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Welcome to USAGOLD's "Gilded Opinion" pages. We invite you to browse our index of outstanding gold-based commentary. Each article or essay is selected on the basis of its long-term relevance for understanding the role gold plays in the individual's portfolio, the overall political economy, or both.
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Gold: Historic spike ahead?
by Brian Durrant
March 22, 2006
It is common knowledge that
the British government sold more than half of the nation's gold
reserves at the bottom of the market in mid-1999. It's less well-known
why.
The Treasury sold 395 tonnes of gold from July 1999 to March 2002
at an average price of $275 per oz. The sale raised $3.5bn.
Why? The Treasury claimed that gold was expensive to store and
keep secure. It was also inconvenient to trade if transactions
involved a change of storage location. But in other words gold
was too traditional and old-fashioned, an anachronism for New
Labour.
Now gold is twice the price at which the government sold it. The
cost to the taxpayer of this policy to "modernise our reserves"
equals some £2 billion. You may recall that the Conservative
Party irretrievably lost its reputation for economic competence
in September 1992 when it spent £800m trying to keep the
pound in the ERM. But alas, the media, the electorate and the
opposition now take a kinder view of wasting taxpayers' money.
According to Tony Blair's comment to the House of Commons, the
gold sale "was carried through perfectly sensibly and we
actually got the best deal for the country". We know the
second part of his statement was rubbish. But were the gold sales
carried out sensibly?
Psst! Sell gold now...
On 7 May 1999 the government announced in advance that it would
sell 415 tonnes of gold. This public announcement seemed to ensure
that the UK would achieve the lowest possible price rather than
the highest. The first auction of 25 tonnes in July was $26 per
oz lower than the price at the time of the announcement!
In selling our gold the government was a great believer in overt
sales. In other words, showing its hand to the market. The Treasury
reckoned that predictability and transparency would increase revenue
by increasing participation in the sale. The government bent over
backwards to be "fair" to buyers of gold, wanting to
maximise sales rather than striving to get the best price. The
issue of "fairness" for the taxpayer took a back seat.
So is that the end of the story, just another example of government
incompetence? Or was there a hidden agenda? There is an extremely
controversial piece of research that, if true, suggests the British
government is more knave than fool.
A recent report from metals and mining analysts at Cheuvreux --
part of France's largest bank, Credit Agricole -- says that the
sale was in fact designed to keep the gold price down. The British
Government's actions of mid-1999 are cited as clear evidence of
a global conspiracy to rig the gold market.
Easy money... until gold took off
The conspiracy theory begins in the 1980s. Central banks began
to lend or deposit part of their gold holdings with leading bullion
banks like JP Morgan Chase, Goldman Sachs and Citibank. In return
the central banks earned a fee known as the gold lease rate.
At the time this seemed a sensible use of gold. Otherwise it earned
no income for the central banks. But the bullion banks who borrowed
it then sold this gold into the physical market. There it was
most likely turned into jewellery, and was lost from the global
bullion market forever.
The bullion bank used the proceeds of these gold sales to buy
a higher yielding asset like bonds. This was a classic "carry
trade". Borrow at a low gold lease rate, lend at a higher
government bond rate. Money for old rope, in fact... provided
the gold you borrowed in the first place didn't rise in price.
Not surprisingly this transaction was very popular in the 1990s.
The gold price was flat on its back. In fact, Cheuvreux reckon
central banks loaned out between 10,000 and 15,000 tonnes more
from their gold reserves than they've declared!
And you can see the problem. Sooner or later the bullion bank
will be obliged to deliver the borrowed gold back to the central
bank. It has to buy it in the physical market, incurring substantial
losses at today's 25-year highs, and also squeezing the gold price
higher still -- thus making the situation worse for other bullion
banks that are also short of gold. The risk of a serious global
'crunch' becomes very real.
Huge short covering ahead
Was the Bank of England aware of the risks posed by a rising gold
price? Cheuvreux's research cites a lawsuit filed in December
2001 by Reginald Howe, a member of the Gold Anti-Trust Action
Committee (GATA), a group hitherto seen as on the lunatic fringe
of the "goldbug" community, but now supported in its
claims by the French bank's report.
Mr Howe charged the Bank of International Settlements, Alan Greenspan,
the leading investment banks and many others with rigging the
gold market -- which is illegal under US law. In his suit, he
alleged that in 1999 the then Governor of the Bank of England,
Sir Edward George, made the following comment to the Chief Executive
of Lonmin, the gold mining company:
"We looked into the abyss if the gold price rose further.
A further rise would have taken one or several trading houses,
which might have taken down all the rest in their wake. Therefore
at any price and at any cost, the central banks had to quell the
gold price, manage it. It was difficult to get the gold price
under control but we have now succeeded."
What might Steady Eddie have been referring to? The UK government's
announcement that it would sell half the nation's gold reserves
came just eight months after the notorious bail out of Long Term
Capital Management (LTCM) in September 1998. That collapse had
indeed threatened the global banking system. Cheuvreux now claims
there were strong rumours that LTCM, a hedge fund, was short of
300 tonnes of gold when the company crashed. This short position
is thought to have been assumed by those banks involved in the
bailout operation.
In other words, the new revelations from Cheuvreux add weight
to the circumstantial evidence surrounding a global conspiracy
to suppress the gold price. But history tells us that governments
cannot rig prices forever. At some point, the free market will
out.
The US could not hold the gold price down at $35/oz in 1971. The
Tin Council failed to hold up the price of tin in 1985. And the
British government, thankfully, couldn't stop the pound falling
out of the ERM in September 1992.
Why gold shot higher last year
The scale of official gold reserves that have been lent on to
bullion banks mean there is a huge 'short' position which needs
to be covered by gold purchases in the physical market. Indeed,
this short covering seems to be underway.
From mid-2004 to mid-2005, the central banks' official short position
in the market fell by 2,430 tonnes. During the same period some
232 tonnes of new mined gold was delivered back to the central
banks. So there was short covering of gold of some 2,198 tonnes.
This figure dwarfs official central bank sales, which would have
been 500 tonnes at most. No wonder the gold price shot up during
this period!
And according to Cheuvreux there is much more short covering to
come. Its conservative estimate of the central banks' total short
position is 10,000 tonnes. Only a fraction of this will be met
by new production. The rest will be made up of either physical
purchases of gold or the bullion banks' cash settling. In either
event, the central banks must give up any hope of getting their
gold back.
Or so the story goes. What do other members of the gold market
think of Cheuvreux's claim? There has been no official statement
rejecting the thesis. But the word in the City is that no one
in the gold market believes it. It's a crackpot piece of research
playing into the hands of the conspiracy theorists.
Indeed, a spokesman at the World Gold Council believes the research
has zero credibility. But what's for sure, is that the Cheuvreux
story is not remotely priced into the value of gold today.
In other words, Cheuvreux's thesis may indeed be proved as nonsense.
But the gold price will not flinch if this is the case. And you
can conclude, as we did in 1999, that the British government was
simply incompetent in disposing of half the nation's gold.
On the other hand, however, Cheuvreux's claims -- if correct --
mean that Britain sold gold to shore up the global financial system.
The verdict of government incompetence would be changed to one
of duplicity.
There are plenty of other reasons to hold gold -- as a hedge against
inflation, an alternative asset to paper currencies, and as a
safe haven in times of heightened geopolitical tension. But in
holding gold you are also paying nothing for the option that Cheuvreux's
controversial thesis might be true! If you haven't bought gold
already, we advise you take a position in the physical market,
buying gold coins that trade for a small premium to the spot price.
Original article at The Daily Reckoning, March 22, 2006
by Brian Durrant
A Cambridge economics graduate with nearly 25 years experience in the City, Brian Durrant is investment director of The Fleet Street Letter, (founded 1938). He has worked in stockbroking, the foreign exchange markets and headed the research department at one of London's leading futures and options brokers.
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