We Have a ‘Green Light’

December 23, 2002 – There have been several important developments regarding gold since the last newsletter. These include:

December 2^nd – A strike erupts in oil producer Venezuela to protest the rule of autocratic president, Hugo Chavez. Though initially dismissed by many as unimportant, the strike continues as this is written, and the price of the NYMEX spot crude oil contract has risen 14.8% from $26.40 to $30.30. Little noticed, but extremely important to gold, was the declaration on December 5^th by Petroleos de Venezuela, the state owned oil company, of a force majeure on its petroleum derivative contracts, claiming that the strike prevented the company from meeting all product delivery and financial obligations of these derivative contracts.

December 4^th – Reg Howe publishes his and Mike Bolser’s commentary: “Gold Derivatives: Moving towards Checkmate”. (See: www.goldensextant.com)  Using a report compiled by the BIS that measures outstanding derivative contracts, this commentary provides further evidence that the total short position in gold is much higher than the level generally acknowledged by the gold mining industry’s consultants, and further, that the Howe/Bolser “figures align quite closely with Mr. Veneroso’s estimate of a total short physical position in the range of 10,000 to 15,000 tonnes.”

Then on December 14^th GATA published a speech delivered by Frank Veneroso a few months earlier, but which had received little attention: www.gata.org. This speech is important because it uses an entirely different methodology than Howe/Bolser to establish that the weight of borrowed gold is “something like 10,000 to 15,000 tonnes“. That different highly respected authorities on gold can use two entirely different methodologies to reach the same conclusion about the weight of borrowed gold makes it highly probable that their comparable findings are accurate.

December 6^th – Paul O’Neill and Larry Lindsey tender their resignations. The White House spin-meisters immediately go to work. Typical of the media reports was the Financial Times the next day: “George W. Bush yesterday moved decisively to shake up his troubled economics team with the resignations of…“. I find this report interesting because I thought it was the economy that was troubled, not the economics team. Further, this report makes it sound as if a decisive Bush asked for their resignations. Recognizing that the White House only tells you what they want you to hear, what if O’Neill and Lindsey acted on their own initiative? Here’s my take on these events. O’Neill’s resignation caught everyone by surprise. As co-head of the Exchange Stabilization Fund with the president, what if O’Neill got fed up with the lies and distortions being put out by the White House about the ongoing gold manipulation directed by the ESF? What if O’Neill – who many consider to be a man of exceptionally high integrity – wanted out with what’s left of his reputation and integrity intact? What if O’Neill saw the ‘writing on the wall’ about the future of the dollar and no longer wanted any part of maintaining the deception that the dollar is worthy of being the world’s reserve currency?

Lindsey’s resignation can be similarly explained. With O’Neill gone, he didn’t want to be made the scapegoat for the new incoming Treasury Secretary. But I think the most important question is: What if O’Neill and Lindsey saw from their insider positions the beginning of a new derivatives crisis, similar to the one that was touched off by the collapse of Long Term Capital Management in October 1998?

December 6^th – Gold breaks above $325. I find it very significant that the breach of this long-standing hurdle about which I have been talking about for years comes hard on the heels of the O’Neill/Lindsey resignations. It is to me a signal that the market agrees with my interpretation of the resignations of these two individuals, and more importantly, that there are big problems immediately ahead.

December 9^th – United Airlines files for bankruptcy, “the biggest corporate failure in aviation history” according to the Financial Times. The newspaper goes on to report: “Moody, the credit rating agency, estimated that United had total debt of more than $18bn at the end of September, of which around $8bn was off-balance sheet.” Off-balance sheet debt? Just like Enron?

December 12^th – Gold hurdles above $330, breaking through the downtrend line on the chart below. This breakout provides further confirmation that a major event is occurring. It adds to my perception that we are in the very early stages of another financial blow-up, the likes of which have not been seen since the 1998 LTCM collapse or the Asian Crisis the year before that.

By the way, if you think the last week or two has been exciting for us gold bulls, look closely at the above chart. The reality is that this recent experience is insignificant compared to the years of price history on this chart. This observation suggests that what’s to come will be truly stunning to everyone, except perhaps to those of us who lived through, experienced and remember gold’s bull market in the 1970’s.

December 18^th – Conseco goes belly-up, earning the dubious distinction of being the third largest bankruptcy in US history, declaring $51 billion of debt. I was not able to determine from its SEC filings the size of its derivatives position, but it was clear that Conseco used derivatives and other off-balance sheet instruments extensively in its operation. Gold closes in New York above $342.

December 18^th – Blanchard & Co., the largest retail dealer of physical gold in the US, files suit in federal court accusing Barrick Gold Corp. and J.P. Morgan Chase of “unlawfully combining to actively manipulate the price of gold“. According to Blanchard’s Chief Executive Officer, Don Doyle: “If gold had kept pace with inflation, the price today would be approximately $760.” In the press release announcing the suit, he also states: “The same type of accounting maze that hid Enron’s debts made it possible for Barrick to manipulate the price of gold without the checks and balances that come from public scrutiny. As a percentage of Barrick’s total assets, its off-balance sheet assets make Enron look like a champion of full disclosure,” said Doyle. “Is Barrick a gold mining company, or is it a hedge fund with a mine out back?” (For more information on this important suit, see: www.savegold.com.)

December 19^th – As the war clouds gather as the US declares Iraq committed a “material breach” – not a ‘material omission’ – of the UN’s disarmament resolution, Alan Greenspan makes a notable policy statement in a speech before the Economic Club of New York. This speech marks an important turning point. (See:Federal Reserve – Speeches)  Mr. Greenspan states what every working person in the US already knows, bank economists and stock market bulls excluded: “The U.S. economy has been working its way through a soft patch. And the patch has certainly been soft.” The tone of the speech suggests that the Federal Reserve’s current policy is on hold for a long time – low interest rates will continue. So is it surprising that he mentions ‘gold’ three times in the very first paragraph of his speech?

Clearly, Mr. Greenspan understands gold, which is a point I’ve made many times before (see for example, Letter No. 285, “Two Alan Greenspans“, June 4^th, 2001). And his repeated, periodic defense of the classical gold standard are by now very familiar to all Greenspan watchers. Therefore, when reading between the lines of his latest speech, it seems very clear to me, Alan Greenspan is giving everyone the ‘green light’ to buy gold. It is for me every bit as important as his July 1998 declaration that central banks stand ready to lend gold in increasing quantities should its price rise. Thank you, Mr. Greenspan for sharing with us this important message.

Summary – The derivatives force majeure by Petroleos de Venezuela and bankruptcies of United and Conseco are the most significant financial debacles since the Russian default of August 1998 caused the collapse of Long Term Capital Management. The knock-on effects from these recent defaults have only just begun to ripple through the global financial system. Gold is now riding one of these ripples.

I believe that a derivatives crisis has already been triggered. Gold is reacting to this developing explosion of derivative books of the big banks and other financial institutions. We’re seeing the beginning of a nuclear chain-reaction, but it is one that occurs over days and weeks, not seconds.

In the last newsletter I said: “I want to continue riding the trend, and for now the trend remains up for both gold as well as my recommended mining shares. So for now, stay long. And continue to stay long until the uptrends in gold and the mining stocks end.” That continues to be my advice.

The action over the past few weeks in gold and other markets like the dollar confirms what the Fear Index already told us this past May – gold has begun a major bull market. And looking at the other side of the coin, the dollar is in a major bear market.

Further, the dollar’s bear market is one that I think will be so severe – as I have already discussed in these letters – as to make the dollar unrecoverable. In other words, the dollar will die just like every other fiat currency throughout history has died. Look at today’s Argentine peso if you want to see the future for the dollar, and it is a future that I think will unfold in 2004.