Things That Make You Go Hmmm...
Twisted (By The Pool)
By Grant Williams
December 2, 2013
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"Give me control of a nation's money and I care not who makes its law."
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"Sunlight is the best disinfectant."
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"There is not a crime, there is not a dodge, there is not a trick, there is not a swindle, there is not a vice which does not live by secrecy."
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"Total transparency risks country's stability."
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"Telling the difference between transparent and invisible is an acquired skill. Until you've practiced, you can't make the choice between looking through and looking at."
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This is an early warning. I'm going to be talking about gold (again) this week, so those amongst you who just kinda wish I wouldn't do that may be excused.
There. Now it's just us.
On November 1, 1961, an agreement was reached between the United States and seven European countries to cooperate in achieving a shared, and very clearly, stated aim.
Actually, let me adjust that last paragraph ever so slightly in the interests of accuracy:
On November 1st, 1961, an agreement was reached between the central banks of the United States and seven European countries to cooperate in achieving a shared, and very clearly stated, aim.
Did you see what I did there? A small amendment, I'll concede, but an important one — particularly as, 52 years later, we witness the incredible power now wielded by those august institutions.
But back to November 1961 and those eight central banks.
The signatories to this particular agreement were, in alphabetical order, the central banks of Belgium, France, Germany, Italy, the Netherlands, Switzerland, the United Kingdom, and the United States; but unlike other agreements of the time — such as that signed at Bretton Woods in 1944 — this one had no catchy title and was agreed upon with no fanfare and no publicity. In fact, this particular agreement was, if not exactly secret, then secretive by design.
It was put into place after a sudden spike in the gold price from its "official" level of $35.20 to over $40 on concerns in late 1960 that whoever won the impending US election might devalue the dollar in order to address the country's balance of payments problem.
The agreement became known as the London Gold Pool, and it had a very explicit purpose: to keep the price of gold
The construct was a simple one.
The eight central banks would all chip in an amount of gold to the initial "kitty." Then they would sell enough of the pooled gold to cap any price rises and then replace that which they had been forced to sell on any subsequent weakness.
The United States — which at that stage owned roughly 47% of the world's monetary gold (excluding that owned by the Soviet bloc) — promised to match every other bank's contribution, ounce for ounce. The value of the US gold hoard was very easy to calculate, thanks to the fixed price of gold at the time ($35):
$17,767,000,000.
Or, put another way, roughly 6 days' worth of QE.
Or, put another way, roughly 6 days' worth of QE.
However, somewhat remarkably, only seven years prior, the United States' gold hoard constituted 72% of the world's gold (ex-those pesky Soviets) and was worth an additional $7,000,000,000. More than $5,000,000,000 had been sold between 1958 and 1960.
The other tiny problem, what with the dollar's being convertible into gold and all, was that official institutions, banks, and private holders abroad had roughly $19,000,000,000 of short-term and liquid dollar claims.
So... the US Federal Reserve offered to match the contributions of Happy, Bashful, Grumpy, Sleepy, Dopey, Greedy, and Doc the other seven central banks, which meant that, at its inception, the London Gold Pool looked like this:
Country
|
Contribution
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Tons
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Value (1961)
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United States
|
50%
|
120
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$135 mln
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Germany
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11%
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27
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$30 mln
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United Kingdom
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9%
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22
|
$25 mln
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France
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9%
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22
|
$25 mln
|
Italy
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9%
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22
|
$25 mln
|
Belgium
|
4%
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9
|
$10 mln
|
Netherlands
|
4%
|
9
|
$10 mln
|
Switzerland
|
4%
|
9
|
$10 mln
|
TOTAL
|
240
| $270 mln |
We interrupt this letter to bring you an important message from the Commodities Futures Trading Commission:
There is no evidence of manipulation in precious metals markets*
*Statement is subject to standard terms and conditions and is not necessarily reflective of any evidence. Government entities are excluded from inclusion based on the fact that we can't really do anything about them; and, anyway, they could put us out of business, and it would make things really, really bad for them.
Also, bullion banks are not covered under this statement because we were told they shouldn't be, but individual investors are, and we can categorically confirm that, to the best of our knowledge, no individuals are manipulating the precious metals markets (at this time).
We now return to our regularly scheduled programming.
Initially, everything ran smoothly, and the satisfied grins at those eight central banks must have been borderline sickening to behold. The chart of the gold price looked like this:
Source: Bloomberg
Now, of course, the members of the Pool had the help of the official gold price set by the Bretton Woods agreement; but market forces sometimes inconveniently dictate that prices don't behave as they're supposed to, and that means interested parties need to nudge things back where they need them to be.
The Cuban Missile Crisis in October 1962 (why do these crises always happen in October, I wonder?) tested the Pool's mettle (sorry, irresistible), and increasing tensions between Washington and Moscow hardly helped; but gold was sold to keep the price under control, and the Pool held firm.
(Man, if you were a gold bug back in those days, it must have been frustrating as hell to watch all these situations unfold that ought to have sent the price higher, only to see it languish. Good job... it's... not.... like..... that...... today?)
By the time 1965 rolled around, the London Gold Pool was creaking a little at the seams because — guess what? — the price pressure was in an upward direction and the Gang of Eight were selling far more bullion than they ever had the opportunity to buy back, which meant the Pool was becoming a Puddle.
Then, on November 18, 1967, after a day in which the Bank of England tapped its gold and dollar reserves to the tune of £200 million (equivalent to a little over $3 billion today) to defend the pound, Harold Wilson, Britain's Labour Prime Minister, decided that the 20 denials he'd issued in 37 months about the likelihood of a devaluation of Sterling constituted fair warning, and so he devalued the British pound by 14%.
Of course, his rationale for doing so was that it was in the best interests of "the people":
(Harold Wilson): Let me lay to rest the bugaboo of what is called devaluation.
If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.
The effect of this action, in other words, will be to stabilize the dollar.
Oh ... sorry ... I'm getting my landmark speeches by embattled leaders confused again. That was a different speech about why another devaluation wasn't going to affect a different country's population. (They never do.) What Wilson said was this:
(Harold Wilson): Our decision to devalue attacks our problem at the root, and that is why the international monetary community have rallied round.
From now the pound abroad is worth 14% or so less in terms of other currencies. It does not mean, of course, that the pound here in Britain, in your pocket or purse or in your bank, has been devalued.
"What it does mean is that we shall now be able to sell more goods abroad on a competitive basis."
After the devaluation, the flock to gold became even more pronounced (no surprise there), and before December 1967 turned into January 1968, Britain had been forced to sell 20x its usual amount of gold in the market to maintain price stability.
At this point, London and Zurich both banned the forward selling of gold even as desire to own the precious metal (or, more accurately, demand to NOT own currencies that might be devalued) reached fever pitch.
The Pool was forced to sell over 1,000 tons of gold in the market (equivalent to $1.1 billion in 1967 dollars — which used to be a lot of money); and, as if by magic, in a move that must have surprised nobody everybody, the French surrendered.
French President Charles De Gaulle and his famously feisty economist Jacques Rueff pulled France from the Pool and began exchanging every dollar they held for gold.
French President Charles De Gaulle and his famously feisty economist Jacques Rueff pulled France from the Pool and began exchanging every dollar they held for gold.
Hmmm...
Throw in the escalating Vietnam War, and the surge in demand for gold was ... what's the word? "Dramatic"? Yes ... but that's not quite it. "Momentous"? Yeah, closer, but still not quite there.
"Problematic"?
Bingo!
A Top Secret CIA memo ("Is there any other kind?" I hear you ask), declassified in August of 1997, provided some interesting perspective on what went on behind the scenes between the United States and its "oldest ally," France, as well as the extent of the now-quaint American paranoia towards communists:
(CIA): French government attitudes, and the actions of some French officials, were important factors contributing to the massive speculation against the dollar and the pound during the recent gold crisis. In the weeks immediately following the devaluation of the pound on 18 November 1967, the French fanned the speculative flames by leaking unsettling financial news to the press and may have encouraged some countries to convert their dollars into gold*.
* Throughout November-March crisis, the USSR, Communist China, and other Communist countries played a small role in Western gold markets. Reported Communist purchases of gold were about $47 million for Communist China and $143 million for the USSR and Eastern Europe. However, the absence of these purchases would not have significantly diminished the intensity of the rush against the monetary gold reserves of the gold pool members.
The memo went on to outline what America's oldest ally, France, had been up to in recent times:
Under De Gaulle, the French government has consistently opposed the dominant role of the dollar in international finance, has pressed for elimination of the US balance-of-payments deficit, and has called for an increase in the official price of gold and the use of gold as the only international reserve.
Sacre Bleu!!!
Over recent years, the French have converted nearly all their official reserves from dollars into gold, reduced their cooperation with the other financial powers by withdrawing from the London gold pool, and delayed agreement on and adoption of US proposals for increasing world reserves through creation of new international assets under the International Monetary Fund.
Over recent years, the French have converted nearly all their official reserves from dollars into gold, reduced their cooperation with the other financial powers by withdrawing from the London gold pool, and delayed agreement on and adoption of US proposals for increasing world reserves through creation of new international assets under the International Monetary Fund.
But of course there's a slight problem with central banks trying to manipulate the price of a physical commodity lower when it has both a finite supply and a relatively small and consistent annual production curve.
Actually, let me adjust that last paragraph ever so slightly in the interests of accuracy:
But of course there's a slight problem with trying to manipulate the price of a physical commodity lower when it has both a finite supply and a relatively small and consistent annual production curve.
Did you see what I did there? A small amendment, I'll concede, but an important one — particularly as, 52 years later, we witness the incredible power now wielded by those august institutions.
Something had to give, of course.
Philip Judge takes up the story:
On Friday March 8th [1968], London sold 100 ton of gold at market, up from around 5 ton on a normal day. The following Sunday evening, the pool released the statement "the London Gold Pool re-affirm their determination to support the pool at a fixed price of $35 per oz".
This was, of course, the financial equivalent of the under-fire football manager receiving the "full backing" of his chairman.
The end was definitely nigh:
Fed chairman William McChesney-Martin announced the US would defend the $35 per oz gold price "down to the last ingot". That week the London Gold Pool continued to fight the free market process and defend $35.20 gold. By midweek it had emergency airlifted several planeloads of gold from the US to London to meet demand. On Wednesday the London market sold 175 ton, 30 times its normal daily turnover, and by Thursday demand exceeded 225 tons.
OK. So we have a group of central banks fighting the free-market process, with a promise to essentially "do whatever it takes" to defend something.
History may not repeat, but it sure as hell does rhyme.
Back to the '60s we go:
That evening, emergency meetings were held in Buckingham Palace, with the Queen subsequently declaring Friday 15th March a "bank holiday". Roy Jenkins, Chancellor of the Exchequer, announced that the decision to close the gold market had been taken "upon the request of the United States".
Hmmm... a "bank holiday" declared on a Friday evening, after which time there was no access to gold for two weeks for anybody who owned it and didn't have it in their physical possession?
Yeah. Right... Like THAT could ever happen today???!!! <coughcoughcoughcypruscough>.
What happened next? Let's see:
The London gold market remained closed for two weeks, during which time the London Gold Pool was officially disbanded. During that two weeks, Zurich and French markets continued to trade with open market prices for gold exceeding $44 per oz (up 25% from London's official price of $35.20 per oz).
A fortnight later, an official "two-tiered" Price was announced to the world, where the official price of $35.20 would remain for central banks dealings, while the free market could find its own price, the London market re-opening again on the 1st April.
Yes, the "free market" price of gold was 25% higher than the level at which it had been maintained by the London Gold Pool. As De Gaulle no doubt said at the time, "Quelle surprise!"
By now, the chart of the gold price looked a little different from the one that had left the Pool members slapping each other on the back and congratulating themselves on a job well done:
Source: Bloomberg
Of course, as anybody with even a passing interest in gold knows, once the London Gold Pool cracked, dominoes began to fall in rapid succession.
De Gaulle's aggressive moves to perfect the gold backing France's dollar reserves was tolerated begrudgingly until it reached the point where others were starting to want THEIR gold, and that just wasn't going to be allowed to happen.
In August of 1971, Richard Nixon made his famous speech about devaluation, removed the gold backing of the dollar, left France and everybody else queueing up to get their gold twisting in the wind, and ushered in the age of pure fiat currency.
The parallels are frightening if you look at them closely enough — except that this time, rather than being backed by gold, the dollar is backed by "the full faith and credit of the United States government."
Yes ... the full faith and credit of the government of a country with public debts of $17 trillion ... and rising.
Yes, THAT government.
One difference, however, is that today, with no direct link between gold and confetti fiat currencies, there is of course NO official interference in the setting of the gold price.
Whatsoever.
No. Today, the gold price is set by the natural forces of market supply and demand.
Twice a day.
In London.
At something quite coincidentally called a "fix":
(Bloomberg): Every business day in London, five banks meet to set the price of gold in a ritual that dates back to 1919... The London fix, the benchmark rate used by mining companies, jewelers and central banks to buy, sell and value the metal, is published twice daily after a telephone call involving Barclays Plc, Deutsche Bank AG, Bank of Nova Scotia, HSBC Holdings Plc. and Societe Generale SA.
The process, during which gold is bought and sold, can take from a few minutes to more than an hour...
We interrupt this letter to bring you an important message from the vast majority of the mainstream media:
There is categorically NO manipulation of
*Statement is subject to standard terms and conditions and is not necessarily reflective of any evidence. Government entities are excluded from inclusion based on the fact that we can't really do anything about them and anyway; they could put us out of business; and it would make things really, really bad for them.
Also, bullion banks are not covered under this statement because we were told to turn a blind eye; but individual investors are, and we can categorically confirm that, to the best of our knowledge, no individuals are manipulating the precious metals markets (at this time).
We now return to our regularly scheduled programming.
Having laid out the mechanics of this airtight, foolproof, tamperproof solution to ensure fair pricing in the gold bullion market, the Bloomberg article gets a little more interesting:
Now, dealers and economists say knowledge gleaned on those calls could give some traders an unfair advantage when buying and selling the precious metal.
The U.K. Financial Conduct Authority is scrutinizing how prices are set in the $20 trillion gold market, according to a person with knowledge of the review who asked not to be identified because the matter isn't public.
Fascinating. Another snowjob on its way just in time for winter, no doubt.
BUT ... the problem is that, after the large fines recently levied against those found guilty of nothing at all untoward in the various manipulated markets, there are a few peccadilloes going on in the gold market that may make brushing this particular investigation under the carpet a little more difficult, now that they are in the public domain.
To wit:
The participants also can trade the metal and its derivatives on the spot market and exchanges during the calls.
'SCUSE me??? They can do WHAT, now???
Just after the fixing begins, trading erupts in gold derivatives, according to research published in September. Four traders interviewed by Bloomberg News said that's because dealers and their clients are using information from the talks to bet on the outcome.
"Traders involved in this price-determining process have knowledge which, even for a short time, is superior to other people's knowledge," said Thorsten Polleit, chief economist at Frankfurt-based precious-metals broker Degussa Goldhandel GmbH and a former economist at Barclays. "That is the great flaw of the London gold-fixing."
Participants on the London call can tell whether the price of gold is rising or falling within a minute or so, based on whether there are a large number of net buyers or sellers after the first round, according to gold traders, academics and investors interviewed by Bloomberg News.
It's this feature that could allow dealers and others in receipt of the information to bet on the direction of the market with a high degree of certainty minutes before the fix is made public, they said.
"Information trickles down from the five banks, through to their clients and finally to the broader market," Andrew Caminschi, a lecturer at the University of Western Australia in Perth and co-author of a Sept. 2 paper on trading spikes around the London gold fix published online in the Journal of Futures Markets, said by phone. "In a world where trading advantage is measured in milliseconds, that has some value."
In an age where such things are measured in milliseconds, I'd say an hour's headstart could be said to generate a slight trading advantage, yeah ...
The article goes on to say something that I couldn't even copy and paste with a straight face:
There's no evidence that gold dealers sought to manipulate the London fix or worked together to rig prices, as traders did with Libor. Even so, economists and academics say the way the benchmark is set is outdated, vulnerable to abuse and lacking any direct regulatory oversight.
Errrr ... one small point, if I may? It's probably nothing, but ... there wasn't any evidence of Libor being rigged until the regulators went looking for it aggressively and then, funnily enough, there turned out to be plenty of it.
There are two things about this "probe" that are worth highlighting:
Firstly, take it from someone who has worked in investment banks for the best part of 30 years; if a group of banks are offered a way to manipulate prices to their advantage in order to generate huge profits, they will.
Period (as Barack Obama would say).
Secondly, any investigation into gold price manipulation will differ from that into Libor, FX, or mortgages, in that a lower gold price directly benefits the government. Or, more accurately, a materially higher price directly impacts the government.
Secondly, any investigation into gold price manipulation will differ from that into Libor, FX, or mortgages, in that a lower gold price directly benefits the government. Or, more accurately, a materially higher price directly impacts the government.
Putting those two points together allows a potentially interesting conclusion to be drawn.
If we assume it is a given that, when offered an opportunity to manipulate a price in order to generate huge profits, a group of banks will take it; and if we assume that, just as the five-year investigation into silver markets managed to uncover no evidence whatsoever of price manipulation (despite some overwhelming evidence to the contrary, including Andrew Maguire's now-infamous mind-reading exercise), that the investigation into manipulation of the London Gold Fix will also end up without any charges being laid; then one could argue that the manipulation has been proven, along with government complicity.
(Yes, I know that sounds a little like something from the Middle Ages when witches were burned at the stake on the basis that if they didn't burn they were guilty and if they did burn they were innocent, but there is definitely no witchcraft at play here. Just conjuring tricks.)
... but so far the banks are batting 1000 when charged with manipulation of markets, and the Gold Fix is by far the easiest of them all, mechanically-speaking.
Believe me, it is a LOT harder to manipulate FX and Libor markets than it is the gold market ... just ask the signatories to the London Gold Pool arrangement.
Up to a point, anyway.
(Bloomberg): Spokesmen for Barclays, Deutsche Bank, HSBC and Societe Generale declined to comment about the London fix or the regulatory probes, as did Chris Hamilton, a spokesman for the FCA, and Steve Adamske at the CFTC.
Joe Konecny, a spokesman for Bank of Nova Scotia, wrote in an e-mail that the Toronto-based company has "a deeply rooted compliance culture and a drive to continually look toward ways to improve our existing processes and practices."
Folks, all banks have a "deeply rooted" compliance culture. The problem is that, when talking about them, the Australian meaning of the phrase "deeply rooted" is by far the most appropriate.
We've seen how the London Gold Pool operated (selling to cap the price and buying back on any weakness), but today's London Gold Fix is a real thing of beauty.
(Bloomberg): At the start of the call, the designated chairman — the job rotates annually among the five banks — gives a figure close to the current spot price in dollars for an ounce of gold. The firms then declare how many bars of the metal they wish to buy or sell at that price, based on orders from clients as well as their own account.
If there are more buyers than sellers, the starting price is raised and the process begins again. The talks continue until the buy and sell amounts are within 50 bars, or about 620 kilograms, of each other. The procedure is carried out twice a day, at 10:30 a.m. and 3 p.m. in London. Prices are set in dollars, pounds and euros....
The traders relay shifts in supply and demand to clients during the calls and take fresh orders to buy or sell as the price changes, according to the website of London Gold Market Fixing, which publishes the results of the fix.
So that's the mechanics of it, but what does the "gaming" look like, we wonder?
Caminschi and Richard Heaney, a professor of accounting and finance at the University of Western Australia, analyzed two of the most widely traded gold derivatives: gold futures on Comex and State Street Corp.'s SPDR Gold Trust, the largest bullion-backed exchange-traded product, from 2007 through 2012.
At 3:01 p.m., after the start of the call, trading surged to 47.8 percent above the average for the 20-minute period preceding the start of the fix and remained 20 percent higher for the next six minutes, Caminschi and Heaney found. By comparison, trading was 8.7 percent higher than the average a minute after publication of the price. The results showed a similar pattern for the SPDR Gold Trust.
"Intuitively, we expect volumes to spike following the introduction of information to the market" when the final result is published, Caminschi and Heaney wrote in "Fixing a Leaky Fixing: Short-Term Market Reactions to the London P.M. Gold Price Fixing." "What we observe in our analysis is a clustering of trades immediately following the fixing start."
The researchers also assessed how accurate movements in gold derivatives were in predicting the final fix. Between 2:59 p.m. and 3 p.m., the direction of futures contracts matched the direction of the fix about half the time.
From 3:01 p.m., the success rate jumped to 69.9 percent, and within five minutes it had climbed to 80 percent, Caminschi and Heaney wrote. On days when the gold Price per ounce moved by more than $3, gold futures successfully predicted the outcome in more than nine out of 10 occasions.
"Not only are the trades quite accurate in predicting the fixing direction, the more money that is made by way of a larger price change, the more accurate the trade becomes," Caminschi and Heaney wrote. "This is highly suggestive of information leaking from the fixing to these public markets."
I have nothing to add to that.
Except to say this:
Human beings, when given means and motive, have rather a poor history of eschewing the easy profit in favour of doing the right thing. Governments, when faced with dilemmas, have a rather poor history of doing the right thing as opposed to whatever they think they need to do in order to cling to power. It's quite simple.
Libor, FX rates, and mortgages trades are all fiat in nature. The contracts that are exchanged have no tangible value. (Yes, technically speaking, mortgages have houses underneath them, but the houses are so far down the securitization chain as to be invisible). Such contracts can be created at the push of a button or the stroke of a pen and manipulated easily right up until the point where they can't.
Gold is a different beast altogether.
The manipulation of the gold price takes place in a paper market — away from the physical supply of the metal itself. That metal trades on a premium to the futures contract for a very good reason: it has real, intrinsic value, unlike its paper nemesis.
If you want to manipulate the price of a paper futures contract lower, you simply sell that paper. Sell it long, sell it short, it doesn't matter — it is a forward promise. You can always roll it over at a later date or cover it back at a profit if the price moves lower in the interim.
And of course you can do it on margin.
If the trading were actually in the metal itself, then in order to weaken the price you would have to continue to find more physical metal in order to continue selling; and, as is well-documented, there just isn't so much of it around: in recent years what little there is has been pouring into the sorts of places from which it doesn't come back — not at these price levels, anyway.
The London Gold Pool had one thing in common with the rigging of the FX, Libor, and mortgage markets: it worked until it didn't.
The London Gold Pool proved that central banks can
Source: Bloomberg
The last time an effort was made to manipulate the price of gold lower than the market wanted it to be, it ended in a quick 25% spike in the price, followed over the next decade by the manifestation of those market forces in no uncertain terms and ending in a blow-off top some 2,332% higher than the price at which gold had been held for two decades.
If anything were to come of the supposed investigation into the gold price fixing and if charges were filed similar to those laid at the feet of the banks that admitted no fault in the Libor rigging, it would start a mad dash by owners of physical gold to take custody of their assets.
The problem with that eventuality is that currently there are almost 70 claims on every ounce of gold in the COMEX warehouse and serious doubts about the physical metal available for delivery at the LBMA.
The London Gold Pool was designed to keep the price of gold capped in an era when the world's reserve currency had a tangible backing. In defending the price, the eight members of the Pool were forced to sell way more gold than they had initially contributed in order to keep the price from going where it desperately wanted to go — higher.
This time around, the need for the price to be capped has nothing to do with any kind of gold standard and everything to do with the defense of the fractional reserve gold lending system, about which I have written and spoken many times.
Gold is moving to ever stronger hands, and when the dam does inevitably break again, the true price will be discovered by natural market forces, free of interference.
This time, however, those chasing what little gold is available will include all those central banks that have kept their holdings "safe" in overseas vaults.
The Bundesbank has seen the writing on the wall and demanded its gold back. They were told it would take seven years before their 30 tonnes could be returned to them.
My guess is, this little scheme doesn't have seven years left to play out.
Everybody outta the pool!
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