A Gold conspiracy? - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
A Gold conspiracy? A  A  A
23 JUNE 2008

The financial world has been in trouble since the Bear Stearns hedge funds blew up in August 2007. Bear Stearns itself imploded and had to be rescued by a US government sponsored bail out.

The world has been on a shaky wicket for the past 10 months.
Oil has risen to record highs.
Wheat had risen to record highs - and declined by over 30% since then. But wheat prices are still higher than where they were in the year 2006.
Also true for rice.
And gold?

Well, this is a bit of a mystery.
The chart from Bloomberg shows that, since July 31, 2007, oil has risen by 85.8%, gold is up 34.6%, and the global stock markets (as depicted by the MSCI All Country World Index) are down 3.7%.

Now, I can understand why the stock markets are down. With all the uncertainty in the world and the way the banks are raising capital to stay in business, it is easy to justify stock prices beaten down.

And one can make a case for oil prices to be firm - though USD 130 does seem a little too high to me. While those who are bullish on oil are correct to say that oil demand is increasing, I think a lot of the increase may have to do with oil producers holding back on supplies. Buying activity in the oil financial futures market may also be making oil prices a little bubbly. But there is a case for rising oil prices.

But gold? Why is it flat since March 2008? The global financial crisis has not disappeared. By most estimates we are not even half-way through the long dark night.

The central banks have little idea what to do. On one hand they have inflation from their years of happily printing money to save the banks; on the other hand they have the issue of dealing with a slowing economy and lower job creation.

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The logical conclusion in any such situation would be to dump the currency notes and move into gold.
This means that the price of gold should still be increasing.
Well, it is not.
Gold is moving like a dead animal. Which is to say: it is not moving.

The gold conspiracy?
I started to read up some more on gold - and spoke to a few "gold bugs", people who have dedicated their lives to investing in gold. Effectively, these "gold bugs" are taking a bet against the ability of the central banks around the world to act rationally.
So, I must caution you, their comments may be very biased - and not necessarily a reflection of reality.

The conspiracy theory on gold alleges that central banks around the world don't want people to lose faith in paper currencies.
So they play around with the only other alternative currency that exists: gold.

Central bankers don't own huge stocks of oil or rice or wheat. When the prices of these commodities increase - as they have in the past 2 years - they stand back and blame it on demand dynamics, supply problems, or speculation.
But when gold increases in price, the central banks can act very quickly.
Because they own a lot of gold.
Gold that is stored in vaults in USA and Europe.

No one really knows how much gold they own - or which central banks own it.
Ed Wener (in an article written in the year 2005) suggests that central banks own about 1 billion ounces (31,000 tonnes) of gold. His study showed that central banks sell anywhere between 180 tonne to 350 tonnes of gold in any given year. Assuming an average gold sale of 250 tonnes per year, it means that the central banks can sell gold for 120 years to depress the price of gold.

The problem is that, if the central bankers sell all their gold, then what is the paper currency they issue worth?
Well, one could argue that it is paper currency and there is no gold standard - no backing of any gold for every paper note printed - so why should there be gold behind the currency notes? Paper currencies move on faith.
But, human psychology - and rational behaviour - would tend to have more faith in paper currencies that have some gold behind them that in currencies that have no gold behind them.
So, while still paper, the currencies in use are seen to be more valuable than the money we use in monopoly. Because of the gold behind them.

Breaking the faith?
Unless of course, getting back to the original thesis, the central bankers in the world are trying to break our faith in gold.
And they do this by arranging to "lease" gold to the large commodity players at very low rates. And for large quantities.

So, if you are a commodity broker you go "short" on gold. You agree to sell more gold than the gold you actually can deliver.
This sale by the commodity broker puts a pressure on the price of gold - it falls. The broker makes the profit on his "short" as the price of gold declines.

If, for any reason, there is a willing buyer at the other end who buys all that there is to sell, the commodity broker calls the central banker and asks to activate the "lease". Gold is lent or "leased" by the central banker to the commodity broker. The broker gives the buyer the physical delivery of the gold.

The commodity broker is happy to always go short on gold. They know that, in case there is a large demand and they are in a "short squeeze", they can get as much supply as possible. From central banks.

There is never any shortage of gold - the central banks are willing to step in and supply as much as the buyers want. Remember they have over 1 billion ounces of gold.
And very few people have, at USD 900 per ounce, the USD 900 billion in value required to clear out all the gold in the vaults of the central banks.

As an aside, if every oil-producing nation sold all the oil they produced in one year they could buy all the gold in the central bank vaults.
So, while USD 900 billion is a lot of money but - in 10 years - all the oil producing nations could afford to buy the gold from the central bankers.

But, till then, the central bankers may be acting in concert to depress the price of gold, allege the "gold bugs".

The conspiracy theory may be right - or may be a figment of one's imagination. I don't know.
But the price charts of gold, oil, rice, and wheat are interesting.

Central banks cannot break the price of the other commodities as they have no stock lying in their vaults. But they can break the price of gold. They have a fair amount of gold in their vaults. And by breaking the price of gold, they maintain the price of their paper currencies.

Maybe these "gold bugs" are crazy people. Or maybe they are sensible people who sound crazy because the idea of a central bank cheating on its own people sounds far-fetched. Who knows?
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Note: Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Private Limited.

Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments.

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