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Debunking the Precious Metals Fear Mongering Campaign - Erik Townsend

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  • #46
    Re: Debunking the Precious Metals Fear Mongering Campaign - Erik Townsend

    Originally posted by gnk View Post
    The US thinks they have everyone on board with the increased issuance of SDRs. That's just a temporary ploy to soften the transition caused by the next Triffin dilemma. The big one.
    Taken literally, this reference to the Triffin Dilemma makes no sense to me.

    The Triffin Dilemma, if I understand it properly, observes that it doesn't work forever to have a nations currency as the world's reserve currency. Everyone else needs to "make stuff" to sell to the originating nation (the U.S. for instance) for more reserve currency, and the originating nation needs to make more currency to buy stuff. This results in an imbalance of payments that cannot be resolved, rather tends to get progressively worse.

    Granted the Chinese have done a bang up job of making ever more stuff, and the Federal Reserve has done a bang up job of making ever more currency. But this cannot continue indefinitely. So it some day (soon, perhaps) it shall stop, as anticipated by Triffin.

    However SDR's (replacing the Dollar) as the world's reserve currency, managed by such institutions as the G20, IMF and BIS, and as a currency separate from the currency of any particular goods producing nation, are not subject to Triffin's Dilemma any more than was gold. SDR's are not the currency of any one nation.

    Oh, I'm confident that SDR's (or whatever they call the new-world-order-meta-buck) will come to no good end. They are still subject to the deep corruption which has infused our human financial, economic, political, moral and other systems. I'm just being a bit of a nit picker here. I would not call the inherent flaws of SDR's a manifestation of Triffin's Dilemma.
    Most folks are good; a few aren't.

    Comment


    • #47
      Re: Debunking the Precious Metals Fear Mongering Campaign - Erik Townsend

      Originally posted by gnk View Post
      I don't want to be rude here by jumping in. But I just want to make a couple comments.
      Please chip in gnk. We are not a snobish/exclusivist bunch. At least me and Bart. I can't vouch for Jtabeb though
      Now seriously, any comments are welcome.

      Originally posted by gnk View Post
      1)Gold Standard - I think people too often confuse how technological advances and monetary systems affect our everyday lives - they blur the two. Actually, monetarism piggy-backs on technological advances in productivity in particular to mask inflation - which is a great theft. All the while taking credit for our lifestyle where none is due.
      Very much agree.


      Originally posted by gnk View Post
      Much of the wealth we see today is illusory. If it were not, there would be no takeover of GM, AIG, bank bailouts, and QE.
      Agree. If you also define the term of "illusory wealth" as the zero value byproduct of forced wealth extraction from an economy (I put some UC links on this subject on the Wealth Distribution threat in the News forum) then we are in absolute agreement with respect to the first sentence. With the second sentence, I have some reserves about defining what we are experiencing now as a true QE. It may look like QE but in the end it may proove it actually wasn't QE (but this is a subject for another thread.... we are already waaaaaay off topic).

      Originally posted by gnk View Post
      2) The dollar, actually most currencies are already collapsing. It's happening right now.
      Honestly, I see no clear sign of that. The Euro may collapse soon, but the dollar seems to do pretty well in the current global economic environment. Treasury yields look pretty good to me (I'm sure that metalman, who is keenly watching them for more than a year, agrees ), good bid-to-cover ratios at auctions, I see no Fx dislocations happening and none coming (except the dollar-yuan, but that would be the yuan's problem), USD is not diving with respect with other currencies. Moreover, even the Finster Dollar Index looks pretty good, various velocity measures don't look catastrophic and the real M1 Money Multiplier, looks damn good.

      There is a lot of smoke screen, the economy is still lousy and the Fed doesn't seem to be interested to clearly explain the situation of the dollar, but I see no clear signs of dollar collapse. Bart and Finster are masters of this subject and maybe one of them sees evidence of impending collapse, but I don't. So let's ask them if there are any signs of such collapse, to get an impartial and qualified opinion.


      Originally posted by gnk View Post
      As for gold - it is already replacing the dollar in the reserves of many central banks.
      OK, this is serious news. I knew that many CB's are increasing their gold reserves, (my guess is that they prepare to attenuate a possible spike of the gold price produced by a yuan revaluation), but I was not aware they are actually replacing dollars with gold as a main reserve storage. Judging from treasury yields and holdings and the gold price, I personally don't see any significant sign of replacement. Am I right, Bart?

      Originally posted by gnk View Post
      Let's think back just 2-5 years ago. What was the fear from China and many Oil producing countries? That they would replace the dollar with the Euro. How'd that work out? How are those same countries viewing gold today?
      I always laughed so hard whenever hearing the Dollar replaced by Euro stories and I annoyed so many people here on this forum being very skeptic about Dollar replaced by Yuan or a new BRIC currency based on Yuan-Ruble....
      Also don't see that those countries considering gold as a viable replacement for dollar in their reserves. The problem is that there isn't enough gold to replace dollar reserves and a forced gold revaluation (needed for such replacement) would be to painful for everybody. But I may be wrong here, since I know little about gold. Any big CB's have made any announcements?

      Originally posted by gnk View Post
      There is a panic in China, India, and Russia - they are accumulating as much gold as they can in anticipation of the big event.
      Well, the big event they fear in China is a sudden revaluation of the yuan, which gets completely,out of control, not a dollar collapse. If they feared a dollar reserve they would have began already a vigorous reval, in order not to loose completely the whole value of their reserve.

      In Russia they have the opposite problem, and they fear another big rubble dip. Recently Russia sold another dollar bond, and there are persistent rumors about stealth gold sales by the Russian Central Bank. That doesn't sound to me as fearing a collapse of the dollar.

      Don't know anything about India, in this context, and I have no first hand information from there.

      Originally posted by gnk View Post
      The US thinks they have everyone on board with the increased issuance of SDRs.
      Not sure about that either. To my knowledge there is some hypocrisy with pumping the SDR stash. The countries that USA wants to protect (the members of the coalition of the ZIRPING) have been offered by the FED, solid swap lines for rescue. The countries USA is not interested in protecting, can hope only at World Bank help (maybe a Chinese loan if they have natural resources, or a small Russian loan if they are ex-soviet and their leaders are Putin's suck-ups). IMHO, these days, throwing SDR at a country in serious economic trouble is similar to throwing straws at drowning man.... I'm sure those countries appreciate our good intentions though....:rolleyes:

      Comment


      • #48
        Re: Debunking the Precious Metals Fear Mongering Campaign - Erik Townsend

        Originally posted by ThePythonicCow View Post
        From http://en.wikiquote.org/wiki/Knowledge :
        I know that you believe you understand what you think I said, but I'm not sure you realize that what you heard is not what I meant.
        • Attributed to Robert McCloskey, U.S. State Department spokesman, by Marvin Kalb, CBS reporter, in TV Guide, 31 March 1984, citing an unspecified press briefing during the Vietnam war.

        Thanks cow- I stand corrected, my assumption that Janet said this was wrong - but I am still assuming that Janet is using this phrase to make a point, and more importantly, she used a narrative to explain the weaknesses in the gold paper market.

        Comment


        • #49
          Re: Debunking the Precious Metals Fear Mongering Campaign - Erik Townsend

          Originally posted by ThePythonicCow View Post
          Taken literally, this reference to the Triffin Dilemma makes no sense to me.

          The Triffin Dilemma, if I understand it properly, observes that it doesn't work forever to have a nations currency as the world's reserve currency. Everyone else needs to "make stuff" to sell to the originating nation (the U.S. for instance) for more reserve currency, and the originating nation needs to make more currency to buy stuff. This results in an imbalance of payments that cannot be resolved, rather tends to get progressively worse.

          Granted the Chinese have done a bang up job of making ever more stuff, and the Federal Reserve has done a bang up job of making ever more currency. But this cannot continue indefinitely. So it some day (soon, perhaps) it shall stop, as anticipated by Triffin.

          However SDR's (replacing the Dollar) as the world's reserve currency, managed by such institutions as the G20, IMF and BIS, and as a currency separate from the currency of any particular goods producing nation, are not subject to Triffin's Dilemma any more than was gold. SDR's are not the currency of any one nation.

          Oh, I'm confident that SDR's (or whatever they call the new-world-order-meta-buck) will come to no good end. They are still subject to the deep corruption which has infused our human financial, economic, political, moral and other systems. I'm just being a bit of a nit picker here. I would not call the inherent flaws of SDR's a manifestation of Triffin's Dilemma.
          If the world's currency collapses - a flight from dollars - how does world trade continue? I'm not professing I know everything, or that SDRs are a viable long term solution. But something has to be created as insurance, so to speak. That much I'm pretty certain of. As for the BRICS really wanting the SDR, which is a creature of the IMF, which in turn is a creature of the US with heavy European influence, that is the moment in the analysis that I put on my tinfoil hat.

          Comment


          • #50
            Re: Debunking the Precious Metals Fear Mongering Campaign - Erik Townsend

            Originally posted by $#* View Post
            OK, this is serious news. I knew that many CB's are increasing their gold reserves, (my guess is that they prepare to attenuate a possible spike of the gold price produced by a yuan revaluation), but I was not aware they are actually replacing dollars with gold as a main reserve storage. Judging from treasury yields and holdings and the gold price, I personally don't see any significant sign of replacement. Am I right, Bart?
            I was sloppy with my choice of words in using "replace." Google "dollar reserves at central banks" and you will see a large amount of articles on this topic clearly showing a roughly 9 month trend of diversification away from dollars.

            Meanwhile, since last year, Central banks in general have become net buyers of gold.

            I'm just pointing out a larger trend. There is definitely a policy of gold accumulation/retention and the opposite for the dollar/treasuries. It may be premature to say this will continue. I think this year will be telling.

            You bring up a lot of other good points, I will try to address later today as time permits.

            Comment


            • #51
              Re: Debunking the Precious Metals Fear Mongering Campaign - Erik Townsend

              Originally posted by gnk View Post
              If the world's currency collapses - a flight from dollars - how does world trade continue? I'm not professing I know everything, or that SDRs are a viable long term solution. But something has to be created as insurance, so to speak. That much I'm pretty certain of. As for the BRICS really wanting the SDR, which is a creature of the IMF, which in turn is a creature of the US with heavy European influence, that is the moment in the analysis that I put on my tinfoil hat.
              So far as I can tell, we're not really disagreeing on one thing -- SDR's are being considered as a replacement for the Dollar as the world's reserve currency (what central banks exchange with each other to back their individual national currencies.)

              Also I suspect that I was reading a narrower, more exact definition into "Triffin's Dilemma" than you had in mind when you said that would be the reason (or part of the reason) that SDR's would fail in their new role. We agree they (SDR's) will eventually fail in that role and I'm just quibbling over the proper technical term to describe the failure mechanism. That's fine.

              You're also in good company with the tinfoil hat, as I note that FRED or EJ moved an earlier thread I started (based on a ZeroHedge post) on this topic to Rand & Rave. See the thread IMF Prepares For Global Cataclysm, Expands Backup Rescue Facility By Half A Trillion.

              One thing I would point out to you is that the BRIC (Brazil, Russia, India and China) nations are taking a new and major role in the IMF's funding of SDR's. To quote that link I just gave you:
              If you look at the numbers in that article, the U.S. is just 19% of the total funding of the IMF. Japan is about another 18%. The BRIC nations are another 16% or so, up from 0% last week.
              My fading recollection is that I have read other articles stating that China in particular is openly working toward a major roll in the IMF, suitable to it's status as a major nation. I would also point out that while the G7 or G8 had in past years dominated the IMF and related such world banking discussions (leaving China out in the cold) now it seems to be the G20, which includes all the BRIC nations, who are in the drivers seat.

              So I really do expect to see a major role for the BRIC nations in world finance and G20/IMF/SDR institutions and mechanisms.

              SDR's will eventually die in this role, but it will take longer (as in decades, at least) for this to happen than I suspect you anticipate, and when they die, it will not technically be an example of Triffin's dilemma.

              At least that's what my crystal ball (got it for $3 at a fortune teller's garage sale :rolleyes is predicting.
              Most folks are good; a few aren't.

              Comment


              • #52
                Re: Debunking the Precious Metals Fear Mongering Campaign - Erik Townsend

                Originally posted by $#* View Post
                There is a lot of smoke screen, the economy is still lousy and the Fed doesn't seem to be interested to clearly explain the situation of the dollar, but I see no clear signs of dollar collapse. Bart and Finster are masters of this subject and maybe one of them sees evidence of impending collapse, but I don't. So let's ask them if there are any signs of such collapse, to get an impartial and qualified opinion.
                From here, it appears that things have calmed down over the last few months or so on a comparative or relative basis... and we're far from out of the woods. The various CBs, being cooperative partnerships, are doing a fair job of keeping the fiat currency support boogie going via various interventions and "perception management". On a more positive basis, the MSM have talked about collapse which in my book means its not near by.

                Chart wise:


                Financial Crisis:



                As you can see by the line including "early warn", something appears to be developing.




                Fear/calm





                Originally posted by $#* View Post
                OK, this is serious news. I knew that many CB's are increasing their gold reserves, (my guess is that they prepare to attenuate a possible spike of the gold price produced by a yuan revaluation), but I was not aware they are actually replacing dollars with gold as a main reserve storage. Judging from treasury yields and holdings and the gold price, I personally don't see any significant sign of replacement. Am I right, Bart?
                CB reserves isn't exactly an area that's clear as glass, but there's an unquestionable trend since 2001 of moving away from the dollar, and also towards much less transparency.

                Here's a chart of the "unallocated" portion of CB reserves:







                Originally posted by $#* View Post
                To my knowledge there is some hypocrisy with pumping the SDR stash.
                I'm not sure precisely what you're looking at, but in the last year about $325 billion of SDRs have been created... and a useful analogy is that SDRs are the monetary base of worldwide CBs (and were called an engine of inflation back in the early/mid '70s), and the concept of fractional reserve applies - as in 6-10x expansion.
                Last edited by bart; 04-21-10, 08:47 AM.
                http://www.NowAndTheFuture.com

                Comment


                • #53
                  Re: Debunking the Precious Metals Fear Mongering Campaign - Erik Townsend

                  Symbols man is again pushing his monetarist world conspiracy view.

                  I don't disagree on the explanation of some of the mechanisms, but the piece notably missing is how said regime can switch.

                  The implicit assumption is that this Fed scam cannot change until the people of the US kill the Fed.

                  Yet there have been a number of monetary regime changes in history. None of them were due to a specific money issuing entity being dismantled; all of them were due to the currency itself being debased.

                  All this talk has done little to address the very real debasement that is going on.

                  Comment


                  • #54
                    Re: Debunking the Precious Metals Fear Mongering Campaign - Erik Townsend

                    Originally posted by bart View Post
                    From here, it appears that things have calmed down over the last few months or so on a comparative or relative basis... and we're far from out of the woods. The various CBs, being cooperative partnerships, are doing a fair job of keeping the fiat currency support boogie going via various interventions and "perception management". On a more positive basis, the MSM have talked about collapse which in my book means its not near by.
                    Actually the MSM nonsense is a great indicator.......

                    Originally posted by bart View Post
                    Chart wise:
                    Financial Crisis:
                    Fear/calm
                    Great charts Bart. Thank you. I would say things are already prepared for a Greek show in Euro area.

                    Originally posted by bart View Post
                    CB reserves isn't exactly an area that's clear as glass, but there's an unquestionable trend since 2001 of moving away from the dollar, and also towards much less transparency.

                    Here's a chart of the "unallocated" portion of CB reserves:

                    Well, the increase in the unallocated share of reserves is tough to link with gold. There was an old Setser paper about the ratio gold and SWF-ish fortune and his conclusion was that there was no major increase in the share of gold (this was sometimes at the begining of 2008), so if there is important accumulation of physical gold that should be a recent trend

                    Originally posted by bart View Post
                    I'm not sure precisely what you're looking at, but in the last year about $325 billion of SDRs have been created... and a useful analogy is that SDRs are the monetary base of worldwide CBs (and were called an engine of inflation back in the early/mid '70s), and the concept of fractional reserve applies - as in 6-10x expansion.
                    I'm was trying to say that the countries that rely on IMF-WB for financial rescue are basically f@!&ed, and there are some countries which have received a preferential treatment from the FED, with the establishment of the famous currency swap lines.

                    Comment


                    • #55
                      Update from the author

                      Greetings everyone,

                      I'm delighted to see what an outstanding discussion has flourished. I regret not being able to participate sooner, but I've been caught up in the combination of a lot of follow-up on the article with GATA and other parties, plus attending to the real market which has been interesting the past few days.

                      Originally posted by $#*
                      On a separate note I was wondering if the Guest Post we are debating was an exclusive interview for iTulip, and if the answer is affirmative, I would like to tell to Fred that someone is stealing content from iTulip without offering any credits. The same material was published on Financial Sense without any disclaimer that it was an iTulip guest post.
                      The article was submitted to iTulip, FinancialSense, ChrisMartenson and SeekingAlpha. It appeared on all of the above except SeekingAlpha who said I had to have 3 blog posts on their site before I could publish an article. Whatever...
                      Originally posted by $#*
                      Also it would be nice if our guest can be so gracious to offer at least some brief comments to our feed-back. Not everybody is also a member of ChrisMartenson.com forum where he can get some comments from Mr Townsend.
                      Unfortunately there was a technical problem and the wrong version of the article appeared on FinancialSense for two full days. It was an early draft that didn't clearly address the matter of LBMA Forward contract terms, and had some other substantive shortcomings. That's a big part of why I've been absent from this discussion until now.

                      Also, just for the record, the forums at ChrisMartenson.com are free. You do need an account to post, but it's a free account.

                      Moving on to the feedback you asked for, I'm not sure exactly what you're seeking. I have now read all the comments here, and didn't see any specific, directed questions. Most of the content here - and I think it's a good thing - has moved well beyond the scope of the original article and into the nuances of the interactions between the paper and physical markets and other economic subjects. I'll comment on that briefly later in this post.

                      The main point of the original article was to debunk the misinformation that's been circulating in the blogosphere. I was quite taken aback when a few people criticized the article, essentially saying "Hey, we NEED an organization like GATA, so get off their case!" I thought I was clear in the original piece in emphasizing that my primary contention is exactly that: The need for an organization with GATA's charter is enormous and cannot be understated. The whole point of the article was to point out that instead of focusing on their chartered mission, GATA has been instead engaged in a rhetoric campaign pertaining to issues on the LBMA that the GATA people clearly don't understand and have not represented accurately. Meanwhile the critical issue of actual market manipulation and the still-pending CFTC review of position limits on the COMEX was taking a back seat to baseless allegations of fraud and default in London.

                      Some people seem to think I am refuting the possibility that the market is manipulated. The opposite is true: I think the market is manipulated, and for that reason I think it critical that someone do a competent job of the task GATA has undertaken incompetently.

                      Update since the article was released:

                      I received several e-mails from GATA disputing the article, and was shocked to learn that their understanding of the marketplace is far worse than even I had imagined. They vehemently refute my contention that the information about the 100:1 ratio of paper to physical was well known before the CFTC hearing. In response to that allegation, I pointed out to them that had they done even the most basic research, they would have known that information has been available to anyone free for the asking at www.lbma.org.uk since 1997, and that they needed only to visit Jeff Christian's web site or buy his book, where they would have found this chart:

                      LBMA Clearing Volumes.png

                      Umm, well, for some reason the chart pasted into the edit window really small and wouldn't resize.. Try Clicking on it. If my preview pane is accurate, you should be able to click to get an enlarged view. If you can't read it, it's showing the LBMA clearing volumes in millions of ounces. The green and yellow bars are the derivatives and the teeny weeny red bars at the bottom are physical bullion volume.

                      The GATA guys expressed great shock to learn, apparently for the first time at the CFTC hearing, that LBMA was mostly paper. They have now posted a rebuttal to my article here, where they insist this information was not "well-known" as I claimed. Ok, fine, if they are using themselves as an example, it's apparently not well known. But my point was that its public knowledge and they needed look no further than Christian's book or LBMA's website to find it. It's certainly never been a secret, as GATA has repeatedly insinuated.

                      It sounds to me like GATA's next "breaking story of a shocking scandal" will be fractionalization of unallocated bullion accounts. I predict yet another episode of the "Greatest Fraud in History" series on KWN, "breaking" this news. Of course Jim Puplava did a fine job of covering that subject in a level-headed segment on last week's show. But apparently Adrian Douglas of GATA has convinced himself that this is "news". It sounds to me like Mr. Douglas didn't even realize that unallocated accounts work this way until very recently, and he seems to think he's discovered something shocking and new.

                      Don't get me wrong - I certainly agree that the fact that bullion in an unallocated account can be hypothecated is an important fact that most retail investors don't understand. That's why I covered the issue in the unallocated bullion section of my article. But the solution to this lack of wide-spread understanding is level-headed education, not wildly exaggerated sensationalism and intimations of fraud and scandal. From the e-mails I got from GATA, it sounds like they're gearing up for another scandal story.

                      I've come to recognize a pretty consistent pattern here. It seems to me that the GATA folks' knowledge of the marketplace is extremely limited, but for whatever reason they view themselves as experts. So each time they learn something new (to them, not the rest of the market) such as the ratio of paper to physical or that unallocated accounts can be hypothecated, they "break the scandal wide open" with a KWN interview, as if the fact that they didn't know something fairly basic about the market somehow implies the existence of a great conspiracy or scandal.

                      I've been invited to write a rebuttal to GATA's rebuttal of my article, and I may do so. But I'm resisting the idea of a back-and-forth war of rebuttals rebutting rebuttals because I don't think it serves any useful purpose. So instead, I'm lobbying Jim Puplava to host a GATA vs. Jeff Christian debate. The way I see it, there have been several interviews on KWN (Maguire, Douglas, GATA Round table, Organ) telling one side of this story, while there have been some interviews on FSN telling the opposite side (Christian, Barisheff). The result is that investors who follow one show or the other only get half the story, and they never get a chance to hear an even perspective on both sides of the argument in a single broadcast. I think the best solution is a polite, respectful debate between GATA and Christian. Nothing is cast in stone yet, but discussions are occurring that may lead to that outcome. Cross your fingers!

                      Reactions to the excellent discussion here:

                      The article was written to debunk the misinformation that had been circulated. For the most part, this discussion has moved far beyond the scope of the original article, to the more intricate aspects of the relationships between paper and physical. That could be the subject of a whole other article, of at least equal length. I can't really do justice to the whole subject here, but I'll make a couple of observations.

                      First, the biggest risk of financial derivatives is what I call interconnectedness risk. The reason AIG "had to" be bailed out was not to save the company, but because so many other companies were counterparties to their derivative positions that if AIG defaulted on everything, it would cause a domino-effect through the entire global financial system. To me, this is just like the rest of the "too big to fail" mess - if something poses a risk that could literally take down the world economy, it's not too big to fail. It's too big to be allowed to exist in the first place. To some extent, financial derivatives are an essential thing. Farmers really do need the ability to hedge the sale of their crops in order to secure financing to buy the seeds. But allowing the system to grow to the level of a quadrillion-plus in interconnected speculation that is collateralized by stolen taxpayer money is ludicrous. The whole system needs a regulatory overhaul, and the politicians are not inclined toward meaningful reform because they're in Wall Street's pocket. So IMHO, that's the "really big" problem. If the trigger event ever happened and it went non-linear, physical bullion in your posession outside the financial system would be the only thing that would save you. On that point GATA and I agree completely. I just wish they understood the market a little better and were inclined to take a more informed approach to lobbying for reform.

                      The next big theme I saw in the numerous comments here was questioning whether the existence of derivatives interferes with natural price discovery in the physical market. That's clearly a matter of opinion, and is a very complex subject. But very briefly, my opinion is that if derivatives are not abused - meaning they are used for legitimate hedging and also for speculation that does not involve conscious application of manipulation techniques, I don't think they disturb natural price discovery at all. The arguments about the ratio of paper to physical inherently biasing price discovery are invalid, or at least that is my opinion.

                      However, (and it's a really big "however"), the opportunity to abuse financial derivatives to effect conscious and intentional price manipulation is just huge. And it would be naive to think it's not happening. That's why we so urgently need someone to competently do what GATA has incompetently attempted.

                      The issue about manipulation potential (in my opinion) isn't about ratio of paper to physical - what GATA keeps calling leverage. Quite to the contrary, it's about leverage when the term is used correctly. The leverage ratio in futures is 10:1, not 100:1, but that still means someone trying to move the market needs 1/10th of the amount of cash they would have needed in a pure physical manipulation scheme.

                      The other big theme I sensed in the comments was some confusion (or difference of opinion) about what would happen if too many longs suddenly stood for delivery. The answer is that in anything short of an instantaneous meltdown (like world nuclear war), the price system is self-correcting and the connection between paper and physical price is maintained. It can break down in theory, but it's a big outlier. I'll explain below.

                      First the world is a big place and there are inter-relationships between different markets such as COMEX, LBMA and TOCOM. But to keep this simple let's talk it through as if there was just one big futures excahange. The explanation really does carry over to the more complex scenario of multiple interdependent exchanges.

                      Let's assume the open interest in gold futures is one million contracts. And following the 100:1 ratio that's been so hotly debated, assume that only 10,000 shorts actually have the metal. The rest are "naked".

                      In a "normal market", the number of longs and shorts who intend physical delivery are approximately equal, and the warehouse inventory absorbs any small differences. The paper longs and shorts are far more numerous. Some of them may be playing games, unfairly affecting the price the physicals are paying, but that is what it is. Price discovery functions as if it were a pure physical market, except to whatever extent games are being played with concentrated positions that somehow got away with evading position limits.

                      Now suppose the sovereign debt crisis escalates (yes, that's a prediction by the way). More and more longs want to stand for delivery, and fewer and fewer shorts want to deliver metal. What will happen? The answer is the price will go up until fewer longs are willing to pay it and more shorts are enticed to take profits.

                      The key concept to understand here is that the open interest is always equal long and short. Every contract has to have someone on the other side of it. So as the first notice date approaches, the naked shorts have to close their positions. The price to close the position is whatever a long is willing to close his side of the contract for. If nobody wants to give up their long at a given price, the price goes up until someone does.

                      If World War III is imminent, the price is going up rapidly and the shorts may be reluctant to lock in a loss. But they have to constantly keep enough margin (collateral) in their account to assure the broker can always liquidate them if necessary. So when world leaders start issuing deadlines for nuclear strikes if the other guy doesn't cave and the price goes sky high, what happens is the shorts all suffer "forced liquidation". In a normal market they would be closed out when they drop below maintenance margin, but they would still have money in their account. In a crisis situation, the slippage in the contract price (from margin trigger to execution in the face of everyone else suffering forced liquidation simultaneously) might wipe out their entire account equity. The broker's job is to move fast enough to make sure they liquidate before the account equity can go negative. As all the naked shorts are force-liquidated, the market goes through the roof and all the naked shorts loose everything. But the price integrity from physical to paper is still preserved.

                      The system can indeed break down. That happens when the market moves so fast that wiping out the shorts' entire account isn't enough to overcome a few seconds worth of price slippage. For example, suppose gold is trading at $1200, and moves rapidly to $1300 as the Iran affair escalates. The ask is now at (for example), $1302. It would normally take thousands of contracts of buying to move it to $1303. But then Reuters breaks news that the first U.S. strategic nuke has just flattened several middle-east countries and destroyed everyone and everything there. Russia, China and N. Korea announce within minutes that they intend a full nuclear counter-strike. Obviously that's unlikely but I'm illustrating a point. Now all the longs withdraw their offers. In a matter of five minutes, assuming no daily price cap on the contract, the ask moves from $1,304 to $25,000 per oz. The shorts are all instantly force-liquidated, but even wiping out their account equity doesn't even begin to cover the losses they suffered in those last five minutes.

                      Could this really happen? Probably not. Depending on the exchange and the commodity in question, the daily price limit mechanism is the preferred way to stop this from happening. Some contracts don't have a daily price change cap, but the exchanges have the authority to void trades retroactively. They would most likely declare force majure and halt trading, voiding all trades above a certain threshold, say $1350. Then the world ends and it doesn't matter anyway. If it doesn't, the situation would almost certainly be resolved by retroactive implementation of new rules decided based on national security criteria. The only thing you could have reasonable faith in is that everybody who doesn't have physical bullion outside the system still wouldn't. Who gets to keep most of the money being traded back and forth on paper would be decided based on who's got the most political clout to influence government officials. It's safe to assume that won't be you.

                      Setting aside doomsday, the point of all this was that in all but the most extreme examples, the connection between physical price and paper price is strongly maintained. Manipulations in the paper market will affect that single price (concentrated paper shorts can push the price up or down), but the physical price and the paper price stay the same until an exchange default occurs. In theory only a "thousand year outlier" event could ever trigger such a thing. But a rapid escalation of the nascent sovereign debt crisis could very possibly provide such an event.

                      I hope that's helpful. Feel free to post any specific questions and I'll try to respond.

                      xPat (Erik)

                      Comment


                      • #56
                        Re: Update from the author

                        Thanks for that informative update Erik. As a novice/non-futures trader, I still don't quite understand why you feel that the physical gold price is reflective of demand in this system?

                        My limited understanding of what you are saying is that largely the spot price is set by the willingness of traders to go short OR long at a given price, with the price moving in accordance to the imbalance on either side. But it appears that regardless of open interest buildup, the gold supply/inventory is not a factor in this price movement/discovery. In other words, the supply/demand equation (for lack of a better term) is completely thwarted/removed by this system of paper trading with no linkage to actual supply.

                        For instance, an entity whose only concern was to either limit or control the price, with deep enough pockets, can just stand in front of every buyer and overwhelm buyer demand by naked selling, which would act to cap or even lower the price with resulting open interest build up. Even if the buyers all stood for delivery (which I understand can't happen with most brokers), in theory the only time we would get to real "price discovery" with an increase in the gold price under this scenario is when/if the gold runs out for delivery, not as supply dwindled in the face of increased demand.

                        Perhaps it's just my lack of understanding, but in my mind I always thought that as supply went down and demand went up, the price of some commodity would reflect that in a normally operating market? That doesn't appear to be a valid opinion to hold in this case. Sure, it MAY reflect that situation but it appears that it would be entirely coincidental because there is no feedback loop from supply/inventory to price discovery.

                        Do you feel this is a good system for setting the price of gold, if not, what would you change?

                        Comment


                        • #57
                          Re: Update from the author

                          Excellent questions, skidder!

                          First, I didn't say the system assures the price is reflective of what a pure physical market price would have been. What I said is that the physical and paper prices are tied together by this system. As the paper specs bid the price up above or down below fair spot market price, the difference is arbitraged out. That doesn't mean the system yields a price equivalent to what a pure physical system would set. It means that the paper market affects the physical market and the physical market affects the paper market until a common price value is discovered. The "linkage to actual supply" of which you speak comes from the fact that any paper contract can be used to demand or deliver physical. Because of that connection, any discrepancy between physical market price discovery and paper market price discovery opens the opportunity for price arbitrage. Any time that opportunity exists, the arbs show up in the market and the two prices come together.

                          Do I feel this is an ideal system? No, definitely not. The opportunity for concentrated paper positions to artificially manipulate the physical price is way too high. The problem is I don't have a good answer for your next question - what would I change? In a perfect world, I'd say that you absolutely need the paper market because there are lots of legitimate needs for hedges. So, in a perfect world you'd just tell all the kids to behave and not take advantage of the system's weaknesses. That clearly doesn't work - the weaknesses are exploited relentlessly.

                          What you really need is a physical market tied directly to the paper market in a system where everyone is forced to behave and nobody can take advantage of the system. The would-be physical market price always dominates, and the paper players never get a chance to unduly influence it. Somebody needs to invent a system in which some clever set of rules enforces that outcome. I'm afraid I'm not smart enough to propose rules that would assure that panacea, but I do feel certain that position limits on the COMEX would be a good start. What got me riled up enough to write the article was watching GATA focus their attention on an irrelevant distractions when, for the first time in years, we have the chance to lobby CFTC to enact just that improvement.

                          Best,

                          xPat

                          Last edited by xPat; 04-22-10, 09:05 AM.

                          Comment


                          • #58
                            Re: Update from the author

                            " I don't think they disturb natural price discovery at all. The arguments about the ratio of paper to physical inherently biasing price discovery are invalid, or at least that is my opinion.

                            However, (and it's a really big "however"), the opportunity to abuse financial derivatives to effect conscious and intentional price manipulation is just huge. And it would be naive to think it's not happening. That's why we so urgently need someone to competently do what GATA has incompetently attempted."

                            Could you please expand on this idea, because (respectfully) taken together these statements appear contradictory. (Or it could be that I don't understand what you are intending to say).

                            The volume of non-hedging contracts expands (much faster than the increase in physical supply). How does this NOT decrease legitimate price discovery for the underlying commodity? Clearly, ( I think) as the paper market grows exponentially relative to the underlying physical supply, more bets will be purely speculative and fewer bets will be actual legitimate hedging activity. The housing bubble, or any bubble would seem to prove my point in that as credit expands (or as derivatives expand in this case) price discovery is based not on physical supply, but on the amount of money available to bet with.

                            I could agree with your conjecture about ratios being immaterial IF I accepted your implied premise which is essentially that ALL speculation present is gain seeking vs manipulative (non-economic).

                            If you allow for non-economic speculation (where the objective in entering into the contracts is NOT to MAXIMIZE GAIN, but to MINIMIZE or MAXIMIZE price moves) your whole argument goes right out the window, doesn't it?

                            I guess what I'm trying to say is that your whole conjecture is based on the implied premise that all speculation is economic (to maximize gain). Could you talk about the implications if this were NOT the case? (And if you see evidence of this?)


                            Thanks!

                            V/R

                            JT
                            Last edited by jtabeb; 04-22-10, 10:10 AM.

                            Comment


                            • #59
                              Re: Update from the author

                              jtabeb,

                              I think we're basically agreeing here. My point is that the issue is not paper to physical ratio, but what tricks the speculators are up to. You could have a paper to physical ratio of 1,000:1 or 10,000:1 and if all that paper was somehow legitimately hedging real metal transactions elsewhere in the system, it wouldn't matter. On the other hand, you could have a paper to physical ratio of only 25:1 with the vast majority of that held in a concentrated position being consciously used to manipulate the market, and in that case honest price discovery is out the window.

                              The key is here:
                              Originally posted by jtabeb View Post
                              I could agree with your conjecture about ratios being immaterial IF I accepted your implied premise which is essentially that ALL speculation present is gain seeking vs manipulative (non-economic).

                              If you allow for non-economic speculation (where the objective in entering into the contracts is NOT to MAXIMIZE GAIN, but to MINIMIZE or MAXIMIZE price moves) your whole argument goes right out the window, doesn't it?
                              Yes, exactly! When there is NO manipulative (non-economic) speculation, there is honest price discovery, regardless of paper to physical ratio. When there is non-economic (manipulative) speculation of any significance, price discovery is compromised regardless of what might be a relatively low paper to physical ratio.

                              Does that make sense?

                              xPat

                              Comment


                              • #60
                                Re: Update from the author

                                Originally posted by xPat View Post

                                Yes, exactly! When there is NO manipulative (non-economic) speculation, there is honest price discovery, regardless of paper to physical ratio. When there is non-economic (manipulative) speculation of any significance, price discovery is compromised regardless of what might be a relatively low paper to physical ratio.

                                Does that make sense?

                                xPat

                                Yeah, it sure does.

                                Thanks

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