Chart Of The Day: Monetary Supply - It's Not A Marathon, It's A Steroid-Fueled Frenzy

http://www.zerohedge.com/news/chart-day-monetary-supply-its-not-marathon-its-steroid-fueled-frenzy

Naked shorting of precious metals

This is my take on how bullion banks naked short sell gold and silver bullion. First one has to understand the difference between a short sale and a naked short sale.

A short sale is perfectly legal and desirable, as every transaction has two counterparties: a buyer and a seller. Hence, short selling provides liquidity to markets. The mechanism involves a short seller borrowing the assets (e.g. shares of a company, gold bullion, bonds, etc.), selling that asset at a determined price, and hoping the value of the asset declines, so the seller can buy it back at a lower price, profiting from the difference between the higher sales price and the lower purchasing price. It's identical to a buyer who goes "long" an asset: the buyer buys an asset, hopefully at a lower price, watches the asset value increase, and sells it at a higher price, profiting from the higher sales price. A short seller executes the same buy/sell transactions--only in different time sequence. A short seller sells the borrowed asset before buying it back (covering). Another difference is that the short seller has to pay interest for the borrowed asset, until the buyer covers his short position with the purchase.

Of course, not all long and short positions are profitable. If a long buys a stock at $10/share, and ends up selling at $8, the long position has a net loss of $2/share. Likewise, if a seller shorts a stock at $10, and the price rises to $12, the loss is again $2, plus the cost of interest for the borrowed shares. A long or short position is a directional bet: a long expects the asset value to rise in price, and a short expects the value to decline in price.

Naked short selling is contentious, and illegal in most markets, on par with fraud. A naked seller never borrowed the asset, never took possession, and hence, doesn't pay interest. It's particularly onerous because the asset doesn't exist, and therefore an infinite amount can be created out of thin air. For instance, phantom shares of a company can be created--and thus shorted, driving the shares of a company down, sometimes to zero. This is exactly what happens in a bear raid when there's a concerted effort from multiple parties betting against shares of a company, debt of a sovereign country (e.g. Greece), or precious metals.

With gold and silver, a few bullion banks borrow gold from a central bank (e.g. the Federal Reserve Bank) at the gold lease rate, sells the gold for cash, and lends out the cash at a higher rate, say the LIBOR. The bullion bank pockets the difference between the higher LIBOR rate and the gold lease rate, the so-called Gold Forward Offered Rate (GOFO). And since they are short gold, they also profit when the price of gold declines. Hence, the bullion banks have another motivation to see falling prices for precious metals, as they have huge short positions in gold and silver. Also, the concentration of a few bullion banks who have large net short positions allows them to manipulate prices lower, especially when they work in concert. This is what gold bugs have been complaining to the CFTC for years, and why the Department of Justice is finally investigating these anti-competitive practices.

What this investigation should expose is that these gold leases and sales are not backed by physical inventory, and hence are "naked." This price suppression scheme is fraudulent, and it's allegedly being carried out by the Fed, US Treasury, other foreign central banks, and a group of bullion banks, most notably JPMorgan Chase. A few years ago, Morgan Stanley was ordered to pay a fine when they fraudulently charged customers custodial fees for storing gold that never existed in their vaults. Many are questioning not only the existence of gold in the vaults of bullion banks, but also the ETF's, the futures exchanges (e.g. COMEX), and central banks themselves. It could be another reason why the Fed has resisted audits, which Ron Paul has pushed for with legislation. Ft. Knox has not had an independent audit of its vaults since 1953! Who knows how much gold there is in vaults worldwide, because the authorities certainly won't allow verification.

Why is this important to anybody--other than a few gold and silver bugs? Firstly, central banks artificially suppress precious metals prices to hide their reckless printing of paper currencies. After all, politicians have to fund entitlement programs--even if a country is bankrupt. A rising gold price exposes monetary inflation, simultaneously signaling currency debasement. Monetary inflation is a hidden tax on the citizens; a slow, grinding decline in a nation's standard of living. Until it reaches hyperinflation, when a sudden currency crisis becomes obvious to all. Gold is a fear indicator, and an inverse proxy for confidence in a government's finances--and currency.

In a fiat, fractional reserve currency financial system, banks and central banks have a vested interest in maintaining confidence in the status quo. If confidence is lost in our banking system, there would be a run on every bank, as all depositors would demand their deposits immediately. Well-capitalized banks take $1 of deposit, and lend that same dollar out to 10 other borrowers. Under-capitalized banks (highly leveraged banks) may loan that same dollar out to 40 or more other borrowers. Clearly, if every depositor wanted their money bank, every bank would be declared insolvent, unable to honor the 90+% of other depositors.

With the explosion of precious metals ETF's (which trade like a stock) allegedly backed by gold or silver, paper trading in the precious metals futures exchanges, and gold swaps and leases, it is speculated that the ratio of gold paper claims vs. physical gold above ground is 100:1. In other words, 99 out of 100 parties who believe they have claim to gold bullion do not own it at all. And if there's a run on physical gold, many "owners" of gold assets will be disappointed, much like many depositors would be disappointed (or angry) if there was a run on banks.

Another reason for concern is since the prices of precious metals have been suppressed for years, mining for them has been uneconomic. Many mines have been closed as a result in order to stem losses, further compounding the physical shortage. And since silver is also an industrial metal, in addition to being an investment and used for jewelry, when the shortage occurs, the severe crunch will cause prices to soar, while shutting down manufacturing lines. This has severe economic and national security implications, since silver is used in many high-tech, biotech, cleantech, and military applications.

The short-term profits of a few banks and their central banking cohorts will ultimately doom the long-term prospects of a global economy. This is why many mainstream financial pundits are starting to sound the alarm bell on what could be the biggest financial fraud in the history or mankind: the big NAKED short of gold and silver.

See disclaimer in side bar.

Disclosure: long physical gold and silver, long precious metals mining shares.

The gold put option

The European Central Bank (ECB) extended the cap on gold sales, only this time limiting sales to 400 metric tons, instead of the current limit of 500 tons.

http://www.bloomberg.com/apps/news?pid=20601068&sid=a5S1sSNJDGvc

This is bullish for the price of gold, as central banks cannot indiscriminately dump gold into the market, causing the price of gold to sink. By my own deduction, the first 5-year cap instituted 10 years ago catalyzed the impressive run up in the price of gold. In that time span, gold has almost quadrupled in price, while equities have languished in negative territory. Reality is setting in--central bankers can print currencies ad nauseum in an effort to stimulate their domestic economies, but they cannot print gold. Gold has to be mined, and it is only being added to existing world supplies by 0.5% per year. By contrast, central bankers are increasing the money supply by double digits.

This is a direct consequence of easy money policies enacted by central banks worldwide, including the Federal Reserve. With money supply increases come price inflation of real assets--including precious metals.

Using back-of-the-envelope calculations, we can establish a floor for the price of gold. Last year's panic selling of all liquid assets to honor hedge fund redemptions depressed pricing of all asset classes--including gold and gold ETF's, which are liquid. The 2008 bottom was $660/ounce. Factor in a 20% reduction in potential gold sales from ECB sales, and we arrive at an adjusted bottom of $825. Thus, that is an effective put option for the price of gold.

Should we experience another liquidity crisis when stock markets tank, and commodity prices also plummet, if the price of gold approaches $825 (gold currently hovers at $960), I would accumulate more gold-related assets. Gold is a prudent hedge against monetary inflation with no counter-party risk, as it has been accepted as a monetary store of value for centuries.

I don't believe gold will correct to that level--if anything, it will elevate its price, as the threat of selling pressure has largely been removed.

Another bullish indicator for gold is the increased interest in gold purchases by Chinese and Russian sovereign funds, as they diversify away from USDollar-denominated securities, mainly Treasuries. Monetary inflation debases the dollar, causing their holdings in reserve accounts to sink in value. Exporters no longer wish to be paid in devalued USDollars.

Despite rhetoric from Fed Chairman Bernanke and Treasury Secretary Geithner that the US advocates a strong dollar policy, their actions are contrary to their claims. Sovereign fund managers and foreign finance ministers already know that is a lie. Unfortunately, American consumers will be the last to figure it out, as their purchasing power and standard of living become progressively diminished.