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THE
ROCKET SCHOOL OF ECONOMICS


Who Put the Holes in the Swiss Cheese?
by Professor von Braun

February 20th, 2001

The decision of the Swiss National Bank to sell half their gold reserves in the final stages of a very long bear market in precious metals has, to this observer of the gold market, always been a tad suspicious. It was one of those announcements that seemed to be rather rushed, since approval was sort in very short order. The Swiss banking industry has been around too long to have engaged in rushed decisions on not other than what has been a cornerstone of it's soundness, bullion, secrecy of course being another. Although it's fair to say that the secrecy thing is not quite what it used to be. But selling half of ones gold reserves, well that's a different story altogether.

What did the SNB know that the Swiss politicians did not is a question that comes to mind. Could it be that they needed access to a large amount of physical metal for some purpose other than what they told the gullible Swiss public? The new legislation allows them to sell gold as they see fit, whatever that means.

Could it be possible that they needed access to such a large amount of physical metal to allow certain Swiss banks to cover derivative positions held by their bullion trading divisions if they had to? Was this exposure a threat to the Swiss banking system and could it only have been covered by the national reserves?

The Swiss have of course been playing in some rather large ponds in recent times what with a host of mergers and acquisitions such as Credit Swiss and First Boston. Then there was the rather rapid merger of Swiss Bank Corp with UBS, a case of a smaller fish swallowing a bigger one it seems, along with several UBS heads been given the rapid "goodbye". We never did hear what actually happened there but it is safe to assume that rapidly announced bank mergers, especially when a smaller bank takes over management of a larger one, usually mean that a balance sheet may have needed some help.

What was at risk in that merger one has to ask? Could it have been exposure to gold? Even the merger by Chase Manhattan with JP Morgan was done in a rather rapid time frame, Goldman Sachs apparently was JP Morgan's first choice but after some initial due diligence, they said thanks, but no thanks. Both JP Morgan and Chase Manhattan have considerable exposure to the gold market as well, as does Deutsche Bank, another JP Morgan suitor that withdrew fairly quickly, perhaps with some help from the Bundesbank. Who knows what goes on behind central bankers doors these days, apart from waffling?

Certainly 1999, the year following the LTCM bailout was, as evidenced by the work of that excellent gold sleuth, Mr. Reginald Howe, the year that certain banks involved in the gold business increased their derivative positions in this metal at an astonishing rate. Did the LTCM shake out give the SNB something to think about when it came to their own "local" banks positions? Approval for the Swiss sale was given in April 2000 after being announced in 1999. Fancy that.

I don't think there is any doubt in the minds of those that follow the gold market, with a perplexed look on their face resulting from gold's apparent inability to close any of the last four years above $290 per ounce -- when demand is increasing, mine supply is reducing and there is a recognizable shortage -- that something fishy is going on here. Most of the damage was done from Feb '96 through to Dec 97 when gold fell from $417 to close out the 1997 year at $290, as it did in 98 and again in 99.

The worldwide derivatives market is estimated at $100 trillion dollars, a mind boggling number, one which serves to remind us that such a large derived amount is required to keep the game going, a game which sees the underlying real assets representing only a small portion of this amount. Isn't that interesting. What would the players in the derivatives game use to pay off their commitments if things went sour?

Even the Bank of England can't have forgotten what happened the last time they sold 2/3rd's of their gold holdings gold then went on a rally that lasted through to Jan 1980. Will the same thing happen to the Swiss? Who knows? But Central Bank selling is final, after gold is sold it is not so easy to get back. South Africa take note!

We believe that the weak link in the world wide derivative market is gold, real gold, not the paper variety and that there are some central bankers who are aware of this. Who will act to save themselves first? Or perhaps the Swiss already have.


The Prof can be contacted by email at profvonb2@aol.com

Copyright by Professor von Braun. All Rights Reserved. Reprinted at USAGOLD by permission.

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