The Role of Gold in the Unified GCC Currency
The manipulation of the gold market since the Nineties
Various studies have come to the conclusion that gold is severely underpriced. They expect a gold price of at least USD 700; some estimates even reach USD 1500 and more. The chosen approaches are manifold and include comparisons between the gold price and money supply (M3), long term ratios of the gold price with oil and stock markets, supply and demand figures in the gold market or the
39- See Al-Alkim, op.cit., chapter 3-6.
40- Ugo Fasano and Zubair Iqbal, "Common Currency. GCC Countries Face Fundamental Choices as they head for Monetary Union," Finance and Development 39, no. 4 (December 2002), available under http://www.imf.org/ external/pubs/ft/fandd/2002/12/fasano.htm, p. 2.
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hypothetical amount of gold needed for a reintroduction of a gold cover clause. 41 Although the liquidity driven stock market frenzy and serious currency crisis in some emerging markets (Mexico, Asia, Russia) supported the US dollar in the 1990s and thus reduced the attractiveness of gold, the sell off in gold between 1996 and 2001 that propelled it below USD 260 is highly suspicious, as it happened during a time of increasing supply deficits in the gold market. This has led a number of distinguished experts who are affiliated with the Gold Antitrust Action Committee (GATA) 42 to assume that Western central and commercial banks have manipulated the gold market since the middle of the 1990s in order to defend the paper dollar standard. Such interference is quite reminiscent of the gold market interventions in the sixties during the establishment of the Gold Pool. The evidence collected encompasses comparisons between different kind of statistics and issuers, historical probabilities and standard deviations as well as anecdotal material about more or less obvious efforts to suppress the gold price. While this is not the place to discuss the material in great detail,43 it is important to be aware of the basic argument and its implications for the future gold price, should the paper dollar standard deteriorate further.
Based on 2000 figures, Frank Venoroso challenges the official statistics of Gold Fields Mineral Services (GFMS) and the World Gold Council (WGC) and assumes that annual mine
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41- Van Eeden, op. cit.; Tim Wood, "Gold-oil link all but dead in 2004," (August 10, 2004): http://www.mineweb.net /sections/energy/oilgold.htm; H. Reginald Howe, "Dow/Gold Ratio=1 at 3000$: Don’t Laugh!," under http://www.goldensextant.com/ commentary5.html; Frank Veneroso, "Facts, Evidents and Logical Inference. A Presentation on Gold/ Supply/ Demand, Gold Derivatives and Gold Loans," (May 2001): http://www.gata.org/fv.pdf; Bill Fox, op. cit., p. 18.
42- GATA was founded in 1999, see. http://www.gata.org.
43- Frank Veneroso, Reginald H. Howe, Mike Bolser and James Turk have conducted the most important studies so far. For a thorough compilation, see John Embry and Andrew Hepburn, "Not Free and Not Fair. The Long-Term Manipulation of the Gold Price," Sprott Asset Management Special Report, August 2004 under: http://www.sprott.com.
production (2,568 t), scrap supply (602 t) and official central bank sales under the Washington Agreement of 1999 (400 t) are only partly covering an estimated world wide demand of 4,844t. Venoroso thinks that the supply gap of about 1,274 t and the supply gaps of preceding years have been closed by leased central bank gold. That leads him to the breathtaking thesis that instead of the officially acknowledged 5,000 t on lease and swap arrangements, up to 16,000 t of a total of 28,000 t may have actually left the vaults of central banks. Venoroso points out that the gold carry trade that started in the 1980s gradually went out of hand. Thereby, central banks are leasing gold to the commercial banks for a low leasing rate of about 1%. The commercial banks sell the gold in the market and invest the proceeds in higher yielding assets like treasuries, thereby earning a nice spread. As the commercial banks now have a delivery risk of physical gold to the central bank, they can hedge themselves against a gold price rise by going long on the derivative markets. Mining companies, proprietaries trading desks and hedge funds have taken the short side of these trades. Thus, on a limited base of physical gold, a gargantuan mountain of derivatives has developed. And this mountain continues to grow, although mining companies have reduced their hedges dramatically in recent years.44 To put it in a nutshell, the gold still exists in the books of central banks as receivables, and on the books of hedge funds and commercial banks as liabilities. But the actual physical gold itself has long left the vaults and now hangs around the necks of the women of the world. These women are the "ultimate longs" in the market while the banking system stays out in the rain with a gigantic derivative short position of up to 16,000 t.
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44- It is estimated that the notional value of derivative "paper gold" is 10 times higher than yearly physical production and nearly as high as all official sector gold. H. Reginald Howe, "Gold or Dross? Political Derivatives in Campaign 2000," August 2000, http://www.goldensextant.com/campaign 2000.html#anchor48727 and Howe, "Hitting the Iceberg," December 20, 2003, http://www.goldensextant.com/ commentary 26.html#anchor25233.
At current prices, it is inconceivable that this short position could be covered. A much higher gold price would be needed. This, in turn, would not only seriously hurt the profits of the banking system but would also endanger the already ailing paper dollar whose liquidity is fuelling the US and world economy alike. This is why Veneroso, Embry and others assume that an official sector of central and commercial banks has started to manage the gold price at least since the plight of the LTCM hedge fund in 1998, which purportedly held a huge short-position in gold. Occurring trading patterns suggest that apart from lending physical gold into the market, the gold price is suppressed by derivative short selling and spread trading. Similar accusations exist in the case of silver.45
This management will ultimately fail, as the supply gap will increase rather than decrease.46 Gold production is expected to decline significantly in coming years as mining companies reduced their investments in new projects during the last decade of suppressed prices. As a mining project needs 5-8 years to mature to production, this will not change anytime soon. Groundbreaking new technologies that could raise the output drastically like the discovery of cyanidation in 1887 are not likely. And epochal new discoveries like those in USA, Australia and South Africa in the 19th century47 can also not be expected, as nowadays such terra
