Gold: Sending Out False Signals

In a recent article in Grant’s Interest Rate Observer, "Old Money for a New Era" refers extensively to our February ’99 "Spin Meisters" article on conditions in the gold market. Since these appeared, the UK Treasury announced a multiple year sale of more than half of its gold reserves. The announcement broke the back of a promising rally in the gold shares and sent the metal back to retest multiple year lows. Since the UK news, many others have been suggesting, in various ways, the plausibility of gold price manipulation.

For example, a recent note from Bridgewater Daily Observations shows that the spread between US Treasury inflation indexed bonds and Treasury nominal bonds has widened steadily this year while the gold price has trended lower. Bridgewater cites similar discrepancies in many other indicators including foreign bond markets and numerous commodity indices. Also noteworthy is the resurgence in cyclical stocks likely to benefit from a return of pricing power. The recent CPI report is another harbinger, although it is only one month of a volatile series.

Gold is the premier instrument for discounting inflation, but it is not the only one. The importance of gold price manipulation, which can only be inferred from the forgoing, is the magnitude of the potential opportunity that gold represents. The community of interests that have shorted gold, including the various gold producers, depends heavily on a point of view as to how the gold price will behave. One would not sell forward, write calls, or engage in a gold carry trade without strong conviction that the gold price will trade in a certain range or trend lower. The distinction between forceful wishful thinking, which creates self-fulfilling results and outright collusive behavior, is not important. What matters is that the premise of the bearish case for gold, endless official selling/leasing, which is in itself extreme and unlikely, wholly ignores the possibility of awakening investment demand. As to gold demonetization, the shorts might wish to ponder Alan Greenspan’s May 19th statement before Congress supporting gold’s role as money of last resort.

What is at risk for the gold shorts is the continued plausibility of a low interest rate/ benign inflation environment. Rampant money creation in the US, Japan, and Europe has inflated prices of financial assets, while deflation in emerging markets has dampened traditional inflation measures. Rising interest rates will decrease the attractiveness of financial assets and divert flows into commodities, real estate, and other hard assets. Gold will not be excluded, irrespective of official sector actions. Financial markets have developed a nasty habit in recent years of sudden, sweeping shifts of opinion. The gold bears are out on a limb and at increasing risk. The downtrend in gold is fueled only by their resolve to build even larger short positions. Bearish sentiment is as thick as Internet euphoria, and the opportunity in gold has never been greater.

The Grant’s article linked here provides an extensive discussion containing our views and those of others on how the gold market is being influenced by bullion dealers, gold producers and central banks. One must conclude that the normal inflation discounting function of gold has been temporarily short-circuited by specific and temporary technical and structural factors. The closely watched gold price is throwing off false and misleading signals to the financial markets and policy makers. Price manipulations are inherently unsustainable. Once the manipulators run out of ammo, i.e. credit and credibility, the price adjustments will be sudden, high magnitude, and irreversible.


John Hathaway


May 1999
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