Short position bigger than even Hathaway says


11:50p EDT Thursday, October 7, 1999

Dear Friend of GATA and Gold:

Here's another crucial essay by John Hathaway of
Tocqueville Asset Management, who, like GATA
Chairman Bill Murphy, has called the gold market
exactly for months now. You may remember
Hathaway's essay, "The Golden Pyramid," which
forecast the collapse of the gold carry trade, and
his alert, on the Friday before the gold market
rocketed up, that a huge rally was imminent.

Those essays remain posted at the GATA
eGroups web site,

Hathaway is a man to be heeded.

Please post this as seems useful.

Gold Anti-Trust Action Committee Inc.

* * *

Simple Math and Common Sense:
A $66 Billion Problem

By John Hathaway
Tocqueville Asset Management

October 7, 1999

Don't be confused by self-serving outcries from various
parties trapped in the gold short squeeze.

I am amazed to hear reports that so-and-so has
restructured their hedge book or that this or that
group has covered its short position in gold. Such
statements are misleading if not false.

What is happening is that the self-made victims of the
growing gold short squeeze are passing the hot potato
back and forth among themselves in a desperate attempt
to wriggle free. This activity amounts to little more
than frenetic paper shuffling. The gold market is in
the throes of a spreading credit crisis.

The short squeeze will be over when, and only when,
there has been a full repayment of the bullion deposits
owed by dealers to the central banks. These deposits
are the foundation of the "Golden Pyramid" described in
our recent article. Without repayment of central bank
gold, the massive short squeeze we forecast when gold
was trading around $250/oz a few weeks ago will
continue even if distribution of risk among various
players changes slightly with their desperate

Let's do the simple math. At 6,000 tons, a conservative
estimate based on the usual reputable sources, the
mark-to-market value of the short interest in gold at
$330/oz is approximately $66 billion. That doesn't
sound like a very big number in today's financial
markets with flows several multiples of this amount,
until you consider how concentrated the exposure is
relative to the thin financial resources of the

For example, a 1 percent increase in the cost of carry
equals $660 million. When most of this business was put
on the books, the cost of carry was around 1 percent
per year. Based on current lease rates, there has been
a negative swing of $2.6 billion.

By the way, as the price of gold moves higher, so does
the interest burden. A $10/oz increase in gold equals
$1.9 billion. In the last two weeks since the ECB
announcement that lending would be capped, the $60
adverse swing has added over $11 billion to the shorts'
obligation to repay. Who's paying the price?

What is the equity of the gold mining industry, hedge
funds, and bullion desks involved in this position? The
world gold mining industry's equity on a very rough
basis is only $20-$25 billion. The equity of the 10 or
so major bullion traders is very likely less than $1
billion, even though the resources of the institutions
that stand behind them is far larger. The depleted
equity of the hedge fund community may stand at $30-$50
billion. Only the bullion desks are committed to
trading gold. Of course hedge funds have no generic
interest other than to make a profit. Even the mining
companies have other things to do with their capital
than trade bullion.

For example, Chase Manhattan reports gold derivative
notes outstanding of $20 billion. These are
"structured" notes where the obligation of the issuer
varies, possibly quite dramatically, with the spot
price of gold. Chase was among the most aggressive of
the bullion banks, doubling its gold derivative
position over the last 18 months, at the same time gold
prices were plummeting. The book value of Chase was $23
billion as of June 30.

One of Chase's clients, Ashanti Goldfields, is
suffering severe margin calls on their gold hedge,
which stands at 10 million ounces. Each $10 increase in
the gold price costs Ashanti and/or its bankers an
additional $100 million of pain. Ashanti's stock has
declined by more than 50 percent in recent trading,
despite the sharp runup in gold prices. Ashanti seems
likely to disappear as a freestanding entity, and its
shareholder equity could easily vaporize despite
valuable, world-class assets.

Ashanti is not alone. Several other companies suffer
from hedge book troubles at current prices. A further
$100 runup in the gold price would raise questions on
even more. Since the liquidity and financial resources
of the gold mining industry are limited, the financial
exposure to higher gold prices will inevitably pass
through to the bullion dealers that were so eager to
put this business on the books in the first place.

In a conference call, Ashanti management characterized
the relationship with their 17 bullion banks as
"orderly and stable," yet another misleading statement
emanating from the current mess. In reality, the only
step that will spare Ashanti and its bankers further
misery is a 10-million-ounce buyback and delivery of
physical gold to satisfy the credit. Of course a $3.2
billion purchase order for physical gold cannot be
filled for the time being. More likely, Ashanti will be
carved up and its credit subsumed by that of Barrick,
Anglo, the government of Ghana, or some other better
balance sheet.

The price of a rescue will be high both to Ashanti
shareholders and the bullion dealers. The risk profile
of the bullion desks will then deteriorate in return
for the appearance of "business as usual," awaiting the
next disaster. As the gold price rises, the credit
position of the bullion dealers and producer hedge
books will deteriorate further. The process could well
accelerate, and possibly culminate in a divine
intervention by the central banks in yet another
spectacle of "too big to fail." By then the good name
of gold should be restored.

Expect to see a retreat of capital from gold hedging
and short selling in the coming months. Within the gold
mining industry, a witch-hunt mentality towards hedge
book risks is certain to commence. Pressure for
buybacks will grow. The speculative blood lust for
shorting gold among the hedge funds is a thing of the
past. If anything, hedge funds are likely to line up on
the BUY side now to attack the short position. We doubt
whether risk managers of financial institutions will
favor additional allocations of capital to the trading
of paper claims based on gold in the bullion trade.
Essentially, credit has seized up in the paper gold

Once the initial shock has been absorbed, the paper
gold market should enter a protracted workout mode in
which producers buy back hedges and speculators steer
clear of the short side. Issuance of equity shares to
fund hedge book buybacks -- in other words, outright
purchases of gold -- would not be surprising.

There is just one problem. If the gold producers all
act simultaneously, as they did in herd-like fashion on
the way down, the gold price will skyrocket. For there
is no physical gold to buy, other than from the central
banks, and then only if they choose to sell or lend

This short squeeze has the potential to send gold
hundreds of dollars higher.

It took years of stupid collective actions by many very
clever people to set this trap. A miscalculation of
this magnitude is unlikely to be rectified in a few
short weeks or with just a proportionally small change
in the gold price. We have a long way to go before the
market is correctly balanced.

In the meantime, the squeeze has the potential to
threaten the health of some major financial
institutions. It certainly has the potential to disrupt
the earnings and finances of mining companies that have
hedged excessively or foolishly.

The degree of "excessive" hedging will rise with the
gold price. Even those companies that will soon be
proudly proclaiming their "hedge lite" position stand
to be shocked at the degree of risk they have

Officers and directors should understand the potential
for shareholder suits from investors who bought shares
as a play on higher gold prices.

Without hedging and short selling over the last several
years, the gold price would be several hundred dollars
higher based on the shortfall of mine production
relative to consumer demand. Panic short covering could
drive the gold price well above any theoretical

The existing and potential exposure of this massive
trade gone wrong must be frightening to those trapped
in it. Still many others have no grasp of what is
happening and regard themselves as secure. Time will
tell who is holding the bag on basis risk and lease
rate exposure. For now, nobody knows or is telling the