A Line in the Sand

May 17, 1999 – For months it has been my contention that central banks are manipulating the Gold price. More proof came on May 7th.

The British government, through the Bank of England, announced that it intends to dishoard 415 tonnes of its 715 tonne Gold reserve. In contrast to the other governments(e.g., Belgians, Dutch, Australians, etc.) which have announced their dishoarding after they have sold in order to get the highest possible price from their sale, why did the British announce in advance what they intend to dishoard, unless their intention was to drive down the Gold price, rather than maximize the proceeds from their sale? Also, why did the British grossly misrepresent the present composition of their foreign reserves to make it appear that they had a relatively large percentage comprised of Gold? See the brilliant letter to theFinancial Times on May 12th by Ms. H. Fakuda, the newly appointed Chief Executive of the World Gold Council, explaining this point. Although she addressed only the facts of this matter and left unanswered the British government’s motivation, can anyone reasonably doubt that their specious attempt to justify this dishoarding is anything but a brazen attempt to talk down the price of Gold?

This contrived announcement to change the composition of the British government’s reserve assets – conspicuously timedd precisely as the Gold price was beginning to break-out of its downtrend channel – is but the latest instance of this ongoing manipulation of the freemarket price of Gold. On cue, the Gold price swooned after the announcement, stopping a promising rally dead in its tracks.

The motivation of central banks to manipulate the Gold managing the asset portfolio in many central banks appear too have little understanding of why their employer holds Gold in the first place. Consequently, these wizards have been turning this reserve asset into a revenue asset.

Instead of holding Gold within their vault to provide the ultimate monetary protection for the currency issued by the central bank, these young hot-shots have been lending that Gold.

They have turned the central bank’s Gold from a tangible and unencumbered asset into a promise, namely, that the borrower promises that he will repay (return) that Gold in the future. But what if the borrower doesn’t repay?

To put the best possible light on this matter, this new breed of central banker seems to believe that the interest income earned from the Gold while it is being loaned is more important than the prudential objectives achieved by holding the Gold as a reserve.

To put the worst possible light on this matter, this new breed of central bankers may in fact be no different from any of their predecessors throughout this century, who regularly and repeatedly demonstrated their palpable anti-Gold bias. If so, this new breed may be using the revenue generating capability of Gold loans as a smoke-screen to achieve their primary objective, which is to drive down the Gold price and to make Gold appear to be an monetary asset that has outlived its usefulness.

In any case, this lending has increased the weight of bullion readily available to the market. The Gold price has declined as the market absorbed this additional supply.

This downward pressure on the Gold price dovetails nicely with the other reason that central banks are motivated to manipulate the price of Gold. Gold is the barometer by which central bank management of a country’s currency and economy is being gauged and evaluated. A rising Gold price is a sign that monetary danger lies ahead, such as inflation or banking problems. A falling or low-and-steady Gold price is taken by the market as a sign that all is well with the national currency and the economy.

Clearly, central bankers would rather not have Gold looking over their shoulder at their every move. So the central bankers have been at war with Gold. This war is not new. Battles have been raging all century long, and include many fierce stand-up, knock-down, drag-out conflicts. The removal of Gold coins from circulation during and after WW I. Implementation of the Gold Exchange Standard in the 1920’s. Attempts to confiscate and outlaw the ownership of Gold in the 1930’s. Bretton Woods and the aim to make the Dollar, and not Gold, the center of world finance after WW II and into the 1950’s. Price manipulation from the London Gold Pool in the 1960’s. Dishoarding in the 1970’s by the IMF and US Treasury to try breaking the rising Gold price. And Gold lending in the 1980’s and 1990’s to keep a lid on the Gold price. And add throughout the century, deft control of the media which devoutly reports whatever central bankers want you to hear, regardless whether or not it is the truth.

Gold has won some of these battles; governments have won others. But the most important battle has just begun. The British government has drawn a line in the sand, and is challenging the Gold mining industry – and indeed, anyone who believes that Gold is a useful monetary asset – to step across it. The point is that an object’s usefulness determines its value, and the higher this value, then the higher its price. The British are maligning Gold’s usefulness as a monetary asset. I believe that the British government is blowing smoke because Gold is the only money that is no one’s liability. But is the Gold market ready to call their bluff? Are the mining companies going to continue to sit idly-by watching in the hope that national governments and their captive central banks do nothing harmful to the Gold market? Or will they finally respond to this challenge?

Governments are two-faced about Gold. They disparage it, but not because Gold has little value or usefulness. Rather, it’s because governments cannot control Gold anymore than they can control the freemarket process. Consequently, Gold undermines the power of governments that pursue reckless monetary policies, and no politician likes that. But the reality is that governments recognize one basic truth about Gold. Gold is money, and money is power. If governments dishoard Gold, they lose an important source of their power, and no politician wants to lose that.

So the British government has for once and for all thrown down the gauntlet. Will the Gold mining industry rise to the challenge? Will some of the companies that have contributed to the low Gold price by their hedging, cover some of these hedges by bidding for the Gold the British government is auctioning?

It is my hope – indeed it is my expectation – that this announcement by the British government will prove to be a watershed event. No longer can anyone reasonably doubt that the Gold price is being manipulated.

This observation is now sinking into the mind of the market’s participants. They will therefore seek answers for the reasons behind these manipulations. More importantly, as a result of this process of detailed examination, they will also be forced to make some basic conclusions about the value of national currencies, all of which are for all practical purposes because of the global linking of banking and finance subject to these manipulations.

I expect that this process will result in some meaningful changes in the future compared to the way Gold has been perceived in recent years. Namely, only one basic conclusion withstands the test of logic and monetary history – if governments hold less Gold, their national currencies will be worth less in terms of Gold,not more.

The removal of the Gold reserve that is backing a national currency diminishes the value of that currency; it does not enhance it. Take away the Gold reserve and a currency is worth less than when the Gold reserve was there, providing its useful and prudential function.

Consequently, the demand for Gold will continue to increase (studies by the World Gold Council indicate that demand continues at record levels) as the realization sets in that removing the Gold backing from a currency debases that currency in terms of Gold. And with this increase in demand, so too will the price of Gold increase.

Therefore, in the days immediately ahead, the market will look through this announcement by the British for what it really is – anti-Gold propaganda, nothing more, nothing less. And when the market looks through this announcement to reach this basic conclusion about Gold, the underlying fundamentals, bullish as they are, will still be there for anyone to see if they are prepared to look.