CFTC's March 25th Hearings on the Metals Markets

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The CFTC (Commodities Future Trading Commission) held hearings on March 25th on whether to set controls on metal's trading in the U.S. futures markets. A representative from CME (Chicago Mercantile Exchange) testified that the CFTC's attempt to put hard limits on speculative activity in the U.S. metals markets is an attempt by the government oversight agency to overstep its bounds. A spokesman for HSBC claimed that limits on metal trading were simply unnecessary. The CFTC itself said it continues to look into allegations of market manipulation in the silver market in the summer of 2008.

The CFTC has previously held hearings on setting trading limits in energy and agricultural commodities. One of the reasons that the CFTC claims it needs to set position limits in trading is because of the finite supply of any commodity. The limits are supposedly protecting the market (from itself apparently) and the CFTC claims that government bureaucrats know more about how trading should be done than market participants. While there are actual glaring examples of how the gold and silver markets are manipulated by the big players, these are rarely on the CFTC's agenda. Like the other major market regulatory body, the SEC, the CFTC just doesn't seem to notice the behavior from the big money insiders that really distorts the market. For instance, CFTC hearings last summer on energy focused on ETF UNG, which held 20% of natural gas futures contracts. Even though this was an investment vehicle heavily used by small investors, the CFTC decided it was a danger to the integrity of the markets, as opposed to the trading activities of the big banks and hedge funds. The SEC took the same approach by paying limited attention to Bernie Madoff's $65 billion investment scam for almost two decades, but during the same period was very likely to use its resources to investigate some dentist in New Jersey who suspiciously bought a 1000 option contracts and made a couple of bucks.

The CFTC's concerns with energy and agricultural trading are obviously politically motivated. Politicians want to keep the prices of these commodities down since they are necessities and the source of destabilizing inflation. The UK prime minister and French president actually wrote a widely circulated article about how energy prices need to be determined by the big government's of the world just before the CFTC's energy hearings last summer. The U.S. had price controls on energy commodities in the early 1970s and the results were long lines at gas stations and fuel shortages. Under pricing in the markets always leads to trouble down the road.

The excuse for the CFTC considering limits on metal trading is even less justified than for energy or agriculture. As the HSBC representative pointed out, metals are not wasting assets that are consumed and then no longer available as is the case for oil and food commodities. Metals get recycled. Almost all of the gold that has ever been mined is still thought to be in existence. Higher prices increase the recycling rate and bring more supply to market, so the markets for gold and silver are self-correcting. While 50% of silver is used for industrial purposes, only 13% of gold is employed for manufacturing practical items. Most gold is used to make jewelry. Does the gold market need to be controlled, so the rich can be assured of getting good prices on holiday presents?

The CFTC is also not looking at where the actual manipulation is taking place in the gold market. This is done through central bank leasing to the large banks and hedge funds. They lease the gold for a small price and then can sell it on the market to raise some quick cash. This activity held down the price of gold in the 1990s and the early 2000s. The price of gold rose as leasing activity diminished. Artificially lowering the price of a commodity doesn't seem to come under the definition of market manipulation as far as the CFTC is concerned. Central banks, large international banks and big hedge funds also seem to be citizens above suspicion as Madoff was for the SEC.

While the CFTC is looking into manipulation into the silver markets, it may not mean that much. This is probably happening because silver investor Ted Butler has worked tirelessly to bring the situation to the public's attention, thereby putting some heat on the agency. How much the CFTC actually looks this time has yet to be determined. The SEC investigated Madoff many times, but just couldn't discover his blatantly obvious crooked activities. For some time, two big banks have frequently had huge short positions in silver futures -seemingly bigger than the Hunt Brother's who were convicted on federal charges on manipulating the silver prices in the 1980s. The CFTC has already investigated silver twice before in the 2000s and didn't find any irregularities. The SEC investigated Madoff more than two times.

Steve Sherrod, acting director of surveillance at the CFTC’s division of market oversight noted in today's hearings that when Comex silver prices fell sharply in the summer of 2008 that there was no significant change in the total long or short positions in the commitment of traders’ positions in the agency’s weekly data. Nor was there a significant change in open interest during the period of July and August 2008. Sherrod tried to explain away this seeming impossibility by stating, “One could explain a change in short open interest on the BPR (bank participation report) by a change within the classification system; if the usage code changed from non-bank to bank for a trader with a short position, then an increase in the short open interest would appear on the BPR, without any change in the COT (commitment of traders) Report. Another explanation would be a merger or acquisition where a bank assumes the position of a non-bank entity, both of whom were under the same commercial classification. That may not result in a change in open interest and may not result in a change in aggregate position within a COT classification. But it may result in an increase in the reported position on the BPR.”  Readers should carefully note Sherrod's wording (and language that seems more geared to hide what is going on than to clearly explain it). While this may have been what happened, Sherrod indicates that it also may not have been what happened. So how does this enlighten us?

The small investor shouldn't expect much, if anything, from the CFTC. It is realistically a government body that uses its powers to protect the big money interests, although it will claim that whatever it does is to benefit the public. Markets can also not be controlled without serious negative consequences. Government's have attempted to do so hundreds of times throughout the ages and it has never worked. Most commodity trading is international as well (natural gas is an exception), so restrictions in trading in the U.S. means that business will just move overseas. In this doesn't happen quickly enough, shortages will appear. You will have the CFTC to thank for them when they do.

Disclosure: None

NEXT: Euro Zone Support Package Doesn't Solve the Problem

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Real Story About Gold Supply and Demand

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

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Just once I would like to see a media article that had a accurate supply and demand analysis for a commodity. Usually reporting is completely one-sided with only supply or demand discussed out of context. No matter how much detail is provided for one, it is meaningless unless you have information on the other. Media coverage of oil is notorious for providing this incomplete picture. The gold market is apparently not immune to it either.

Media reports today include "Gold Demand Falls 34% in 3rd Quarter: World Gold Council". A dire picture of falling demand for gold is painted. Supply issues are at least lightly, albeit very incompletely broached. While you are left with the impression that this news should be devastating for gold prices, if you check you will see that gold had a nice rally between July and September. Anyone who took the first week of economics 101, would immediately conclude the supply versus demand picture must have improved. Reporters are most likely to have been journalism or English majors and may not have even the rudimentary knowledge needed to be aware of this. They frequently miss the real story for the same reason.

Much is made in the gold supply figures about a drop in Indian demand, down 42% to 111.6 metric tons year over year in the third quarter. Not mentioned was that there are times that are considered inauspicious for buying gold in India and that period was twice as long in Q3 2009 as it was in Q3 2008. India consumer demand for gold is followed closely because it has been the number one source of demand for gold from seemingly time immemorial. However, World Gold Council figures indicate that the Chinese bought 128.6 metric tons of gold in the third quarter of this year outpacing the Indians. A little research also reveals that the Chinese bought more gold in the first half of the 2009 than the Indians as well. Retail price controls were only abolished in China in 2001 and since then consumer gold purchases have consistently outpaced GDP growth. China is clearly becoming the top market for gold knocking India off its perch. This is a big story. While that's the the headline you should be seeing, that's not what is being reported.

The World Gold Council also claims that investment in gold coins and bars were down 31% year over year and gold ETF inflows were down 72% year over year in the third quarter. If this is true, something has to be taking up the slack, either more demand elsewhere or decreasing supply. This is some vague reference in their press release about financial instruments and dehedging somehow creating more demand for gold. The specifics are not stated though. Hedging by mining companies is indeed dropping rapidly falling from 530 metric tons in Q3 2008 to 359 metric tons in the third quarter of this year. Barrick Gold (ABX) has been closing out its large hedge book and this has been helping to push gold prices up lately. Closing out hedges has the same effect for commodities as short covering does for stocks.

Miner hedges are only the tip of the iceberg however when it comes to short covering in the gold market. Mining hedges represent only around 20% of central bank leasing for gold. Central banks have been lending out their gold for years to miners, big banks and hedge funds (this is how they make money on their holdings). This usually results in an immediate sale of gold on the market and this was a major factor in keeping gold prices down in the 1980s and 1990s. Leasing has been in rapid decline during the 2000s however and you may have noticed the price of gold has gone up as leasing has diminished. It is estimated that there were 4300 metric tons of gold leased by central banks in 2004 and this was down to 2345 tons by the end of 2008.

The World Gold Council admits gold supply fell 5% in the 3rd quarter. There have been 3 main sources of market supply for gold in the last two decades - mining, scrap and central bank selling. So far gold mine production peaked in 2001 and then dropped year after year. It looks like it will be up this year. Supply from scrap is highly variable. Sales were 569 metric tons in the first quarter of this year, but were down to 283 tons in the third quarter. Central bank selling seems to have turned into net buying. Central banks accounted for 14% of gold market supply just a few years ago. This fell to 8% in 2008. Central banks bought a net 15 metric tons of gold in the third quarter of 2009 (this doesn't have anything to do with the Indian central bank purchase of 200 tons of gold recently, that took place in the 4th quarter). Central banks shifting from being a source of supply to a source of demand represents a major sea change for the economics of the gold market - something else that is worthy of headline coverage.

Spot gold has reached as high as $1153.90 recently and has been hitting one all time high after another in the 4th quarter so far. The market tells you what the actual supply demand picture is quite clearly. If it contradicts the information you are receiving, it is because that information is incomplete or wrong. Believing otherwise is a sure way to lose money.

Disclosure: Long gold, no positions in ABX.

NEXT: U.S. Interest Rates Go Negative Again

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21


This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The January 8th Meeting of the New York Investing meetup

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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The New York Investing meetup monthly meeting on January 8th had a record turnout of 200 people. The first talk was our view for the stock market in 2009. This was followed up by an excellent talk by Jeff Glenn on manipulation in the gold and silver markets. The final talk was on the latest scandals, including Madoff, Dryer, and Saytam compter, recent economic figures and then a review of some Saint Louis Fed charts that clearly show the financial sytem is in serious trouble.

While the indicators for the U.S. stock market were highly negative in the beginning of 2008, they were essentially neutral for 2009. A comparison was made of the charts for the major stock indices at the beginning of 2008 and 2009. In 2008 there was a large drop, while in 2009 almost everything went sideways. One way of interpreting this is that the market will move in an overall sideways pattern this year, albeit with possible big moves up and down. This does not mean the market can't go lower, it most certainly can. Our long term prediction is that it will. The Dow still has not hit major support at 7200 and this could happen even in the earlier part of this year. Lower lows are also possible. A flat market for the year can include the scenario of significant selling and recovery toward the opening price at the end of the year.

Jeff Glenn's talk on gold and silver manipulation helped clarify how central governments try to control the price of gold and silver through leasing. How much gold the U.S. actually owns is not really known, since there has been no audit since 1955. A lot of government action seems to take place with precious metals, but there is little transparency. Investors should ask themselves, "Why the need for secrecy?" Jeff also stated that he thought it very possible that gold could skyrocket one day because of a sudden revaluation by the government. I agree that this is indeed a realistic possibility. You will need to own gold and silver before this day arrives if it does occur.

The final talk was on the Madoff scandal and how incredible it was the SEC missed this obvious scam that seems to have gone on for decades. We also reviewed the accusations of major security fraud against Drier, the head of one of the largest New York law firms, and how Satyam Com hid its declining sales by lying about it cash holdings (something that is almost impossible to do because it requires multiple parties outside the company to be involved with the fraud). After that we warned the employment report and the GDP figures this month would be ugly. We wrapped up by showing updated charts on the Monetary Base and Banking Reserves from the St. Louis Fed.

Our next general meeting will be February 3rd and we will be having a guest lecture on investing in art.

NEXT: The U.S. Trade Deficit - There's Good News and Bad News

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.