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Double
standard in gold hedging?
This is in answer to Mike Mish Shedlock’s rejoinder
Double Standard in Gold Hedging?
http://globaleconomicanalysis.blogspot.com (September 11, 2007) to my Peak Gold! - Part Two (September 10,
2007). Mr. Shedlock challenges my claim that
unilateral hedging by a gold mine, in particular, the practice of selling
forward longer than one year, or quantities in excess of one year’s
mine output is, in effect, a naked short sale, involving unlimited risk. I have
suggested that unilateral hedging and forward sale of several years’
output are imprudent, fraudulent,
and should not be allowed by the exchanges - as they certainly are not in
case of agricultural producers.
At this point I would like
to remind my readers that the series
Peak Gold! has not
been concluded as I have not yet fully discussed what true (or bilateral) hedging as opposed
to fraudulent
(or unilateral) hedging is. But before I do that I feel it is
necessary to answer the points raised by Mr. Shedlock,
which I now do point by point in the same order he raised them.
Unlimited risk is real
- There is fraud involved in the practice of unlimited
forward selling of gold beyond one year precisely because it may not be possible to deliver the
gold as contracted. One year is the logical production cycle for gold.
There is a difference between selling forward gold already in the
pipelines moving towards the market, and selling forward gold still
locked up in ore bodies. It is safe to assume that gold already in the
pipelines will make it to the market. By contrast, gold locked up in ore
bodies may not. The oft-quoted dictum that „there’s many a
slip between cup and lip” applies. Ore has to be extracted, pulverized,
processed, and refined. The company may not be there to do it if it goes
bankrupt in the meantime - for example, as a result of its foolish
unilateral hedging policies.
- The idea of
’unlimited risk’ involved in naked forward sales is real. The
miner does not have the gold in hand. He has only a bird in the bush. In
addition to the risk to potential profits there is the risk that the
company will be foreclosed on its gold leases and go into receivership. Mr.
Shedlock simply ignores the dynamics of the
gold market. He ignores that lease rates may significantly exceed the
dollar-rate of interest. I am grateful to Tom Szabo
of www.silveraxis.com for pointing out to me that this could and would
happen if the demand for gold becomes greater than the lease supply. In
fact, the lease supply could evaporate altogether, leaving the lessee
exposed high up and dry. There is no
way to hedge against this risk. The fact is that gold could
go into backwardation so fast as not to allow time for the company to
cover its short positions. Bullion bankers are, no doubt, a nice bunch
of people when they coax the gold miner into the trap of unlimited risk.
They will not be nearly so nice when they get ready to make their margin
call and take their pound of flesh, as any Shylock worth the name would.
- Sure,
profit risk runs in both directions. This is exactly why true hedging must be bilateral
involving forward purchases to complement forward sales. This is exactly
why unilateral hedging is false
hedging. It fails to be symmetric. Bullish sentiment is nipped in the
bud, while the bearish variety is cheered on. It pretends to market a
product at the best price available, but all it does is ruining its own market by inviting
competitive short sales
from other gold mines and speculators. Profit risk running in both
directions is the whole point of my series on Peak Gold!, a primer on true
hedging, if you just have the patience to hear me out. I wonder if Mr. Shedlock has read the section in Part Two on bilateral hedging,
namely, how a downstream short leg (forward sale) of a hedge ought to be
complemented by an upstream long leg (forward purchase) representing
gold bearing properties that the gold mine is in the process of
acquiring. Bilateral hedging works with four-legged straddles, a short
and a long leg downstream, plus a long and a short leg upstream. Unilateral
hedging tries to get by with one-legged straddles: the only leg being
the short one downstream. I ask you: which is going to win the race?
- A gold mine
can never be smart enough to outsmart speculators who make it their
business to forestall other market participants. It is outright stupid
to pursue a market strategy of long-term forward selling, given the fact
that in the futures markets nimble speculators make split-second
decisions to turn from a buyer into a seller. By the time the gold mine,
a dinosaur in comparison, has
made its long-trumpeted forward sale, the speculators have run away with
the best of the pick. Unilateral long-term forward selling of gold could
work, but only if
governments or central banks have underwritten the losses that are
almost certain to accrue.
- It is not a
question of liking or not liking hedged mines. The demonstrable fact is
that the leading hedger takes unfair advantage of all the other mines,
hedged or unhedged, by forcing them to sell
ahead of schedule at lower prices. Unilateral long-term forward selling
is a predatory practice
which enables the big fish to gobble up the small. No fair play is
possible as long as the practice is allowed. For this reason the
suggestion that if you don’t like hedged mines you should short
them is puerile. Shorting a predator may be suicidal.
- It is true
that every production process has its production cycle. As Mr. Shedlock remarks, for agricultural commodities it is
typically from harvest to harvest, or one year. Although for gold it is
not so sharply delineated, it is reasonable to make the fiscal year to
play that role. Once a year shareholders meet, elect new directors and
there may be changes in management. Important decisions are made about
acquiring new gold-bearing properties, prospecting, exploration, mine development. In this sense, yes, you plant in
the first quarter to reap in the fourth, typically the busiest season
for the gold mining concern.
- It is true
that, as far as its fundamentals are concerned, gold production is far
more stable than the production of any agricultural commodity or, for
that matter, the production of any other good. This is what makes gold
such a superb monetary metal. It is foolish to suggest that gold, as a
result of its ’demonetization’, has
ceased to have stable value ? fluctuating gold
price notwithstanding. What the fluctuating
gold price shows is not the lack of stability in the value of gold; it
is the lack of stability in the value of paper currencies, issued by
devaluation-happy governments, in which the price of gold is quoted. It
is certainly not indicative of a mysterious disappearance of stability
in the value of gold.
- The
fluctuating price of gold, as well as fluctuating forex
and interest rates, are not nature-given as are the fluctuating prices
of agricultural products. They are man-made.
They have deliberately been inflicted upon the people by governments in
betrayal of their sacred mission to protect them. The fluctuating gold
price and gyrating bond prices are the instrument of the most vicious
exploitation the world has seen since chattel slavery. The government in
regulating futures trading has approved „double standards”
in an effort to create a practically infinite supply of ersatz gold, including paper gold
(such as gold futures that can be sold greatly in excess of physical
gold in existence), and unmined gold locked in
ore bodies below ground (which can then be sold forward), in the hope of
keeping the price of cash gold in perpetual check. This is not a myth.
This is a well-established fact admitted, at one time or another, by
many a government in its more sober moments.
Niagara-on-Potomac
The world-wide regime of
irredeemable currency would have come to a sorry end decades ago if it
weren’t for gambling casinos foisted upon the world by governments
hell-bent to keep the game of musical chairs going non-stop. Governments, in
the best tradition of casino owners, want people to gamble in gold, bond, and
forex futures. The futures markets in gold, bonds
and forex serve a purpose,
and one purpose only: to provide an outlet for the Niagara-on-Potomac,
money supply gushing forth from the Federal Reserve that could drown the
entire world in a hyperinflationary deluge. If it hasn’t, that’s because excess money has been soaked up by the
gambling casinos. So far. People scramble for the excess supply of money because they could use them as gambling chips. But as
growth in the derivatives markets (the size of which doubles every other year
and by now exceeds half a quadrillion
dollars or $500.000,000,000,000) shows, this is not a stable
process secured with proper checks and balances. This is a runaway train on
which the brakes (i.e., the natural limitations of gold production) have been
deliberately disabled. Fraudulent
hedging of gold mines, and double standards in
regulating futures trading are part of the sabotage. This is a world disaster
waiting to happen.
Hedge fund masqerading as a gold mine
Mr. Shedlock
has missed my point. We may honestly disagree on the question whether
long-term unilateral hedges are prudent or fraudulent.
But there is no ambiguity about the fraudulent
nature of a hedge fund masquerading as a gold mine. If it is the
world’s biggest gold mining concern, then the masquerade assumes cosmic
proportions.
I repeat the verdict: the
gold carry trade is criminally fraudulent.
In more details: to lease gold, to sell it for cash, to invest the proceeds
like a hedge fund, and to report the income from these investments as profit
to shareholders, as if they were profit from gold mining operations,
constitutes fraud. Paper profit is
no profit. It is encumbered with a contingent liability, the extent of which
cannot be ascertained until the hedge is lifted and the hedgebook
closed. The trouble is that by that time management will have spent the
’profit’ taken out of the corporate treasury fraudulently.
The practice of
window-dressing income statements using unrealized paper profits, especially
as they are encumbered with unlimited liabilities, is a blatant fraud dealt with by the Criminal Code.
Gold Standard University
Live
It has been announced that
Gold Standard University Live, as part of its Session Three, is planning an
open-ended debate and panel discussion on True
versus False Hedging of Gold Mines, scheduled to take place
during the weekend February 8-10, 2008. Sprott
Asset Management of Toronto, Canada, has agreed to sponsor the event. Representatives
of gold mines, hedged and unhedged, will be invited
to participate. For further information please contact GSLU@t-online.hu
.
.
Antal E. Fekete
Gold Standard University
aefekete@hotmail.com
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