Gold Under The Microscope
This is the second installment of a five part series on gold.
In part one of my series on gold,Was Gold In A Bubble, I discussed why I thought that the gold price had gotten ahead of itself, like any asset in a bull market, but was not in a bubble. I compared it with bubbles of years past and showed the distinction between gold’s price action and that of true bubbles. Today I will talk about what caused the unnaturally sudden, dramatic drop in the price of gold.
For one thing, there is India, the world’s biggest consumer of gold for jewelry, with an astonishing 25% share. (China bought more gold last year, but was not tops for jewelry use.) The current Indian government continues to try to improve its balance of trade by raising taxes on the metal and restricting gold imports in various ways.
Not only does this add costs that impinge on demand, but the regulations change month to month and are so confusing and byzantine that the red tape alone curtails trade. The regulations also have gotten even more burdensome recently.
Still, this has been going on for years, and the incremental effect of the latest heightened aggravation does not account for the majority of the anomalous movement we see in gold prices. We have to move back to America to find an explanation for that.
There have long been accusations of manipulation of the prices of precious metals. Coming in fresh off the Street, one has to wonder how much of these charges are sour grapes, spawned by losses in trading positions. Let’s examine the evidence and make our own decisions.
First, let us recognize that even without any deliberate manipulation, commodity prices can move radically due to factors that have nothing to do with supply and demand and everything to do with speculation in the futures market.
The clearest recent example of this may be the price of crude oil in 2008. After being driven to nearly $150/bbl, West Texas Intermediate crude plunged to below $40 within a few months. Had demand for oil dropped that much? Did a majority of cars, buses, trains and planes stop moving? What about oil-fired power plants and the chemical industry. Did these uses dry-up overnight? Clearly they did not.
The huge drop in oil prices came from the action of traders who had bid up the price of crude in the futures market by momentum trading based on unrealistic assumptions about demand growth. When the price started heading in the opposite direction, traders couldn’t catch a bid on their positions, and the whole market went drastically net short, bidding down the price of the commodity.
A few years later we see that WTI is back around the $100 mark. A look at production and usage statistics will readily show there was no proportional change in those metrics to match the radical price shifts. We can see from this that without the slightest bit of skullduggery, the futures market can greatly affect commodity prices in ways that have nothing to do with supply and demand.
That said, it would be beyond naïve to think that manipulation is not possible. Just recently the Commodity Futures Trading Commission told Goldman Sachs and a few other entities to retain internal documents and e-mails relating to their commodities warehousing activities. That is often the first step on the road to a formal investigation. Meanwhile, the Senate has scheduled hearings looking into the commodities operations of major banks such asJPMorgan Chase JPM -0.34%, Morgan Stanley MS -0.88% and Goldman Sachs.
After the tech crash, all of the major investment banks settled with the SEC on charges they misled investors for their own profits. The lawsuits stemming from the actions of the big banks during the 2008 crash are still going on, with hundreds of millions of dollars already paid out in validated claims of misconduct.
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I should point out that these are the tip of the iceberg. SEC actions and censures have been constant for decades. Most of them result in little in the way of fines, and, of course, the company shareholders take the hit. The responsible executives in the vast majority of the cases don’t even have to give up their bonuses, much less face prosecution. Hence, bad behavior has little if any negative consequences for the parties involved. That, of course, promotes such behavior.
So, this is the environment in which we operate. Now let’s see what’s been going on lately, directly relating to precious metals.
….read page 2 HERE
