If automatically dismissing allegations about the suppression of gold and silver prices as tinfoil-hat madness helps you to sleep better at night, then I wish you sweet dreams.
If you prefer to consider the evidence on the merits; and draw your own conclusions, then you will want to read on.
A recent extraordinary hearing held by the Commodity Futures Trading Commission (CFTC) to discuss the need for position limits in metals futures morphed unexpectedly into what I will argue was the grandest expose of potential fraud in modern financial history.
A little background
There is not an investor among us who has not been deeply disappointed by revelations of shady dealings in the financial sector over recent years. The list of prior assumptions about the economic landscape that people have been forced to begrudgingly shed stretches out like a list of Bernie Madoff's unsuspecting victims. We've witnessed the forensic discovery of Lehman's pre-collapse book-cooking, and now Goldman Sachs (NYSE: GS ) has admitted (and defended) its role in disguising some of Greece's sovereign debt woes.
Given a financial industry so awash in systemic impropriety, perhaps the notion of a scheme to manipulate and suppress the prices of gold and silver isn't so loony after all.
I have been tracking this topic for several years, and we would need to sit down over a gigantic cup of coffee to pore over all the verifiable evidence amassed by researchers like GATA (Gold Antitrust Action Committee), John Embry of Sprott Asset Management, silver analyst Ted Butler, and many others.
Fools may recall GATA from a full-page ad that appeared in the Wall Street Journal in 2008 calling for an independent audit of the United States' gold reserves. GATA also "seeks to disclose and publicize the huge speculative short positions in gold taken by financial institutions and bullion banks" and has spent more than a decade compiling evidence of gold price suppression.
One year ago, GATA board member Adrian Douglas issued a seminal report entitled Pirates of the COMEX, in which he deduced by comparing two sets of government-supplied data that JPMorgan Chase (NYSE: JPM ) and HSBC (NYSE: HBC ) were the principle holders of derivatives in precious metals. When only two entities control 85%-100% of a futures market segment, as Douglas alleged, they can effectively control the price of the underlying commodity. Fools eager to dig further into the reams of evidence pointing to price suppression in gold and silver are encouraged to visit my CAPS blog post here for a collection of relevant links.
They finally have a whistleblower
Whereas this research has come from the outside looking in, during the CFTC hearings the world was finally offered a glimpse from inside the alleged manipulation process. Andrew Maguire, a professional metals trader in London, has claimed colleagues from JPMorgan Chase bragged of their ability to knock down the price of silver at will.
On February 3, 2010, in an email message posted here on GATA's website, he reportedly informed the CFTC's enforcement division of a manipulation event that would occur two days later when U.S. non-farm payroll data was released. He apparently then followed up with detailed insight into the process while it was occurring.
Ultimately dissatisfied with the CFTC's response to his communications, Mr. Maguire alerted GATA of his allegations ... which were then made public by GATA Chairman Bill Murphy during the recent hearings.
But wait ... the story gets bigger still.
Is your "physical" gold or silver leveraged at 100:1?
A critical exchange occurred after GATA's Adrian Douglas chimed into a conversation with his assertion that the leveraged market for physical metal is essentially a game of "paper backing paper." The underlying argument here is that the volume of gold traded daily at the London OTC metals exchange (LBMA) is so large (at about 20 million ounces of gold per day), that in fact the over-the-counter market for "physical" metal can not possibly be backed on a 1:1 basis by actual physical supply. As Mr. Douglas asserts: "it's fractional-reserve accounting, and you can't trade that much gold -- it doesn't exist in the world."
Jeffrey Christian, founder of commodity consultancy firm CPM Group and "one of the world's foremost authorities on the markets for precious metals," brazenly confirmed Douglas' characterization of the metals market:
The previous fellow was talking about hedges of paper on paper and that is exactly right. Precious metals are financial assets like currencies, T-bills, and T-bonds; they trade in the multiples of a hundred times the underlying physical and so people buying them are voting and giving an economic view of the world or a view of the economic world.
In case you're thinking that Mr. Christian surely must have miscommunicated his intended point, he clarified most pointedly:
People say, and you heard it today, there is not that much physical metal out there, and there isn't. But in the "physical market," as the market uses that term, there is much more metal than that. There is a hundred times what there is.
I repeat: "There is a hundred times what there is." Did he learn from Bill Clinton what the definition of is is? I sure hope that kind of leverage never comes toppling down the way lesser leverage did in the mortgage securitization industry. Not to fear, assures Mr. Christian while commenting earlier on the short segment of the market, "there are any number of mechanisms allowing for cash settlements." It appears that he actually perceives no structural problem inherent in a metals market that would seek to deliver cash in lieu of physical bullion to investors who may be inclined to call this paper bluff. In some circles, one could call that for what it would be: default.
Fools may recall a couple of instances in 2008 when physical supplies of bullion were very tight even as spot prices were mired in weakness. I believe that kind of anomaly results from an enormous disconnect between a leveraged market for paper gold and a much smaller market for actual, hold-it-in-your-hands physical bullion.
Taking it all in
If you have never considered the topics of price suppression or leverage in silver and gold before, this is a lot of material to process all at once. I believe that these revelations place this entire leveraged house of cards at risk. Conceivably, all it would take would be a few deep-pocketed investors overseas to call the market's bluff by demanding physical delivery of bullion, and the world's major futures exchanges could break down before our very eyes. Adrian Douglas points out that the LBMA exchange in London alone trades some $5.4 trillion per year in "gold" on a net basis. If the leverage of paper instruments to bullion stands anywhere near 100:1, then the implications are sufficient to make the Enron debacle look like child's play. Without mincing words, if the supposed quantities of gold and silver bullion simply are not there, then we may witness the greatest incidence of fraud in financial history.
Investors with exposure to the popular gold and silver "bullion" proxies have some very critical assessments to make. Fools are encouraged to note that HSBC is the custodian for the holdings of the wildly popular SPDR Gold Trust (NYSE: GLD ) . On the silver side, we have JPMorgan Chase serving as custodian for the holdings of the iShares Silver Trust (NYSE: SLV ) . Both trusts indicate that underlying metal holdings are held on an allocated basis for the trusts, although the silver vehicle permits some 1,100 ounces of unallocated silver per trading day. This allocated nature of the holdings is enough to reassure many investors, but I still have my concerns.
For my part, I have consistently stated my preference for Central Fund of Canada (AMEX: CEF ) , which has been around since 1961, and offers the magic words that discerning precious metal investors pine for. The fund holds "allocated, segregated and unencumbered gold and silver bullion and does not speculate in gold and silver prices". Another compelling alternative, the Sprott Physical Gold Trust ETV (NYSE: PHYS ) , was launched recently by the very firm that has been a vocal advocate for terminating the manipulation of the gold price for many years running.
Please stay tuned for additional analysis of this tremendously important topic, which holds further implications far beyond what I have discussed above. Please also share your reactions by voting in our Motley Poll, and by posting your comments below.