Currency Intervention and the Leap-Year Gold Massacre

Although Fed Chairman Ben Bernanke would like for you to think otherwise, gold is immutably money.

Central banks hold it within strategic currency reserves, and are busily acquiring more. Observing the unsustainable deficit-spending that continues to plague U.S. fiscal policy, and the unprecedented campaigns of intervention conducted by the relevant central banks in response to the global debt crisis, one can hardly feign surprise at the resurgent role of gold as a counterweight to the impaired condition of the world's major paper currencies.

As much as Bernanke may like to promote the impression that the Federal Reserve maintains a dismissive attitude toward gold, a growing body of evidence tells another story entirely. On two particularly noteworthy occasions over the past year, the gold and silver markets exhibited behavior so thoroughly bizarre and deeply counterintuitive that even former skeptics were forced to acknowledge the likely hand of central banks in these dramatic sell-off events.

The first such event took place Sept. 6, 2011, when Switzerland's central bank declared it was prepared to "purchase foreign currencies in unlimited quantities" in order to prevent the Swiss franc from appreciating beyond the euro exchange rate of 1.20. On that same date, $740 million worth of gold bullion changed hands on the COMEX during just one single minute. I encourage readers to review my article "Is Gold Being Suppressed?" that revealed that even the head gold trader for Goldman Sachs considered the possibility of an official-sector role in gold's counterintuitive plunge.

The unforgettable Leap-Year Gold (and Silver) Massacre
If you ask me 10 years from now for a rundown of the most memorable moments in this entire precious-metals bull-market cycle, I'll place the events of Feb. 29, 2012, right near the top of my list. The astonishing circumstances surrounding the sell-off -- popularly dubbed the "Leap-Year Gold Massacre" -- were so divorced from normal market dynamics as to yield a chorus of memorable commentary from some surprising sources. It appears more and more market observers may be ready to concede that GATA was right all along.

To set the stage, it's important for readers to recall that this sell-off in gold and silver occurred on the very same day that the European Central Bank reported doling out $713 billion in low-cost, three-year loans to a staggering 800 financial institutions! Meanwhile, the financial headlines of the day were dominated by Bernanke's congressional testimony, and the purported revelation that further monetary easing may not be immediately forthcoming. Stunned by the ferocity of the concurrent sell-off, I spent the day surveying public reaction to the event within a blog post titled: "Gold Manipulation, Currency Intervention, and the Death of Free-Market Capitalism". And I wasn't alone.

Jean-Marie Eveillard, who manages some $60 billion in assets at First Eagle Funds, had this to say in an interview with King World News: "Usually I don't have much to say for bullion regarding day to day trading. But a move of $75 is somewhat striking. Central banks acknowledge they intervene in foreign exchange markets. They (central banks) sort of don't exactly deny, but they are very quiet about the fact that obviously they also intervene in the gold market."

After looking over the data, fund manager Eric Sprott noted in a separate King World News interview that the paper equivalent of 500 million ounces of silver changed hands on the COMEX that day. That included an astounding 225 million ounces -- or nearly $8 billion in market value -- in the span of just 30 minutes! For context, Sprott points out that "in one year the silver miners only produce 800 million ounces." Sprott then concluded: "No rational person could believe it had anything to do with the real market for silver."

Although the U.S. Commodity Futures Trading Commission's investigation into silver manipulation is now in its fourth year, Commissioner Bart Chilton has already stuck his neck out for silver investors by declaring publicly: "I believe that there have been repeated attempts to influence prices in the silver markets. There have been fraudulent efforts to persuade and deviously control that price."

How to succeed in this market
One might reasonably ask: Just what on earth am I thinking by continuing to invest in a market in which I perceive frequent price suppression that is coordinated by powerful and deep-pocketed Western central banks? To that question, I would respond in two parts.

For starters, the meaningful appreciation of gold and silver in U.S. dollar terms over the trailing decade confirms that any such price suppression is employed not as a mechanism to prevent the metals from rising in price. Even central banks have limits to the reach of their power. Rather, I share James Turk's view that intervention in gold and silver facilitates a "managed retreat" vis-a-vis the currency-related impacts of fiscal imbalances plus monetary and liquidity interventions.

Second, I believe that a maturing bull-market cycle combined with a constrained physical supply of the metals is eroding the efficacy of such measures over time, and in my view the increasingly obvious nature of those interventions coincides with a closing window of opportunity for the banks to engage in such practices. Patience, then, and the conviction to stare gut-wrenching volatility in the face without darting for the exits, are key hallmarks of a successful precious-metals investor.

Investors have a voice in the matter, and that voice is amplified through the offtake of physical supply. A strongly held stake in Central Fund of Canada (AMEX: CEF  ) , for example, theoretically disempowers price manipulation by gradually reducing the available physical supply of gold and silver as the basis for highly leveraged shorts in the paper markets. Sprott Asset Management also has a pair of physical bullion offerings that are likewise widely trusted as representing 100% unencumbered bullion. They are the Sprott Physical Gold Trust (NYSE: PHYS  ) and the Sprott Physical Silver Trust (NYSE: PSLV  ) . Tax implications for all three bullion vehicles must be well understood. First Majestic Silver (NYSE: AG  ) , whose management recently revealed to me the secrets to their success, offers silver bullion products through its website.

Before rushing to a popular vehicle like the iShares Silver Trust (NYSE: SLV  ) , Fools may wish to take note of recent research by Nanex -- the same firm that provided important insights into the "flash crash" of 2010 -- regarding extremely high-frequency trading that coincided with an unusually abrupt price-drop in the security on Wednesday. According to Nanex, the quote rate for the silver ETF exceeded 75,000 quotes per second during a 25-milisecond period. As if the precious-metals market were not already strewn with a sufficient array of hazards, now investors have to contend with countertrend raids by flash-crashing super-computers.

Thus far, it seems, no one can confuse honest money with easy money.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of First Majestic Silver. Motley Fool newsletter services have recommended buying shares of Goldman Sachs. The Motley Fool has a disclosure policy.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On March 24, 2012, at 8:43 AM, INVESTWISE2010 wrote:

    The Swiss Government intervened in the currency market and pegged the Swiss franc to the Euro as the Swiss franc kept going up relative to all other currencies and that was hurting Switzerland’s export competitiveness. The US government has been having a long standing dispute with China as it believes that the Chinese government is keeping the yuan down to stay competitive in its export markets. These are understandable courses of action although some may not agree that they are justified.

    Why should any country be threatened by a rise in gold prices? In a world where almost every country is debasing its currency, how does it hurt these governments if gold appreciates relative to their currencies.

    I would very much appreciate, if you would be so kind as to explain why governments feel threatened by a rise in price of gold.

  • Report this Comment On March 24, 2012, at 9:26 AM, ryanalexanderson wrote:

    > I would very much appreciate, if you would be so kind as to explain why governments feel threatened by a rise in price of gold.

    I can take a crack at explaining.

    As a non-consumed commodity, gold represents a relatively stationary point by which currencies are judged. Other commodities, like oil, can have their relative values affected by the ups and downs of the economy, so you can't use them as a benchmark.

    However, the supply of gold is relatively small compared to the total amount out there. When its price goes up and down, it's mostly due to investor perception. Not consumption demand. As many gold skeptics point out, gold is inedible. There is no bond coupon or yield on it. The -only- reason you expect to hold it is that you are losing faith in government issued currencies.

    So, people watch the price of gold as a gauge of currency sentiment. Sharp gold price increases beget inflation expectations, and these expectations beget actual inflation - loss of faith in the currency.

    And the government does actually want inflation. There is no other way they can get out from under the mountain of debt they've created. But they want the inflation to be slow and steady. And a skyrocketing gold price may begin a process that leads into a disorderly devaluation (hyperinflation). So, they try to keep tabs on it. But they did seem a bit heavy-handed this time, as Sinch and his citations pointed out.

    Or so I believe.

  • Report this Comment On March 24, 2012, at 10:28 AM, XMFSinchiruna wrote:

    Ryanalex,

    A reasonable attempt. Gold is first and foremost a currency, with the label "commodity" applying only in a secondary way. That's the real reason that it's an effective barometer for devaluation in paper currencies. I would also add that price dynamics and implications may be more direct that the indirect psychological mechanisms you portray. But to the extent that central banks will be keenly aware of the impact upon public perception of a sharply rising gold price, it is correct to focus upon the links between price and perception.

    Investwise,

    Central banks around the world are currently engaged in a race to debase their respective currencies. Because they can not be printed, gold and silver do not play along. Punctuated by Switzerland's move to remove its currency from contention as a viable safe-haven alternative, gold and silver represent the sole viable safe-haven currencies from the wealth-reducing impact of competitive currency debasement. To the extent they can forestall the appreciation of gold and silver, the notion that competitive currency debasement can proceed without consequence is thus reinforced. Suppression of gold and silver, then, is a means of masking the consequences of unsavory monetary policy.

    In former Fed Chairman Alan Greenspan's own words, gold is "the canary in the coal mine".

    http://www.fool.com/investing/general/2010/11/08/bernanke-fi...

    On a separate point, Investwise, please find my reply to your excellent question regarding total shareholder returns by Silver Wheaton:

    http://www.fool.com/investing/general/2012/03/23/43-million-...

  • Report this Comment On March 24, 2012, at 3:14 PM, INVESTWISE2010 wrote:

    Many thanks, Sinch and Ryanalex. That explanation has cleared much of my confusion. I would also like to understand why some other institutions seem to have a vested interest in not letting the prices of gold and silver appreciate.

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