it had suddenly become sacrosanct. In fact, there is growing body of credible evidence that the US government and others may have been manipulating the metal price for some time. A few years ago, such claims were unsubstantiated and lacked credibility, but recently some weighty evidence is beginning to accumulate. Credit for the heavy lifting on discovery of possible price fixing activity goes to Bill Murphy, Reginald Howe, James Turk and their associates. A useful source to learn more are the two Gold Antitrust Action Committee web sites: ( or (

The Exchange Stabilization Fund controlled by the US Treasury, and essentially unaccountable to Congress or the American people, appears to be a key instrument for intervention. It appears that US gold reserves have been swapped or in some way encumbered. The basis for this supposition can be found in the ESF financial statements themselves. According to James Turk in his Freemarket Gold & Money Report ( dated August 13th, 2001, SDR Certificates held by the ESF declined from a peak level of 10.2 billion to 2.2 billion as of year end 2000. A precipitous decline from 9.2 billion as of year-end 1998 to current levels coincided with an accelerated decline in the gold price that began in May 1999 (announcement of UK Gold Auction) and the breakout of the trade weighted dollar index from a multiyear trading range. Each SDR represents 1/35th/oz of gold held by the Treasury as monetary reserves for the United States. What is going on here? Mr. Turk’s very erudite but complex explanation of the mechanics is available on his web page. A decline equating to 227.7 million ounces, or 87% of the US gold reserve demands a more than perfunctory explanation.

Reg Howe ( has turned up a number of curious efforts to reclassify various portions of the gold reserve. These reclassification attempts have occurred only since Mr. Turk noticed that some of the gold held on deposit at West Point had been reclassified as custodial gold from gold bullion reserve as of 9/30/00. This designation stood until July 2, 2001 when the West Point gold along with 92% of US gold reserves or 245 million ounces was again reclassified, this time as "Deep Storage Gold", peculiar to say the least. There has been no high level official response to these points or many others made by Howe, Turk, or GATA. There are only a few desultory low level denials including an almost generic e-mail denial on the Treasury’s web site (

If the US and other governments have been actively involved in manipulating the gold market, there is far greater upside potential for the gold price than I had previously imagined. The US government may have already expended considerable resources to hold the gold price in check. Public, press and congressional scrutiny of these matters should commence in earnest. It would have five possible outcomes: (1) there is no monkey business at all and the government provides the requisite information to satisfy all legitimate questions on the subject, (2) there has been active intervention but because of public scrutiny and accountability, carrying on will be much more difficult, (3) resources for future intervention have been severely depleted, (4) because of a combination of #2 and #3, government activity in the gold market ceases altogether, (5) there is something going on but the government is able to deflect and otherwise thwart all attempts to illuminate the facts. The investment implication of #1 is simply a non-event. The implications of #’s 2, 3, and 4 are very bullish. Only #5 would be somewhat problematic, as it would prolong the status quo.

On his Golden Sextant web site (, Reg Howe has unearthed an article co-authored by Lawrence Summers, former Treasury Secretary and current President of Harvard University. The article, "Gibson’s Paradox and the Gold Standard" was published in June 1988 in the Journal of Political Economy. In this article, the two Professors observe that in a "truly free market…gold prices will move inversely to real long-term rates, falling when rates rise and rising when they fall." Most interesting is the failure of this relationship to persist post 1995 during Summers’ tenure at the Treasury. "During this period, as real rates (30 year T-bond less CPI rate) have declined from the 4% level to near 2%, gold prices have fallen from $400/oz. to around $270 rather than rising toward the $500 level as Gibson’s paradox and the model of it constructed by Barsky and Summers indicates they should have." Howe goes on to observe "the low real long-term interest rates of the past few years may have been engineered with far more sophistication than those of a generation ago, including the coordinated and heavy use of both gold and interest rate derivatives."

This chart is courtesy of Nick Laird, proprietor of It plots average monthly gold prices inverted on the right scale and real long-term interest rates (30-year t-bond minus latest twelve month CPI) on the left scale. The historical relationship disintegrates in 1995.

The mispricing of any commodity leads to a shortage or a surplus depending on whether it has been overpriced or underpriced relative to its clearing price in a free market. Investment capital is no less a commodity than soybeans, milk, or natural gas. The systematic underpricing of investment capital achieved by:

o        the manipulation of the gold price,

o        the debasement of inflation measuring statistics issued by the Bureau of Labor Statistics*. Much about this has been written including Grant’s Interest Rate Observer and the Richebacher Letter.

o        the shrinkage of supply of 30 year treasuries,

o        and the use of derivative instruments

would indeed be a "sophisticated" scheme. The contributions of the most brilliant academic minds of the day would perfectly suit the needs of an administration addicted to spin and manipulation to achieve its goals. Academicians and politicians indifferent to the distinctions between substance and artifice, and with a shared disregard for free market forces, would be easily drawn into a complicated price manipulation scheme if it were deemed to be "in the public interest". Underpricing investment capital played a key role in creating the financial mania that explains willingness of investors to finance the dot com craze, telecom infrastructure companies with only a business plan, and other harebrained schemes too numerous to mention.

The underpricing of investment capital occurred in the context of Greenspan’s repeated willingness to commit sovereign credit throughout the market crises of the late 1980’s and the entire decade of the 1990’s. Since the Latin American Crises of the early 1980’s, the Federal Reserve’s response to anyone who had made a bad investment was a massive bailout. The 1987 market crash, the banking crisis of the late 1980’s and early 1990’s, Long Term Capital Management, and the Asia Meltdown all drew the same response---a flood of liquidity and low interest rates. By sending the message that big mistakes would bear no adverse consequences, the Federal Reserve engineered a tectonic shift in the risk profile of investors, speculators, and financial institutions in favor of ever more leverage. It is the proliferation of leverage which has rendered the economic system intolerant of the kind of old fashioned recession that would cleanse the excesses of the previous cycle and place the economy on a sound footing for renewed expansion.

Those jeopardized by the Fed’s bailout strategy and the Clinton Treasury’s flood of underpriced investment capital extend well beyond lenders to bankrupt hedge funds, sinking foreign economies, or bad banks. The American public, having been suckered into pouring its life savings into a dangerously overvalued stock market, is now being called upon to maintain its unhealthy spending patterns to keep the economy from sinking further. The Fed is targeting equity prices in order to prop up the wealth effect, quite an evolution from its original role of preserving the purchasing power of money. In his May 24th, 2001 speech before the Economic Club of New York, Alan Greenspan said: "Owing to the variable and long lags of monetary policy, the effect of our recent policy initiatives will take time to strengthen financial portfolios and spill over into demand for goods and services." The game plan is clear -- reflate the stock market bubble. Money supply (M-2) is growing at 9.2% year over year, the fastest pace since 1987, the year of the October stock market crash.

Public policy has been painted into a corner by the misdeeds of economic and political leaders held in the highest esteem during the preceeding mania. There are no choices left but to open the floodgates once again. Prepare for more policy panic. The neat trick will be inflating stock prices in the face of deteriorating fundamentals. The investment mania in technology and telecom has created sufficient overcapacity to last many years. It also sparked a boom in consumer goods that will take years to unwind as individuals struggle with record indebtedness.

It will not be long before widespread recriminations and finger pointing become a favorite media blood sport. As the malpractice of economic policy and misdeeds of the financial community come to light, investors will rightfully begin to distrust the half-truths, misconceptions, gurus, and institutions at the core of the mania. They will gradually discard the idea that the Fed or the Administration can "fix" any problem and that buying the dips is savvy. Greenspan, the "price fixer and central planner", will replace Greenspan, the "Maestro", in the estimation of public opinion. As James Grant wrote back in April (NY Times Op-Ed 4/20/01), "How does he do what he does? Nobody knows. It is a mystery. He collects data and ponders them. He conceives a course of action. This action takes the form of a double manipulation, first of an interest rate and second of the mind of the market… This is a mighty tall order. In fact, it is reminiscent of the task that the economic planning agencies of the former Soviet Union were famously unable to carry out."

Unfortunately, Clinton’s wild party has become Bush’s hangover. The equity markets are completing the first year of a bear market. Rallies of course will interrupt the decline, but will reach a string of lower highs. The process has much further to go. Bull markets are born in skepticism and die in overconfidence. The prevailing views on gold are, if anything, skeptical. It has been said that in bull markets investors are more scared than is justified and in bear markets, they are not as scared as they should be. We have traveled only a short distance along the way to public disaffection with financial assets.

Instead of clinging to the mantras and rhetoric of the previous decade, economic policy makers should declare a clean break with past practice. Secretary O’Neill should be familiar with the time honored private sector practice of taking huge writedowns to lower the bar for the next regime. This would include permitting gold to trade freely. Gold, which has been viewed as a problem and a threat to public policy, can still be used as theater but in a positive sense. As the world economy continues to globalize, there is no reason that the dollar or the euro should be called upon to perform the role to which they now aspire, that of a reserve currency beyond national borders. As an apolitical financial asset, gold represents the superior foundation for a new currency to facilitate the expansion of borderless commerce.

The late 1990’s mania stretched well beyond tech stocks, dot coms, media and telecom. It included the unprecedented and exuberant accumulation of physical goods by American consumer ranging from SUV’s to MacMansions, made possible by the overvaluation of the US dollar. The willingness of foreigners to exchange their goods and services for our IOU’s made every American consumer wealthy by comparison to any other time in history. We had low inflation because foreign capacity became a substitute for home grown capacity. Artificially low long term interest rates helped consumers to spend more than they saved simply by enabling them to issue record amounts of mortgage debt. Government agency housing debt is now $2.4 trillion or 23% of GDP. At current growth rates, it will exceed national debt in four years. It has reached a level, according to the American Enterprise Institute, that threatens systemic risk to the financial markets and the US Economy.

The so-called globalization of the world economy was in one respect a massive exchange of US paper assets for non-domestic resources that enabled US consumers/voters to dramatically improve their living standards during the 1990’s. Foreigners now hold on a net basis $2 trillion of US assets, or 20% of GDP. They own 44% of the liquid treasury market, 23% of the US corporate bond market, and 12% of the US equity market. Nobody can say that the Clinton/Rubin/Summers strong dollar scheme didn’t work, at least for a while. However, it could only work on the belief that the paper issued represented real value. For this to be the case, foreigners had to buy into the rhetoric and mythology promoted over the period. A reassessment of these beliefs will bring about high inflation and high interest rates. The alternative to the virtuous circle is not pleasant to contemplate, but the long running current account deficit that now exceeds 4% of GDP is unsustainable. Foreign investors have every reason to ask "where’s the beef?" A bear market in stocks, declining interest rates and vanishing profits all qualify as "less than expected." When the dollar loses its lofty status, American consumers and voters will no longer be happy or confident. This will have political and financial market repercussions.

The case for gold is that the dollar has been overvalued for an extended period, as we wrote a year ago in The US Dollar: Over Owned and Over Valued. Its overvaluation was integral to the financial mania that has come and gone. The depressed price of gold has been core to the system of beliefs underpinning dollar overvaluation. To the extent the depressed price of gold reflected more than natural causes, one can expect the retribution of market forces to be fierce once they gain the upper hand. The mania and the supremacy of the dollar are history. With so many of these positive macroeconomic developments becoming more evident, it is disappointing that the gold producers continue to emphasize the promotion of gold as jewelry. A higher profile and stronger stance on monetary issues would be timely and most welcome. It would not take much of an investment to bolster the intellectual rationale to rehabilitate the metal’s role as a financial asset. Restoration of gold as the foundation for a multinational global currency is something the global economy could actually use. Now, that would be really good theater.

John Hathaway, CFA, Senior Managing Director, Co-Portfolio Manager

Mr. Hathaway is a co-portfolio manager of the Tocqueville Gold Fund, as well as other investment vehicles in the Gold Equity Strategy. Mr. Hathaway also manages separately managed accounts for individual and institutional clients.  He is a member of the Investment Committee and a limited partner of Tocqueville Asset Management ( Mr. Hathaway began his career in 1970 as an Equity Analyst with Spencer Trask & Co. In 1976, he joined investment advisory firm David J. Greene & Co., where he became a partner. In 1986, he founded Hudson Capital Advisors and in 1988 became Chief Investment Officer of Oak Hall Advisors. He joined Tocqueville as a Senior Partner in 1998. Mr. Hathaway has a BA degree from Harvard College and an MBA from the University of Virginia.  

Throughout history the ruling class has always sought to own gold and silver because they represent purity and longevity.

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