Eric Sprott discussing Silver and Silver Investment News on Financial Sense News Hour
Silver Investment News: Eric Sprott discusses Silver on Financial Sense News Hour
Wednesday, July 27, 2011
Tuesday, June 28, 2011
Gold And Silver Prices Clobbered Repeatedly, Hit Bottom, Start To Recover!
Beware June 30–The End Of QE2! US Government Takes Two More Steps Toward Nationalization Of Private Retirement Account Assets!
In aftermarket trading on April 29, the price of gold reached around $1,570 and silver climbed to about $49.50. With building momentum, it looked like gold had a good chance to reach $1,600 the following Monday and for silver to reach an all time high (ignoring inflation) above $50. Neither metal made those targets. In plain English, the prices were bushwhacked.
Before I give you the nuts and bolts of what has happened over the past month, let me review what happened to end the 1979-1980 bullion boom.
How The 1979-1980 Bullion Boom Ended
Among the most outrageous rule changes was a prohibition against new purchases of long silver contracts on the COMEX. Parties who already owned long silver contracts were restricted to only one option–to sell it to a party holding a short position. Prices quickly collapsed.
What Happened This Time Around?
Jump to the past six months. When the December 2010 and March 2011 COMEX silver contracts matured, the available COMEX registered inventories were hopelessly inadequate to meet delivery commitments. So, as COMEX rules permit, unusually large numbers of these contracts were settled for cash. There were multiple reports of March contracts being settled for cash at prices more than 30% above the spot price.
Further, the US dollar had been incredibly weak in late April. Adjusted for inflation, it was at its lowest level since the US government allowed its value to float against other currencies starting in 1973. Even without adjusting for inflation, the US Dollar Index, a measure of the value of the dollar against a market basket of other currencies, had reached a three year low and was not that far from its all-time lowest level.
Both silver and gold prices started to climb after Fed Chair Ben Bernanke’s press conference on April 27, a sure sign that foreign and domestic investors realized that Bernanke’s remarks did not instill confidence in matters American.
It was obvious that the US government had to take further measures to cap gold and silver prices.Fortunately for the feds, the Tokyo market was closed on Friday and China, Vietnam, and most European markets were closed on Monday. More thinly traded markets magnify the impact of any manipulation efforts.
The basic reason the US government wants to hold down gold’s price is that it is basically a report card on the US dollar, the US government, and the US economy. If the price of gold is rising, that is a sign that one, two, or all three are headed in the wrong direction. Silver often trades in sympathy with gold. If the prices of gold and silver were to rise, that would eventually force the US government to pay higher interest rates on its soaring debt. A fall in the value of the US dollar (the counter-party to rising gold and silver prices) would also lead to much higher consumer prices. Higher interest rates would also force up the cost of mortgages.
On Friday April 29, the COMEX, for the second time in one week, imposed a 13% increase in silver margin requirements. Late the same day, a subsidiary of TD Ameritrade raised its internal margin requirement for silver contracts to $30,000, more than double the new COMEX margin requirements. Also that Friday, Man Financial Global (MFG) raised its internal margin requirements for its customers holding leveraged silver accounts to $25,000 per contract.
As part of the network of allies working on the suppression of precious metals prices, you need to understand some of the relationships. JPMorgan Chase is the lead trading partner for the Federal Reserve and Goldman Sachs is the lead trading partner for the US Treasury. These firms are intimately involved in helping the US government pass along orders to other trading partners about the execution of tactics designed to meet the goals of the respective agencies. For instance, former top Goldman Sachs officials hold significant positions, including Jon Corzine (CEO of Man Financial Global), Gary Gensler (chair of the Commodity Futures Trading Commission, and William Dudley (president of the Federal Reserve Bank of New York).
Now, let me get back to the silver market. As I had previously written, there was also a developing shortage of available physical silver outside of the COMEX. It looked to me that the Wall Street firms that had (and still have) huge short positions in gold and silver were on the brink of default on these contracts, if not outright bankruptcy.
So, it was not a total surprise to me that, once again, there were numerous rule changes during the last week of April into early May made by the COMEX and some trading houses to force down the silver price (in particular) and gold.
Many people make investments borrowing money to leverage their results. As prices rise, it is sensible for the exchanges to raise margin requirements on such investments. However, the COMEX raised margin requirements for silver contracts five times over a two week period!
Before these hikes, the minimum margin per contract was $8,700. On May 9, when the fifth increase took effect, it then took more than $21,000 minimum per contract!
The last four margin requirement hikes occurred after the price of silver was falling–which does not make sense unless the real purpose was to suppress prices!
The net effect of these rule changes was that it has left many leveraged investors unable to meet these margin calls. As a result, a significant number of long contracts were liquidated during the first half of May without regard to the price.
In addition, the mainstream media gave more coverage to the silver market in early May than it seemed like they had given it over the past few years. Virtually all of this coverage was along the lines that there were major sellers out there, everyone was taking profits, the “bubble prices” of gold and silver had peaked, and the like.
Yes, it is true that in an overall boom market for gold and silver, there will be periodic bouts of profit-taking, where prices dip for a short-time. The trick is to ascertain whether such a decline is a normal market correction, a permanent reversal, or if it was the result of price manipulation at the behest of the US government.
The information available indicates that virtually the entire decline in prices can be attributed to the desperate actions by the US government, its trading partners, and allies. As prices started to drop there was some profit taking selling by “weak hands” buyers locking in profits, but this was not significant.
Let me list some of the more obvious gold and silver price manipulation tactics used during early May.
As I said, the raising of internal margin requirements had the effect of forcing many customers of these companies to liquidate leveraged accounts.
In addition to the manipulation of trading activity, there were also three story lines fed to the mainstream media on Sunday as supposedly explaining why gold and silver prices should fall. First, the death of Osama bin Laden was claimed to have instantly made the world a safer place, so there was less demand for gold and silver as safe haven assets.
Second, the president of Bolivia in his May Day speech did not announce further nationalization of the country’s mining industry as he had sometimes done in recent years. Opposition to doing so had come from that nation’s miners. Therefore, the threat of a small decline in silver mine production did not come to pass.
Third, China was supposedly backing off its demand to purchase commodities as part of the nation’s efforts to combat rising consumer prices. This story was especially spurious, as the only commodity that experienced a significant price decline was silver.
As would be expected in the circumstances, a large number of sell orders were executed as the Japanese market opened for trading on Monday May 2 (at 6 PM Eastern time zone Sunday evening). Shortly after trading started, the price of silver dropped 12% in only eleven minutes. Freely traded markets do not move like this in the absence of major market developments.
While gold was comparatively little affected, it also declined a few percent. Some “weak hands” technical traders, who focus more on price movements than the reasons behind the changes, sold their long gold and silver positions to lock in some profits.
Both prices proved to be more volatile than normal on Monday. Lower prices continued into Tuesday.
This greater price volatility had the desired impact (from the perspective of the US government) that owning gold and silver were less attractive as safe haven options for investors. Demand for physical precious metals on May 2 and 3 was subdued compared to the past two weeks. Beginning on May 4, bargain hunters resumed buying, though not quite at the same frenzied pace we experienced in March and April.
Friday, May 27, 2011
Saturday, January 22, 2011
Central banks and gold liquidity
Aside from issuing the nation's currency, formulating monetary policy and implementing it though interest rate measures and managing the money supply, a central bank is also a regulator of the nation's banking system, and as such it can set the discount rate, the interest rate charged to commercial banks and other depository institutions on loans they receive, in the case of the United States, from their regional Federal Reserve Bank's lending facility - the discount window.
The Federal Reserve banks offer three discount window programs to depository institutions: primary credit, secondary credit, and seasonal credit, each with its own interest rate. All discount window loans are fully secured.
A central bank also acts as a lender of last resort to commercial banks and other financial institutions and even non-financial corporations during periods of systemic financial stress. It aims at applying a monetary policy that will stabilize the credit and money markets by providing needed liquidity to the banking system and the credit markets in times of systemic financial distress.
To add liquidity to the gold market, many central banks provide gold to bullion banks and commercial banks with proprietary gold trading desks. According to the World Gold Council, bullion banks are investment banks that function as wholesale suppliers dealing in large quantities of gold. All bullion banks are members of the London Bullion Market Association.
Bullion banks differ from depositories in that bullion banks handle transactions in gold and the depositories store and protect the actual bullion. For example, the Federal Reserve Bank of New York stores and protects gold for a number of central banks and foreign governments. The US Bullion Depository in Fort Knox, Kentucky houses most of the gold bullion belonging to the United States.
Significantly, central banks choose to release gold to market participating institutions by leasing out gold for fees denominated in dollars instead of selling gold outright for dollars. This is because central bankers know from experience in recent decades that fiat currencies, led by the US dollar, had been repeatedly devalued against gold by deliberate Federal Reserve policy.
Gold price and the debasement of fiat currency
This policy-induced debasement of fiat currency by central banks can be expected to continue well into the foreseeable future until market confidence in fiat currencies is exhausted, and a new international finance architecture is formulated. Before that final crisis happens, central bankers would look for another white knight in the form of a reincarnated Paul Volcker to slay the inflation dragon with another blood-letting cure of sky-high short-term interest rates, as he did in the 1980s.
However, within the pattern of protracted steady decline in the purchasing power of fiat currencies over the long run, the price of gold can be highly volatile at any one time for a range of obscure reasons. Peaking at $850 per troy ounce on January 21, 1980, gold fell to $285 in February 1985 and recovered to reach $800 in November 1987, all within a period of seven years. Having failed to overtake its historical peak price for the second seven-year period, gold fell back down to $357 in July 1989. It rose to a high of $417 seven years later in February 1996, only to fall back to $250 in July 1999. Gold was $35 cheaper per ounce in 1999 that it was on 1985, 14 years before, and $35 was the price set for an troy ounce of gold at Bretton Woods.
Notwithstanding common perception, the above indicates that gold is not a totally reliable store of value even for the long run. The price of gold had been and still can be detached from general inflation rate in the global economy for extended periods. For example, from its peak of $850 per troy ounce set in January 1980, the gold price was falling towards the end of the same year when economic data and central bank policy would suggest that it should be rising, with US inflation rate reaching 14.5%, bank prime rate at 20.5% as a result of Fed chairman Volcker setting the Fed funds rate at 20% by December 1980, with the unemployment rate at 10.8%, and 30-year fixed rate mortgage at 18.5%.
Gold price unrelated directly to inflation rate
In 2008, the gold price kept rising when economic data would suggest that it should be falling, with the US inflation rate falling from 5.6% abruptly to 1.07% by November, and the bank prime rate fell to 3.5% while the Fed funds rate was lowered to 0-0.25% in December, with unemployment at 10.7% and 30-year fixed rate mortgage at 6%. These figures were clear signs of a severe liquidity trap, which John Maynard Keynes defined as a drastic fall in market confidence giving rise to a liquidity preference that overrides otherwise normal stimulus effects of low interest rates on the economy.
The peak gold price of $850 per troy ounce set in January 1980 was not breached for 28 years, an extraordinary long period for a bear market for gold. It fell to a historical low of $250 in July 1999 while inflation was rampant, after which gold took off to reach a historical high of $1,421 on November 9, 2010, an extraordinary rise of 569% in just 11 years, in a period of general deflation.
Gold price volatility not driven by supply and demand
The volatile gold price pattern in the past three decades obviously was driven by more than market supply and demand for the precious metal, or by the persistent debasement of fiat currency. In fact, central bankers know that central bank monetary policies and continuing central bank intervention in the gold market had much to do with this wide volatility in the price of gold.
A secondary reason why central banks lease out gold is to earn interest and to capture arbitrage profit from the differential between the dollar interest rate and the gold lease rate. Central banks do this to lower the carrying cost in a contangoed forward price curve, while at the same time capturing anticipated gains in gold price.
Contango depicts a pricing situation in which futures prices get progressively higher as maturities get progressively longer, creating negative spreads as contracts go further out in time. The time-related price increases reflect carrying costs, including storage, financing and insurance. Contango is a term used in the futures market to describe an upward sloping forward curve (as in the normal yield curve). Such a upward sloping forward curve is said to be "in contango" (or sometimes "contangoed"). Formally, it is the situation where, and the amount by which the price of a commodity for future delivery is higher than the spot price, or a farther future delivery price higher than a nearer future delivery.
Why central banks lease gold to the market
Focusing on gold leasing fees is a diversion from the fundamental reason why central banks lease out gold. Central bankers know from experience that even as the price of gold rises, the monetary profit gold owners make from holding gold does not necessarily add up to net gains after inflation. Gold owners are merely hedging to reduce, but not avoid fully, monetary losses from the inevitable debasement of fiat currencies caused by escalating loose central bank monetary policies.
Gold leasing does allow central banks to earn rental income with the gold they hold to cover some holding expenses. But more importantly, gold leasing by central banks provides gold-backed liquidity to gold-related financial markets. In a fundamental manner, adding gold liquidity slows the rise in the price of gold which in effects slows the debasement of fiat currencies caused by deliberate central bank monetary easing policies.
When a government issues fiat money that is legal tender for payment of taxes (the publics debt to the government) and private debts, it is in essence issuing interest-free sovereign credit to the bearer of its currency, which is "legal tender for all debts, public and private" - a declaration that appears on all US dollar bills - which are Federal Reserve notes.
Tax liabilities until paid to the government are debts to the government owed by members of the public within its jurisdiction. The government charges no interest for its sovereign credit in the form of fiat money it issues, unless new fiat money is issued to quantitatively increase the existing money supply to reduce through inflation the purchasing power of the money in circulation.
Thus mild inflation, up to 3% annually, is a benign way the government charges interest for holding its fiat money in the form of sovereign credit certificates. In that sense, the mild debasement of fiat money orchestrated by the central bank is an inherent structural characteristic of sovereign credit. In addition to other positive economic effects, mild inflation increases tax revenue from fixed progressive tax rates, through bracket creep. Milton Friedman's monetarist conclusion that a steady expansion of the money supply at 3% annual rate is the optimum rate that balances inflation and economic growth is a confirmation of this fact.
The issuing of fiat money as sovereign credit certificates should not be confused with government fiscal spending of fiat money already in circulation in the form of sovereign credit certificates already issued. Only the Federal Reserve, as a central bank, can issue fiat money. The dollar is a Federal Reserve note, not a bank note. The word "bank" does not appear in any dollar bill. The US Treasury cannot and does not issue money. It receives money by way tax revenue denominated in dollars issued by the Federal Reserve.
Fiat money in the form of sovereign credit certificates issued by the central bank is accepted by members of the public because, by law, fiat money can be used by the bearer to discharge tax liabilities to government. Payment of taxes with fiat currency is in essence the canceling of tax liability with sovereign credit earned by the taxpayer. The debasement of fiat currency is caused by central bank new issuance, but not by government deficits if such deficits are repaid with higher future tax revenue in the form of sovereign credit certificates (fiat money issued by the central bank) already in circulation. Fiscal deficits are only inflationary if a government pays for them with newly issued fiat money from the central that enlarges the money supply without expanding the economy.
History and politics of US central banking
In the United States, central banking was not born until 1913 with the establishment of the Federal Reserve System.
The first national bank in the US was the Bank of the United States (BUS), founded in 1791 and operated for 20 years, until 1811. A second Bank of the United States (BUS2) was founded in 1816 and operated also for 20 years until 1836.
The first national bank, modeled after British experience, was established by Federalists as part of a nation-building system proposed by Alexander Hamilton, the first secretary of the Treasury, who realized that the new nation could not grow and prosper without a sound financial system anchored by a national bank.
Jefferson's opposition to the establishment of a national bank was key to his overall opposition to the entire Hamiltonian program of strong central government and elite financial leadership. Jefferson felt that a national bank would give excessive power over the national economy and unfair opportunities for large certain profits to a small group of elite private investors mostly from the New England states. The constitutionality of the bank invoked the dispute between Jefferson's "strict construction" of the words of the constitution and Hamilton's doctrine of "implied power" of the federal government.
Hamilton's idea of national credit was not merely to favor the rich, albeit that it did so in practice, but to protect the infant industries in a young nation by opposing Adam Smith's laissez-faire doctrine promoted by advocates of 19th-century British globalization for the advancement of British national interests. This is why Hamilton's program is an apt model for all young economies finally emerging from the yoke of Western imperialism two centuries later, and in particular for opposing US neo-liberal globalization of past decades.
The creation of a national bank was one of the three measures of the Hamiltonian program to strengthen the new nation through a strong federal government, the others being (2) an excise duty on whiskey to extend federal authority to the back country of the vast nation and to compel rural settlers to engage in productive enterprise by making subsistence farming uneconomic; and (3) federal aid to manufacturing through protective tariff and direct subsidies.
To Hamilton, a central government without sovereign financial power, which had to rely on private banks to finance national programs approved by a democratically elected congress, would be truly undemocratic and to rely on foreign banks to finance national programs would be unpatriotic, if not treasonous.
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