With incredible turbulence in the gold and silver markets, today John Hathaway sent King World News an incredible snapshot of the big picture for the gold and silver markets, along with 5 absolutely spectacular charts. KWN was given exclusive distribution rights to this outstanding piece by superstar John Hathaway of Tocqueville Asset Management L.P.. John is without question one of the most respected institutional minds in the world today regarding gold, and his fund was awarded a coveted 5-star rating.
In our opinion, the severe pressure on gold prices since April 16, 2013 has been caused by a coordinated bear raid orchestrated by large bank trading desks and hedge funds. The method used was naked shorting of gold contracts on the futures exchange (Comex), which means that physical gold was never sold, only paper. Gold was rarely, if ever, delivered to a buyer. Trades were settled in cash.
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The notional amounts of the transactions on many days exceeded annual mine production, absurd on the face of it. The motive was most likely to break the gold price for profit. The result is that short positions of these traders are higher than at the bottom in 2008 (chart below), after which gold rallied 167% and mining shares 256% (basis XAU).
Traders exploited and exaggerated the technical vulnerability of gold in our opinion simply because it was possible to do so. Because the gold futures market offers deeper capacity than almost any other physical commodity market, it was a perfect target for bonus seeking traders who have also profited (some of which are now being prosecuted or investigated) in the manipulation of Libor and Foreign Exchange rates.
The price decline in paper gold has been met with a surge in physical demand worldwide. The most dramatic image is the disparity between paper and physical gold, which is depicted in the chart below showing the premiums over paper gold prices paid in China for physical.
While China is by far the larger market, U.S. coin sales are exceptionally strong as well, surpassing volume at the 2011 price peak by 23%. The conclusion we draw is that the paper market has severely mispriced gold on the downside. The physical market indicates a shortage of gold at the same time the paper market is extremely short.
In April 2013, Dutch banking giant ABN Amro notified clients that they would no longer be providing physical delivery of precious metals including gold. Claims would be settled in cash with account balances adjusted by the prevailing bid prices “offered by merchants.”???? The bank explained that new custodial relationships would no longer allow physical “extradition.”????
In January 2013, the WSJ reported that Germany, which stores 1500 of its 2600 ton gold reserve within the vault of the NY Federal Reserve bank, was taking steps to return 300 tons to Germany. One would think this would be a simple matter, with 1000’s of tons trading daily on the COMEX and LBMA. Not so fast, Germany. The requested delivery of German gold will not be completed until 2020 even though 300 tons could easily be shipped overnight on a few jumbo jets. ????
Could it be that the NY Fed, in the heart of the NY financial district, had allowed many of the 6700 tons of gold held there for the account of foreign central banks, to be re-hypothecated to investment banks for the lucrative gold swaps, leasing, and derivative business? As commercial (i.e., bullion dealers such as JP Morgan and Goldman Sachs) CFTC positions have swung sharply away from the short side (refer to chart on p.1), Comex warehouse stocks have dwindled precipitously, dropping 32% or nearly 100 metric tonnes since the beginning of 2013.
Since the beginning of 2013, physical gold held by ETF’s such as GLD has dropped by 586 tonnes. Where does the liquidated gold go? The final destination is impossible to know, but the first stop is into the accounts of “authorized participants”, aka, bullion dealers such as JPMorgan and Goldman Sachs. There are quite a few dots to connect here, but in our opinion, (and it is admittedly our speculation) an historic short squeeze is looming, and the insiders (bullion dealers) see it coming. By using the paper market to crush the price of gold, they have attempted to shake loose physical gold to reduce their short exposure in order to minimize the damage from what lies ahead.
Because the Fed has already cornered the market on longer term Treasuries (they own more than 40% of all maturities greater than five years, and have purchased 41% of new Treasury issuance since 2009), any valid attempt to exit will, in our opinion, drive interest rates to levels far higher than compatible with sustainable economic growth. The same can be said for a reduced pace of asset purchases or tapering.
The Fed’s dilemma is that its actions have caused interest rates across the yield curve to be well below likely free market rates. The thought that the gap between artificial and market rates can be closed gradually seems delusional. The mere whisper of tapering has already lead to substantial markdowns of fixed income valuations. The specter of tapering or exit will not go away. The prospect of a controlled exit is likely to be extremely challenging. If the markets force the Fed’s hand ahead of its schedule, as we expect, the second order effects on financial asset values could be as unprecedented as the Fed’s past five years of intervention.
Why gold now more than ever?
We believe the two year correction has created an unusually compelling entry point. The market is positioned in a very similar manner to the 2008 bottom which was followed by substantial returns for the next three years. Valuations of mining equities are at historic lows, which to us means that one is paying nothing for the potential upside in the gold price.
Rock bottom sentiment suggests extremely negative scenarios have already been priced into the metal and the equities. In our experience, investing against the crowd has generally been rewarding across all asset categories.
We also believe that the macro economic rationale for gold has never been stronger. Should the economy strengthen, inflation risks are high because of the political and practical challenge of shrinking the Fed balance sheet. Should the economy continue to sputter or turn down, the possibility of a financial market downgrade of sovereign credit would result in politically intolerable high interest rates.
Finally, severe pullbacks have typically set the stage for significant advances to new all-time highs.