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Randy Strauss (usagold.com 27August2008; 17:43)
It doesn't require a conspiracy, only common sense

It doesn't take a loosely organized group of conspirators to weigh depressingly upon the mechanism of price discovery coming out of the NYMEX/COMEX futures exchange, all it takes is for the participants who have common sense to gain the upper hand over those who stubbornly don't have any.

Look, the futures contracts are ostensibly put forth by the Exchange as if they were actual contracts between counterparties looking to actually buy/sell the corresponding quantities of metal at their contract's snapshot price.

But everyone with common sense knows that the physical element of the contract is just a pretense, and that after paying a simple margin to play the game for brief awhile, the vast majority of these contracts will be settled with cash - that is, they will be closed out with an offsetting position in yet another contract rather than through a full-bodied payment of cash for delivery of metal between the counterparties.

Those with common sense (and with a memory of the Hunt brothers' experience nearly 30 years ago) know that there is no real meat on the bones of these contracts, and they know that when "crunch time" arrives, default is the institutionalized and very well-worn path of least resistance.

It doesn't take conspiratorial planning for a preponderance of participants to know enough to either steer clear of these contracts, or to short the hell out of them at such times that may be deemed advantageous to themselves to do so. With an eye to the big picture, the shorts know they're simply selling a "contract" that's inevitably to be universally recognized as all fluff and no stuff. It's easy to sell a sure loser right down the river.

And on the other side of the equation are the longs - the very few who haven't yet caught on to the fact that nothing materially is ever really going to be coming out of those contracts - except perhaps some short-term cash if they can trade in and out nimbly enough.

But in the longer term, everyone with common sense understands the pretense and therefore knows that the contract is effectively rubbish, thus ever and always giving the shorters the upper hand when they square off at the Exchange against the addleheaded longs who stand to gain absolutely nothing material out of their position in the overall equation.

This whole thing reminds me of a story shared by a friend of mine who himself is a natural-born wheeler-dealer. His young son was being "interviewed" by an elementary school administrator to assess whether or not the boy was developmentally mature enough to enter kindergarten that August versus waiting yet another year. To assess basic coping skills, the child was asked, "What would you do if you went into the bathroom and discovered that the toilet was broken?"
The boy's response: "I'd sell it."

A chip off the old block, if ever there was one. If the kid could wrap his mind around the structure of a gold futures contract, I'm sure he'd know exactly what to do with those, too.

For those who insist on the conspiracy story, I guess my point is that you can sleep extra soundly knowing that there is a wider population of potential co-conspirators that you can add to your list.

Bottom line: Take advantage of the physical market for as long as the scarce metal is still available at the deeply discounted prices of its exchange-traded papery derivatives.

R.

Randy Strauss (usagold.com 10September2008; 17:40)
Comments inspired by the recent Don Coxe quote:

"This has done more damage to my personal wealth than anything in the last 20 years," he said in an interview yesterday. But he has too much respect for how the U.S. authorities engineered the collapse in commodities -- a move he said was necessary to shore up the global financial system -- to be bitter. "My attitude is, 'Goddamn it, they're good -- it was brilliant.'"

Firstly, a sincere tip o' the hat to the deep reservoir of wisdom and maturity that is demonstrated in that soundbite.

All evidence of sentiment coming from inside the banking sector that I've been getting is that the financial system seizure is on par with that of the Great Depression, and therefore we should not dismiss lightly the current efforts being put forth by monetary officials (both great and small) to keep the wheels from falling off. To acknowledge, even in the face of personal losses, that the global financial system needed shoring up is as accurate an admission as it is mature of Coxe to say so.

It nearly conjures up memories of Spock's famous line, "The needs of the many outweigh the needs of the few."

Unfortunately, the story can't so easily or happily end with a seemingly isolated sacrifice of commodity holders here and there for the benefit of price-conscious shoppers everywhere - even if it is faced bravely and maturely by the aforementioned few.

A basic review of economics and market principles reminds us that free price movements are the necessary swing point upon which physical supply and demand can be balanced. And the ugly truth of the matter at hand is that a mere discounting of the price/value of commodity derivatives amounts to little more than a cheap parlor trick - a trick which, although creating a nice illusion of cheap prices, completely disregards the physical supply/demand pricing balance and thus sets the stage for shortages and other dire dislocations of the physical supply/demand dynamic.

And to be sure, it is the reliable and steady flow of actual commodities that forms the basis of a well-fed, well-clothed, well-housed, well-fueled well-content population of earth's inhabitants. As this seemingly innocent maneuver of derivative-based pricing (esp. the pro-cyclical discounting of this derivatives amid this financial crisis) is being used ostensibly to "shore up the global financial system", the unintended consequences is that the necessary value and the workings of the REAL (physical) economy is being sacrificed for the mere shaping of temporary perceptions and mathematical adjustments within a PAPER (mental) economy.

Simply put, derivative-based pricing of tangibles is very much akin to a child playing with fire and gunpowder. It's a recipe that doesn't end well. I would rather have high-priced food on my plate and expensive gasoline in my car's fueltank and valuable pile of gold coins in my vault all appropriately priced (physically) at their inflation-ridden prices than to live in a world where they are all derivatively-priced at attractively lower levels and yet are physically unavailable.

Before a derivative selloff can cut too deeply into reality, there will have to come a point of price separation by the physical markets from their paper posers, or else we will be in for a REAL crisis, not merely a paper/digital one. In other words, knocking us all the way back into the Stone Age of barter would certainly NOT by any measure be considered an appropriate policy response. The needs of the many would also have been crushed after having crushed the needs of the few. And in the end, after putting on a brave face to no avail, there's no amount of wisdom or maturity that can tolerate such a disastrous outcome from such small-minded bureaucratic meddling as the very structure of the current game implies.

*sigh*

R.

Randy Strauss (usagold.com 17October2008; 17:35)
on contracts and prices

Just a block away from the sandwich shop where I had lunch I crossed paths with an old Uruguayan friend of mind who happens to have a keener interest than average folks in the metals markets. He was puffing on a monstrously large cigar (he's nearly a living caricature of himself) and stopped me in my tracks to pick my brain for a bit about prices in the gold market.

Ultimately the conversation covered the difference between the market in COMEX contracts versus the market in physical metal.

Over the many years people have now gotten themselves firmly into a bad habit of thinking of the COMEX futures prices (duly adjusted for time/contango) as though they were the actual prices for actual metal. To further demonstrate this point, consider this: Whenever a person DOES actually make a purchase of real metal, as the metal always costs more than the (contango-adjusted) COMEX furures price, as a result of their bad habit they always refer to the higher metal price as the "premium" over the gold price.
This is a habit of shoddy thinking that needs to die right here and now.

I discussed with my friend the universal tightness and scarcity in the physical gold outlets around the world, and tried to help him clearly understand how supply shortages in the face of overwhelming demand simply does not square with the soft prices you're seeing on the futures/derivatives markets - doesn't square, that is, UNLESS you rid yourself of the old habit and begin to think things through more clearly.

To demonstrate, I said, "Frank, as we stand here right now, what would you pay me for this actual $10 bill?" [said while pulling one from my wallet] "You'd probably give me two $5's for it, or ten $1's, or maybe even 40 quarters..."

He said, "Sure."

I said, "Right. Exactly. Because there's nothing ambiguous about that exchange happening in the here and now. But now consider this. Instead of offering an actual $10 bill right now, let's say that I were to take a piece of paper and write on it the words, 'Frank, any time after December, when you see me, hand me this note and I'll give you a $10 bill.' What would you pay me for it right now?"

You could see the wheels were really turning as he took a few puffs on his cigar, so I helped him along.

I said, "OK, I know you'd like to think my IOU's are good, but you can't know whether or not I'm going to be hit by a bus sometime between now and then. So instead of paying $10 today for a December IOU, you'd want to discount that note by some amount that adequately reflects the risk of being stuck with a bad note. In other words, you'll say, 'OK, Randy, I won't pay you $10 for it, but I'll buy that note from you for $8, and it'll likely work out to be the easiest 25% I'll ever make.' And of course, if you had less faith in collecting on my note, you'd discount it by an even greater amount, or perhaps not want to buy it at any price."

That's the way it works in the money markets where the future-promised cashflow of commercial paper and bonds are discounted against their present face value, and it's probably the healthiest way to consider the cheap prices you see for the COMEX gold contracts - they are being deeply discounted for their emptiness of substance. And furthermore, the higher prices being quoted in the marketplace to obtain real metal doesn't represent a premium over the contracts, but rather represents the real cost of real metal to be procured and safely delivered from amidst a vast derivative wasteland.

So here it is in a nutshell:
The gold community has been in an old bad habit of thinking along terms of contract gold prices in conjunction with metal premiums.

Instead, the gold community needs to form the more proper perspective and think along the intellectually healthier terms of discounted contracts as compared with actual (full bodied) metal prices.

R.