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It has been an increasingly brutal ride for gold and
silver, beginning around late March and accelerating through April. The gold
price was over $1600 and on Monday April 15, it fell below $1350, a loss of
$250. Silver did even worse, falling from $29 to $22. We called for the gold:silver ratio to rise,
and since the start of February, it has risen from around 52.5 to over 59 as
I write this (with a few periods over 60).
Everyone wants to know why. Why did this happen?
Could the prices fall further? If so, how much? In this two-part article, I
address these questions and put them into perspective. In the first part, I
discuss the conventional theory and in the second part the Monetary Metals
theory.
In this article, I refer to the “gold
bug” frequently. By “gold bug” I mean the dollar-focused
speculators and traders, not the people who buy gold and silver to accumulate
for the long term. The latter understand, implicitly or explicitly, that gold
is money and that it is good to hold money as the world moves closer towards
global bankruptcy and default.
Let’s start with a question. If you knew that
a casino was cheating, if you saw that there was a magnet under the roulette
table, would you gamble there? Would you risk your money, hoping that on the
next spin, the magnet would somehow malfunction?
It would be irrational. You would be better off
going to the next casino where they obey state law and run an honest game. It
is the same with the markets. If you believe that the gold and silver prices
are controlled then why would you risk your capital attempting to trade them?
Technical and fundamental analysis would be at best useless and at worst
misleading, because there are cheaters in the game. No analysis could predict
when the cheater will push the button that raises the magnet under green
“00”, and take your money.
We are not aware of any gold or silver analyst that
called for the crash of last Friday through Monday. There are some analysts
who are generally bearish, and we ourselves have predicting the rising gold:silver price ratio, and we
emphasized that we were not bullish on the silver price in dollars all the
way down from $35. But no one said that the gold price would drop more than
10% in two trading days.
In this paper, I shine some light onto the
conventional manipulation theory and also the very idea of holding gold
waiting for a higher gold price. I present my own theory of what may be
happening in the markets right now, and a different view of the use and value
of gold. If you want to understand the gold market dynamics, then you must
understand the gold basis and the broader credit environment.
If you are firmly committed to the belief that the
gold price is suppressed, then you may want to stop reading right here or
else prepare to be offended. Consider yourself warned.
What follows is a sometimes-humorous and often-irreverent
and hard-hitting discussion. I
write this not out of a desire to insult anyone, but to help people see their
way out of a no-win zero-sum game. I hope to offer a different perspective
and expand your thinking about gold and silver. My other goal is to address
those people who are holding gold and who are nervous about the near-term
price volatility. I hope that in this article, you come away with a stronger
understanding that you are in the right place, that selling low is never a
good strategy, and the dollar is not a store of value.
The
Conventional “Gold Bug” Theory
It is commonly accepted today that as the quantity
of money rises, then prices must rise especially including the prices of gold
and silver (throughout this article, I will use the word gold to refer to
both metals unless I call one metal out explicitly). Prices in the real world
do not move that way, so a convenient explanation has become very popular.
In this theory, there are nefarious forces, composed
of various central banks plus assorted bullion banks (often called
“vampires” and/or “squids”). In some versions, this dark
cabal does not care about taking losses to suppress the price of gold. Other
accounts accuse them of making illicit gains by causing poor old gold
investors to buy high and sell low.
They are supposed to surreptitiously dump physical
metal (which is finite in its supply) onto the market, in order to push down
the price. Alternatively, they might
be dumping unlimited quantities of futures to accomplish their evil end.
The reason they would want to suppress the gold
price is vaguely given as trying to prop up “faith” in the paper
dollar, or otherwise somehow “protect” their paper money.
In any case, when the price is rising, the gold bug treats
it as right and natural. When the price falls, it is due to manipulation. Why
would anyone be satisfied with this simplistic view? It won’t help in trading, though it does offer comfort
after each wounding.
I have written many times to debunk these conspiracy
theories, so I do not want to dwell too much on them here, except to make two
observations. First, the central banks don’t have any silver. If they were
dumping real metal to suppress the price, it would have to be gold only. This
leads to a nagging question. Historically, the gold:silver ratio was around 16 (i.e. 1 ounce of gold
could buy 16 ounces of silver). If gold is artificially cheapened—but
not silver—wouldn’t one expect to see the ratio fall below 16:1?
Today the ratio is near 60:1.
If both metals are suppressed, then it has to be
done using futures. There is an equally nagging problem with this idea. If
they sell futures (but not real metal, which is typically claimed to be
scarce and getting scarcer), then they tear open a large spread between the
price of a future and the price of real metal. For example, if both are
trading around $1600, and they sell hundreds of tons
worth of gold futures—enough to drive the price down $250—then
there would be a $250 spread between real metal which would remain up at
$1600, and futures which would be driven down to $1350.
The term for when the futures contract is cheaper
than spot metal is called “backwardation”. While there is
intermittent gold backwardation, the magnitude is in the cents or perhaps a
dollar or so, not hundreds of dollars. Indeed, on Monday morning, April 15,
the slight backwardation that had existed in the June gold contract
disappeared. The Gold Basis Report
(free registration required) provides weekly coverage of the gold and silver
basis and other related data.
My personal opinion is that the Fed cares far less about
the gold price than we do. Gold is not in the basket of goods whose prices
comprise the Consumer Price Index. Dollars are not redeemable in gold, the
Fed and the banks are not struggling under an obligation to deliver gold, and
there is no run on the gold of the banks.
Monetary
Metals Theory
Monetary Metals was founded on a single idea: gold
is money, and the dollar is credit-of declining quality. One cannot profit by
buying gold and waiting for the price to rise. Sure, one has more dollars,
but each of them is worth less. How much less? The decline of the value of
each dollar is in exact proportion to the gain in the number of them. If the
amount of gold that you own has not changed, then it stands to reason that
you have not gained real wealth (and in the US, you lose wealth due to the
tax on capital gains).
Let me illustrate this point with an example.
Imagine you have 1,000 silver coins. The silver price is about $24, so your
hoard is worth about $24,000 today. What if the silver price rose 0.1% to $24.024, and you spent one coin? Your 999 remaining coins
are worth … $24,000. What if the silver price rose again to $24.048, and you spent another coin? Your remaining 998
coins are still worth $24,000. You continue this process every day (while it
lasts).
Is this really like living on the interest on a
bond? Or, are you consuming your capital? You are certainly reducing the
amount of silver you hold, even if the dollar value of it remains constant.
This is the picture of capital destruction that everyone should have firmly
in mind whenever a central banker or talking head uses the term “wealth
effect”. Rising prices can make one feel wealthier, but it is not real
wealth.
We must operate in the real world. Few people hold
our unconventional view. Most Westerners think of a rising gold price as a
gain, and a falling price is a loss. (attitudes are
quite different in India and parts of Asia). Western gold bugs have to sell
gold. They sell when the price rises, to realize their gains. They sell when
the price falls, to stop their losses.
Though many call themselves investors, gold bugs are
speculators. They are described aptly by John Maynard Keynes (who did not get
much else right) in 1935:
“Or,
to change the metaphor slightly, professional investment may be likened to
those newspaper competitions in which the competitors have to pick out the
six prettiest faces from a hundred photographs, the prize being awarded to
the competitor whose choice most nearly corresponds to the average
preferences of the competitors as a whole; so that each competitor has to
pick, not those faces which he himself finds prettiest, but those which he
thinks likeliest to catch the fancy of the other competitors, all of whom are
looking at the problem from the same point of view. It is not a case of
choosing those which, to the best of one’s judgment, are really the
prettiest, nor even those which average opinion genuinely thinks the
prettiest. We have reached the third degree where we devote our intelligences
to anticipating what average opinion expects the average opinion to be. And
there are some, I believe, who practise the fourth,
fifth and higher degrees.”
They play a zero-sum game, hoping to front-run the
others, to buy first, and then let everyone else’s buying drive up the
price so they can sell. Or, often, they are the greater fools who buy from
other speculators who are selling to take profits. Then, when the price
drops, they sell to avoid further losses.
Although they tell the story of the falling dollar, this
is just lip service. Gold bugs measure their gains in dollars, and they sell
gold for dollars as their modus operandi. When they are buying en masse, the
price of gold can rise sharply. When they are selling en masse, we can see
precipitous sell-offs, as over the last week.
What could have caused these people to sell en masse
right now?
In Part II, we address the root causes (free registration
required).
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