Gold, The Dollar and Manipulation
September 9, 2008
There has been many words written pro and con the idea that the price of gold is being manipulated. I don't know about gold, but the stock market is always being manipulated by the Big Players, and always has been.
Let's start with a story from Fernand Braudel's masterful 3-volume history of modern capitalism, credit and trade,
The Structures of Everyday Life (Volume 1)
The Wheels of Commerce (Volume 2)
The Perspective of the World (Volume 3)
Here's market manipulation, circa 1690. Trading ships took as long as three years to sail to the Indies for a load of spices, Chinese silk, etc. and make it back to Holland. These were highly capital-intensive voyages; ships and crew cost more than most could afford, so stocks or shares in the voyage were sold to accumulate the necessary capital.
If the ship sank--not an uncommon occurance--then the investors lost everything (unless it was insured--also an innovation of modern capitalism). But if the ship came in, yowza, the profits were stupendous.
if a ship was late, nervous investors began to sell at deep discounts, reckoning getting something for shares which might soon be worthless was better than losing their entire investment.
Enter the manipulators. On occasion, a trading ship would be sighted off France, on its way to Antwerp or other home port. If the trader could get that information before anyone else, he could snap up all the heavily discounted shares, knowing the ship was just days away from docking. He could then make a killing--via "insider trading."
The other basic mechanism is well described by master investor Jesse Livermore in the classic Reminiscences of a Stock Operator.
The basic idea is simple: if you have deep enough pockets, you can sell a stock short and bring it down below support levels, where many traders have place stop loss orders. Boom, the stock gets sold off hard as all those stops kick in. Wait a few days, then sell the bejabbers out of the stock again, dropping into below the next support.
More stops get blown, and now traders are wary--it's a "downtrend," one you have engineered, knowing how other traders operate.
If you can drop a stock below it's 50-day moving average, or the 38.2% fibonacci extension, so much the better--there are a lot more stops set around those levels, too.
This is easier than taking candy from a baby. And then when you've destroyed the stock and selling gets climactic, then you have sufficient liquidity to start buying/covering your shorts without moving the market much. At the bottom, you switch over and start accumulating, working the game on the long side in the same fashion. Drive the stock back above its 20-day moving average, and technical traders will start buying.
For an example, let's look at a small gold mining stock, Golden Star (GSS). Never mind what gold reserves the company has; let's just look at the chart:
This stock only trades 3.5 million shares a day on average, or about $4 million. If you're a hedge fund, given the leverage available to you, that is chump change.
Notice that GSS was about $3.75/share when gold was around $550/oz., and well over $4/share when gold was $700/oz. Now the stock is $1.25/share when gold is $800/oz. Huh?
No problem--just sell it short when it approaches key levels of support, and other traders will dump it. Rinse and repeat. It's perfectly legal to sell short and cover, and then go long; you could kill a little $300 million company like this with a mere $10 million sold short at critical junctures. (Note: I do not have a position in GSS at this time but am considering going long.)
That's the market, and it has always been open to manipulation by large traders. We small players join the game at a huge disadvantage. Jesse L. knew it, and described the game; we should take heed.
We should also be careful not to believe the accepted causal wisdom about gold and the dollar being 100% correlated. Lately, gold seems to move in lockstep with the dollar; if the dollar rises, gold tanks, and vice versa. This correlation is often stated as a causal factor, i.e. the reason gold dropped is the dollar rose.
Not so fast. I asked frequent contributor Harun I. for help in preparing a chart which displays the positive and negative correlation of the dollar and gold:
As you can see, most of the time gold and the dollar are negatively correlated, as per the standard causal line: when gold rises, the dollar is declining, and vice versa.
But it isn't entirely causal, because there have been periods in which a positive correlation occured, i.e. gold and the dollar rose or fell together. This suggests the relationship between the two is at times more complex than a teeter-totter, i.e. when one up then the other must be down.
What could trigger such a positive correlation? Just as pure speculation, how about a pervasive fear in the global financial system? The dollar might benefit from investors shifting cash to the U.S. from shakier economies and governments, as gold too benefits from a "flight to safety."
But let's also not forget the larger context, which is that the dollar and the credit bubble in the U.S. are both toast. As $1 trillion of credit default derivatives are getting called on Fannie and Freddie debt, let's recall the oozing swamp that is the derivatives market, as so ably described in the classic Fiasco: The Inside Story of a Wall Street Trader.
As for the mortgage market now being all repaired and happy, let's recall what author Richard Bitner described in Greed, Fraud & Ignorance: A Subprime Insider's Look at the Mortgage Collapse.
In short: the mortgage bubble is not coming back, regardless of what the new management of Freddie and Fannie say or do.
Lastly, let's recall that no economy, even the Imperial economy of the U.S., can sustain trade deficits on the order of 5-7% of GDP--and here we are, running trade deficits years after year at 5-6% of GDP. There is a cure to this imbalance, and it's called massive dollar devaluation, as described in this must-read book, The Dollar Crisis: Causes, Consequences, Cures.
Put these books together, and you get a simple but profound context:
1. Yes, manipulation exists; it is the warp and weave of the market and always has been. "Free markets" are a fantasy beloved by theoreticians who don't live by trading.
2. The mortgage mess was/is a hyper-credit bubble which cannot be re-inflated, which means Fannie and Freddie's "rescue" is meaningless in terms of "saving" U.S. housing from further declines.
3. No country can sustain massive trade imbalances forever, and the dollar's demise via catastrophic declines is already baked in as a result of years of structural trade imbalances. Cheerleading pundits are hysterically gleeful about rising U.S. exports, but if you look at the data, the current account deficit has barely budged: down from $750 billion to $700 billion, whoopie. That's still 5% of GDP, folks--unsustainable.
Modest reductions don't alter this fact. The only way for the imbalance to be rectified is via a decline of the dollar's value against our trading partner's currencies that is deep enough to cause imports to absolutely crater and make anything made or grown in the U.S. an absolute bargain.
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