The Day the Bank of England Ran Gold Down to $256 -- Selling Its Gold at the Bottom. Here's Why.
Reality Check (May 30, 2002)
SELLERS OF GOLD
At every recorded price, there is an exchange. For
every buyer, there is a seller. Gold has a price. Someone
is selling gold.
There are several possibilities. (1) He thinks the
price of gold has peaked. (2) He thinks he has a better
use for his capital. (3) It isn't his gold; he's selling
it on behalf of someone else. If "someone else" is the
electorate, then the seller can do what he wants. Voters
have no meaningful understanding of gold. In this respect,
they are a lot like University of Chicago economists.
Who are the major sellers of gold? Gold mining
companies, central banks, gold speculators, and Indians.
(Patel, not Tonto.) Then there are short-term speculators
who sell promises to deliver gold in the future at a fixed
price, but who own no gold. We call them short sellers.
Gold mining companies sell gold because that's their
business. Their gold reserves in the ground are well known
and are factored into the prevailing price. Those mines
that have in effect sold short at a fixed price reap no
profit from a rising price of gold. They already locked in
a price, and this is what they are paid when they deliver.
He who went long -- promised to buy the mine's output at a
fixed price -- is the winner. For over five years,
numerous mines have been selling short, called forward
selling. They won when gold's price went down. Now they
are losing. The amount of gold being sold by mines for
future delivery is now drying up. The market has been
going against short sellers, i.e., forward sellers.
Central banks have been big sellers, although in a
disguised form. They have lent their gold for about 1% per
annum -- the cheapest borrowed money on earth. They have
not reported these loans as sales. Their official gold
reserves remain constant. But the leased gold is gone. It
was borrowed by large trading companies called bullion
banks. They borrowed at 1%, sold the gold, took the money
they earned by selling the gold and invested it at 5% or
more. It was a sweet, multi-billion dollar deal. But now
they are in a squeeze. They owe billions of dollars of
gold bullion to central banks, but to get it back, they
must buy gold bullion in the open market, which is now a
rising market. They are losing money, big time. What has
saved them so far is that the central banks are not
demanding repayment. Meanwhile, the public doesn't know
that the leased gold is gone. The central banks do not
publish these figures.
Then there are direct sales of gold by the central
banks. The most recent sales were made by the Bank of
England. It sold off at least half of its gold reserves
over a 3-year period which ended in March. The man
officially responsible for the decision to sell gold is
Gordon Brown, the Chancellor of the Exchequer. He has come
under fire this month for having made horrendous investment
decisions. The INDEPENDENT (May 26) published this story.
Chancellor under attack over
sale of gold reserves
By Colin Brown and Jason Nisse
26 May 2002
Gordon Brown has "lost" over 400m pounds by
ordering the sale of part of Britain's gold
reserves by the Bank of England. . . .
Figures obtained by the Independent on Sunday
also show that his decision to order the Bank of
England to part with some of its gold reserves
and switch into the euro and yen was also not a
good bet for the taxpayer. The value of gold has
soared on the world markets as investors have
switched to gold.
However, figures issued by the Treasury last week
showed that the Bank has lost out to the tune of
$578m. Treasury minister Ruth Kelly said the
Governor of the Bank, Sir Edward George, had sold
395 tonnes of gold as part of the restructuring
of the United Kingdom's foreign currency reserves
since May 1999. The last auction was in March
2002 when the price of gold was $296.50 per
ounce. Gold was trading at $320.5 in London when
the markets closed on Friday.
When the Chancellor announced the policy in 1999,
he said he wanted to diversify our store of
wealth. Germany, Australia, Switzerland were
among the major holders of gold who were also
selling. They agreed in September 1999 to limit
sales to 400 tonnes a year in total until 2004.
Gold prices started rising after 11
No public official relishes the prospect of being made
to look like a dolt. Mr. Brown looks now like a dolt. Sir
Eddie George, who heads the Bank of England, looks no
wiser. Other central bankers now must decide whether it is
a good idea to sell gold. They may wind up looking like
Sir Eddie. ("Sir Eddie" doesn't sound very impressive,
Of course, major central bankers have a problem. If
the public ever learns that the central banks' gold leasing
program has turned into an unannounced gold sales program,
with the bullion banks in cahoots with the central banks,
and the bullion banks can't repay the central banks, heads
A rising price of gold threatens to bankrupt the
bullion banks, who dare not go into the market to buy gold
for fear of what this will do to gold's price. So, it's a
waiting game. The bullion bankers are hoping for gold to
go down. So are the central bankers. But, at some point,
the central bankers will have to demand repayment. At that
point, the gold leasing game will end. The bullion banks
will go bust, the central banks won't be repaid, and the
public will find out -- once again -- that you should not
trust central banking.
Will that point ever come? Yes. How soon? I think
before the end of this decade. But even if it doesn't, the
public will still win out. If the gold leasing game goes
on, the public will buy back its gold, which was
confiscated from our grandparents or great grandparents.
If gold leasing ceases, the people who have bought gold and
held onto it will earn enormous rates of return on their
investments. Gold-haters will lose; gold bugs will win.
That is the way it should be.
Can gold's price fall to below the bottom of $256?
Anything can happen, but this now seems unlikely, short of
one last sell-off by central banks.
I have discussed gold sales by gold mining companies
and central banks. What about gold bullion investors?
With the Federal Reserve System expanding credit money
to push down short-term interest rates, and with a
recession in capital investing still in force, the question
is: "Where can I make a better rate of return than gold?"
This year, gold has beaten all other investment categories.
Gold investors have to search long and hard to find a
better rate of return. Only if they think the price has
peaked would they want to sell. But there is little
evidence yet that gold's price has peaked. The predictable
threat of the Bundesbank in early April to sell gold -- no
amount specified -- in 2004 had no downward effect on
gold's price. (See Issue 130.)
So, those who invest in gold have to decide: "What to
do with the money I gain by selling my gold?" The U.S.
stock market is performing poorly. It has been performing
poorly for two years. The investor who thinks that
inflation is beaten might sell gold to buy U.S. government
bonds. But the Median CPI is still above 3.5% per annum
for 2002. No deflation is visible in this statistic.http://www.clev.frb.org/research/mcpi.txt
So, he is less likely to sell than in the past. There
are no clear-cut alternatives. This reduces the supply of
available gold at any price in today's range.
Then there is the traditional buyer of gold jewelry,
the Indian father who has daughters. At some price, he
will sell. India is becoming a modern economy. There are
alternatives to gold for a daughter's dowry. But today,
India is once again facing war. No one likes to think
about it, but this war could go nuclear. The West avoided
nuclear war, but religious hostilities are very high in the
Pakistan is home base for revolutionary guerrilla
forces in Kashmir. That India insists on retaining control
over Kashmir seems nutty to the West. So what if Nehru was
born there? It is overwhelmingly Muslim. Why not give the
residents the right to secede from India? India's answer:
Because they are mostly Muslims, and Nehru was born there.
In the mid-1960's, I met an Indian journalist who was
on a fellowship in the United States. I think he was a
Nieman Fellow, the most prestigious of all fellowships in
journalism. He was therefore at the top of his profession.
He was liberal: anti-caste, pro-democracy. But on the
subject of Kashmir, he was adamant: democracy is an
irrelevant issue regarding Kashmir. There was no arguing
with him. You can imagine what his Pakistani peers
believed, with equal fervency.
One million troops are now massed on the Kashmir
border. India has a stronger economy and more money than
Pakistan. It has far more people. Its conventional
military forces are superior. But Kashmir's mountainous
terrain is on Pakistan's side. If the war stays
conventional, should it begin, India's economy will be
strained to pay for it. If the war spreads to Pakistan,
then Pakistan is at a disadvantage. The risk of the
Pakistan's use of nuclear weapons rises in such a scenario.
SALON (May 28) reports:
A new analysis by the Defense
Intelligence Agency suggests
that between 8 million and 12
million people would be
killed in a nuclear war
between India and Pakistan,
according to a U.S. defense
official, speaking on the
condition of anonymity. http://www.salon.com/news/wire/2002/05/28/pakistani_troops/
The report presumes that both India and Pakistan
successfully use most of the weapons in their
nuclear arsenals and target the weapons on
populated areas, the official said. The death
estimates are in the short-term, and do not
include long-term deaths caused by fallout.
Both countries' nuclear weapons are thought to
number in the low dozens and have yields at or
below 20 kilotons, putting them in the class of
the bomb the United States dropped on Hiroshima,
Japan, in 1945.
Both can deliver the weapons with small
fighter-bombers, such as Pakistan's F-16 and
India's MiG-27, or ballistic missiles.
Why would an Indian father sell traditional gold
jewelry in order to buy conventional paper-money
investments in such a scenario? Why not stick with a
traditional dowry that goes back thousands of years?
I predict that Indian sales of gold will decline, even
though the price of gold is rising steadily. If
hostilities cease, I am willing to reconsider. But
hostilities are increasing. Kashmir isn't going to go
away. Neither is Al-Qaeda. SALON also reports:
In a potential blow to the
antiterror war, Pakistan
appears to be preparing to
pull troops away from the
Afghan border to focus on its
own dispute with India, U.S.
defense officials said
The Pakistani military presence has been a key
element of the U.S. strategy for capturing or
killing Taliban and al-Qaida fighters who may
have slipped across the border. Without
Pakistan's help, the United States has little
short-term prospect of finishing off al-Qaida.
American military officials made clear Tuesday
they are worried that the dispute between
Pakistan and India over the Kashmir region could
disrupt the campaign against the al-Qaida in the
anarchic tribal areas of western Pakistan.
"Attention and troops that cannot be focused
there, because they're focused elsewhere, that's
a concern for us, because we need as much
assistance as possible in guarding that very
porous border," Victoria Clarke, chief
spokeswoman for Defense Secretary Donald H.
Rumsfeld, told reporters.
"It is a concern when they have to focus
attention and people to other parts of the
country," she added.
She said U.S. officials "are encouraging Pakistan
to remain involved, as they have been,
extensively, in the war on terrorism."
Pakistan said last week that it might remove
troops from the Pakistan-Afghanistan border
region, where they are helping the United States
search for al-Qaida and Taliban, and move them
toward Kashmir because of the escalating conflict
SUPPLY AND DEMAND
There has been some increase in demand from Japanese
investors this year. There is at least circumstantial
evidence that the central bank of China has been
accumulating more gold than was believed likely until
recent months. But, so far, the upward pressure on gold's
price seems to be from the supply side. Reduced supplies
of ready sellers are leading to higher prices.
This is understandable. Reduced supplies of gold are
the result more of fear than greed. Gold mining firms
burdened with forward contracts see losses ahead: selling a
commodity whose price is rising, but not for them. Those
competitors who did not indulge in forward sales will
prosper. They will bid up the price of mining equipment
and labor. This will hurt those mines that are loaded up
with obligations to sell at a fixed price. They will face
a profits squeeze. So, they are less likely to add to
their positions of forward sales.
The same fear factor affects Indian families. They
are afraid of war's effect on rupee-based investments. War
also increases demand for gold. So, they could get locked
out of the gold jewelry market. Why sell? Stick with a
Short sellers in the commodity futures market worry
about losses. They buy gold futures to close out their
positions. This raises gold's price. So does their
departure from the short side of the market. Not only does
the supply of gold get tighter, the supply of investors
willing to promise to deliver gold gets tighter.
At some point, gold's rising price will attract the
attention of conventional investors. This may be years in
the future. I think it probably is. For two decades, gold
has moved down. Investors have lost confidence in gold.
But cycles do occur. Floors are reached. At some point,
rising demand becomes more significant than contracting
Traditional market bottoms occur when existing holders
get discouraged and sell. Demand has falls for years. The
market gets a reputation for producing nothing but losses.
Interest by new investors wanes. Only highly
entrepreneurial people are buyers. Existing holders grow
discouraged about ever making a profit. They finally sell
their positions. Capital shifts from older, experienced,
but discouraged holders to new entrepreneurs. This sell-
off is what the gold market experienced in 2001.
I believe there will be rising interest in gold over
the next few years, but that demand, short of nuclear war
in the Indian subcontinent, will be steady rather than
greed-driven. Demand will increase, as more investors are
brought back into the market. I don't expect a gold rush
by Wall Street. Wall Street is too conventional. It is
also allied at the highest levels with central banks and
bullion banks. Wall Street is the Establishment.
There is a long-term re-education process ahead. Gold
has been attacked, steadily, ever since 1914, when European
central banks ceased to redeem their gold certificates, and
their governments authorized this massive confiscation of
private wealth. The United States joined in, but re-
established convertibility after the war ended. Europe
didn't, except for England in 1925, at a pre-war price that
could not be maintained without deflation, which the
economy got. Britain went off the gold standard in 1931.
The United States followed in 1933.
The war on gold is a war of the centralized, grasping
State against people with capital. This war is basic to
modern democracy: the substitution of the welfare-warfare
State for limited civil government. The bias against gold
is in the textbooks. It is in the minds of three
generations of bankers, industrialists, and investors. A
reversal of this bias will not come from within the
Establishment. It will be forced on the Establishment.
The tide seems to have turned for gold's price. As
the truth about the one-way direction of the central banks'
gold leasing programs becomes clear to a minority of
investors (but very few voters and legislators), gold
holders and entrepreneurs will conclude that gold's
supplies are far more limited than previously imagined.
When they recognize that the overhang of gold is based on a
statistical fraud -- that the gold is gone and will not be
coming back -- the upward pressure on gold's price will
The gold leasing phenomenon could become an
international Enron. I think it will. What one company
got away with temporarily, with the connivance of its
accounting form and the regulatory agencies, will be
regarded someday as a minor event. What the central banks
have done with their accounting systems dwarfs anything in
the history of accounting. The stock market eventually
exposed Enron as a gigantic accounting fraud. There will
be a similar day of reckoning for the central banks.