I don't think it is in the major producer's best interest to squeeze the shorts. Not until they've filled their buckets at the bottom of the market.
The gold market is fascinating, and may be one of the most interesting twists on monopolies ever. Just who benefits from the current situation?
Certainly, holders of physical metal have had a hard time of it….or have they? A family in Taiwan, Thailand, or Korea would have done all right compared to holders of their respective local currency. Even the Japanese and Canadians wouldn't have faired as poorly as Americans. Gold producers have been hurt, but not quite as hard as copper, nickel, or even oil producers. Perhaps it's easier to see who has benefited.
Short sellers would have done okay in the US market, but for example, a Canadian who shorted $350 gold with a $0.72 dollar might look okay until one figures that the CAN$486 received has to be replaced with $300 gold and a $0.64 dollar (CAN$468). Hardly worth the risk. Perhaps the winner is one who can negate the risk of currency and supply, and be able to chose on a daily basis whether to cover a short position with real or synthetic gold….ie, the spot deferred contract.
For this group a falling gold market is great, because the supply of synthetic gold is unlimited. All one has to do is convince the buyer that there is adequate gold (real or synthetic) to cover. In a steady environment of dropping prices, one can then draw on the near infinite supply of synthetic gold provided by "sophisticated" investors, AND obtain the benefit of acquiring real gold at much reduced prices. The best of both worlds. What could go wrong.
John Willson's (CEO-PDG) comments in the fall of 1997 about the low gold price and dismal junior market was to the effect "what a buying opportunity". And they have acted as such. Barrick has proven to be no slouch either, nor has Newmont been able to resist the temptation to grow by acquisitions. Very good business.
Just as the simultaneous purchase of a call and sale of a put option creates synthetic gold, the reverse, or simultaneous sale of a call and purchase of a put creates a synthetic gold short position. We now have a market where there is two gold prices reflecting the two gold products, one based on real gold and one based on synthetic gold. But which is which?
Few if any of the major gold producers sell physical gold. They sell synthetic gold at real gold prices (currently US$350 to US$400 per ounce) and then buy synthetic short positions at much lower market prices (currently US$290). AND, they need only buy half of the synthetic position and use real gold to cover the balance of the position. The hedging programs the major producers have is incredible and is to be admired. Bait and switch carried to a new high. And no one knows the difference. What could go wrong.
Just like any fiat currency, synthetic gold relies on faith. It requires the buyer and seller to believe that it is real. As long as obligations are met, everything works well. There is that side-effect that the artificial inflation of product in the gold market reduces the value of the commodity. The faith in the market becomes paramount.
Any rally in the price of gold would endanger the existing gold market, as half of the synthetic gold product becomes valueless, the in-the-money half would be exercised. This would be the holder of the call option. As pointed out previously, the financial market, while consumers of only 15% of the annual gold supply, trade 100% of the world's gold supply every 3 to 4 weeks on the Comex alone! How could this short position every be covered? What could go wrong?
The gold market is far beyond my comprehension. Perhaps the boys at Long Term Capital Management can figure it out but I can't.
Dave |
