By: Jack Adamo
In part one of my series on gold, Was Gold In A Bubble, I discussed why I thought that the gold price had gotten ahead of itself, like any asset in a bull market, but was not in a bubble. I compared it with bubbles of years past and showed the distinction between gold’s price action and that of true bubbles. Today I will talk about what caused the unnaturally sudden, dramatic drop in the price of gold.
Not only does this add costs that impinge on demand, but the regulations change month to month and are so confusing and byzantine that the red tape alone curtails trade. The regulations also have gotten even more burdensome recently.
Still, this has been going on for years, and the incremental effect of the latest heightened aggravation does not account for the majority of the anomalous movement we see in gold prices. We have to move back to America to find an explanation for that.
There have long been accusations of manipulation of the prices of precious metals. Coming in fresh off the Street, one has to wonder how much of these charges are sour grapes, spawned by losses in trading positions. Let’s examine the evidence and make our own decisions.
First, let us recognize that even without any deliberate manipulation, commodity prices can move radically due to factors that have nothing to do with supply and demand and everything to do with speculation in the futures market.
The clearest recent example of this may be the price of crude oil in 2008. After being driven to nearly $150/bbl, West Texas Intermediate crude plunged to below $40 within a few months. Had demand for oil dropped that much? Did a majority of cars, buses, trains and planes stop moving? What about oil-fired power plants and the chemical industry. Did these uses dry-up overnight? Clearly they did not.
The huge drop in oil prices came from the action of traders who had bid up the price of crude in the futures market by momentum trading based on unrealistic assumptions about demand growth. When the price started heading in the opposite direction, traders couldn’t catch a bid on their positions, and the whole market went drastically net short, bidding down the price of the commodity.
A few years later we see that WTI is back around the $100 mark. A look at production and usage statistics will readily show there was no proportional change in those metrics to match the radical price shifts. We can see from this that without the slightest bit of skullduggery, the futures market can greatly affect commodity prices in ways that have nothing to do with supply and demand.
That said, it would be beyond naïve to think that manipulation is not possible. Just recently the Commodity Futures Trading Commission told Goldman Sachs and a few other entities to retain internal documents and e-mails relating to their commodities warehousing activities. That is often the first step on the road to a formal investigation. Meanwhile, the Senate has scheduled hearings looking into the commodities operations of major banks such as JPMorgan Chase JPM -0.34%, Morgan Stanley MS -0.88% and Goldman Sachs.
After the tech crash, all of the major investment banks settled with the SEC on charges they misled investors for their own profits. The lawsuits stemming from the actions of the big banks during the 2008 crash are still going on, with hundreds of millions of dollars already paid out in validated claims of misconduct.
I should point out that these are the tip of the iceberg. SEC actions and censures have been constant for decades. Most of them result in little in the way of fines, and, of course, the company shareholders take the hit. The responsible executives in the vast majority of the cases don’t even have to give up their bonuses, much less face prosecution. Hence, bad behavior has little if any negative consequences for the parties involved. That, of course, promotes such behavior.
So, this is the environment in which we operate. Now let’s see what’s been going on lately, directly relating to precious metals.
Zero Hedge, a Web site run by professional traders, gets data from verifiable sources, such as Comex reports. Back in April, the publication said that JPMorgan Chase, which has the largest private gold vault in the world, showed a 20% drop in “eligible” gold in its vault in one day. That day was April 5, just five days before the two-day $210 plunge in gold prices. (Eligible gold is gold stored that is not registered to a specific owner, but is available to be either registered or traded.)
The ZH report couldn’t say where the gold went, but said that Comex-registered gold remained relatively flat in the following days. JPMorgan’s vault is one of the Comex vaults, so the data suggest that the gold was not reclassified from “eligible” to “registered” but actually left the building.
Where did it go? China? India? Russia? We will probably never know. We do know that while the price of paper gold (ETFs, funds, stocks, futures) plunged, demand for the actual metal soared, with buyers paying significant premiums to the spot price.
A few weeks after the Zero Hedge piece there was another big, suspicious move in gold, this one reported in Barron’s. The number was so absurd, I kept reading it over and over to make sure I read it right. According to the piece, the equivalent of 17 tons of gold was sold on the New York Comex in two bursts in one morning.
The only answer I can come up with is that the sellers had already accumulated huge short positions in derivatives that they wanted to push into the money. The bottom line effect was that someone who wanted a lot of real gold got it, and the seller probably made a bundle on the other side of trade by shorting in the paper market. Two deep-pocketed entities came out happy. Rank and file gold investors were left licking their wounds.
So, are precious metals prices manipulated? Draw your own conclusions. For our purposes, let it suffice to say that the price of gold can move significantly in a relatively short period of time without regard to basic economic or supply-and-demand factors.