"The best thing about yesterday is that the Fed gave us a glimpse of the future. Those people who owned gold with leverage were waiting to have their throats cut – almost begging for it.. The best part is that this market operation has created instability where they once had stability. Nobody will take a levered position against them anymore – not on the stocks short side and not on the levered long gold side.

Here’s what I wrote to clients a couple of weeks ago:

Market Manipulation

The price of gold is a good segue into explaining how the markets are being manipulated.

Anyone who has read about the Japanese martial art known as Judo knows that the basic tenet of the art is to use the attackers leverage against him. Instead of picking up one’s opponent and throwing them down, Judo experts redirect the force created in their opponent’s attacks to knock them down. It’s the same in the markets.

We’re not the only investment firm that understands the problems in our economy and markets. Since 2008, a lot of work has been done to understand the problems in the world and this work has led to bets on the market – oftentimes with leverage such as selling short a stock, buying a put option, or borrowing money and buying gold.

Whenever investors use leverage, they leave themselves vulnerable because leverage turns small losses into big losses – it’s the reason why Lehman Brothers is no longer around. Knowing this, the Fed and its agents wait for these traders to place leveraged bets, and then the Fed’s agents forcefully take the other side of the trade. This is why we include charts of the VIX – they represent leveraged option trades.

A year ago, US corporate earnings growth was slowing meaningfully, Japan was recovering from a nuclear disaster worse than Chernobyl – one that continues to get worse – and at the same time, southern Europe was at the point where nobody would buy their debt and traders were making extreme bets against European markets and the European currency.

All it took was a promise by Europe’s central bank to “do whatever it takes” to prevent bankruptcy and the markets reversed in a huge way. Anyone betting against the European central bank incurred heavy losses. Later in the year, the Fed, then the Bank of Japan did the same thing with similar rallies.

The market has figured out this strategy which is why nobody is willing to bet against the world’s central banks in a meaningful way any longer. It’s the reason why markets are going up despite the tremors we face such as Cyprus, Italy, Spain, Portugal, North Korea, China, Japan, Argentina, and economic stagnation in the US.

Without speculators to crush, the Fed’s ability to keep the markets moving higher is seriously compromised.

Gold was the final bet against the Fed – they’ve won and by winning, they’ve lost!"

Philip M. Byrne, CFA
Chief Investment Officer
GeoVest Advisors Inc.