February 14, 2000. The New Dimension: Running for Cover

[Note: In preparing this commentary, I have received much helpful advice and assistance from Patrice Poyet (, qui s'intéresse aux marchés en France et à l'extérieur, and Sunil Madhok (, whose writings on gold in India have appeared at Gold Eagle. Merci beaucoup à chacun d'eux. Any mistakes, of course, are mine.]

Last week Barrick made its much anticipated announcement on hedging. According to its press release, Barrick during the last quarter of 1999: (1) reduced its exposure on call options written to 2.7 million ounces (versus 4 million as reported at its website at the end of the third quarter); (2) stretched out the delivery schedule on its its spot-deferred contracts, which now cover a total of 13.6 million ounces (versus 14 million as reported at its website at the end of the third quarter); and (3) engaged in "an important new dimension" by purchasing call options on 6.8 million ounces. The release further states that the new purchased call options "cover 100% of production from March 1, 2000 through 2001," at strike prices of $319/oz. in 2000 and $335/oz. in 2001. Thus Barrick's hedging program, according to the release, "has been reduced from 18.8 million ounces at the end of the third quarter to a net 9.8 million ounces at year-end 1999."

While the numbers do not fully jibe with those at its website for the prior quarter, the net reduction in Barrick's hedge book of some 9 million ounces consists of 400,000 ounces delivered under forward contracts, a reduction of 1.3 million ounces in written calls, and the purchase of new calls for 6.8 million ounces. In discussing this information with analysts, Barrick has apparently revealed three further facts of significance: (1) the new purchased calls are for cash settlement only (CSO); (2) they were sold to Barrick by one or more bullion banks, whose name(s) are confidential information; and (3) the total cost of the purchased calls was $68 million. An article in the New York Times last Sunday ( states that the premium (average?) for the 2000 calls was $6/oz. and for the 2001 calls $12/oz.

In fairness to Barrick, the existence of a CSO provision appears ambiguous based on its press releases. The February 7 release states that the purchased calls give Barrick "the right, but not the obligation, to purchase gold." Its February 8 release, however, made after the conference call in which cash settlement was discussed, states that "every dollar above [the strike price] will now be added to Barrick's floor price of US$360 per ounce [in 2000]."

Barrick's reference to the "net" position of its hedging program is somewhat misleading. Indeed, it fooled at least one gold analyst into asserting that since Barrick was able to close nearly half of its hedged position in the fourth quarter without pushing up the gold price, the gold market is not as short as Frank Veneroso and others claim, and Barrick is not "trapped" by its hedge book. However, buying calls, and particularly CSO calls, is not the same thing as closing forward contracts. Had Barrick bought physical gold in the amount of its calls (6.8 million ounces or 212 tonnes), it almost certainly would have caused the gold price to rise substantially. What is more, the very fact that it bought paper gold -- not to mention paper gold that by its very terms is not convertible into physical gold -- suggests that Barrick was in fact unable to cover its forwards in the physical markets without driving up the gold price.

Reaction in the gold market to Barrick's announcement appeared negative. Some have noted the irony of the positive market reaction to Placer Dome's earlier announcement of a mere suspension of further forward sales coupled with prospective buy-backs, and the negative reaction to Barrick's announcement of a substantial "net" reduction in its hedge book. But there is a quite rational explanation: while I was asking who sold Barrick the calls, traders were asking what Barrick would do with the calls. Specifically, would Barrick delta hedge against the calls by going short at or about the strike prices, thus making them serious resistance levels?

Writers (sellers) of naked options (puts and calls) typically limit their risk by delta hedging against their exposure. Delta hedging is described by mathematical formulas and requires quick, reliable access to a liquid market. To oversimplify, let's assume I write a gold call with a strike price of $300 when gold is trading spot at $250. As the gold price rises, I will buy gold in increasing increments so that when the spot price reaches the strike price I am 50% covered. If the price keeps rising, I will continue to buy in decreasing increments until I am fully covered at an average price equal to the strike price. Of course, in the real world the gold price will fluctuate, but the formulas tell me for each price exactly how much gold I should have as cover, and I keep adjusting my cover accordingly. But note, the purpose of delta hedging by an option writer is to prevent loss and keep the premium received as profit. For more on delta hedging and derivatives generally, see

Now let's suppose that I am the purchaser of gold calls for 1 million ounces at $320. My risk is limited to the premiums that I paid for the calls, and I may choose simply to hold them as a bet (or hedge) on a rising gold price. But if I am an active trader with quick, reliable access to the physical or futures markets, I can also use my calls to backstop a trading strategy designed to profit from shorting gold in a delta hedge whenever the spot price is at or near my strike price. That is, if gold is at my strike price, I can sell 500,000 ounces. If my sale, especially when combined with others doing the same thing, knocks the price down, I try to cover quietly at lower prices, book my profits, and wait for another chance to do the same thing again. That's a successful short sale. What is more, as long as I am successful, I can keep repeating the process until the expiry of my options. Thus, the purpose of delta hedging by an option purchaser is to earn a profit.

But suppose I don't succeed, and the gold price does not return below my strike price. There are two possibilities. First, increased volatility may cause the value (price) of my calls to rise by more than the increase in the underlying gold price, so that profits from the sales of my calls would more than offset the losses on my short positions. If so, despite my unsuccessful short sales, I can close out my positions at a net profit. Alternatively, in the absence of any possibility for profit, I can cover my shorts with my calls at no net additional cost to myself since I have delta hedged. Of course, in either of the two unsuccessful short situations, I would also like to recover the premium paid for my calls if I have not already done so through successful short sales. But in any event, my losses should never exceed the premium amount that I was prepared to risk in the first place.

What seems to have rattled traders, then, is the possibility that Barrick has been recruited to the short side with at least 100 tonnes of ammunition for use in a delta hedge, and that the $319 and $335 levels will be strongly defended by Barrick and others, including its bullion banker sellers. And my questions regarding who sold Barrick the calls, who might be backstopping them, and what is really going on here become even more intriguing.

If the calls are CSO, several inferences about them would follow. It is very unlikely that they would be covered calls written for income by a central bank or other big holder of gold. Rather, they would almost certainly have been written either as a short-side speculation or, and in my view far more likely, to support short-side speculation by others. In the latter event, they are almost certainly backstopped by someone with very deep pockets who has an interest in capping the gold price, and who therefore is unlikely to delta hedge them even in the futures (paper) markets since doing so would partially negate the short sales of others. That can only be someone prepared to accept a $680 million loss for every $100 over the strike price. Whomever it is, Barrick apparently believes that the financial resources ultimately backing the calls are adequate to the task.

Another possibility is that they were written as CSO calls precisely because there is not enough liquidity in the physical markets to delta hedge them. But if so, it is hard to imagine any reason for writing them other than to facilitate capping the gold price, or at least to keep Barrick from trying to cover in the physical markets and thereby drive up the price.

Unfortunately Barrick has not provided sufficient details on its purchased calls to calculate with any precision their implied volatility under Black Scholes. Having such a figure, it would be possible to compare the implied volatility of Barrick's calls with the implied volatility of similar COMEX or other market traded calls to see whether Barrick paid the level of premium associated with a typical arm's length transaction. But even absent that evidence, there is much to suggest that its purchased calls may be subject to other special conditions.

Unlike most purchasers of calls, Barrick can by its own actions affect the price of the underlying asset. Whoever wrote the calls appears vulnerable to an effort by Barrick to cover its forward obligations, thereby also driving up the gold price. Done cleverly, especially in combination with delta hedging its purchased calls, Barrick might cover some significant chunk of its written calls and forward contracts without driving gold over $360 -- its claimed 2000 floor price -- at a profit or small loss. Then, more than making up the losses on its remaining forward obligations with the profits on its purchased calls, it could glide smoothly into a gold bull market, leaving its bullion bankers holding a bag of shorts.

Accordingly, it is reasonable to assume that either: (1) the writers of the calls hold enough of Barrick's written call options and forward contracts to ensure that Barrick cannot act in this fashion; or (2) the calls contain restrictions on Barrick's ability to cover further, or require that Barrick maintain some minimum ratio between its purchased calls and its delivery obligations under written calls and forward contracts such that its incentives continue to rest on the side of at most a slow, controlled increase in the gold price. The description of the calls in Barrick's February 8 press release is consistent with alternative (1) above.

Yet another possibility is that Barrick does not really control the purchased calls, but is only entitled at maturity (whether they are American or European style options is unknown) to the appropriate cash payments. It may also be subject to further conditions, e.g., refraining from certain actions that might drive up the gold price. In this event, the bullion bank or banks that sold the calls may be able to use them in their own discretion to delta hedge from the short side, whether for Barrick's account or their own.

Indeed, it is not impossible to imagine a deal where the bullion banks get the profits from successful short sales, Barrick gets the profits on exercise when and if the short sales are unsuccessful, and whoever (Exchange Stabilization Fund?) is ultimately backing the calls has a double obligation: (1) to pay Barrick in full on exercise; and (2) also to pay the intermediary bullion banks on exercise, but subject to partial credit for any profits they may have made on successful short sales.

In any event, the fact that Barrick bought options on paper gold -- virtual gold -- from someone who is either crazy or possessed of very deep pockets and a strong desire to cap gold suggests: (1) that the physical gold markets are so tight that Barrick could not cover in physical metal; and (2) that its so-called "new dimension" -- purchased calls -- is nothing more or less than Barrick running for cover. Market action at its strike prices -- $319 and $335 -- could be ferocious. With a major breach running toward $360 -- Barrick's 2000 floor price and the level where many think the gold banking system might implode --, Katy bar the door.

God made gold the king of money. When He made the king of beasts, He painted him gold. The lion's would-be victims know to run for cover, and when none is at hand, to keep running, and to dodge, feint, bob and weave in hopes of shaking the golden beast. Barrick's instincts are no less sound than those of the zebra or the gazelle. And watching Barrick run from a gold panic partly of its own making promises to be good sport, unless perhaps you are a Barrick shareholder. In that case, Barrick's hedging program is exactly what Randall Oliphant, its chief executive, says: "It is not a theoretical concept, it is about real money." But is real money something that Barrick and other heavily hedged mining companies know anything about?

February 8, 2000. The Greatest Con: The Rubin Dollar

When Robert Rubin resigned last year as Secretary of the Treasury, the question in Washington was whether he had been the greatest secretary since Alexander Hamilton or just the greatest ever. As Rubin himself noted, the last treasury secretary to retire to such praise was Andrew Mellon, who served from 1921 to 1932, when he was appointed ambassador to Britain. My guess is that history will judge Mr. Rubin rather more harshly than Mr. Mellon, and at the other end of the scale from the man who purged Continental paper with the Hamilton gold dollar. For it now appears that the Rubin dollar was based not on real gold but on a new creation of the Exchange Stabilization Fund: virtual gold.

Virtual gold has little to do with virtue. Virtue in international finance, according to both Mr. Rubin and his successor at the Treasury, Lawrence Summers, is market transparency and avoidance of crony capitalism. Both appear missing in the ESF. Two 1999 studies, one by the Joint Economic Committee of the U.S. Congress ( and the other by the Federal Reserve Bank of Cleveland (, decry the almost complete lack of transparency in the ESF, including its policies on the dollar, activities in foreign exchange or other (e.g., gold) markets, financial accounts, and relationships with the Federal Reserve System and the Federal Reserve Bank of New York.

Regarding the latter, the Cleveland Fed is worth quoting, particularly in light of recent market developments arising out of the Treasury's decision to start buying back the long bond.

Since the ESF's inception [1934], the Federal Reserve Bank of New York has been its officially designated agent for the ESF intervention operations. In 1962, the Federal Reserve System's Federal Open Market Committee (FOMC) authorized open-market transactions in foreign currencies for the account of the Fed, and since then, the Federal Reserve Bank of New York has acted as agent for both the Fed and the ESF in such transactions. Starting in 1976, the ESF and the Fed have almost always intervened jointly.

Although the decision to intervene is usually made jointly by the Treasury and the Fed, it falls primarily under the Treasury's purview. While the two entities routinely intervene in the same direction and amounts for their individual accounts, formal independence is maintained. In other words, the Treasury can instruct the Fed to intervene on behalf of the ESF but it cannot force the Fed to intervene for the Fed's own account.

The Congress has thus established a system, ostensibly to stabilize the dollar, where it is possible for the ESF and the Fed to intervene in the foreign exchange markets in opposite directions. What is more, they can do so while leaving the Congress and the American people completely in the dark about what is transpiring with their own currency, and the world ignorant of America's true dollar policy, if any. Certainly the thought that the Treasury and the Fed always coordinate their activities cannot have survived the past week. With the Fed raising short term rates (implying sales of government securities) and the Treasury implementing buy-backs of the long bond, the yield curve inverted sharply, causing chaos particularly in bond and interest rate derivatives. Applying this sort of modus operandi to the dollar and gold raises all sorts of questions.

Before turning to them, however, a review of the pending question to Secretary Summers is in order. Those who read my last commentary and followed the URL to Fed Chairman Alan Greenspan's letter to Senator Lieberman know that Mr. Greenspan was responding to questions raised by GATA in an ad placed in Roll Call, the Congressional weekly newspaper, on December 9, 1999. Links to GATA and its related site, Le Metropole Cafe, can be found in my Recommended Links. GATA and the Cafe, aided by their many members and supporters, have done more in the last year to open a window on the secret world of gold than anyone else on the planet, and in the process provided a stunning example of how the internet can put knowledge and power in the hands of the people. The first question in GATA's ad read (

1. Does the Federal Reserve or the Treasury Department, either on their own behalf or on behalf of others, including other government agencies, such as the Exchange Stabilization Fund, lend gold or silver, facilitate the lending of gold and silver, or trade in any securities, such as futures contracts and call and put options, involving gold and silver?

Here is Fed Chairman Greenspan's answer as contained in his letter to Senator Lieberman (

As for Question 1, the Federal Reserve does not, either on its own behalf or on behalf of others, including government agencies, lend gold or silver, facilitate the lending of gold and silver, or trade in any securities, such as futures contracts and call and put options, involving gold and silver. Thus Questions 2 through 8 are inapplicable because they presuppose an affirmative answer to Question 1.

For Mr. Greenspan, the language of the answer seems refreshingly clear. The Clinton administration's tortured use of language notwithstanding, my reaction is to take the Fed chairman at his word without engaging in minute analysis of the meaning of "agency" or the perhaps inaccurate use of the conjunctive for the disjunctive. What is clear, however, is that he is not speaking for the Treasury or the ESF. What could perhaps be argued is that he is trying to isolate the Federal Reserve Bank of New York acting as agent for the ESF from his answer, but if that is true, he is playing a very dangerous word game with a United States Senator.

All of which leads to several tantalizing questions: (1) If the N.Y. Fed is not acting as agent of the ESF in the gold market, who is? (2) Who would be more likely to play this role than the observed gorilla bullion bank, Goldman Sachs, Mr. Rubin's old firm? (3) What steps were taken to prevent the ESF's agent from taking advantage of its privileged knowledge and position? (3) What, if anything, do Mr. Greenspan and the Fed know about the ESF's activities in the gold market? (4) If they know something, when did they learn it?

One question now foreclosed, absent a squeaky clean bill of health from an outside and independent investigation and audit, is whether the ESF has been writing gold call options or otherwise trading in gold derivatives to the same effect. Prior to placing its ad in Roll Call, GATA's Chris Powell engaged through Senator Dodd (Dem., Conn.) in some correspondence with the Treasury ( A key question put to the Treasury was: "Do the Fed or the Treasury trade in gold or in securities, futures contracts, or options that are related to gold, or otherwise seek to influence trading in gold?" The response by a deputy assistant secretary to Senator Dodd was: "The Treasury Department does not trade in gold or futures contracts to influence trading in gold." Unlike Mr. Greenspan, the Treasury did not include the trading of options in its denial even though they were specifically mentioned in the question.

Accordingly, Mr. Summers' continued silence on this question should be construed as an admission that the ESF does in fact trade in gold call options. Indeed, whatever he may now say, particularly after last week's disruption in the bond market and spike in gold, cannot be given much credence, even if it's as clear as, for example, "I never had sex with that woman."

My last commentary noted that any downward manipulation of the gold price would impair its role as a leading indicator of inflation, misleading in particular those members of the FOMC who regard it as such. But the gold price is far more than a sensitive indicator of domestic U.S. inflation. It is among the best indicators of the true health of the U.S. dollar because, at least until the 1999 introduction of the euro, gold was easily the dollar's most important competition as international money. A rising gold price in 1997 or 1998 almost certainly would have forced a general decline in the dollar, pressured U.S. interest rates higher, slowed growth of the U.S. trade deficit, and in all probability capped the U.S. stock market at considerably lower levels than now exist.

Secret or clandestine interventions today are quite different from public gold sales or official transfers employed in former times to defend fixed gold parities. Under fixed parity regimes, even when the gold parity was in the end successfully defended, the sales or transfers were public notice of trouble. Market players were able to make their own judgments about the likelihood of official success and act accordingly. And their actions could then inform and instruct public policy. Today covert interventions in the gold market, particularly through derivatives that backstop gold lending, do not merely hide problems. They augment them while an apparently quiescent gold market engenders a false sense of confidence that all is well. "Laissez les bon temps roulez" [sic, cajun] may be fine on Bourbon Street in New Orleans; it should not be the policy of the ESF.

Anyone possessing the least familiarity with gold banking ought to know just how dangerous a scheme to facilitate too much gold lending can be. In essence, it is no different than gold banking on an ever shrinking percentage of gold reserves. It amounts to the exponential creation of virtual gold, which -- unlike real gold -- depends on another's promise to deliver. The con is as old as gold banking itself, as the victims of banking panics throughout the centuries have learned to their distress. This time will be no different, except that the resurrection of gold could well spell the demise of the currency built on -- and billed as -- virtual gold.

Broadly speaking, the ESF has misled everyone who holds dollars as to their true value relative to gold. As a result, the world is awash in dollars -- both dollar currency and dollar-denominated debt. Should a rush to convert all these dollars to gold ever begin, it is unlikely to end until an expression known too well to Alexander Hamilton and the other Founding Fathers takes a new form: Not worth a Rubin.

February 1, 2000. Two Bills: Scandal and Opportunity in Gold?

Last week the world's movers and shakers held their annual confab in Davos, Switzerland. Bill C. and Bill G. were there. No doubt the scandal enveloping Helmut Kohl, Europe's greatest statesman since Churchill and De Gaulle, provided much grist for gossip. But here at home, some began to glimpse the outline of a possible new Clinton scandal -- one that could ultimately eclipse Watergate or Teapot Dome.

Evidence is accumulating that the administration of Bill Clinton may have turned the Exchange Stabilization Fund (the "ESF") into a political slush fund to make itself look good and simultaneously profit some of its closest Wall Street friends and supporters. Specifically, the known facts support credible allegations that the Clinton administration has effectively capped the gold price by using the ESF to backstop the selling of gold futures and other gold derivative products by politically well-connected bullion banks. Such interference in the free market price of gold would undermine its traditional role as a leading indicator of inflation. And it would do so at the same time that the administration's many adjustments to the CPI have rendered that lagging indicator of inflation also suspect. Among the bullion banks most heavily involved in selling gold futures and purveying gold loans, forward sales and other derivatives that undercut its price is Goldman Sachs, former Treasury Secretary Robert Rubin's old firm.

These are serious allegations, but the current administration scarcely merits much benefit of the doubt. If these allegations are incorrect, Treasury Secretary Summers can deny them in unequivocal language as Fed Chairman Alan Greenspan did two weeks ago with regard to similar allegations of gold price manipulation by the Fed. Indeed, in a formal letter to Senator Lieberman (Dem., Conn.) (reprinted at, the Fed chairman not only denied that the Fed had intervened in the gold or gold derivatives markets, but also added: "Most importantly, the Federal Reserve is in complete agreement with the proposition that any such transactions on our part, aimed at manipulating the price of gold or otherwise interfering in the free trade of gold, would be wholly inappropriate." [Emphasis supplied.]

The odd behavior of the gold price over the past five years, including massive gold leasing and heavy bouts of futures selling apparently timed to abort threatened rallies, has generated considerable speculation regarding intentional manipulation by governmental authorities. What has made weakness in the gold price all the more perplexing are mounting shortfalls of new mine production relative to annual demand. Because most nations deal in gold through their central banks, they are prime suspects. Clarifying remarks that he made to Congress in 1998, Mr. Greenspan confirmed in his letter to Senator Lieberman that some central banks other than the Fed do in fact lease gold on occasion for the express purpose of trying to contain its price. Gold leased by central banks to bullion banks is typically sold by them into the market in connection with arranging forward sales by gold mining companies or making gold loans to mining companies or others. The attraction of gold loans is their typically low interest rates (known in the trade as "lease rates") of around 2%.

The Fed and the ESF are the only arms of the U.S. government with broad statutory authority "to deal in gold" and thus by reasonable extension in gold futures and derivatives. Were the Fed to engage in such activities, it would of necessity have to do so subject to all the institutional safeguards that govern its more important functions. Unlike the Fed, the ESF is virtually without institutional structure or safeguards. It is under the exclusive control of the Secretary of the Treasury, subject only to the approval of the President. Indeed, direct control and custody of the ESF must rest at all times with the President and the Secretary. The statute further provides (31 U.S.C. s. 5302(a)(2)): "Decisions of the Secretary are final and may not be reviewed by another officer or employee of the Government."

Originally funded out of the profits from the 1934 gold confiscation, the little known ESF is available for intervention in the foreign exchange markets. In the absence of a Congressional appropriation, the Clinton administration used funds from the ESF to finance the 1995 U.S. bailout of Mexico. However, accepting the Greenspan dictum that it "would be wholly inappropriate" for the Fed ever to intervene in the gold market to manipulate the price, it is hard to imagine any situation in which such intervention would be appropriate by the ESF, never mind one involving large profits for the former investment bank of the Secretary himself.

Last week, in response to an inquiry from Bridge News, Secretary Summers "categorically denied" that the Treasury was selling gold. With all due respect to the Secretary, this is not the allegation that knowledgeable gold market participants and observers are making. Their allegation is that the ESF -- by writing gold call options or otherwise -- is making sufficient gold cover available to certain bullion banks to allow them safely to take large short positions in gold, thereby putting downward pressure on the price and in the process making huge profits for themselves.

Two devices that have put the most pressure on the gold price in recent years are sales of gold futures contracts on certain public exchanges, the COMEX in New York being the largest and most important, and sales of leased gold in connection with gold loans and forward selling by miners. Bullion banks that engage in these activities must of necessity take short positions in gold. While these positions can result in large profits for them when the gold price declines, they can -- if unhedged -- also result in large losses should the gold price rise.

The most common tactic used by bullion banks to hedge against such losses is the purchase of gold call options, usually from gold producers, other large holders of physical gold, or entities with sufficient financial resources to guarantee cash settlement. In the absence of such protection, bullion banks leasing gold or selling large amounts of gold futures contracts for their own account (or the accounts of any but the strongest gold credits) would be forced to assume risky net short positions on which they could sustain huge losses in the event of an upward spike in the gold price. At the same time, sellers (often called "writers") of gold call options also assume risk, for they will be called upon to provide gold (or equivalent cash settlement) to the bullion banks in the event that the gold price rises above the strike prices of the options.

Given its own resources of something like $40 billion and its connection to the U.S. Treasury, which controls the nation's official gold reserves of about 8150 metric tonnes, the ESF has the ability to write gold call options in circumstances where private parties would not. Should it do so, it can effectively permit favored bullion banks to engage in gold futures selling and gold leasing under conditions where they would otherwise be forced to curtail these activities as perceptions of increasing risk rendered call options from private sources either too expensive or even unavailable. What is more, the ESF can write these options clandestinely so as to camouflage the true source of what otherwise appears as inexplicable downward pressure on gold, thereby creating market uncertainty that itself augments bearish sentiment and increases the profits of bullion banks privy to the scheme.

With the Fed's announcement that it, unlike some other central banks, does not operate in the gold or gold derivatives markets, the focus of suspicion naturally shifted to the ESF. But to understand fully why gold market participants and observers increasingly sense market manipulation originating somewhere in the U.S. government, it is necessary to recount and highlight some recent history of the gold market, particularly for those not fully conversant with it. And even for those who are, Fed Chairman Greenspan's recent letter requires reassessment of working hypotheses involving assumptions of gold price manipulation by the Fed. More detail on much of what follows can be found in earlier essays and commentaries here at The Golden Sextant, together with various links to supporting or explanatory information.

The story begins in 1995. Gold is slumbering as it has for some time around US$375/oz. Japan's economic situation is worsening, and in mid-1995 the Japanese cut interest rates sharply. Gold begins to stir, jumping over $400 in early 1996, propelled in part by Japanese interest rates so low that they force yen denominated gold futures on the TOCOM into backwardation (i.e., when prices for future delivery are lower than spot). The yen is falling; gold lease rates are rising. From the U.S. perspective, an economic collapse in Japan threatens to exacerbate the U.S. trade deficit and possibly trigger massive dishoarding of Japan's large holdings of dollar denominated debt, including U.S. Treasuries.

From the European perspective, there is concern not only about the obvious economic effects of a Japanese collapse, but also that it might cause sufficient disruption in the existing international payments system to complicate severely or even prevent the planned introduction of the euro in 1999. An accelerating gold price responding to world financial turmoil is hardly a propitious environment for the introduction of a new and untested currency.

The G-7 central banks and finance ministers cobble together a plan to support Japan, including a strategy for controlling the gold price through anti-gold propaganda backed by small but highly publicized official gold sales augmented by leasing of official gold in large quantities at concessionary rates. For Belgium and the Netherlands, the largest European sellers, gold sales also help to meet the Maastricht Treaty's criteria for the euro.

Gold analysts, who at the beginning of 1996 were almost unanimous in predicting a new bull market for gold, are blind-sided. Virtually none foresaw such a coordinated official attack on gold, and many are slow to recognize its broad scope. The gold price steadily declines from over $400 in early 1996 to well under $300 in early 1998, and stays under $300 for most of 1998 and into early 1999. Every time gold looks to rally, it is slammed on the LBMA or COMEX by the same small group of well-connected bullion banks. Particularly notable in these attacks are Goldman Sachs, Chase and Mitsui, which regularly runs by far the largest net short position on the TOCOM.

Scared by falling prices and encouraged to do so by their bullion bankers who are also their lenders, many gold mining companies respond by increasing their hedging activities, expanding forward sales and buying more gold put options. The forward sales, generally made with gold leased from central banks through bullion banks, add to the downward pressure on gold and provide fees to the bullion banks, augmented by further windfall profits on the loaned gold as the price continues to fall. The bullion banks earn further fees by selling put options to the mining companies, who frequently are forced to finance buying shorted-dated puts from the bullion banks by selling them long-dated calls.

Trading around $280 in April 1999, gold is below the total cost of production for many mines and not far above the cash costs of quite a few. What is more, annual gold demand is now almost 4000 tonnes, exceeding annual new mine production of 2500 tonnes by almost 1500 tonnes. This deficit, building over several years, is largely filled by sales of gold leased from central banks by the bullion banks. Analysts trying to calculate the net short gold position of the bullion banks in early 1999 are coming up with some astonishing figures, some as high as 10,000 tonnes, equivalent to four full years of production.

Since much of this leased gold is sold into the Asian jewelry market, particularly to India which regularly absorbs 25% to 30% of annual world production, many question where all the gold necessary for repayment will be found. But at the beginning of 1999, some is expected to come from the proposed sale of over 300 tonnes by the IMF to raise funds for aid to heavily indebted poor countries, an initiative strongly supported by the U.S. and Britain.

On May 6, 1999, gold again nears $290 and is threatening to explode above $300 due in part to increasing doubts that the proposed IMF gold sales will be approved. Short positions are in grave peril. Then comes a wholly unexpected bombshell which will have even more unexpected consequences.

On May 7, 1999, the British announce that the Bank of England on behalf of the British Treasury will sell 415 tonnes of gold in a series of public auctions ostensibly to diversify its international monetary reserves. The manner of the British sales -- periodic public auctions instead of hidden sales through the BIS -- belie any effort to get top dollar and smack of intentional downward manipulation of the gold price. All indications are that these sales were ordered by the British government over the objection of BOE officials. Palpably spurious and inconsistent reasons for the sales are offered, but no persuasive ones. There is only one logical conclusion: the gold sales were directly ordered by the Prime Minister for unknown political or other reasons. What is more, his reasons are unlikely to have been frivolous. As leading supporters of the proposed IMF gold sales, the British clumsily put themselves in the position of front-running them, and ultimately the British sales are an important catalyst in forcing the IMF to change tack.

For most knowledgeable gold market participants and observers, the British announcement is the smoking gun -- proof positive that the world gold market is being manipulated with official connivance and support. But what none yet suspects is that the BIS, the ECB and the central banks of the EMU countries are having serious second thoughts about the gold manipulation scheme.

The British announcement quickly sends the gold price into near free fall toward $250. Gold mining companies panic. Urged on by the bullion banks, led again by Goldman Sachs, the miners add to their hedge positions. The very dangerous practice of financing short-dated puts with long-dated calls expands exponentially as financially strapped mining companies, threatened with reduction or loss of credit lines by their bullion bankers, are often left with little other choice. Then comes a second and even larger bombshell that takes the bullion bankers and their customers completely by surprise. Indeed, it is likely a watershed event for the entire world financial system, comparable only to the closing of the gold window in 1971.

On September 26, 1999, 15 European central banks, led by the ECB, announce that they will limit their total combined gold sales over the next five years to 2000 tonnes, not to exceed 400 tonnes in any one year, and will not increase their gold lending or other gold derivatives activities . Besides the ECB and the 11 members of the EMU, Britain, Switzerland and Sweden are parties. The 2000 tonnes include the remaining 365 tonnes of British sales and 1300 tonnes of previously proposed Swiss sales, leaving only 335 tonnes of possible new sales. The announcement, made in Washington following the IMF/World Bank annual meeting, is ironically christened the "Washington Agreement" although the government in Washington played no role. However, the BIS, IMF, U.S. and Japan are all expected to abide by it, and the BIS is expected to monitor it.

The effect in the gold market is quick and dramatic. Within days, as some gold shorts rush to cover, the gold price jumps from around $265 to almost $330 and gold lease rates spike to over 9%. By late October gold retreats back under $300, and a month later lease rates are almost back to normal levels. But the hugely over-extended net short position in the gold market is clearly revealed and far from being resolved. Two heavily hedged gold mining companies, Ashanti and Cambior, are virtually bankrupt and in negotiations with their bullion bankers. Indeed, soon the entire rationale of hedging is under comprehensive review throughout the gold mining industry as shareholders rebel at practices that take away the upside of their gold investments.

As the details of Ashanti's and Cambior's hedge books are disclosed, the recklessness of gold hedging strategies foisted onto to them by their bullion bankers becomes all too apparent. Ashanti's lead bullion banker, Goldman Sachs, is the subject of scathing comment, including allegations of serious conflicts of interest. See, e.g., L. Barber & G. O'Connor, "How Goldman Sachs Helped Ruin and then Dismember Ashanti Gold," Financial Times (London), Dec. 2, 1999, reprinted at Clearly the most aggressive bullion bankers have been caught completely wrong-footed and totally unawares by the Washington Agreement. Significantly, rumor is that the agreement was hammered out secretly among the members of the EMU, the BIS and Switzerland, that the British were given a chance to sign on after the fact, and that the U.S. was not informed until just before the Sunday announcement. For references to European press commentary on the genesis of the agreement, see W. Smith, "Operation Dollar Storm,"

Besides the three provisions relating directly to central bank activities in the gold market and one calling for review after five years, the Washington Agreement contains this statement: "Gold will remain an important element of global monetary reserves." The ECB and 11 EMU nations hold collectively around 12,500 tonnes of gold reserves (almost 1.4 ounces per citizen), making the EMU as a whole by far the world's largest official holder of gold. What is more, unlike the U.S. which values its gold stock of about 8150 tonnes (under 1 ounce per citizen) at an unrealistic $42.22/oz., the EMU marks its gold reserves to market quarterly.

The notion, shared by many, that the EMU would forever acquiesce in the trashing of its gold reserves by bullion banks operating in the largely paper gold markets of London, New York and Tokyo appears in retrospect to have been incredibly naive. Indeed, a careful reading of the 69th annual report of the BIS issued in June 1999 suggests that European central bankers were already questioning the effectiveness and sustainability of Japan's low interest rate policy, and were very concerned about the implications of the LTCM incident for the world payments system. With the euro successfully launched, they quickly lost reason to continue capping the gold price and became much more concerned about the increasingly parlous state of the gold banking system to which they were lending.

Often referred to as the central banks' central bank, the BIS is not only the principal forum for discussion and cooperation among the world's central bankers but also the world's top gold bank. Established under international treaty in 1930 to facilitate payment of German war reparations, the BIS from its founding has kept its financial accounts in Swiss gold francs, making conversions at designated or market rates as appropriate. It holds approximately 200 tonnes of gold for its own account and records on its balance sheet separate gold deposit and gold liability accounts in connection with the banking services it provides to central banks and other international financial institutions. That the BIS in early 1999 was not as aware as gold analysts in the private sector of the bullion banks' dangerously leveraged condition is almost inconceivable.

Fed Chairman Greenspan's letter to Senator Lieberman is highly significant in that it tends to negate the impression many had, including myself, that a rift had developed between the Anglo-American central banks and those of the EMU over gold. Rather, the Fed's position as expressed in the letter, together with the BOE's position that the decision to sell British gold came from Her Majesty's Treasury, implies a rift not among the major central banks, but between them and the British and American governments operating through their Treasury departments. In this connection, the Fed and the BOE labor under a handicap that does not affect the Europeans, for whereas the central banks of the EMU have direct legal responsibility for their nations' gold reserves, in both Britain and the U.S. this responsibility rest with their Treasury departments.

What is more, a quite plausible scenario now appears to explain the British gold sales. Whether it is true or not, only a very few high officials in the British and American governments and their bullion bankers are in a position to know for sure. But on known and reasonably inferred facts, the following hypothesis can be constructed.

The ESF was writing gold call options for certain bullion bankers, principally those most active in selling futures and arranging forward sales: Goldman Sachs, Chase, et al. As of April 30, 1999, it had outstanding a sizable position at strike prices in the $300 area. For writing these options in a generally falling market, it had net earnings from premiums but these were not in context large amounts, at most a very few dollars per ounce. In the ESF's monthly financial reports required to be filed with the Senate and House Banking Committees, these amounts were listed as miscellaneous income.

When gold threatened to explode over $300 in early May, and with IMF's proposed gold sales in trouble, the ESF found itself in much the same position as that of Ashanti and Cambior after announcement of the Washington Agreement. Gold call options previously sold for a few dollars an ounce threatened to cause losses many multiples of these amounts if the gold price jumped by $50 to $75. If settled in cash, exploding volatility premiums would add hugely to the loss, putting the effective strike price far above the nominal one. On the other hand, if settled in gold at the strike price, the ESF would have to deliver gold from U.S. reserves or go into the market to cover, adding more upward pressure to the gold price.

Worse, unlike the modest premium income from sales of options, huge losses could not be hidden from Congress in the monthly financial reports to the House and Senate Banking Committees. Not to panic. The ESF, being under the direct control of the Secretary and the President, has an option not available to others. Call the British Prime Minister and arrange for a very public official gold sale designed to kill the incipient gold price rally. And for God's sake don't let the BOE or the Fed know what is really afoot. If some of their inflation hawks knew the real situation in the gold market, they might be more inclined to raise interest rates.

The plan worked, sort of. The immediate crisis was bridged. By now, depending on the maturity schedule of its options, the ESF may have substantially worked off its position. Indeed, a reduction in call options available from the ESF after the BOE's announcement may be what pushed the bullion banks to be so aggressive in trying to secure similar options from mining companies in the hedging panic that ensued. But if that was the strategy, the Washington Agreement undid it and left the bullion banks in dire peril. For an excellent discussion of their continuing exposure, see John Hathaway's latest essay, "Rich on Paper," at

If the foregoing hypothesis is correct, there will be time enough at a later date to analyze the full implications of a scandal of such magnitude. To do so now would be to get too far ahead of the story. Probably only an investigation by the U.S. Congress or possibly the British House of Commons could really uncover the truth.

But whether the hypothesis about manipulation of the gold price by the ESF is correct or not, the incredible over-extension of the bullion banks is a fact that ultimately will have to be faced. Currently the European central banks through the BIS and within the limits of the Washington Agreement are engaged in a tightly controlled feed of modest amounts of gold into the market. Of the 335 remaining tonnes under the Washington Agreement, 300 tonnes at a rate of 100 tonnes annually over the next three years were allocated to the Dutch on December 6, of which 65 tonnes have already been sold. Where this gold is going and to whom is unknown, but most assume it is being used in large measure to alleviate critical shortages among the bullion banks. Some of these banks are divisions of very large and important commercial or investment banks, and thus may enjoy "too big to fail" protection.

Plainly too, the American and British governments have put pressure on friendly gold holding countries outside the Washington Agreement to supply gold to the market. Kuwait, for example, publicly announced that it was making its entire official reserve of 79 tonnes available to the BOE for lease into the market. Soon afterwards further new U.S. military aid to the country was disclosed. With regard to the Kuwaiti announcement, a top BIS official observed that it was so far outside normal practice as to permit only one conclusion: someone was trying to manipulate the gold market.

The bottom line is that whether as the result of greed, stupidity, breach of public trust, or some combination thereof, the fate of the bullion banks and the gold banking system itself has passed outside not only the bankers' control but also the power of the American and British governments. They are all hostages now: hostages to the continued goodwill of the European central banks, who could bury the exposed bullion banks tomorrow should they choose to do so; and hostages to events over which they have no control, whether as major as a stock market crash or as minor as a blockbuster bid at the next British auction.

Given a sharp spike to $370/oz. or thereabouts, many believe the gold banking crisis would spiral out of control. Each periodic British auction is for 25 tonnes (803,750 ounces). At $370/oz., an entire auction could be had for less than $300 million, a trifling sum in modern finance. That may seem like a large premium to current prices of around $280-$290, but many gold analysts peg the true equilibrium price of gold today at between $500 and $600. Add in rumors of difficulty finding physical gold in size, and 25 tonnes of deliverable physical gold at $370 could almost look like a bargain.

In any event, anyone -- friend or foe -- with a spare $300 million who cares to bid $370/oz. for the full amount of the next British auction could more than likely crash the gold banking system with consequences far more serious than those threatened by the failure of LTCM. Not long ago Marc Faber publicly suggested to Bill Gates the investment merits of switching his almost $100 billion of Microsoft shares into gold. M. Faber, "An Investment Tip for Bill G.," Forbes, Nov. 29, 1999, p. 248, also My advice to Bill G. would be a little different: Start buying gold, leak that you are doing so, watch the price rise and governments sweat, bid early and high at the next British auction, and wait for a settlement offer you really like. No reason not to have both Microsoft shares and gold. Since the government likes free, unfettered markets, give them one -- in gold.

The next auction is March 21, 2000, a date perhaps uncomfortably close to the ides of March for bullion bankers and would-be Caesars.