Is it Just a Simple Bear Raid?

April 4, 2000

We and others have been watching the Office of the comptroller of the Currency Quarterly Derivatives report with great fascination!! http://www.occ.treas.gov/deriv/deriv.htm

The report has detailed descriptions of the derivative business, and points out that almost all of the derivatives are done by the Seven big money center banks. Chase, Morgan, Citibank., Nations, Bankers Trust, Bank of America, First Chicago. Hereinafter referred to as "The Boys." Not wishing to confuse or corrupt the Big Oil good old-boys called the Seven Sisters. As Merrill Stench, Goldman Sack, Solomon etc., aren't banks they escape the O.C.C. scrutiny, but they are heavily involved in the business. Just ask Orange County.

First a little background. It behooves anyone interested in the financial markets to take more than passing notice of this monster plus $30 Trillion business. Greenspan says it is the most significant issue in recent history. When there is a hiccup, or a sneeze, the results can be swiftly fatal. Just ask the residents of Orange County, the shareholders of LTCM, Ashanti, and Cambior, to name a few.

A must read description of the derivatives business is a little known paperback, "F.I.A.S.C.O.", by Partnoy, Frank. Partnoy describes how the flashing dashing young "quants" at the banks create and design these instruments to do one thing and one thing only. Separate the client from his money. Referred to as, "ripping his face off", and other like descriptions of taking the money to get the fees. How is this done? Simply take some worthless bonds from Mexico, Thailand, Philippines, Ecuador, wherever, whatever, put them in a Cayman company with a bit of Fannie Mae / Freddie Mac paper, thereby cloaking the deal with the mantle of government guarantee! Then buy a government guaranteed credit from Standard and Poor, (qualified with a subtitle). Yes gentle reader I said buy your rating from S. & P. Have the quants do a split of interest and principal, separate the Junk from the Fannie/Freddie bit with a few whistles and bells to guarantee they blow up with interest changes over time, or whatever, and sell them to someone that does not read the fine print. Another excellent but somewhat repetitive book is "Apocalypse Roulette". Sure there are trillions of interest rate swaps and other instruments that are not of this nature, and they are all perfectly balanced with time and for every put there is a perfectly timed call to make it all market neutral. Yes indeed.

The gory details are in the books, but you get the idea, as did the above mentioned corporate entities. The poor gullible management of Cambior and Ashanti buying the wrong product at the wrong time, but no doubt under pressure of much wining and dining from young M.B.A.'s that you owe several hundred million to is another issue.

The Gold related derivatives in O.C.C. report are our focus. The report lists quantities by expiration maturity over time. <1yr., 1–5 years, and >5 years. For brevity we will only look at 1999, but the data going back to 1995 is there. Graph number 8 in the report, gold and precious metals. Most readers would not notice it, and certainly not read it. The metals derivatives are only a few Billion of the Thirty plus Trillion of the grand total. So who cares?

 

Notional Amounts: Gold and precious Metals Contracts by Maturity

( $ Billions) 1999

(There are some footnotes that are no doubt relevant to those in the know. Not us.)

Now for the arithmetic to put the Billions into perspective, with some minor rounding off to make it really simple. Round one tonne of gold to 30,000 Oz. It is NOT, but for simplicity sake bear with me, this exercise is not about precision.

One sees for the first three quarters of 1999, The Boys had a position of a little over 6,000 tonnes on the books. The really interesting part seems to be that the position remained fairly flat for the first three quarters at $65, $61, $63 Billion. The fourth quarter jumped $24 Billion, almost 30% to $87 Billion! Call it about 3,000 tonnes more or less. I know absolutely nothing about the internal logic of The Boys, and the money to be made off the Gold Carry Trade, but one would have thought that the positions would be smaller rather than larger after the wake up call of the price surge following the Washington agreement.

Here we have the documentation of the 9,000 tonnes by the O.C.C. How much is in Europe and elsewhere. Who knows? IS THIS $24 Billion ALL NAKED CALLS FOR A CLIENT? IS IT ALL 3,000 TONNES OF YELLOW BRICKS? Who knows?

One must note that the major gold producers in mid 1999 had a bit over 50 M. Oz. sold forward, and with some of them unwinding, whether they like to or not, they are now down to 40 – 45 M. Oz. , say 1,500 tonnes. Fifteen to twenty percent of the total, maybe only 10%. Certainly a factor but not the driving force.

The readers of this forum are all aware of the timing of the Washington agreement where the European Central Banks agreed to limit gold sales, at the beginning of the fourth quarter. The gold price surged nicely. Thereafter it has been pretty much all downhill, with the usual whipsawing for the traders to make a living. All also know that the worlds production is about 2500 tonnes, and that demand is running at somewhere between 3,500 and 5,000 tonnes. The currently posted excellent piece by Veneroso documents higher rather than lower for the demand.

Are any of our readers prepared to accept that any of this derivative position by The Boys is a long position? With this pounded down bottom crawling Bear Market? It could be that there are some longs there, or that the puts are perfectly matched by the calls and that the whole position is perfectly market neutral in both time and amount. Yes indeed. Could be.

I now direct the readers attention to the other graphs of the derivatives report, 6B, "Trading Revenue as Percent of Gross Revenue". All of The Boys are low single digit's, except for Morgan. 22% in Q4. What is the risk for this puny reward? See Graph 5A, "Percent of Credit Exposure to Risk Based Capital". Morgan has consistently been the high number for some time. The averages and totals for the group are staggering. Running almost 300% for some time, on average with B.T., and Morgan at several hundred percent.

Now for the other bit. Go to the London Bullion Market Association web site. http://www.lbma.org.uk/core_page.html Who do we find as Chairman of the Management Committee, Mr. M. Stokes of Morgan, and the head of the Physical Committee, Mr. P. Smith, both in the Morgan New York office. Talk about who knows, I suggest these chaps might know it all.

The L.B.M.A. has twelve market making members mentioned, but only eleven listed. The FOUR who are listed as member of the London gold Fix, are Rothschild, H.S.BC., Deutsche, and Bank of Nova Scotia. I guess Morgan has not been there long enough to get a chair, but can chair the Management Committee, and the Physical Committee. Fascinating!

I first had to agree with many of the seers on this and other forums that this has been nothing more than a simple gold carry trade. If you have the balance sheet to borrow for 1-3% and make 10-20%, good for you, and of course your shareholders. It did work for the Yen carry trade crowd for some time, maybe still is for all I know. Mr. Martin Armstrong was verbally pounding the Yen down along with gold and silver. Wonder what side of the trade he was on?

With the verbalizing, posturing, and media access used to so conspicuously pound on gold all the while selling, and inducing the weak hands to sell whether they need to or not, selling another years production after the first rally for three years one has to stop believing in coincidences. Kuwait really needed to sell about as bad as Newmont did. At the bottom.

Mr. Veneroso pointed out the real problem at a seminar recently. How do you unwind the PHYSICAL short position with the current supply demand imbalance? Very slowly over several years, the same way it was put on. Or, you cannot, it is Physically impossible.

IF DEMAND IS EXCEEDING SUPPLY BY 50 – 100% WHERE DO YOU GET THE PHYSICAL YELLOW BRICKS?? What happens if the price really rallies, and The Boys and the bullion banks cannot cover. The Central Bank has to save them or let them go under.

I really must highly recommend again Ian Gordon's Long Wave on the War on Gold, and also http://www.the-privateer.com See the Gold pages, for the war on gold, and a history of gold bottoms. (A subscription is ridiculously cheap.)

Au contrare, "Never Assume Intelligent, Malicious, Malice Aforethought when simple stupidity and incompetence will do." If it is NOT a Bear Raid, this applies, and some of The Boys quants have created a little problem. If it IS a Bear Raid, then Who, Why, What For, When, How Much, etc., are going to really the most fascinating issue of our time.

Credit for calling the O.C.C. report to my attention goes to the really superb analytical work of the Contrary Investor. http://www.contraryinvestor.com

Ursel S. Doran

CORE Engineering

A Natural Resource engineering, analysis, and finance group in Vancouver, Canada. urseldoran@hotmail.com

Gold is impervious to rust.