Precious Metals – Historically The Regulator Protected Trading

Here you have Dr. Paul Craig Roberts commenting about gold and silver. He is not known as a gold bug, not at all in fact, but as Assistant Secretary of the Treasury for Economic Policy appointed by President Reagan. After leaving the Treasury, he served as a consultant to the U.S. Department of Defense and the U.S. Department of Commerce.

In his commentary of past week he explains the concern of the US Fed related to specifically gold. His central point is that the threat of the yellow metal towards the dollar became too strong which shows the Fed’s vested interest to see a lower gold price.

The price of gold rose from $272 an ounce in December 2000 to $1,917.50 on August 23, 2011. With the price of the dollar collapsing in relation to historical real money, how could the dollar’s exchange rate to other currencies be valid? If the dollar’s exchange value came under attack, the Federal Reserve would have to stop printing and would lose control over interest rates. The bond and stock market bubbles would pop, and the interest payments on the federal debt would explode, leaving Washington even more indebted and unable to finance its wars, police state, and bankster bailouts. Something had to be done about the rising price of gold and silver.

While we try to stay as objective and unbiased as possible, we have difficulties not to accept that there is a lot of truth in the above thought. Dr. Roberts continues in his article with a description of the ferocity of the price takedown of mid April.

On Friday, April 12, 2013, short sales of gold hit the New York market in an amount estimated to have been somewhere between 124 and 400 tons of gold. This enormous and unprecedented sale implies an illegal conspiracy of sellers intent on rigging the market or action by the Federal Reserve through its agents, the BTBF that are the bullion banks. The enormous sales of naked shorts drove down the gold price, triggering stop-loss orders and margin calls. The attack continued on Monday, April 15, and has continued since.

Note that there are position limits imposed on the number of contracts that traders can sell at one time. The 124 tons figure would have required 14 traders with no open interest on the exchange to sell all together in the same few minutes 40,000 futures contracts. The likelihood of so many traders deciding to short at the same moment at the maximum permitted is not believable. This was an attack ordered by the Federal Reserve, which is why there is no investigation of the illegality.

The key point we want to make is in the sentence in bold. While there is nothing wrong with precious metals prices going up or down, there is an issue when the moves are exaggerated (no matter in which direction). The price action of mid April was simply too aggressive. Any normal market would see at least some form of concern expressed by a regulator. Apparently not in precious metals, as the regulator (the CFTC) even did not attempt to do an investigation (or anything that comes close to it).

The historic role of the regulator in the precious metals market

In what follows, David Levenstein from Lakeshore Trading (one of our contributors) explains how almost nothing is left from the historic role of the regulator in the precious metals market. The main focus is on the regulatory role in the paper market, which is the options and futures market, where the short term price is being set.

“Any normal seller that wanted to exit a position would do it discreetly and slowing thereby trying to ensure the best possible price and not simply dump an enormous amount all at once unless the goal was not profit but to smash the bullion price. Interestingly, the futures markets were established to prevent such huge price swings in commodities. The business of trading futures is not new and in fact it is now more than 100 years old. It began in Chicago during the 1800’s.

Chicago was a growing city in the 1830s and a centre for the sale of grains grown nearby to be shipped to the East. Prior to the establishment of central grain markets in the mid-nineteenth century, the nation’s farmers carted their newly harvested crops up rivers or dirt roads to major population and transportation centres each fall in search of buyers. These seasonal supply gluts drove prices downward to giveaway levels and even to throwaway levels as corn, wheat and other crops often rotted in the streets or were dumped in rivers and lakes for lack of storage. Come spring, shortages frequently developed and foods made from corn and wheat became barely affordable luxuries.

By the early 1850s, the local merchants began to buy corn from farmers which they then sold to the Chicago merchants on time contracts, or forward contracts, to minimize their risk. The farmers risked not having anyone buy their corn or having to sell at rock-bottom prices, and the merchants risked not having any corn to buy or having to buy at sky-high prices. The forward contract set forth the amount of corn to be sold at a future date at an agreed-upon price. Forward contracts in wheat also started in the early 1850s.

As soon as the forward contract became the usual way of doing business, speculators appeared. They did not intend to buy or sell the commodity. Instead, they traded contracts in hope of making a profit.

Speculation itself became a business activity. Contracts could change hands many times before the actual delivery of the corn. During this time, contracts were negotiated and traded in public squares and on street curbs. Then in 1848, 82 merchants formed a centralized marketplace to trade grain, and this was the beginning of the Chicago Board of Trade – more commonly known as the CBOT, the oldest futures exchange in the world. Today it is one of the largest futures exchange in the world.

Now around the same time metals merchants living in London began to sell contracts of copper on forward contracts. Imagine for a few minutes that you are a metals merchant living in London in say 1890. You lease vessels to sail to Chile where you buy copper ore. However, the journey takes several months, and during this time the price of copper fluctuates so you have no idea what it’s going be by the time your vessels return. Hopefully, when your copper is finally delivered the price is high enough for you to cover all your expenses and make a small profit. On the other hand if prices have plummeted you are going to make a large loss. So, you are always at risk.

Now, suppose that while having a cup of tea with some other traders, one of them tells you that he is prepared to pay you a guaranteed price for a specific quantity of copper that you only have to deliver in 6 months’ time. You do your calculations and figure that this price is enough to cover all expenses as well as make you a small profit – risk free. So you agree to this. But in the meantime if prices soar, you cannot claim the higher price, but you are protected if prices plummet. This meant that no matter what the domestic conditions were, when your shipments of copper arrived, you would receive the price agreed upon a few months previously.

Then, once again speculators arrived. They had no intention of taking physical delivery and instead they traded contracts in hope of making a profit. For example, let’s say that you were offered $0.40c per pound. Now some other trader who believes that prices will be a lot higher than this in three months’ time offers say  0.41 per pound, and then another trader makes an offer of say 0.42c per pound, and so on. So, before delivery is made, the actual contract can be traded many times over. And, this is how the London Metal Exchange began.

Fast forward to the 21st century

David Levenstein continues:

“It’s because of the merchants in Chicago and London that the process known as hedging began. And as these exchanges grew, more and more contracts were added Futures trading is now a global industry, and futures can be traded electronically outside the United States in more than 80 countries. While electronic trading is becoming more and more popular, a huge amount of business is still done in the pits.

Now the gold and silver futures markets are not being used for their original purpose, but are being used to manipulate prices by some entity that does not want to see prices of precious metals move higher.  As this is certainly not what the producers want, it is reasonable to surmise that the institution behind this is the US Federal Reserve. While, this has always been considered as another conspiracy theory, it is widely known that central banks and other major financial institutions have been manipulating Libor, bonds, equities as well as the foreign exchange market. So, it is absolutely plausible that they are manipulating precious metals, in particular gold and silver.” ”

That is indeed the most likely scenario: just like so many other markets have been manipulated we can reasonably expect that precious metals are subject to the same greediness of speculators, central planners, and the like. What should people make out of this? The one and only answer is holding PHYSICAL metal. Bullion has no counterparty risk, it is not leveraged, it has sound fundamentals and above all it IS money. Holders of the metal should only stomach heavy price swings.

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