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Urban Legends and Gold

Bob Moriarty
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Jul 13, 2012

There are urban legends that have been around for years. Most gold bugs accept them without the least question. The most endearing and enduring is the mythical “GOLD SHORT” position, first of Long Term Capital Management and now of JP Morgan.

Bill Murphy lost a lot of money in copper and was without employment and came up with a brilliant idea back in 1999. He would start two websites. One would champion the GOLD IS MANIPULATED theory and was the base for GATA. That was a public service site. He had a companion paid website called La Metropole Café where he will share his wit and wisdom with you for a mere $299 per year.

Basic to his loudly proclaimed theory that the world faced an imminent GOLD DERIVATIVES TIME BOMB that could go off at any moment was his claim that he was in Central Park in New York in mid-1998 and overheard someone talking about a 400 ton gold short position held by LTCM and that’s why the company went bankrupt and collapsed in September of 1998 after the Russian Financial Crisis.

Recently a variation of the same urban legend has emerged but now it’s Thomas Pascoe of the Telegraph mumbling on about how JP Morgan was short some mythical two tons of gold in early 1999 and that’s why the Bank of England sold their 400 tons of gold, to bail out the mythical short position of two tons.

“One of the most popular trading plays of the late 1990s was the carry trade, particularly the gold carry trade.

In this a bank would borrow gold from another financial institution for a set period, and pay a token sum relative to the overall value of that gold for the privilege.

Once control of the gold had been passed over, the bank would then immediately sell it for its full market value. The proceeds would be invested in an alternative product which was predicted to generate a better return over the period than gold which was enduring a spell of relative price stability, even decline.

At the end of the allotted period, the bank would sell its investment and use the proceeds to buy back the amount of gold it had originally borrowed. This gold would be returned to the lender. The borrowing bank would trouser the difference between the two prices.

This plan worked brilliantly when gold fell and the other asset – for the bank at the heart of this case, yen-backed securities – rose. When the prices moved the other way, the banks were in trouble.

This is what had happened on an enormous scale by early 1999. One globally significant US bank in particular is understood to have been heavily short on two tonnes of gold, enough to call into question its solvency if redemption occurred at the prevailing price.

You have to wonder why Pascoe would be worried about JP Morgan and any $20 million dollar investment. That’s all a couple of tons of gold was worth in 1999. $20 million is what JP Morgan tips the shoeshine boy; they don’t get the BOE dumping hundreds of tons of gold on their behalf. I’m not even sure how anyone can be “heavily short.” You are either short or long; you can’t be a little short or a lot short. JP Morgan doesn’t give a rat’s ass about any $20 million dollar investment.

Unfortunately and this is going to make me really unpopular, it’s simply not true that either LTCM or JP Morgan was hurt by a gold short position. If they held a gold short position either in September of 1998 for LTCM or early 1999 for JP Morgan the positions would have had to be profitable. For whatever reason the BOE sold gold, it had nothing at all to do with JP Morgan in a money losing gold short position.

It’s an urban legend. No one that I know of besides me ever worked out the math or even thought about it and that includes some of the biggest names in the business. Being gold short in Sept of 1999 or early 1999 mathematically had to have been profitable in any time frame from 1985 on. Actually it would have been profitable for any timeframe from 1980.

Let me prove it to you. No overheard conversations in Central Park, no agenda, no trying to get people to pay for my website, no investing in rumors.

The lowest price gold got to in 1985 was about $285 around May 1, 1985. So if you shorted gold at $285 at the lowest price for gold in 1985 and you had to cover at $265 on September 23, 1998, the day of the bailout, an average investor would conclude you actually made $20 an ounce. So if you short 400 tons of gold as Murphy has claimed LTCM did for a dozen years, you would have been at least $257 million dollars better off.

But not really because people who actually understand how commodity markets work realize at once that if you short at $285 in 1985 and cover at $265 in 1998, you haven’t taken into account the contango. The contango for gold always was positive. It meant that if you shorted gold at the lowest price in 1985 for delivery in a year you have a spot price of $285 but you are selling for something like $295 or $305 for delivery in 1987 or $325 for 1988.

The longer time position, the higher the price of gold. So in theory, if you shorted gold in 1985 at the lowest price of the year for delivery in 1999, you probably got $350 to $400 an ounce. You could not possibly have lost money in September of 1998 or early 1999 being short. And every year after 1985 the price of gold was higher. So if you shorted at the very lowest price in 1985, you may have had a problem in 1986 or 1987 but for certain, the position was profitable in 1999 when gold was the lowest price in 20 years.

But who’s going to let a little logic get in the way of a great story. The gold derivative time bomb and the LTCM and now JP Morgan mythical gold short position are the most popular of the urban legends around gold but not the last. I always enjoy reading about “NAKED SHORTS” and 100 times as much silver is sold on the commodity markets as is delivered. Both claims are true but both are utterly meaningless.

Commodities trading is a zero sum game. For every trade, there is a short side and a long side. While it’s true that someone may have a naked short position where they have no intention or ability to deliver the silver, it’s just as true and just as meaningless that there is a naked long on the opposite side of every trade.

People shouting at the top of their lungs about “NAKED SHORTS” in a piercing shrill voice are doing nothing but advertising their ignorance. There are naked shorts and just as many naked longs and it simply doesn’t matter. The primary purpose of the exchange is to determine price, not move commodities around. If you look at the news and see record high temps in Iowa and buy a corn contract, you don’t really want the corn, you are merely speculating on the price of corn. The last thing you want is to have a railcar of corn dumped on your front lawn. If you sell a contract of corn, likewise you don’t expect someone to demand you show them your garden in the back 40.

Even Eric Sprott didn’t go to the commodities exchange to buy his tens of millions of ounces. If only one person out of a hundred actually takes delivery, that’s no proof that there is something funny going on. The same thing is true of corn, wheat, cotton, copper and everything else. No one takes delivery. One in a hundred contracts actually being delivered is a lot, not a little. Eric Sprott knows what price to pay from silver from the actual trades being made but he doesn’t take silver from the exchange.

So when you see someone mumbling about naked shorts and how more silver is sold than delivered, you know at once that you are listening to noise, not information that you can use in profitable trading.

Gold bugs love manipulation and love talking about it but if you were a buyer of gold at $252 in August of 1999 or silver at $4 in December of 2001, you have made a lot of money when you sell. Everything is manipulated and no one has lost a dime based on silver or gold being manipulated down. It’s just not so. All commodites go up, all commodities go down. There are many reasons why. Manipulation of gold and silver, if true, has been the biggest failure of the last dozen or so years if someone was trying to knock the price down.

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Bob Moriarty
President: 321gold
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