GATA Lawsuit (page 2)
20. By its actions described in paragraphs 18-19 above, Congress effectively relegated gold to the status of an ordinary commodity for purposes of federal law, leaving its value against the dollar to be determined by market forces and without intervention by the Treasury, the ESF or the Fed, none of whom were given any legislative guidance whatsoever with respect to any particular price or price level for gold.
21. Although gold is now an ordinary commodity under federal law, it retains its intrinsic character as permanent, international money. Many of the world's nations, and most of its central banks, continue to hold significant quantities of gold as a part of their international monetary reserves. Of the estimated approximately 120,000 metric tonnes of above-ground world gold stocks, some 32,000 tonnes are currently claimed as reserves by official monetary institutions. (One metric tonne equals 32,150.7 troy ounces.) After the U.S. dollar, gold is the second largest component of official international monetary reserves. In addition, its price is widely regarded as an important economic indicator, particularly as a measure of U.S. inflationary pressures and the international strength of the dollar.
22. Because of its intrinsic character as money and its availability in quantity, gold functions in today's international markets as a stateless currency. Like any major currency, gold is not only borrowed and loaned at interest, but also arbitraged in spot and forward markets against other currencies on the basis of relative interest rates. Although gold interest rates are generally referred to as "lease" rates, the term is technically a misnomer. Gold is borrowed to be spent and repaid like a currency, not rented to be used and returned like a house or a car.
23. Since they were delinked, the dollar and gold have developed different interest rate structures. Lease rates on gold generally run at significantly lower levels than dollar interest rates, creating a situation of "contango" in gold futures, meaning that the dollar prices of gold for future delivery are higher than the spot price for current delivery. (The opposite of contango is "backwardation," meaning that spot prices are higher than futures prices.) Against the dollar, the contango on gold expressed as a percentage is roughly the U.S. Treasury bill rate less the lease rate. For gold to go into backwardation, this number would have to turn negative, i.e., the lease rate would have to exceed the Treasury bill rate.
24. Unlike other commodities where situations of contango and backwardation often result from varying expectations about future versus current supply, contango or backwardation in gold -- as in currencies -- is governed by relative interest rates since ordinarily neither gold nor currencies are subject to significant constraints with regard to current versus future supply. Currencies can be printed at virtually no cost by their issuing authorities. Gold, because it is produced for accumulation rather than consumption, is unique among commodities in that nearly all the gold ever produced remains in above-ground stocks, including the approximately 32,000 metric tonnes in official reserves.
25. Gold is traded internationally on a 24-hour basis in both physical and paper forms, with major markets in London, New York, Hong Kong, Tokyo, Zurich and Dubai. However, from the perspective of price discovery, the most important markets are the London Bullion Market Association ("LBMA") and the COMEX. Historically, the London market has been by far the largest in terms of volume or turnover. It does significant business in both bullion and paper instruments, but lacks transparency. The COMEX does relatively little business in physical gold, being principally a futures and options market. Zurich and Dubai are major physical markets. Most gold derivatives are traded over-the-counter between or among bullion banks, other financial institutions, gold mining companies, hedge funds, speculators and others. Unlike gold derivatives traded in standardized form as futures or options on exchanges such as the COMEX, over-the-counter gold derivatives are private contracts specially tailored to the requirements of the parties.
26. Annual new mine production of gold in 1999 was approximately 2500 metric tonnes, about the same as in 1998 and as estimated for 2000. At the same time, annual gold demand is running at over 4000 tonnes. Notwithstanding the annual excess of demand over supply, gold prices are well below the total cost of production for most mines. These low prices have forced closure of several, including the historic Homestake mine in Lead, South Dakota, high-grading in many others, and numerous job losses. Indeed, general conditions in the gold mining industry are the worst they have been since the 1960's. The deficit between new mine supply and demand, which has been growing steadily during the period covered by this complaint, has been met by scrap recovery, by some sales of official gold, and most importantly, by leased gold mostly from central banks.
27. Central banks lease gold either by making gold deposits with, or by making gold loans to, bullion banks, the largest of which are major international banks or other financial institutions. In both cases, the gold is placed with a bullion bank usually at a very low rate of interest, often 2% or less. This so-called "leased" gold is then sold into the market and the currency proceeds delivered for investment or other use by the bullion bank and/or its customer. When the gold deposit is called or the gold loan comes due, the physical gold required for repayment must generally be repurchased in the market. But during the term of the deposit or loan, the central bank retains the leased gold as an asset on its books and as part of its official gold reserves notwithstanding that the buyer of the leased gold owns it free and clear. The obligation to repay this gold to the central bank puts the bullion bank and/or its customer in a short physical position, i.e., they owe physical gold that they do not have.
28. This short position creates a risk to the borrower that when the loan comes due, the gold required for repayment may not be available in the market at prices at or below those at which it was sold. To mitigate this risk, gold borrowers typically hedge their exposure through the purchase of forward contracts or call options, which in turn are usually hedged by their purveyors, creating a complex web of derivative instruments.
29. Bullion banks, acting as agent or principal, are usually on both sides of these transactions. When acting as agent, their customers include gold producers (mining companies), fabricators (e.g., jewelry manufacturers), investors, traders and speculators. Gold producers often borrow gold through their bullion banks and sell it forward in order to earn the contango on some portion of their future production as well as to gain a measure of protection against falling prices. They may then make repayment by delivering gold from new production. Investors, traders and speculators often take advantage of gold's low lease rates to fund higher-yielding investments through the so-called gold carry trade. In addition, major banks sometimes borrow gold through their treasury departments for purposes of general funding.
30. Most central banks do not disclose the amount of gold that they have on lease. Bullion banks are even more secretive about the amounts of gold that they have borrowed. Accordingly, the current size of the aggregate short physical position is a subject of considerable controversy. Informed estimates range from 5000 to well over 10,000 metric tonnes, or several years of annual production. In April 2000 at a conference in Australia, Dinsa Mehta, head of global commodities trading for Chase, suggested a possible total short position of around 7000 tonnes, an amount that a recent report from Salomon Smith Barney describes as "simply too large to ever be repaid."
31. Gold derivatives, like other over-the-counter derivatives, are generally measured by their notional values, which are the face or reference amounts from which derivative payments are determined. Notional value is similar in concept to open interest, but measures it by face value of contracts instead of their number. Although a tiny portion of all derivatives, gold derivatives are very large in relation to physical gold supplies. Converted at the 1999 year-end gold price of about $290/ounce, the total market value of the world's roughly 120,000 metric tonnes of above-ground gold is $1.1 trillion, official gold reserves amount to almost $300 billion, and annual new mine production is a little over $23 billion. At the end of 1999, the BIS reported $243 billion total notional amount of gold derivatives, which converted at the same year-end price amounts to some 26,000 metric tonnes, ten times annual new mine supply and almost as large as total official reserves. As of June 30, 2000, the BIS reported that the total notional amount of gold derivatives had grown to $262 billion, or by 8%, notwithstanding falling gold prices during the period.
32. The gold derivatives of certain bullion banks, particularly Morgan and Chase, are also quite large in relation to their capital. For example, at the end of 1999, Morgan reported total risk-based capital of $12.1 billion and gold derivatives having a total notional value of over $38 billion, equivalent to roughly 3600 to 4000 metric tonnes of gold. On a position of this size and assuming an equal split between long and short contracts, should a swift upward move in gold prices to $600/ounce result in 20% of its counterparties being unable to deliver, Morgan could quite possibly suffer losses amounting to as much as 10% of notional value, or $3.8 billion, nearly a third of its capital.
33. Today prudential rules developed over centuries of experience with gold banking under earlier monetary regimes are ignored. Formerly bullion reserves of 40% against short-term gold liabilities were usually required. But today, no physical gold reserves are generally required or maintained. Gold derivatives may give theoretical protection against gold price risk, but they can neither replace physical gold when demanded nor substitute for it as a financial asset without credit risk, i.e., one that is not another's liability. Aimed at reducing firm risk, gold derivatives have instead created massive systemic risk in the precise area where the role of the lender of last resort is inherently limited -- gold banking. The Fed cannot print gold to rescue either the bullion banks or other banks that have used the gold carry trade as a source of apparently cheap funding. What it can do, for a while at least and contrary to law, is actively to assist and support manipulation of gold prices so that rising prices do not result in the short positions of the bullion banks causing them crippling and possibly fatal losses.
IV. Manipulation of Gold Prices
34. This complaint alleges manipulation of gold prices from 1994 to the present time by a conspiracy of public officials and major bullion banks. This manipulative scheme appears directed at three objectives: (1) to prevent rising gold prices from sounding a warning on U.S. inflation; (2) to prevent rising gold prices from signaling weakness in the international value of the dollar; and (3) to prevent banks and others who have funded themselves by borrowing gold at low interest rates and are thus short physical gold from suffering huge losses as a consequence of rising gold prices.
35. Support for the price fixing allegations in this complaint comes from various sources, including: (1) official reports of the BIS, OCC, Fed and ESF; (2) analyses of market data; (3) statements by certain participants in the manipulative scheme; and (4) statements by others with knowledge of the manipulative scheme.
36. The basic model for the manipulation appears to be the London Gold Pool, which operated without formal agreement under the auspices of the BIS from 1961 to 1968. However, the present scheme differs in three critical respects: (1) it aims to subvert the free market price of gold rather than to defend an official price sanctioned by formal international agreement; (2) leasing rather than outright sales is the preferred method of bringing central bank gold to market; and (3) gold derivatives, built on a foundation of leased gold, are a new and important tool giving the manipulators a high degree of leverage.
37. While using gold derivatives to force down prices whenever possible, the manipulators must also find or coerce sufficient supplies of gold bullion to meet strong physical demand, particularly from Asia, responding in part to the low prices resulting from their own manipulations.
38. In July 1998, Fed Chairman Alan Greenspan, testifying before the House Banking Committee, stated: "Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise." This statement amounted to a declaration that the gold price had been and would continue to be controlled. Not only did it constitute an open invitation to take advantage of the gold carry trade at very little risk, but also it pressured private holders of gold bullion to sell or lease their gold, thus augmenting the physical supply needed by the manipulators.
39. In a formal letter to Senator Joseph I. Lieberman dated January 19, 2000, Mr. Greenspan elaborated on his 1998 congressional testmony: "This observation simply describes the limited capacity of private parties to influence the gold market by restricting the supply of gold, given the observed willingness of some foreign central banks -- not the Federal Reserve -- to lease gold in response to price increases." Thus the Fed chairman himself has admitted that some central banks lease gold not to earn a return on it as they often claim, but primarily to supply physical gold to the bullion banks during periods when strong demand is pushing up prices.
40. Table 3.13 in the monthly Federal Reserve Bulletin shows month-end balances of total foreign earmarked gold held at Federal Reserve Banks, virtually all of which is kept at the N.Y. Fed. Foreign earmarked gold decreased from 8865 metric tons at the beginning of 1995 to 7318 tonnes at the end of 1999, or by almost 1550 tonnes. While some of this decline may represent official sales rather than leasing, in general over this period surges in outflows from the N.Y. Fed coincided with periods of strength in gold prices. Mr. Greenspan's congressional testimony in July 1998 also corresponded with the first appearance of a noticeable slowdown in withdrawals of foreign earmarked gold from the N.Y. Fed in the face of rising gold prices.
41. According to reliable reports received by the plaintiff, the IMF is now leasing gold through the BIS. As an international financial institution, the IMF qualifies to use the banking facilities of the BIS. Although the IMF claims neither to lease gold nor to have legal authority to do so, a gold deposit made by the IMF to its account at the BIS might arguably be distinguished from a gold loan. Such a deposit would, however, provide physical gold for lease by the BIS. In its most recent annual report for the year ending March 31, 2000, the BIS disclosed that during the year gold deposits by central banks fell almost 12% from 927 metric tonnes to 819 tonnes, and that gold held in bars declined almost 20% from 813 tonnes to 658 tonnes. At the same time, the BIS's total gold lending increased 47 tonnes to 360 tonnes, almost double the level of 185 tonnes as of March 31, 1996.
42. The IMF holds over 3200 metric tonnes of gold. American and British officials tried to tap this supply for manipulative purposes in 1999 through the proposed sale of over 300 tonnes ostensibly to fund aid to heavily indebted poor countries, an initiative that received strong support from both the Clinton administration and the Blair government. On May 7, 1999, just as gold threatened to surge over $300/ounce in response to new doubts whether the proposed IMF gold sales would go forward, the British announced that the Bank of England, on behalf of the Exchange Equalisation Account in the British Treasury, would sell 415 tonnes of gold in a series of public auctions. Although this announcement came with no warning and was completely unexpected by most, the previous evening Bill Murphy of GATA reported in his Midas column at Le Metropole Cafe: "Deutsche Bank's bullion desk is calling their clients saying that the gold market is stopping at $290."
43. Various British officials have offered wholly unpersuasive explanations of these auctions as an effort to diversify Britain's international monetary reserves. But British gold reserves were already low compared to those of other major European nations. British officials have not agreed on who made the decision. However, the timing virtually guarantees not only that it came directly from the prime minister, but also that he must have had extraordinary reasons for making it. His government was a leading supporter of the proposed IMF gold sales. The announcement clumsily put Britain in the position of front-running the IMF, ultimately a significant factor in forcing it to change tack. The manner of the British sales -- periodic public auctions in which the entire lot is sold at the lowest price accepted for any portion -- is so inconsistent with obtaining the best available return for British taxpayers that it has triggered an inquiry by Britain's National Audit Office.
44. Intertwined connections of present and former government officials and high ranking executives of the bullion banks and certain major gold mining companies have facilitated the conspiracy to manipulate gold prices. These connections include but are not limited to: Robert E. Rubin, former U.S. treasury secretary, previously co-head of Goldman and now a top executive at Citigroup; Frank B. Arisman, managing director of gold operations at Morgan and a director of AngloGold; Vernon E. Jordan, presidential confidante and a member of Barrick Gold's international advisory board; and E. Gerald Corrigan, former N.Y. Fed president and now a managing director at Goldman.
45. Many of the most egregious manipulative activities have occurred on the COMEX, which has high international visibility, but being predominantly a paper market, is more easily subject to manipulation. Over the past two years, Goldman, Chase and Deutsche Bank have regularly appeared as heavy sellers of gold on the COMEX whenever necessary to kill any significant rally. In the past year, many observers of the gold market have noticed a tendency for gold prices to rise in overseas trading only to be knocked back to prior levels on the resumption of trading in New York. Recently, amidst volatility in many other markets caused in part by a disputed presidential election in the United States, gold settled on the COMEX for 21 straight trading days within $1 of $266/ounce.
46. Among the more rigorous analyses of the gold market is an article by Michael Bolser entitled "Anomalous Selling in COMEX Gold, 1985 to November 2000" recently published at The Golden Sextant. Mr. Bolser identifies six extreme episodes of very heavy or "preemptive selling" in COMEX gold since 1994. For this purpose, preemptive selling is defined as the COMEX closing price falling by more than three times the decline in the London PM fix from the AM fix on the same day. In other words, if the AM fix is $300 and the PM fix is $295, the COMEX price would have to fall by more than $15 to less than $280 in order for the day to register as one with preemptive selling. For each month, the days with preemptive selling are taken as a percentage of the total trading days, and the percentages for each month are then charted.
47. Although defined solely on a statistical basis, each period of extreme preemptive selling coincides with a period when gold prices displayed marked weakness in circumstances where historical trading patterns called for just the opposite behavior. Although the manipulative scheme has operated on a daily or as needed basis to control and subdue gold prices, analysis of these six periods of extreme preemptive selling illustrates the operation of the scheme.
48. Since January 1985, there have been only seven episodes of preemptive gold selling on the COMEX in excess of two standard deviations from the mean, of which only three have exceeded three standard deviations. Of these seven episodes, all but one have occurred since January 1994. These six are shown graphically as waves 1 through 6 on Figure #7 below, which is taken from Mr. Bolser's addendum.
49. The only other preemptive gold selling in excess of two standard deviations occurred very briefly in early 1985. It was followed in late 1986 by a longer period of heavy preemptive selling not quite reaching the level of two standard deviations. This 1986 episode, which took place as gold prices moved sharply higher while the Iran-Contra affair unfolded, is the longest sustained high level of preemptive selling until 1994. It corresponds with the most significant activity of the ESF in the gold market prior to 1999 as revealed by tables 1.18 and 3.12 in the relevant monthly Federal Reserve Bulletins. (See paragraphs 62-63.)
50. The first wave of preemptive selling in excess of three standard deviations occurred in mid-1994, coincident with Mr. Greenspan's decision to assume the two seats on the BIS's board allocated to the American issue. Gold prices, which had been in a generally rising mode for the prior year and a half, went into an extended sideways move that lasted until 1996. The OCC reports on gold derivatives only go back to the first quarter of 1996, at the end of which the total notional amount of gold derivatives held by reporting U.S. commercial banks stood at $57.6 billion. Thus by mid-1994 it is probable that American bullion banks had already established a short position in physical gold of sufficient size and risk to concern the Fed. |
