This from Roger Arnold email newsletter today (no link avail.):
"Gold : recent history
Gold prices are at $300 an ounce, up $9 yesterday alone. Gold had hit an interday low last February of $252 an ounce and has been trending steadily higher since then. The 10 year average price of gold is about $333 an ounce although that doesn't tell the real story. Due to coordinated central bank selling of gold over the past 10 years, at the request of the Basel Capital Accord from the Bank of International Settlements, gold prices have fallen from about $450 an ounce 10 years ago steadily down to where they are today. The average cost of getting gold out of the ground is about $250 an ounce, a ground floor which, if broken to the downside could not sustain itself below that level long. This is one of the reasons I have been advising that from a protection of principal investment gold looks very good. The bonus is the potential increase in its value should the world economy sustain paper currency devaluation. The rapid increase in gold prices over the past few days and few weeks indicates an erosion of confidence in paper currencies, including the US dollar, US Treasuries, and US GSE debt, (fannie / freddie) by investors all over the world.
Gold : Carry Trades revisited
Gold carry trades begin with a central bank or large money center bank renting or leasing a quantity of gold to another financial institution. The largest gold carry trade and gold derivatives market participant is JP Morgan Chase. That means they are the ones doing most of the renting from the other institutions. This gold is then sold by JP Morgan Chase, and others doing this, into the open market. The cash they raise by selling the gold is invested in "safe" income vehicles, namely US treasuries, or GSE debt. The income that comes in from the US treasuries is used to pay the lease on the gold they rented from the central bank. The money left over is cash flow profit.
Gold : Here is the Catch
Loss concern number 1: In essence, by doing this, JP Morgan and the others have shorted gold. Which means they will eventually have to buy it back to deliver, upon demand, to the banks they borrowed the gold from. Well, if they leased gold from the "counterparty" bank and immediately sold it at say $270 and ounce and are forced to buy it back at $300 an ounce they have lost $30 an ounce. Compounding this concern for investors is that nobody knows how much there is in potential losses on the books at JPM since they are not required to 1) carry the trade at market value as a liability or 2) even carry on their balance sheet. The growing concern is that many of the institutions have simlair trades being carried off balance sheet and nobody knows what their status is.
Loss concern number 2, bond losses : Remember they purchased US treasuries and GSE debt with the money they received from having sold the gold. Treasury yields have been rising recently due in part to the selling of US treasuries and GSE debt and the flight to safety into gold. As yields rise, the underlying principal value of the treasury decreases. Remember yields and bond prices have an inverse relationship; as bond yields; i.e. interest rates rise, bond prices and value fall. As bond values fall, reserves shrink. As reserves shrink, the potential for forced selling of other investments to meet reserve requirements increases. Forced selling is a reactive situation indicating a lack of internal business and financial controls. A lack of control can cause a crisis of confidence by investors in a companies management and the potential for a systemic route out by investors increases. This route can then self validate the destruction of the company. This is, in essence, what occurred to Enron.
Loss concern number 3, stock losses : Exaggerating all of this for investors is the fact that most of these trades are Over the Counter or OTC which mean they are not exchange traded, which means they are not transparent, which means they may or may not be carried on the balance sheet of the company doing these trades. This is called off balance sheet financing. The concern over off balance sheet financing and lack of transparency that goes with it is what caused lenders to stop lending to Enron, instigating its collapse. Although every major money center is involved in this, by far the largest player in derivatives of all kinds, including gold, is JP Morgan Chase. Equity investors are aware of this fact and are also aware that nobody knows what their exposure really is due to the lack of transparency. Which brings us to loss concern number three, the stock price falling. JPM's stock is off by 50% in the past year. Company treasury stock is also carried as a reserve asset on the books of the bank.
The immediate future : What I suspect will happen from here however is for central banks around the world to make more gold available for leasing and sale into this flight to safety in an attempt to meet the demand and to keep gold prices from going much above these levels. However, they will have to do so very quickly and in very large quantities in order to have an impact. The other side of that coin becomes, if the central banks make the gold available who is going to buy it and who is going to lease it. We know there are buyers but remember, leasing gold in this environment is the same as shorting gold. JPM and other FED member institutions will have no choice but to lease more gold and sell it into the demand to try to cap the price increase. I believe that they have already been instructed by the FED after consolation with the Treasury to do this. This is not a conspiracy theory it is common sense. If the FDIC; i.e. tax payers are going to be expected to step in to make depositors hole in the event that these organizations become illiquid they damn well better do everything in their power to prevent that eventuality ahead of time.
Cautionary point : If central banks and money centers even hint at slowing gold leasing and selling it could unravel the Basel Accord over night and lead to a run on gold. The only reason the gold carry trades work is because gold is constantly liquidated by central and money center banks ensuring gold price stability born out of the manipulation which itself is the result of the steady gold liquidation. If these same institutions that have been leasing their gold to others begin to believe that the companies they have leased their gold to are going to become illiquid soon they may try to get their gold back out by issuing a demand for its return. This would force the reversal of the gold carry trade process, a collapse of the Basel Accord and a spike in gold prices to a level that is incalculable. It could also lead a systemic collapse of the world wide financial system. I am not saying this will happen. I am saying you need to understand the process. The possibility, plausibility and probability of this occurring is increasing.
There is a lot more we can talk about in relation to this but right now this is enough to absorb for one day."
Regards,
ldo79 |
