The Sell-Off in Gold & Silver Prices is Foreboding of What is to Come

Have a good look at the following two charts. I believe gold is about to bounce back sharply (following its massive manipulation), because the physical ultimately wins it always from the paper (futures).  And the S&P500 is in my point of view bouncing off the unbreakable resistance of the 1600 level and probably trying for one more attack on the 1600 level. Gold “had to go down in order to rise” on the steep decline that is in store for the equity markets. Don’t forget everything is interconnected! We will see if my thesis is correct.

 

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Several potential reasons for the huge sell-off in gold and silver?

1.    One theory is that the $200+ gold sell-off, “triggered” by a Goldman Sachs sell recommendation, hitting technical stop loss levels (on purpose) just before and after the weekend (most effective) was based on the “misleading idea” that potential central bank gold sales (Cyprus, Portugal) might hit the market and that the bull market in the precious metals is over. Since October 2012 gold had been falling on anticipation that the economy was recovering bringing an early end to the QE. Though in my point of view the Fed can’t stop its QE because what the economy would contribute in more growth would be taken away by the effect of much higher interest rates!

We all know that we have passed the tipping point for a lot of Western economies (Debt/GDP ratio above 90%), this is when the overwhelming debts in relation to the size of the economy start to have an adverse effect on the size of Government expenditures to stimulate growth because of the higher debt servicing costs (inherent higher interest rates and downgrades).  In other words reducing the QE doesn’t seem to be an option. Debt levels are unsustainable and keep on increasing (not stabilizing or decreasing). Only the stock and bond markets appear to be in positive territory for the time being.

2.    Anyway I believe, having seen the volatile economic figures in the last couple of years, that the conclusion can be drawn that there is no sustainability in the improvements and that the additional marginal gain, the effectiveness from more QE is declining rapidly and could soon be negative and have adverse effects. The emperor is losing its clothes.

In other words what if gold was sold off because investors don’t believe that the easing is working and therefore are concluding that we are getting back to deflation?

Investors in Treasury Inflation-Protected Securities were selling their debt yesterday following a weak auction of 5-year notes. TIPS, a $883 billion market of securities whose principal grows alongside inflation, have been in selloff mode for the last few weeks. When we experience deflation initially money “will become worth more (more purchasing power, more goods can be bought with $100)” whilst gold will “lose its value (less purchasing power)”. After all, gold is the inverse of the US Dollar. We have commodities breaking down including gold. Whilst at the same time we have bonds rallying very strongly, “clear indications” of strong deflationary pressures in the system. As a result company results are likely to suffer. As we know deflation destroys an economy because consumers will wait making their purchases in expectation of continuously lower prices. And thus margins will narrow following future anticipated lower sales prices. Consumers will pay down debt
instead of taking on new debt. The economy will subsequently shrink and unemployment will increase further. It is an unstoppable downward spiral that destroys everything in its path even money. That is why the monetary authorities are so committed to prevent deflation.

Since reductions in general price level are called deflation, a deflationary spiral is when reductions in price lead to a vicious circle, where a problem exacerbates its own cause. The Great Depression was regarded by some as a deflationary spiral. Some theories argue that excess debt can cause a continuing deflation! Sounds familiar!?

In the end investors will need to protect their capital and what will ultimately be a better protector of your capital than gold and silver, which have value of themselves and are for their value not dependent on the state of the economy, considering the un-repayable debts and the destruction of the economy.

3.    Also the idea has been hinted that a large party got into financial problems and that it had to liquidate its gold holdings. In three days the gold price fell 15% or $243 from $1,564 to $1,321 is the largest decline in the last 32 years. We probably will find out soon if indeed an institution was experiencing problems and had to sell. Adding further to the sell-off in the market has been the margin increase by the CME. Margins to trade benchmark CME 100-troy ounce gold futures would be increased by 19%, CME said in a notice emailed late Monday. The margin to trade silver would increase 18%. Again I can’t stress enough the potential domino effect from forced liquidation!

4.    Another reason for the sell off in gold could be theweakness in the Yen triggering profit taking in many dollar denominated assets and especially gold and silver. If this is the case I would like to emphasize how powerful the potential outcomes can be following strong swings in the currency exchange rates resulting in big losses or gains. This confirms my point that, and even more in the international intertwined world we are living in, a stable currency should be regarded as the real benchmark of your wealth though currencies have the potential to cause tremendous price swings in assets leading to very disruptive results.

5.    Or is the fall in the precious markets indicating what is in store for the general markets. Is it a forebode for what is in store? As I mentioned in previous articles I believe that the artificially depressed interest rates can no longer be regarded as the real benchmark of valuation and risk. Their integrity has been eroded by the QEs. And as a natural replacement gold has filled this void being the new constant. Therefore could it be that the new constant, see the HUI chart as a derivative for the precious metal future, is forecasting a huge sell-off a la 2008 before the precious metals will leap to new highs. 

6.    Blatant manipulation carried out to prevent the gold from rising, which would challenge the hegemony of the US dollar!

In my point of view the last and one of the most likely reasons for the sell-off is that it is a blatant manipulation of the gold and silver prices preventing it from skyrocketing following the very aggressive QE measures around the world recently given new impetus by the BOJ at $75bn a month. There is an approximately 80%+ correlation between the growing of the central banks balance sheets and the price of gold! The money has to go somewhere so where does it go, equities, bonds, real estate and precious metals. It reminds me of the situation in Japan where asset prices, going only in one direction, where also blown up pushing the Nikkei to an all time high of 38,957 on December 29th, 1989 and we all know what happened afterwards.

Strongly rising gold prices is not really on option for the FED it would challenge the hegemony of the US dollar. Gold is the mirror image of the US dollar, showing the weakness and strength of the US dollar. The world is so twisted right now that the Dow is considered a safe haven investment for the simple reason that the Fed supports it.  Since gold is the opposite of the US Dollar a strong gold price means a weak dollar and thus with all its consequences, might frustrate the confidence building exercise the Fed has been on in strengthening the stock, bond markets and real estate markets in order to stimulate growth in the economy.

The confidence building efforts of the Fed are a farce as we all know the middle class is still licking its wounds from the housing market collapse and the difficult employment market and thus the only ones that are really benefitting from the inflated asset prices are the people in the 10-20% upper income bracket of the population. Everybody else simply doesn’t have the savings to invest and can thus not benefit from this desperate act by the Western central banks blowing up asset prices. As a result we have quite some polarization going on for the moment whereby the rich are getting richer and the poorer getting poorer, a massive source for potential unrest. I would also like to refer to the situation in China which is not that dissimilar from the situation in the US where you have a small layer of people that “enrich” themselves and the middle class and poor people that are getting more disgruntled by the day. Anyway my conclusion is that the “recovery” is very uneven and that the so-called moderate recovery despite the central bank efforts is bound to fail anyway. Though for the moment the central banks (Fed, ECB, BOJ) have no option from a political point of view but to pump money in the market hoping it will reverse the tide till the music stops. And at the same time the Fed is ferociously defending the US dollar from being challenged and undermined by gold becoming the new world currency.

Manipulation, lowering the gold price using naked shorts

Anyway back to the gold price manipulation. I myself are not so much a conspiracy believer, doesn’t fit in with the Dutch culture, though this whole exercise of selling gold doesn’t make any sense whatsoever. Some reasons detrimental opposite the strong fall in the gold price are the continued debasement of the currencies following the worldwide QEs and the ever increasing sovereign debts that can’t be repaid even with the best intentions.

Is it because the Fed is defending the US dollar? Is it because a big financial institution got into massive problems or is it because of a combination of these factors? But manipulation it is in my point of view.

According to Wikipedia the price of gold is affected (read manipulation) by various well-documented mechanisms of artificial price suppression, arising from fractional reserve banking and naked short selling in gold, particularly involving the London Bullion Market Association (LBMA) , the United States Federal Reserve System, and the banks HSBC and JPMorgan Chase.

Gold market observers have noted for many years that the price of gold tends to fall artificially at the start of New York trading (New York is the paper or futures market whilst London is regarded as the physical market). Naked short selling is a case of short selling without first arranging a borrow of the physical. If the physical is in short supply, finding the physical gold to borrow can be difficult. The seller may also decide not to borrow the physical, in some cases because lenders are not available, or because of the costs of lending or because of any other “murky” reason. A naked short is when the short seller does not have or borrow the item that he shorts, but sells shorts regardless.  In the paper gold market, the participants are betting on gold prices and are mostly content with the monetary payment.  Therefore, generally, as is the case when participants are not interested in taking delivery of the gold, naked shorts do not need to be covered with the physical metal. In other words, with naked shorts, no physical metal is actually sold. This would be different if the participants would be interested in the physical. And if the parties would be interested in physical delivery the CME can always call a force majeure and replace the physical delivery with “worthless” monetary payment if it needs to do that because of its own particular reasons. As recently happened with ABN AMRO’s gold delivery obligations to its clients.

But basically by selling naked shorts you “force” people out of their (physical) positions and allow interested buyers to purchase the physical at much lower prices. And as such you achieve the goal of much lower prices at a profit because you buy the contracts back at much lower prices and you ensure that the buyers don’t push the price from say for example $1,600 to $1,900 but from $1,300 to $1,600. In other words it equals pure manipulation and artificially forces huge losses on investors who didn’t intend to sell their positions.

A former trader exposed and clarified the workings of the gold and silver manipulation

I have always wondered why if there was manipulation going on that never ever anybody would come forward. Well that has changed. Andrew Maguire, a former Goldman Sachs trader, went public in April 2010 with assertions of market manipulation by JPMorgan Chase and HSBC of the gold and silver markets, prompting a number of lawsuits. One wonders why lawsuits were filed if it isn’t true, who cares? In other words the lawsuits seem to confirm the truth or at least the sensitivity of his statements.

The banks, JPMorgan Chase and HSBC, which do the Federal Reserve's bidding in the metals markets, have long been the government's lead actors in keeping down the prices of gold and silver, according to Andrew Maguire who used to work at the London Bullion Market Association (LBMA) and therefore had a good insight and knowledge of workings of the participants in the gold and silver markets. Maguire was scheduled to testify before the Commodities Futures Trade Commission, which was investigating the activities of large banks in the metals market, but was knocked off the list at the last moment! As a result he went public.

According to Maguire JPMorgan acts as an agent for the Federal Reserve; they act to halt the rise of gold and silver against the US dollar. JPMorgan is insulated from potential losses (on their short positions) by the Fed and thus the US taxpayer. In other words the taxpayer is safeguarding JP Morgan to manipulate the precious metal markets! In the gold pits, Maguire noticed HSBC betting against, manipulating, the precious metal's price, using naked shorts. He also added that silver price is much easier to manipulate due to the fact that it is a much smaller market. Jeff Christian, founder of the commodities firm CPM Group, said that the LBMA, the physical delivery market for gold and silver in the UK, has been using leverage, which is another way to depress the price of gold and silver. The LBMA has leverage of about 100-1 on the gold bars settled on the exchange meaning that if 100 clients requested their bullion bars be delivered, the exchange could only give one client the precious metal. This is similar to the workings of the fractional reserve banking system. In fact the Goldsmiths in the 17th century in England were at the cradle of the fractional reserve banking system. The remaining requests would have to be settled for cash equivalent. "That is tantamount to a default on the trade," says Bill Murphy, chairman of the Gold Antitrust Action committee. Maguire goes further and calls it a fraud: "If you sell something you do not own, then that is fraud."

Again it is like there are certain rules for the Government and banks and different rules for individuals, what kind of justice is that? Why have laws? Back in 2007, Morgan Stanley agreed to settle a $4.4-million lawsuit brought by precious-metal clients, who alleged that Morgan offered to buy gold and silver and store it for the investors, but never purchased any metal and still charged them storage fees. How crooked are banks? Another “fraudulent” behavior was committed by the ABN AMRO (100% owned by the Dutch State) who “couldn’t” deliver its clients the agreed physical gold and thus paid them in cash! What about legal contracts? where is the equality? Again why do different rules apply to different parties? This is the way you get manipulation and improper practices. What happened to free-market capitalism if the monetary authorities can manipulate prices whenever that suits them and they are not held responsible?

According to Maguire an imminent LBMA default of not being able to deliver the physical was behind the gold sell-off

With massive futures selling once again in the gold and silver markets, Andrew Maguire gave as the reason for the recent fall in the gold and silver prices an imminent LBMA default.  According to him gold and silver only have this type of selling when there are extreme shortages of the physical metal. Probably because it triggers speculators to sell their physical gold and silver. “We had already seen COMEX inventories plunging.  In 90 days COMEX inventories saw an incredible decline.  So immediately available physical gold was disappearing.  People around the world don’t understand what has been happening since Cyprus. Entities went to the LBMA and said, ‘We don’t trust anybody anymore.  We want our physical metal.’  They were told they would be cash settled instead by a bullion bank.  The Western governments have been trying to plug holes, and the reason for it has to do with the default that was taking place at the LBMA.”

“This is why this smash has been orchestrated because of the run that has been taking place on physical metal.  So Western governments had to do this because of an imminent run on the unallocated LBMA system.  The LBMA bullion banks had become so mismatched at one point on their trading positions vs real world demand that they had to orchestrate this smash.

This orchestrated smash in gold and silver was nothing short of a bailout for the bullion banks.  So there is a run on physical gold that is taking place and the Ponzi scheme the West is running is being threatened because of it.”

Maguire also added: “We are nearing the end of this decline.  Physical demand is already beginning to catch up with leveraged paper.  If gold were to trade into the low $1,300s it would be unsustainable for very long.” The question is how much gold is still there to sell, the leveraged players and trading oriented holders are most likely out.  And thus it will be very difficult to push the price down further.

Next to that I believe the more investors buy the physical instead of the paper (futures) the less leverage the monetary authorities will have in pushing down the gold and silver prices. Don’t forget that one of the main reasons that the gold and silver prices can be manipulated is because of the margin requirements, which are a fraction of the total gold and silver price. As a result of the margin dynamics institutions can bring down the market by increasing the margins investors have to put up and thus forcing market participants to sell. But what if people increasingly buy the physical to have an exposure to gold and silver and not so much the leveraged futures because they don’t trust that they will get delivered in the future? At that moment the impact of margin increase will become very limited and thus the potential for manipulation. Lower forced prices by naked futures selling will then be met by ever increasing physical buying, which will force prices higher.

A bit more information about the LBMA to understand the dynamics that play here

The London bullion market is a wholesale over-the-counter market for the trading of gold and silver. Over-the-counter (OTC) or off-exchange trading is done directly between two parties, without any supervision of an exchange. Parties may agree on an unusual quantity, for example. In OTC market contracts are bilateral (i.e. contract between only two parties), each party could have credit risk concerns with respect to the other party. OTC derivatives can lead to significant risks, especially counterparty risk. Counterparty risk is the risk that a counterparty in a derivatives transaction will default prior to expiration of the trade and will not make the current and future payments required by the contract. In other words the OTC market is much less regulated and thus is much more risk involved.

Products traded on the exchange must be well standardized. This means that exchanged deliverables match a narrow range of quantity, quality, and identity, which is defined by the exchange and identical to all transactions of that product. This is necessary for there to be transparency in trading. An exchange has the benefit of facilitating liquidity, mitigates all credit risk concerning the default of one party in a transaction, provides transparency, and maintains the current market price.

Trading is conducted amongst members of the London Bullion Market Association (LBMA), loosely overseen by the Bank of England. Most of the members are major international banks or bullion dealers and refiners (Wikipedia). According to some industry specialists the LBMA operates a fractional reserve system. It sells much more gold than it has. Though there is nothing new about gold bankers selling gold they don't have, as mentioned before the goldsmiths invented the scheme in the 17th century and were at the birth of modern banking. The LBMA keeps on hand the amount of gold that it estimates, in the worst-case scenario, it will be called upon to deliver. It is like the banks, it is all well till……! Exactly! At the moment there is a rumor going around that the Comex (Nymex and Comex are part of CME Group, the world's largest and most diverse derivatives marketplace) or LBMA could default in the next couple of weeks and that all contracts will be settled in cash.

Who exactly are the members of the LBMA? The clearing members are as follows:

• HSBC Bank USA National Association
• JP Morgan Chase Bank
• The Bank of Nova Scotia
• Barclays Bank
• Deutsche Bank
• UBS AG

According to some sources HSBC and JPMorgan Chase are the biggest short sellers on the New York Commodity Exchange. It is also rumored that together they own 95% of the over-the-counter precious metals derivatives. They are also custodians of the bullion supposedly held by the GLD and SLV exchange-traded funds, respectively, and they are clearing agents for the LBMA. Do you smell a rat?

Unlike many commodity markets, the forward market for gold is driven by spot prices and interest rate differentials, similar to foreign exchange markets, rather than underlying supply and demand dynamics. This is because gold, like currencies, is borrowed and lent by central banks and in the interbank market. This gives gold quite different dynamics because on the one hand it has the characteristics of a commodity (supply and demand) and on the other hand it is regarded as a currency (spot price/interest rates/forward price). Interest rates for gold tend to be lower than US domestic interest rates. This encourages gold borrowings so that central banks can earn interest on their large gold holdings.

Except in special circumstances, the gold market tends to be in positive contango, i.e. the forward price of gold is higher than the spot price. Historically this has made it an attractive market for forward sales by gold producers and contributed to an active and relatively liquid derivatives market. But what happens when the TIPS sell off and you go into a deflationary environment? You get backwardation! The spot price is higher than the forward price. As a result the LBMA might have got completely wrongly positioned and incurred huge losses and “the banks” had to save the LBMA by selling massive amounts of futures to reverse the backwardation and “forcing” investors to sell the physical. Or is it because investors were requesting physical delivery whilst the LBMA didn’t have enough physical gold and the LBMA would have to buy the physical in an already tight market which would have fuelled gold and silver prices and would have resulted in huge losses for the LBMA. Or was it a combination of the two?

It is still unsure what exactly the situation is, we can only guess. But I believe that we will soon see a strong bounce back because the sell-off created the opposite of its purpose, strong physical buying. Anyway the bull market is definitely not over if anything it is just beginning and people that think that the real value of gold is $800 should not get involved in gold because they clearly don’t understand gold. Gold is money, it is the ultimate currency and not a commodity which showed a meteoric rise since 2001 following the continued debasement of the currencies. So every reference by people that gold is not a productive asset and therefore is valued far too high again clearly illustrates their ignorance of what gold embodies and represents.

Conclusion

The sell-off in the gold and silver prices reeks like blatant manipulation either to prevent the hegemony of the US dollar to be challenged by gold or to help out a financial institution that was not able to fulfill its obligations because of strong physical demand or deflation forces. I believe that under normal circumstances the manipulators would get away with their crimes though this time it is different. The demand for the physical is getting very strong and even got stronger following the sell-off enabling people to buy at subsidized prices. The Cyprus affair has shown the need for real assets within your own possession and not within a bank. Investors want to have an insurance for uncertain times and the uncertainty is increasing by the day.

The Fed is likely to have to print a lot more than it’s currently printing in order to stem the tide of deflation (Japan situation) and it cannot afford to see the dollar decline, or in other words gold go up too much, at this point in time. The Fed will try to do anything to prevent the hegemony of the US dollar to be challenged by much higher gold and silver prices. Although gold is being regarded as a currency (BIS has named gold a risk free asset!!) it also is a commodity and ultimately the physical supply/demand situation will rule and determine its price thereby strongly diminishing the importance and leverage of the futures or paper gold. As a result it will be far more difficult to manipulate the gold and silver price down.

In conclusion, gold and silver are one of the few assets that will hold their (relative) value over time in my point of view especially during the debasement of the currencies and even in a deflationary environment. In the end, in these challenging and debt ridden times, our main objective should be to preserve capital. Yield is almost not existent and basically confirming the worthlessness/debasement of paper money. Next to that the argument for choosing bonds above gold (no interest) is therefore getting less valid by the day. As spelled out in other articles we are transforming from a paper based system to a gold-based system and accordingly see a shift from yield to preservation of capital.  The bull market in precious metals is not over if anything it has barely started!

© Gijsbert Groenewegen

g.groenewegen@goldarrowpartners

www.groenewegenreport.com