PANDORA'S BOX
Considering the tumult in the gold market over the past month, a review is in order. It's not often that you see a major asset class move from a 20 year low to a 2 year high, in a matter of weeks. The fact that it was gold, arguably the most emotional asset class, added to the drama. And the fact that there was more emotion among the professional and institutional investment community, including the mining world, rather than among the public at large was noteworthy. The gold price explosion stemmed from the joint statement by 15 Central Banks that they were effecting a cap on sales and lending. More on that a bit later, first, let's review.
Over the past six months, I have written a good number of articles whose central theme was the distortions caused in the gold and silver market by the practice of leasing/forward selling. No surprise there - it's all I've ever written about on these pages for the past 2 or 3 years. But in the past six months, I embarked upon a campaign of specificity in the hope of terminating the decade-old downward price manipulation of gold and silver. I figured that if I could narrow the discussion down to a specific manipulator, I would stand a better chance of exposing and proving the fraud, than if I continued to analyze on a broad and general level. For the manipulator I chose Barrick Gold Corp. For good measure, I singled out the Commodity Futures Trading Commission (CFTC) as the prime regulator who was dropping the ball by not ending the manipulation. Barrick was chosen because of their high visability and rich public record in hedging matters, the CFTC, because their number one mandate is to guard against manipulation.
When I review the charges and language that I used towards the CFTC, I am somewhat taken back myself at the force and emotion that I displayed. That subsequent events have justified my rage at the CFTC for clearly evading their mandate brings very little pleasure. My fervent desire still, is to see them do their job and end the manipulation. The hallmark of a manipulated market is to suddenly lurch into disorderly trading conditions, just what we've seen in gold. It will be interesting to see at which point the CFTC can no longer pretend that all's well in the metals, and enters into the fray. My guess is sometime after the expiration of December COMEX options on gold and silver, when their short selling benefactors are off the hook. That this key government watchdog has sat by, while innocent parties and the markets themselves have been irreparably damaged, will be their mark of shame for years to come.
If you remember, my central theme with the CFTC was that leasing/forward selling was manipulating the market and simultaneously, destroying the legitimate practice of hedging. In particular, I charged that the selling of more than one year's production was a specific violation of the Commodity Exchange Act. In spite of my unwavering conviction that what the mining companies were doing was certainly not hedging - even I was surprised that two weeks and fifty dollars would see two mining companies, Ashanti and Cambior, effectively go bankrupt. If you think that is too strong of a word, let's substitute the word "restructuring". Be sure to know, however, that restructuring in this definition means, "screw the shareholder", a.k.a., bankruptcy. The sad truth is that when the Grim Reaper of Margin visits each and every one of the short sold miners, it will be the financial interests of the existing shareholders that will be sacrificed first. Let's face it, in the battle between the interests of the bankers and counter party creditors aligned against existing shareholders - it's no contest. I would like to emphasize this point - miners brought to their knees by shorting will not see their reserves in the ground disappear, but the inevitable restructuring will strip existing shareholders of ownership going forward. What a rotten deal - management and their bankers blunder badly, and the innocent shareholders are turned into bagholders. That the CFTC blew an important opportunity to prevent this from happening years ago will serve as further testimony to their failed stewardship. If the miners were truly hedging, as they contend, and as the CFTC pretends, you wouldn't see bankruptcies on the first two-week rally. This is anything but hedging. That the CFTC has sat by and let this happen is shameful. Shareholders who remain passive while their investment is threatened by short selling will be as rudely awakened as were their counterparts at Ashanti and Cambior. This is not the time to hold mining companies with open gold and silver short liabilities. Puts, no problem. Forward sales and short call options, big problem.
Nowhere is the problem bigger, now that Ashanti has been eliminated as a living, breathing short seller, than it is at Barrick Gold. In their third quarter earnings report and conference call, they confirmed that not only had they not covered any shorts during the 20 year low prices of the entire quarter, they actually added substantially to their short position. You have to love these guys - of the 5 or 6 articles I've done on them since May, I've had to revise their short position higher in each subsequent article. As of 9/30, Barrick is up to 18 million ounces of gold sold short (14 million ozs forward, 4 million calls). That is the equivalent of 5 full year's production and 22 per cent of annual world production. They've increased their short position by almost 50% during the first 9 months of this year - a year of the lowest gold prices in two decades. While I have no question about it - I ask you to decide if they have lost their collective mind. To do that objectively, consider my words and actions versus Barrick's words and actions over these past few months. Then, you decide who's crazy.
I remind you (although not from any petty human emotion), that I wasn't just pounding the table at sub $260 gold. What I did was much different - at least, I've never seen it done before. This was not just a buy gold or silver recommendation. What I did was publicly accuse Barrick of manipulation and fraud, in addition to succumbing to terminal stupidity, in the strongest terms available. I petitioned the SEC, the CFTC, Barrick's auditors (Price Waterhouse Coopers), Barrick management, and Barrick shareholders and employees. I wrote well over 10,000 words on Barrick on this site alone. To this day, I am amazed they haven't moved against me for libel - but they do know that the truth is not on their side. What I said clearly was that Barrick wasn't hedging. Selling short five years worth of production is not hedging. I would hesitate to call it a speculation, as the term in some contexts, connotes reasoned risk-taking. That Barrick's outsized short was held and added to at 20 year unadjusted price lows, denotes lunacy. Out of concern to innocent employees and shareholders, I offered the only possible solution - convince management to immediately cover the short and restore Barrick to the world-class gold producer it is capable of being.
But this management of Peter Munk and Randall Oliphant (Barrick's Chairman and CEO, respectively), see it differently. They are addicted to short selling. They hedge with no regard to price. Rather than admit that the $60 gold move cost their commodity account a billion dollars, they are reduced to defending their position by claiming Barrick's shorts are somehow different than those of other miners. Folks, a short is a short. A naked call is a naked call. Gold in the ground that will take years to extract, does not convert a naked call into a covered one, no matter how many times Barrick, or their crooked bankers, proclaim it. They are trapped in what increasingly looks to be the commodity blunder of all time. Having missed the bottom by a billion dollars, Barrick can't stomach the thought of admitting they misjudged the market and cover now. This is the real danger to shareholders and employees, management frozen in a trading nightmare. A rapid move to $500 in gold would equate to an additional $3 billion hit to their commodity account. What do you expect them to say? Would you expect this - "Damn, that Butler was right, we should have covered below the cost of production, after all, it was there for four months. This hedging business isn't panning out like we thought"? Current management has demonstrated that they have no right to run this company.
This hedging business isn't turning out the way any miner, or investment or central banker, or regulator thought. And all because of Pandora and her box. Pandora is the joint announcement by the 15 Central Banks on Sep 26 to curb the leasing of gold. As I've written in the past, it's my opinion that the announcement came because leasing had drained the CB's vaults so dramatically, that they were forced into the statement. But the $60 price explosion in gold that resulted from the announcement was not in the CB's game plan. This move in gold seriously impacted the institutional and professional gold world. Using as a naked short position an amount of 500 million ounces (I think conservative when including leasing/forward selling, COMEX futures and calls, the much bigger OTC, the LBMA, and all the gold bank certificates worldwide, etc.), the math isn't complicated. For the $60 move, a resultant loss/gain of $30 billion was created. Thirty billion dollars, in a highly concentrated market, and the only casualties were Ashanti and Cambior? I don't think so. Losses of hundreds of millions and billions of dollars are littered among the bullion banks, mines and other counterparties. This is not a guess, this is simple arithmetic. That someone is keeping a lid on this news is disturbing. It is not possible that there are not money-center financial firms that have suffered serious losses. Major defaults on physical metal commitments exist just below the surface. You can rest assured this was not what the Central Banks had in mind when they made their announcement.
What the central banks had in mind was sending a clear signal to the bullion banks and the metal world that leasing's time was up. It was not physically possible for them to extend leasing indefinitely, so they thought their disclosure would guide the market accordingly. But what the central bankers misjudged was the fact that there could be no soft landing at the true end of leasing/forward selling. It either existed, or didn't exist - you're either pregnant or you're not. There are no degrees in leasing, there are net new leasing supplies coming to market on a daily basis, or there are no net new supplies coming to market. For a few days after the announcement, there were no new net supplies of metal coming to market via leasing. That's why the price exploded $60. Afterwards, in a panic, the central bankers drew back from the precipice and released more leasing supplies, lest the market start running $60 everyday. So, now we are at a temporary stalemate. But the key word is temporary. For fifteen years, demons and serpents and vermin in the form of massive gold and silver short positions by the thousands were stuffed into the box. One or two escaped when the lid was briefly lifted by the CB announcement, before being shut again. The lid on Pandora's Box, hastily repositioned, is no permanent fix. After all, how many Kuwait's are out there? How many national treasures can be sacrificed to the leasing gods? In spite of vicious engineered selloffs, the lid is on for only a short while, not just because the central banks don't have the ability or the will to continue this stupid and manipulative practice. There's even a better reason why it's all over, but the shouting, for leasing.
The unreported key aspect of the announcement was to render leasing/forward selling as non-viable to the other participants in the leasing daisy chain - the miners, bullion banks and other short selling speculators. It did this in two ways. One, the announcement was a clear indication that leasing supplies going forward were not available. With the long-term prospect of supplies turned off, plans for new forward and other short selling were abandoned. Two, the sudden price increase and disasters in the mining world, proved overnight that the one way short sell bet was the wrong bet. Believe me, of the hundreds of mining companies who hold an open short exposure (maybe 95% of the mining community), there is not one who's prime current focus is not on their short sale. Right now, and for the immediate future the hedge book will be the only concern. Over night, the perception of what a hedge book is, has done an about face in every miner's mind. As well it should. Only those miners who move aggressively to close any and all short exposure will be spared the coming short inferno. Forget about Barrick and any other stubborn shorts, they're toast. Only a fool will not see that the leasing handwriting is on the wall. So here we have supply restricted, and the concept of forward sales finally discredited - this is the recipe for a bull market of historic and violent proportions. It's another way of saying many buyers and few sellers for as far as the eye can see. The metal excitement has just begun. Because the hedge book question is mostly unresolved, physical gold and silver are the best bets, by far. Get them now.
In closing, I would like to announce the launch of my new advisory service - Butler Research - butlerresearch.com It's a twice-monthly newsletter and daily commentary on the issues I've discussed on these pages. It is targeted at the metal professional and substantial investor, and will go much deeper and stronger into these same issues. I think and hope that I will add value to your effort of rationalizing these markets. It will be all content and opinion, zero fluff. As you might expect, it will be mostly "outside the box" thinking. The real test of analysis in the gold and silver markets is not just in recognizing the outstanding value that currently exists, but in adapting to the historic journey that lies ahead. I think I can assist you on that journey. I would like to thank Vronsky and Westerman for the opportunity of presenting my opinions here, and intend to continue to submit articles in conjunction with my new service. Thank you for taking the time to read and think about what I've written. Good luck to us all.
Ted Butler
October 24, 1999
For more information on Ted Butler -
butlerresearch.com
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