Sellers of Gold

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At
every recorded price, there is an exchange. For every buyer, there
is a seller. Gold has a price. Someone is selling gold.

Why?

There
are several possibilities. (1) He thinks the price of gold has peaked.
(2) He thinks he has a better use for his capital. (3) It isn’t
his gold; he’s selling it on behalf of someone else. If "someone
else" is the electorate, then the seller can do what he wants.
Voters have no meaningful understanding of gold. In this respect,
they are a lot like University of Chicago economists.

Who
are the major sellers of gold? Gold mining companies, central banks,
gold speculators, and Indians. (Patel, not Tonto.) Then there are
short-term speculators who sell promises to deliver gold in the
future at a fixed price, but who own no gold. We call them short
sellers.

Gold
mining companies sell gold because that’s their business. Their
gold reserves in the ground are well known and are factored into
the prevailing price. Those mines that have in effect sold short
at a fixed price reap no profit from a rising price of gold. They
already locked in a price, and this is what they are paid when they
deliver. He who went long — promised to buy the mine’s output at
a fixed price — is the winner. For over five years, numerous mines
have been selling short, called forward selling. They won when gold’s
price went down. Now they are losing. The amount of gold being sold
by mines for future delivery is now drying up. The market has been
going against short sellers, i.e., forward sellers.

Central
banks have been big sellers, although in a disguised form. They
have lent their gold for about 1% per annum — the cheapest borrowed
money on earth. They have not reported these loans as sales. Their
official gold reserves remain constant. But the leased gold is gone.
It was borrowed by large trading companies called bullion banks.
They borrowed at 1%, sold the gold, took the money they earned by
selling the gold and invested it at 5% or more. It was a sweet,
multi-billion dollar deal. But now they are in a squeeze. They owe
billions of dollars of gold bullion to central banks, but to get
it back, they must buy gold bullion in the open market, which is
now a rising market. They are losing money, big time. What has saved
them so far is that the central banks are not demanding repayment.
Meanwhile, the public doesn’t know that the leased gold is gone.
The central banks do not publish these figures.

Then
there are direct sales of gold by the central banks. The most recent
sales were made by the Bank of England. It sold off at least half
of its gold reserves over a 3-year period which ended in March.
The man officially responsible for the decision to sell gold is
Gordon Brown, the Chancellor of the Exchequer. He has come under
fire this month for having made horrendous investment decisions.
The Independent (May 26) published this story.

Chancellor
under attack over sale of gold reserves
By
Colin Brown and Jason Nisse
26 May
2002

Gordon
Brown has "lost" over 400m pounds by ordering the sale
of part of Britain’s gold reserves by the Bank of England. . .
.

Figures
obtained by the Independent on Sunday also show that his
decision to order the Bank of England to part with some of its
gold reserves and switch into the euro and yen was also not a
good bet for the taxpayer. The value of gold has soared on the
world markets as investors have switched to gold.

However,
figures issued by the Treasury last week showed that the Bank
has lost out to the tune of $578m. Treasury minister Ruth Kelly
said the Governor of the Bank, Sir Edward George, had sold 395
tonnes of gold as part of the restructuring of the United Kingdom’s
foreign currency reserves since May 1999. The last auction was
in March 2002 when the price of gold was $296.50 per ounce. Gold
was trading at $320.5 in London when the markets closed on Friday.

When
the Chancellor announced the policy in 1999, he said he wanted
to diversify our store of wealth. Germany, Australia, Switzerland
were among the major holders of gold who were also selling. They
agreed in September 1999 to limit sales to 400 tonnes a year in
total until 2004. Gold prices started rising after 11 September.

No
public official relishes the prospect of being made to look like
a dolt. Mr. Brown looks now like a dolt. Sir Eddie George, who heads
the Bank of England, looks no wiser. Other central bankers now must
decide whether it is a good idea to sell gold. They may wind up
looking like Sir Eddie. ("Sir Eddie" doesn’t sound very
impressive, does it?)

Of
course, major central bankers have a problem. If the public ever
learns that the central banks’ gold leasing program has turned into
an unannounced gold sales program, with the bullion banks in cahoots
with the central banks, and the bullion banks can’t repay the central
banks, heads will roll.

A
rising price of gold threatens to bankrupt the bullion banks, who
dare not go into the market to buy gold for fear of what this will
do to gold’s price. So, it’s a waiting game. The bullion bankers
are hoping for gold to go down. So are the central bankers. But,
at some point, the central bankers will have to demand repayment.
At that point, the gold leasing game will end. The bullion banks
will go bust, the central banks won’t be repaid, and the public
will find out — once again — that you should not trust central banking.

Will
that point ever come? Yes. How soon? I think before the end of this
decade. But even if it doesn’t, the public will still win out. If
the gold leasing game goes on, the public will buy back its gold,
which was confiscated from our grandparents or great grandparents.
If gold leasing ceases, the people who have bought gold and held
onto it will earn enormous rates of return on their investments.
Gold-haters will lose; gold bugs will win. That is the way it should
be.

Can
gold’s price fall to below the bottom of $256? Anything can happen,
but this now seems unlikely, short of one last sell-off by central
banks.

GOLD
INVESTORS

I
have discussed gold sales by gold mining companies and central banks.
What about gold bullion investors?

With
the Federal Reserve System expanding credit money to push down short-term
interest rates, and with a recession in capital investing still
in force, the question is: "Where can I make a better rate
of return than gold?" This year, gold has beaten all other
investment categories. Gold investors have to search long and hard
to find a better rate of return. Only if they think the price has
peaked would they want to sell. But there is little evidence yet
that gold’s price has peaked. The predictable threat of the Bundesbank
in early April to sell gold — no amount specified — in 2004 had
no downward effect on gold’s price.

So,
those who invest in gold have to decide: "What to do with the
money I gain by selling my gold?" The U.S. stock market is
performing poorly. It has been performing poorly for two years.
The investor who thinks that inflation is beaten might sell gold
to buy U.S. government bonds. But the Median CPI is still above
3.5% per annum for 2002. No deflation is visible in this statistic.

http://www.clev.frb.org/research/mcpi.txt

So,
he is less likely to sell than in the past. There are no clear-cut
alternatives. This reduces the supply of available gold at any price
in today’s range.

Then
there is the traditional buyer of gold jewelry, the Indian father
who has daughters. At some price, he will sell. India is becoming
a modern economy. There are alternatives to gold for a daughter’s
dowry. But today, India is once again facing war. No one likes to
think about it, but this war could go nuclear. The West avoided
nuclear war, but religious hostilities are very high in the Indian
subcontinent.

Pakistan
is home base for revolutionary guerilla forces in Kashmir. That
India insists on retaining control over Kashmir seems nutty to the
West. So what if Nehru was born there? It is overwhelmingly Muslim.
Why not give the residents the right to secede from India? India’s
answer: Because
they are mostly Muslims, and Nehru was born there.

In
the mid-1960′s, I met an Indian journalist who was on a fellowship
in the United States. I think he was a Nieman Fellow, the most prestigious
of all fellowships in journalism. He was therefore at the top of
his profession. He was liberal: anti-caste, pro-democracy. But on
the subject of Kashmir, he was adamant: democracy is an irrelevant
issue regarding Kashmir. There was no arguing with him. You can
imagine what his Pakistani peers believed, with equal fervency.

One
million troops are now massed on the Kashmir border. India has a
stronger economy and more money than Pakistan. It has far more people.
Its conventional military forces are superior. But Kashmir’s mountainous
terrain is on Pakistan’s side. If the war stays conventional, should
it begin, India’s economy will be strained to pay for it. If the
war spreads to Pakistan, then Pakistan is at a disadvantage. The
risk of Pakistan’s use of nuclear weapons rises in such a scenario.

Salon
(May 28) reports:

A
new analysis by the Defense Intelligence Agency suggests that
between 8 million and 12 million people would be killed in a nuclear
war between India and Pakistan, according to a U.S. defense official,
speaking on the condition of anonymity.

The
report presumes that both India and Pakistan successfully use
most of the weapons in their nuclear arsenals and target the weapons
on populated areas, the official said. The death estimates are
in the short-term, and do not include long-term deaths caused
by fallout.

Both
countries’ nuclear weapons are thought to number in the low dozens
and have yields at or below 20 kilotons, putting them in the class
of the bomb the United States dropped on Hiroshima, Japan, in
1945.

Both
can deliver the weapons with small fighter-bombers, such as Pakistan’s
F-16 and India’s MiG-27, or ballistic missiles.

http://www.salon.com/news/wire/2002/05/28/pakistani_troops/

Why
would an Indian father sell traditional gold jewelry in order to
buy conventional paper-money investments in such a scenario? Why
not stick with a traditional dowry that goes back thousands of years?

I
predict that Indian sales of gold will decline, even though the
price of gold is rising steadily. If hostilities cease, I am willing
to reconsider. But hostilities are increasing. Kashmir isn’t going
to go away. Neither is Al-Qaeda. Salon also reports:

In
a potential blow to the antiterror war, Pakistan appears to be
preparing to pull troops away from the Afghan border to focus
on its own dispute with India, U.S. defense officials said Tuesday.

The
Pakistani military presence has been a key element of the U.S.
strategy for capturing or killing Taliban and al-Qaida fighters
who may have slipped across the border. Without Pakistan’s help,
the United States has little short-term prospect of finishing
off al-Qaida.

American
military officials made clear Tuesday they are worried that the
dispute between Pakistan and India over the Kashmir region could
disrupt the campaign against the al-Qaida in the anarchic tribal
areas of western Pakistan.

"Attention
and troops that cannot be focused there, because they’re focused
elsewhere, that’s a concern for us, because we need as much assistance
as possible in guarding that very porous border," Victoria
Clarke, chief spokeswoman for Defense Secretary Donald H. Rumsfeld,
told reporters.

"It
is a concern when they have to focus attention and people to other
parts of the country," she added.

She
said U.S. officials "are encouraging Pakistan to remain involved,
as they have been, extensively, in the war on terrorism."

Pakistan
said last week that it might remove troops from the Pakistan-Afghanistan
border region, where they are helping the United States search
for al-Qaida and Taliban, and move them toward Kashmir because
of the escalating conflict there.

SUPPLY
AND DEMAND

There
has been some increase in demand from Japanese investors this year.
There is at least circumstantial evidence that the central bank
of China has been accumulating more gold than was believed likely
until recent months. But, so far, the upward pressure on gold’s
price seems to be from the supply side. Reduced supplies of ready
sellers are leading to higher prices.

This
is understandable. Reduced supplies of gold are the result more
of fear than greed. Gold mining firms burdened with forward contracts
see losses ahead: selling a commodity whose price is rising, but
not for them. Those competitors who did not indulge in forward sales
will prosper. They will bid up the price of mining equipment and
labor. This will hurt those mines that are loaded up with obligations
to sell at a fixed price. They will face a profits squeeze. So,
they are less likely to add to their positions of forward sales.

The
same fear factor affects Indian families. They are afraid of war’s
effect on rupee-based investments. War also increases demand for
gold. So, they could get locked out of the gold jewelry market.
Why sell? Stick with a traditional dowry.

Short
sellers in the commodity futures market worry about losses. They
buy gold futures to close out their positions. This raises gold’s
price. So does their departure from the short side of the market.
Not only does the supply of gold get tighter, the supply of investors
willing to promise to deliver gold gets tighter.

At
some point, gold’s rising price will attract the attention of conventional
investors. This may be years in the future. I think it probably
is. For two decades, gold has moved down. Investors have lost confidence
in gold. But cycles do occur. Floors are reached. At some point,
rising demand becomes more significant than contracting supply.

Traditional
market bottoms occur when existing holders get discouraged and sell.
Demand has fallen for years. The market gets a reputation for producing
nothing but losses. Interest by new investors wanes. Only highly
entrepreneurial people are buyers. Existing holders grow discouraged
about ever making a profit. They finally sell their positions. Capital
shifts from older, experienced, but discouraged holders to new entrepreneurs.
This sell-off is what the gold market experienced in 2001.

I
believe there will be rising interest in gold over the next few
years, but that demand, short of nuclear war in the Indian subcontinent,
will be steady rather than greed-driven. Demand will increase, as
more investors are brought back into the market. I don’t expect
a gold rush by Wall Street. Wall Street is too conventional. It
is also allied at the highest levels with central banks and bullion
banks. Wall Street is the Establishment.

There
is a long-term re-education process ahead. Gold has been attacked,
steadily, ever since 1914, when European central banks ceased to
redeem their gold certificates, and their governments authorized
this massive confiscation of private wealth. The United States joined
in, but re-established convertability after the war ended. Europe
didn’t, except for England in 1925, at a pre-war price that could
not be maintained without deflation, which the economy got. Britain
went off the gold standard in 1931. The United States followed in
1933.

The
war on gold is a war of the centralized, grasping State against
people with capital. This war is basic to modern democracy: the
substitution of the welfare-warfare State for limited civil government.
The bias against gold is in the textbooks. It is in the minds of
three generations of bankers, industrialists, and investors. A reversal
of this bias will not come from within the Establishment. It will
be forced on the Establishment.

CONCLUSION

The
tide seems to have turned for gold’s price. As the truth about the
one-way direction of the central banks’ gold leasing programs becomes
clear to a minority of investors (but very few voters and legislators),
gold holders and entrepreneurs will conclude that gold’s supplies
are far more limited than previously imagined. When they recognize
that the overhang of gold is based on a statistical fraud — that
the gold is gone and will not be coming back — the upward pressure
on gold’s price will accelerate.

The
gold leasing phenomenon could become an international Enron. I think
it will. What one company got away with temporarily, with the connivance
of its accounting firm and the regulatory agencies, will be regarded
someday as a minor event. What the central banks have done with
their accounting systems dwarfs anything in the history of accounting.
The stock market eventually exposed Enron as a gigantic accounting
fraud. There will be a similar day of reckoning for the central
banks.

June
3, 2002

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