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The Gold Cartel at Work

By: James Turk, The Freemarket Gold & Money Report


-- Posted Monday, 18 December 2006 | Digg This ArticleDigg It!

Copyright © 2006 by James Turk.  All rights reserved.

 

 

December 17, 2006

 

The following chart from Kitco presents the intraday price movement of gold for the three days ending this past Friday. 

 

 

Note the huge sell-off late Friday afternoon.  It is an unmistakable example of the gold cartel at work. 

 

The gold cartel is the unholy alliance between a few of the big bullion trading banks, several central banks with large gold holdings and the US government.  This reprehensible group seeks to manage and completely control the gold price to their advantage, regardless of the disruption that they cause to the free-market.  There has been considerable analysis and documentation of the gold cartel’s activity, much of which has received wide-spread attention because of the persistent efforts of the Gold Anti-Trust Action Committee, www.GATA.org.

 

Each of the cartel members has a different objective.  The US government aims to make the dollar look worthy of being the world’s reserve currency, which it hopes to do by beating up on gold, which was the world’s global currency until it was supplanted by the dollar. 

 

Ironically, the dollar became the world’s reserve currency in the 1940’s because back then it was “as good as gold”, being backed by and redeemable into the precious metal.  So gold and the dollar were complementary to one another.  Gold gave the dollar its value, and the dollar circulated in place of gold as it was a more efficient currency.  That harmonious relationship changed in 1971 when the dollar became fiat currency with its value no longer defined as a weight of gold.  The result was that gold and the dollar became competitors, their respective values depending upon the relative demand for each currency.  So by keeping the gold price low and therefore unattractive, the US government aims to lessen the demand for gold, diverting instead that monetary demand into the dollar.

 

The central bank members of the cartel are simply following the US government’s wishes through IMF dictates.  They are loyal members of the central banking ‘club’, and are also fiat currency addicts.  Their respective governments want to print money ‘out of thin air’, which is a result only made possible by fiat currency.  In this way a government has at its command whatever money, albeit an inflating fiat currency, that it needs for its spending aspirations.

 

The objective of the few bullion banks selected to participate in this scheme is more pedestrian.  They are in it merely for the profits, executing central bank instructions and front-running those trades with their own in-house trading positions.  The above chart shows how profitable it can be for them.

 

Because London closes at 12:00 noon New York time, trading during the 1½ hours to the 1:30pm New York close is notoriously thin, which means it is a difficult time to liquidate large positions.  The gold cartel knows this, so the late Friday sell-off depicted above is not the first time one has happened.  For example, here is what I wrote after the late Friday sell-off on July 23, 2004, to explain how the gold cartel ‘picks pockets’.

 

There is a huge pool of capital – running well into the tens of billions – that trades the commodity markets.  When leveraged, this capital can have the impact of hundreds of billions of dollars.

Much of this capital is traded according to proprietary ‘black-box’ trading models (often based on mathematical formulas) that seek to measure trends in the various markets, and then take positions either short or long in accordance with the trend (i.e., buying the commodity when its trend is rising and selling short the commodity when its trend is falling).  The underlying mathematics of these models varies widely, but they all come back to one general and basic common denominator – is the trend rising or falling. 

These models make no distinction about the type of commodity being traded.  Nor do they care about fundamentals.  So gold is traded just like any of the other commodity markets on one basic factor – is gold’s trend rising or falling.

Over time, smart floor traders and market observers can ‘reverse engineer’ some of these ‘black-box’ models.  By observing when they enter and exit from positions, one can begin to anticipate their trading pattern. 

As a rule of thumb, the ‘black-box’ trading models start covering shorts and go long when the commodity crosses above its 21-day moving average.  Conversely, they start exiting longs and go short when the commodity falls below its 21-day moving average.  This of course is just a sweeping generalization and each model has different filters and refinements, but this basic description provides an accurate assessment of how these trading models work.

When the trend is protracted, i.e., the commodity stays above or below its 21-day moving average for a long time, these ‘black-box’ trading models make a lot of money.  But in the short term, when the commodity crosses above and then falls back below the average (or vice versa), then the ‘black-box’ models get whipsawed, and take a small loss.  It is this set of circumstances that the gold cartel seeks to exploit to its own advantage.

 

I then went on to explain how the gold cartel sells short into the buying underway by ‘black-box’ trend following trading models, and then covers these shorts on the price collapse they engineer.  It is easy for the cartel to engineer a collapse like the one that occurred on Friday. 

 

When the black-box traders get a sell signal from their proprietary trading model, they are obligated because of representations they make to their customers to immediately act on that signal and sell.  In normal market periods, selling is not a problem.  But late on a Friday afternoon in thin market conditions, the question is, who do they sell to?  The gold cartel members take advantage of this predicament by providing liquidity but only after dropping their bids, forcing the black-box traders to execute their trades in a declining market, creating an avalanche that feeds upon itself to the gold cartel’s advantage while victimizing the black-box traders and their customers. 

 

In the July 2004 example, the cartel was selling gold short above $405 to keep its price from advancing.  They then covered their shorts on the Friday afternoon rout that took gold back into the $380s.  In the present example, the gold cartel was adding to their shorts in the $640s to keep gold from advancing, and covering those positions on Friday’s rout below $620.  This conclusion can be reached by looking at the Commitment of Traders report on the Comex, and particularly at the reporting provided by the Tokyo Commodity Exchange with its extensive and transparent disclosure of trader positions.

 

In my July 2004 commentary, I went on to say:

 

I think these reversals [i.e., the gold cartel covering its short positions while the black-box traders sold longs and went short] reached a peak on Friday, but there may be some more liquidation in the week ahead.  After all, it is option expiry week, and I have noted this particular type of end-of-month market manipulation before. 

The gold cartel sells many of the calls traded on the Comex and over the counter market.  If the gold price drops below the call price on expiry date, the gold cartel takes in as profit the entire premium that it received when it sold the call.  Thus, gold will in all likelihood stay below $400 this upcoming week.  [It did.]

But to maximize the cartel’s profit, the cartel may also attempt to manage the gold price so that it stays below $390 this week so those calls expire worthless as well. [It did.]  In fact, we may see real downside pressure on Tuesday and Wednesday so that gold is even below $380 on option expiry, so that the $380 calls expire worthless as well.  And yet again, the longs will get their pockets picked by the gold cartel.

 

Indeed, the low was reached that week during option expiry.  The options expired at $387.  Three weeks later gold was firmly established over $400, and it never again fell below that price.

 

The gold cartel could not push the paper market any lower back then because physical demand for gold at that level was just too great, which is the Achilles heel of the gold cartel.  In contrast to fiat currency, they cannot create gold ‘out of thin air’.  When the demand for physical gold accelerates, they have to dishoard gold from central bank coffers or allow the price to rise to bring the market back into balance. 

 

Neither option is palatable to the gold cartel, but they recognize their gold is too precious to dishoard liberally.  So they are always forced to allow the gold price to rise, while not letting it get away on the upside so as not to undermine their fiat currency game.  But in the end, markets are bigger than banks and governments, even when they are acting as a cartel.  As I observed in July 2004 with gold at $394:

 

But don’t be disheartened by this ongoing manipulation by the gold cartel.  They will in time have their head handed to them when gold soars over $500 because no market can be manipulated forever.  And the gold cartel is operating on borrowed time. 

 

That borrowed time has become even shorter.  Not only has the gold price once again been pushed down to an artificially low price, which will stimulate demand for physical metal just like it did in July 2004, but gold’s relentless rise is attracting attention – and new buying – around the world.  So the demand for physical metal is simply too great, and beyond the gold cartel’s capacity.  Therefore, the gold cartel must in time fall back to Plan B, and let the gold price rise to enable the market to once again achieve some semblance of balance.  In July 2004 it took three weeks.  This time around it could be even quicker for gold to re-establish its uptrend, given the strong demand for physical gold and the growing nervousness about the dollar’s prospects.

 

So in summary, while there is reason to get upset with the gold cartel for their nefarious deeds, we should also be thanking them for making gold as cheap and undervalued as it is.  They are enabling us to dump our overvalued dollars as we earn them each month by using them to buy undervalued physical gold.  We are in effect getting more gold for our dollars, and that is indeed a pleasant situation.

 

 

 

James Turk is the Founder & Chairman of GoldMoney.com.  He writes The Freemarket Gold & Money Report, and his latest book is The Coming Collapse of the Dollar.


-- Posted Monday, 18 December 2006 | Digg This Article


Contact James Turk:



 



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