Antal Fekete: Gold is pale because so many thieves plot against it

By Antal E. Fekete
Professor of Money and Banking
San Francisco School of Economics
Friday, August 28, 2009

Twenty-five years ago I visited New York Commodities Exchange at the World Trade Center and watched the feverish activity in the gold pit from behind the glass wall in the gallery.

A gentleman standing next to me whom I did not know remarked: "One day this make-believe charade will come to a bad end. All that these guys are doing down there is creating ever more claims to the same lump of gold -- just as governments have been doing before they met their ignominious fate."

Later that day I went to see the director of research of Comex. Our chat lasted about an hour. He intimated that he was greatly disturbed by the mystery of the gold basis, which has been steadily declining year in and year out. Perhaps it was his inability to solve the puzzle that caused him to quit a few months later.

I must confess that I could not solve that puzzle myself until the twin towers of the World Trade Center came tumbling down many years later. For me it was a symbolic event, conjuring up the unknown gentleman and bringing back his cryptic remark.

We are watching a game of musical chairs. When the music stops, paper claims to gold will be dishonored and the gold futures markets will tumble down just like the twin towers.

In my recent article "Dress Rehearsal for the Last Contango" (http://www.gata.org/node/7716) I observed that "a very strange phenomenon has been manifesting itself for 35 years, since the inception of gold futures trading. The basis as a percentage of the rate of interest, rather than remaining constant, has been vanishing and, by now, it has dropped to zero." In the rest of that article I drew attention to the apocalyptic consequences of the prospect of the permanent backwardation in gold that is threatening the world, which is ignored by the makers of monetary policy, as I had opportunity to convince myself during my recent encounter with Paul Volcker, the chairman of President Obama's Economic Recovery Advisory Board.

As I see it, the debt tower will topple when hit by permanent gold backwardation, just as the twin towers of the World Trade center did. The reason is that the availability of gold is indispensable for maintaining our system of irredeemable debt. Only then are bondholders, like the participants of the game of musical chairs, satisfied that there are plenty of vacant chairs available, so let's get on with bond trading and gold futures trading, and let the music roar on.

But once permanent backwardation in gold establishes itself, gold is no longer available at any price. Bondholders will scramble to sell their irredeemable bonds before they lose all remaining value. There is no other way to pacify bondholders than letting the game of musical chairs go on -- that is, to continue the charade of gold futures trading, putting ever more claims on the same lump of gold.

The response to my recent article was overwhelming. I have never realized how many people out there are following my writings on the Internet. I want to thank every one of you and assure you that I take this responsibility most seriously. Even if I cannot answer every message I get, I will continue to do my best to explain the results of my research in simple, understandable terms.

Let me spell out for my readers what the vanishing of the gold basis means from the point of view of the puppet-masters of the gold futures markets.

It means that they are fighting a losing battle. They are desperately trying to coax gold out of hiding by offering ever higher bribes -- not in terms of the price but in terms of the basis. A low basis means that they offer to take your cash gold and let you have gold futures in exchange at a discount price. (The discount is contango minus the basis, so that the two are inversely related: As the basis falls, the discount increases.) This will allow you to invest an amount equal to the price of gold (less 5 percent, the margin on the gold future) in any way you want and, having paid the reduced contango, you can keep the profits. The point is that you will still benefit from any advance in the gold price, just as you would if you owned cash gold. You can have your cake and eat it too.

Remember, in a full carrying charge market, such as the gold futures markets were at inception, no such bribe money was offered.

But, lo and behold, people who are willing to take the bribe are few and far in between now. So the pot is sweetened. The basis is lowered. Maybe at one point gold
will be coaxed out of hiding, once the bribe is high enough.

No such luck. When the basis gets as low as zero, it means that the discount on gold futures has gone so high that it is equal to the opportunity cost of holding gold. Therefore, again, if you give up your cash gold in exchange for gold futures, you can invest an amount equal to the price of gold (less 5 percent) in any way you wish, but now they let you keep your profit in its entirety. And you can still benefit from any advance in the gold price, just as you would if you had the cash gold in your hands.

This is where we are now. Indications are that the game fish still does not bite. What now? Where do the futures markets in gold go from here?

Well, the pot can be further sweetened. The basis can be pushed down into negative territory. Gold could be forced into backwardation. Let's see what that means.

It means that you can sell cash gold and buy it back for future delivery at an outright discount. Somebody wants your gold so badly that he is willing to pay you for
the privilege of holding it for a few days, a few weeks, or a few months, paying your storage and insurance fees. You get your gold back at a cheaper price. You make
a risk-free profit on this deal. If the gold price goes up in the meantime, you benefit fully, just as if you have held on to the cash gold.

Now risk-free profits are a promise of unlimited profits because, if you are nimble enough, you can make any number of round trips. But opportunities to earn risk-free profits from arbitrage do not last. Other nimble speculators would jump in and their unlimited action would close the spread that gave rise to the risk-free profit in the first place.

Yet I predict that, after a period of initial vacillation between backwardation and contango (due to action by misinformed traders) gold will settle in permanent backwardation.

Wouldn't that be loverly? Risk-free profits galore. No need to bother with storage charges and insurance premiums. Just sit back and enjoy the ride to riches.

But wait a minute! Is the arbitrage really risk-free?

You give up your cash gold, but what if your gold futures contract expires and they refuse to return your gold? After all, commodity markets can change the rules of the game mid-stream. They just declare "cash settlement only" for outstanding contracts. Unsaid and unstated, not even mentioned in small print, is that trap door may be sprung open and the investor who has taken the bribe can be neatly separated from his gold when the hairy godfather waves his magic wand.

"Gold is pale because it has so many thieves plotting against it." There are all too many trap doors, able to be sprung wide open, ready to devour gold belonging to the unaware.

That's it. That's why more people do not fall for the bribe even when tickled with promises of risk-free profits. The promise is mendacious. There is a risk: the risk that you lose your gold and you may never be able to buy it back at any price.

There is no other explanation why the promise of risk-free profits does not eliminate the discount on the futures price of gold. This is the true explanation for the coming permanent backwardation in gold.

Gold futures trading is clearly a con game, but it is in a symbiotic relation with the regime of irredeemable currency and irredeemable debt on which our
"democracy" is based. So we have a double con game.

We have a smaller con game of gold futures trading inflicted upon gullible people who want to have their cake and eat it too, and then we have the much bigger, all-embracing con game of irredeemable currency, inflicted upon the rest of us, innocent bystanders. It is inflicted by the U.S. government, which stoops so low as to trample on the Constitution, which mandates a metallic monetary system for this country precisely to outlaw all Ponzi schemes.

The government could never muster the moral courage to propose an amendment that would make the Constitution conform to its monetary system, as that would open Pandora's box. Rather, the government would live with the onus of being in contempt of the Constitution.

The U.S. government looted gold from its own subjects in 1933. In 1971 it looted even more gold from people not under its jurisdiction. It continues to operate in the same tradition.

The larger con game of the irredeemable dollar could not have gone on so long but for the smaller con game of gold futures trading from which it takes its strength. Historically, every regime of irredeemable currency has met its Nemesis in no more than 18 years. The present experiment with irredeemable currency has been going on for twice that long. Of course gold futures trading is a relatively new invention that was not available to the managers of the assignats, mandats, and Reichsmarks. Nor was it available to the managers of the most recent experiment with the Zimbabwe dollar.

But as the relentless fall in the gold basis clearly shows, people cannot be conned forever. The clock is ticking. Sand in the hourglass keeps dropping. When it runs out, the present experiment with fiat dollar will also meet its Nemesis, as all the previous experiments have. That's the good news.

The bad news is that the government of the United States persists in continuing the double con game and Ponzi scheme through thick and thin. The government is callous to the worldwide economic damage it is causing, and it disregards the danger of permanent gold backwardation, which would inflict utter economic pain on the innocent people of this country, to say nothing of the people of the rest of the world.

As explained above, it would make the runaway debt tower of Babel topple, burying people under the rubble as the twin towers of the World Trade Center buried the people working inside.

When that happens, the U.S. government will not have the excuse that it was not warned.

In July I delivered the message in person to Volcker when we met at the Santa Colomba Conference in Italy. I also consider it my moral duty to warn everyone willing to listen about the danger ahead.

It is incredibly naive to believe that gold can be removed from the international monetary system with impunity at the stroke of a pen, as they pretended to do in 1973. The gold corpse still stirs. When it rises from its prostrate position it will, like Gulliver, dust off the Lilliputians, who, like ants, have been scurrying all over his body. The day of reckoning will have dawned.

Keynesian and Friedmanite economists bear a special responsibility for the looming disaster. They dug in and monopolized their positions at universities and research institutes. They never allowed a free discussion on the gold standard. They did everything to aggrandize and perpetuate their own power as the sole advisers on government policy. They will not be able to live down this shame in a thousand years.

. . .

Masters Gold Fund

In my other recent article "More Dress Rehearsal for the Last Contango" (http://www.gata.org/node/7723) I mentioned the unique Masters Gold Fund, which is about to start and will be structured to take advantage of the permanent backwardation in gold when it comes, which will ground all other gold funds. I have acted as adviser to the Masters Gold Fund from its inception and during the incubation period. In "More Dress Rehearsal for the Last Contango" I listed seven exclusive features spelling out how the Masters Gold Fund would operate in these perilous times. It would take its cues not from the gold price, which is susceptible to manipulation, but from the gold basis, which is a pristine indicator telling you about the willingness of gold holders to continue playing the game of musical chairs and putting their gold at stake.

In response to subsequent inquiries, I provide here the name and e-mail address of the manager of the Masters Gold Fund, who will be happy to send the prospectus to interested parties upon request:

Sandeep Jaitly at Sandeep.Jaitly@soditic-cbip.co.uk.

If you come to the Gold Standard Institute's seminar in Canberra, Australia, in November (http://www.gata.org/node/7720), you will be able to meet Jaitly in person and ask him questions directly.

... Disclosure

I have not been paid by Masters Gold Fund or its parent company for writing this article or any other article representing the fund. My interest in the project is purely intellectual. I want to demonstrate that under the regime of irredeemable currency it is possible to have gold locked up in a vault and still make it bear a return in gold and thereby to disprove Aristotle's dictum, "Pecunia pecuniam parare non potest" -- "Gold does not beget gold."

What we have here is an historical anomaly. Never before could one earn a return on gold in gold unless one surrendered control, thus incurring a risk. The risk in investing in the Masters Gold Fund is that the gold price stabilizes -- that is, the world willy-nilly goes back to a gold standard. But this is a risk that anybody should be glad to take.

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Antal E. Fekete is an economist and retired professor at Memorial University of Newfoundland. He can be reached by e-mail at AEFekete@Hotmail.com.

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