Adrian Douglas: A run on the Bank of the Gold Cartel

By Adrian Douglas
Monday, September 7, 2009

An interview by MineWeb with GFMS CEO Paul Walker is headlined, "This May Not Be the Gold Rally You Have Been Waiting for":

http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=88713&sn=Detail

The sub-headline says, "The GFMS CEO does not believe this is the rally that will sustain gold above $1,000 an ounce."

Well, it looks like Walker has just given a way a lot more information than he intended.

Walker "believes that the recent jump in the gold price is the result of 'a few fairly significant lumpy transactions' that have gone through the market at a time when he, and his colleagues at GFMS maintain, there has been a degree of illiquidity. Speaking to Mineweb, Walker said that although gold still has some upside potential, the current jump, if anything, represents 'a little more downside risk in the short term.'"

I have recently described what is going on in the physical market to be the equivalent of a "run on the Bank of the Gold Cartel." There are many factors that are leading to that conclusion and here are just a few:

-- China is a confirmed large buyer of gold, along with Russia.

-- Germany has apparently asked for its sovereign gold stored in New York to be returned.

-- Hong Kong is repatriating its sovereign gold from London and will be the repository for gold to back the Shanghai Futures Exchange.

-- Greenlight Capital sold $500 million of the GLD exchange-traded fund and bought physical bullion.

-- The European Central Bank gold sales have dried up to almost nothing.

-- AnglogoldAshanti has reduced its hedges to less than one year of production.

-- Central banks are net buyers of gold for the first time in more than 20 years.

-- China has declared its right to default on commodity derivatives.

-- China is encouraging its citizens to buy gold and silver.

-- The contango on silver and gold has almost disappeared.

-- Gold and silver movements from the COMEX warehouses are inconsistent with the delivery notices.

-- Mine supply of gold continues to contract.

And Walker is talking of "significant lumpy transactions." What does that mean?

My guess is that he can be referring only to the physical market and that it means that some big players have asked for delivery of gold in large quantities.

Walker says this has come at a time when "there has been a degree of illiquidity." What does that mean? It means that the Gold Cartel doesn't have the gold to meet these large deliveries.

Remember that GFMS recently published its second quarter report on the gold market. I wrote a critical analysis of this report:

http://www.gata.org/node/7699

I pointed out that GFMS, with a blatant manipulation of the statistics, had turned a 2 percent growth in gold demand to an 8.6 percent decline. This was because central banks had turned net buyers of gold in the quarter and GFMS excluded their purchases from the demand statistics because, in GFMS' words, central banks traditionally are a source of supply.

Now we learn that the gold market is illiquid. Isn't it disingenuous at best or fraudulent at the worst to turn a 2 percent demand surge into an 8.6 percent plunge just when the market is drying up, knowing full well this report is widely followed? It also brings into question the motives of the World Gold Council, which commissions the GFMS reports.

There is nothing new about the scam perpetrated by the Gold Cartel. Goldsmiths as early as the 16th century invented the fraud of "fractional reserve banking." They found that customers would buy gold from them but not take it away, leaving it with them for safe keeping. As long as the goldsmiths had a gold bar to show a new customer, they could sell him gold and give him a deposit receipt. The gold bar then was returned to the vault and could be sold several times over. The goldsmiths discovered that the "safe" buffer of gold to have in inventory was about 10 percent, as that was in practice the typical maximum demand they would see from customers wanting to take delivery.

I estimate that today 1 ounce of gold backs about 20 ounces of gold sales. Just like 500 years ago, investors are prepared to accept a paper IOU for gold in lieu of physical gold -- whether that IOU be in the form of pool accounts, futures, derivatives, unbacked ETFs, etc. Just as it did in history, the game will come to an end when there is a demand for physical that cannot be met.

As recently as 2005 Morgan Stanley was selling precious metals that did not exist. The firm even had the audacity to charge customers a storage fee for non-existent metal. The firm settled a class-action suit, admitting no wrongdoing, because, in the words of a company spokesman, no investor lost money and each investor was given metal or cash. As far as I know there has been no criminal action. But since when did the definition of criminal activity depend on no one having lost any money at the time a crime was discovered?

So if Morgan Stanley had rediscovered the old scam of the goldsmiths, what are the chances this firm was the only ones doing it?

What is curious is that GFMS' Walker offers investment advice that encourages investments in instruments that will not require gold to be delivered to customers. He singles out the Paulson Fund as a shining example, as it invested in Anglogold and ETFs and, MineWeb reports, he suggests that we should all follow that trend:

"As an example of this Walker says hedge fund manager John Paulson's strong move into gold could well have had an effect.

"'There's no doubt that the gurus in the market will definitely bring people along with them. And, as you say, John Paulson's made a lot of his stake in AngloGold; very large positions in ETFs. And I think a lot of people will be looking at somebody who's got one of the largest hedge funds in the world, saying maybe this guy knows something that we don't know and, given that he's made tremendously good calls in the recent past, maybe we should just in a sense trend-follow him and get on the back of this."

Now isn’t that convenient advice just as the gold market is becoming "illiquid"?

The GFMS Internet site says "GFMS can claim to be the only genuinely independent researchers of the gold market, as we do not rely solely on financial support from one sector of the industry. You can trust us to give it to you straight."

I don't get a feeling there is much straight talking coming out of GFMS.

"In the 1980s inflation was running high; gold prices went down. And conversely, if you have a look at the very low rate of inflation we've had in the last seven or eight years, that's when we've had the bull rally. Without getting into too many technicalities, I think that's because we have some rather curious ways of measuring inflation rather than the actual fundamental issue underlying price trends, and housing would be just one example of that."

And GFMS claims that we can trust it to give it to us straight!

Walker is alluding to the manipulated Consumer Price Index and Producer Price Index, where everything that is going up is systematically excluded or given less weight. So if Walker knows that there is a government manipulation of price indices "without getting into too many technicalities," I wonder how he explains why gold -- which serves only one real purpose, to store wealth instead of storing fiat paper alternatives -- does not have a price in fiat money terms that has kept pace with the manipulated CPI and PPI.

The answer is simple. The gold supply has been artificially inflated at a rate similar to that of fiat money by supplementing mine supply and central bank dishoarding with a blizzard of paper IOU gold. In this way the gold price is suppressed. The Gold Cartel hasn't cared about the damage inflicted on the mining industry, because why bother to mine gold when you can create paper substitutes?

But every time in history when this has been done there eventually has been a "bank run" when it was revealed that the gold in the vaults had been encumbered or sold many times over.

This is what is beginning to happen right now. The market is entering a very different phase. As the run on the Bank of the Gold Cartel gathers pace, the price moves are going to shock even the most bullish. The usual shenanigans of the cartel to turn the market down by selling a blizzard of paper future gold promises will be impotent against a marauding crowd of investors hungry for real gold.

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Adrian Douglas is publisher of the Market Force Analysis letter (www.MarketForceAnalysis.com) and a member of GATA's Board of Directors.

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