Central Banks vs. Gold: Winning Battles but Losing the War?


12:30a EDT Monday, June 12, 2000

Dear Friend of GATA and Gold:

The following essay by Reginald H. Howe of www.GoldenSextant.com
may summarize and document the manipulation of the gold price
more comprehensively than anything yet written. An understanding
of the gold market and the forces GATA is confronting starts
here. So please post this as widely as you can.

CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.

* * *

Central Banks vs. Gold: Winning Battles but Losing the War?

By Reginald H. Howe
June 11, 2000

Many in the gold community, including myself, have assumed that
the European Central Bank and the Bank for International
Settlements are operating with a definite strategy for restoring
gold to the center of the international monetary system, and in
the process making the euro the preferred currency for
international transactions. But evidence is accumulating to shed
doubt on this assumption, or at least to suggest that whatever
their strategy, it is rapidly being overtaken by events and by
their own short gold positions or those of the bullion banks for
which they are responsible.

Suspicious Gold Activities of Deutsche Bank

Disclosure of Deutsche Bank's huge gold derivatives position,
much of it obviously built up in the wake of the Washington
Agreement, was the first major public indication that the central
banks of the Euro Area may not be as together on gold as
advertised. Perhaps the most benign explanation of Deutsche
Bank's gold derivatives, as well as Dresdner Bank's, which are
similar in pattern but smaller in absolute scale, is that
reaction in the gold market to the Washington Agreement revealed
a short position far larger than the signatory European central
banks anticipated. Facing a melt-up in gold prices and possible
defaults on their own outstanding gold loans, these banks --
probably further prodded by Anglo-American pressure -- permitted
the two German banks to participate in a rescue operation
alongside Morgan Guaranty Trust and Citibank.

Of course, this hypothesis does not explain how Deutsche Bank
apparently learned of the British gold sales a day ahead of the
announcement, and perhaps not coincidentally at the very time
that its acquisition of Bankers Trust was being finalized. As The
Economist recently reported (May 27, 2000, p. 81): "Deutsche Bank
is still striving for a place in investment banking's 'bulge
bracket' of big American firms." There is nothing in the modus
operandi of the Clinton administration to suggest that it would
have been averse to using the German bank's ambitions and its
desire for Bankers Trust as a lever to recruit it into the gold

But if Deutsche Bank became a quisling to the euro in May 1999,
that does not necessarily mean that it could not have rejoined
the euro camp in September. In that case, pitching in to help
contain the unexpected strength of the gold market's response to
the Washington Agreement, it might still have remained visibly on
the short side although working for a different master. Still,
according to recent reports from sources of the Gold Anti-Trust
Action Committee, Deutsche Bank remains one of the prominent
sellers on the COMEX whenever gold approaches important technical

Continued Rapid Growth of Gold Derivatives

On June 6 the Office of the Comptroller of the Currency released
its report on the off-balance-sheet derivatives of the U.S.
commercial banks as of March 31, 2000. The total notional amount
of gold derivatives increased from $87.6 billion at year end to
$95.5 billion at March 31. Morgan's decreased slightly from $38
billion to $36.3 billion, but Chase's increased by more than 40
percent from $22 billion to $31.5 billion. With respect to
maturities, Morgan reduced the notional amounts of its longer
maturities (over one year) by $5.3 billion but added $3.6 billion
to its shorter (under one year) maturities. However, Chase more
than made up for the decline in Morgan's longer maturities, so
that at the end of the period the total notional amount for
under-one-year maturities increased by $6.2 billion from year
end, and for one-to-five-year maturities the total increase was
$1.7 billion. Over-five- year maturities remained essentially
unchanged, as did the amounts of Citibank's gold derivatives and
the amounts for all others.

Converted at $300/oz., the total increase of $7.9 billion amounts
to about 820 tonnes, and Chase's increase of more than $9.4
billion to 980 tonnes. Chase has the reputation of doing a lot of
its gold derivatives business with gold mining companies.
Accordingly, the increases of $4.9 billion (510 tonnes at
$300/oz.) in its one-to-five-year maturities and $2.3 billion
(240 tonnes) in its over five year maturities suggests
considerable producer covering of forward contracts given the
industry's aversion to forward selling precipitated by the
Ashanti and Cambior fiascos. Perhaps more companies are
negotiating the same sort of deal on purchased calls as Barrick.
(See "The New Dimension: Running for Cover.")

On the other hand, some of the increases may represent new
forward sales by Australian mining firms, which have been tempted
by a very weak Australian dollar. It is also possible that some
troubled hedge books may have been consolidated at Chase to take
advantage of its expertise in this area. So again, as is always
true with derivatives and hedge books, it is impossible to arrive
at very definite conclusions without more knowledge of the
underlying details. Still, given the size of the increases and
the general circumstances in the gold market during the quarter,
it is very hard to see how the bulk of these increases could
represent normal commercial or producer business.

Another strange aspect of the startling growth in the notional
amounts of gold derivatives over the past two quarters is that it
has been paralleled by an equally striking slowdown in the
average daily volume of gold transactions on the LBMA, where
presumably most of these OTC derivatives are sold and hedged.

The following table shows these figures from June 1999 through
April 2000, the most recent month for which there are clearing

Month Transferred Value Number of
(tonnes) (US$billions) Transfers

Jun-99 948.6 8.0 1044
Jul-99 1082.4 8.9 1043
Aug-99 1132.1 9.3 1034
Sep-99 1153.9 9.8 1087
Oct-99 1157.0 11.5 1205
Nov-99 786.9 7.4 845
Dec-99 886.4 8.1 942
Jan-00 690.5 6.3 774
Feb-00 933.1 9.0 907
Mar-00 752.7 6.9 800
Apr-00 783.8 7.1 791

January, March, and April of this year show the lowest average
daily clearing volumes as measured in all three categories since
the LBMA began reporting these figures in October 1996. November
and December 1999 also show volumes far below historic norms.
This pattern too is consistent with protective hedging for the
recent large increases in the banks' gold derivatives coming from
other than normal sources, almost certainly official.

From the BIS: Pulled Punches
and Indications of Strain

On June 5, 2000, the Bank for International Settlements held its
annual meeting and released its annual report for the year ending
March 31, 2000. The report is unusual for the candor with which
it covers the major dangers facing the world economy. But this
hard-hitting approach turns to pulled punches when the BIS
addresses the gold market (pp. 99-102), perhaps a sign that here
is where the greatest danger lies.

The British gold sales are not mentioned, just that the gold
price "trended downwards ... to a low of $254 in late August."
This decline is attributed "to a surge in forward sales by gold
producers ... [who] stepped up their hedging sales by more than
400 percent in the first three quarters of the year, an increase
equivalent to about 10 percent of the total annual gold supply."
The report continues: "In 1999, gold producers appear to have
started to lock in their output prices at longer maturities (10-
15 rather than 5-10 years), while banks in response were trying
to lengthen the maturity of their gold borrowing beyond three to
six months."

By not naming these foolhardy producers, the BIS spared them
instant removal from most gold investors' buy lists. Less
excusably, the BIS failed to address the real problems of the
gold mining industry, including increasingly uneconomic
production and dangerously ill-advised hedge books, both of which
carry obvious and important long-term implications for gold
banking, especially in its current highly leveraged condition.

Gold leasing and gold derivatives are mentioned only in the
context of describing the Washington Agreement, which commits the
signatory banks to no further expansion of either. A lengthy but
rather inconclusive analysis on the effects of news about
official gold sales on gold prices notes that if the Washington
Agreement is "excluded from the list of positive events, they are
on average followed by a small decline in the gold price." There
is a table showing the largest official gold holdings segregated
by banks that are parties to the Washington Agreement and those
that are not, but no indication of the amounts of these reserves
that are held in physical storage or are out on loan or swap

Accordingly, the BIS provides no enlightenment at all on the net
short physical position, the exposure of the central banks or the
bullion banks to possible gold loan defaults, the huge increases
in the gold derivatives of certain major bullion banks in the
last half of 1999, or the long-term ramifications of continued
low gold prices on gold production. Rather, the general message
that the BIS seems to want to convey is that "the global lowering
of inflation expectations has reduced gold's attractiveness" and
that "the gold market has seen a return to calmer conditions"
since last October.

A truer picture of the actual state of gold banking emerges from
the operations section of the report, where the BIS describes its
own gold banking activities during the past year. Briefly
summarized, the picture here is less gold working harder. Gold
deposits by central banks fell almost 12 percent from 927 tonnes
to 819 tonnes, and gold assets also fell by 108 tonnes to 1,018
tonnes. However, gold held in bars declined almost 20 percent
from 813 tonnes to 658 tonnes, while total gold lending increased
47 tonnes to 360 tonnes, and accounted for more than 35 percent
of total gold assets versus 28 percent the prior year. All of the
increase in gold lending was in time deposits over three months,
while those under three months actually declined by a nominal
four tonnes.

Looking at historical trends, total gold assets of the BIS
remained stable from 1992 through 1996 at around 1,500 tonnes,
and have declined steadily since then by about a third to their
present level just over 1,000 tonnes. Over the same period, its
total gold liabilities have declined in tandem, being always
about 200 tonnes less than total assets to reflect gold held by
the BIS for its own account. At the same time, its gold lending,
which grew from 134 tonnes in 1992 to 185 tonnes in 1996, has
since then almost doubled to its current 360 tonnes, with
maturities over three months nearly doubling since 1997 as
maturities under three months shrank, particularly from 1998 to

Since the BIS accepts deposits only from central banks, the
decline in its gold liabilities suggests that at least some of
its depositors have been under increasing pressure to use their
own gold for other purposes. Similarly, on the asset side, the
decline in gold bars and increase in gold lending also suggest
increasing demand for physical gold. The BIS retains a reputation
for great prudence in all its banking activities, and its balance
sheet remains a textbook example of what sound gold banking
should look like. Accordingly, one would think that running down
deposits at the BIS would be among the last measures to which
central banks in need of gold would resort.

Tightening Availability of Official Gold

My friend Elwood has very kindly updated his prior chart showing
reductions in foreign earmarked gold at the New York Federal
Reserve Bank along with total U.S. gold exports, imports, and
production on a monthly basis, and comparing them against daily
gold prices. The figures for March indicate a sharp rise in
imports to 46 tonnes, the highest level recorded in recent years.
Fed outflows and total U.S. exports declined in March as gold
prices retreated.

Interestingly, the sharp February spike in gold prices did not
escape notice by the BIS in its annual report: "The second [major
event since last August] took place on 7 February 2000, when [the
price] leaped by about $20 per ounce within a few hours of the
decision of a major gold mine [Placer Dome] to alter its hedging
strategies. This change was, however, reversed over the next few
days." The chart suggests that the gold that did the reversing
came directly out of one or more foreign earmarked accounts at
the New York Fed. The BIS is silent on who engineered the
reversal or why.

From Manipulation to Loss of Control

As the first major paper currency with no history of prior
development from gold or silver, the euro was nevertheless
supposed to draw strength from the large total gold reserves of
the Euro Area countries. Available to support the euro, these
gold reserves are marked to market by the European Central Bank
quarterly. Some have hypothesized a more formal euro/gold link in
the future, especially should the new currency run into serious

However, unlike the Swiss National Bank or the BIS, neither the
ECB nor its member central banks, at least as far as I can
ascertain, report in any detail on their gold loans or gold
derivatives. Accordingly, it is impossible to tell how much of
their gold reserves are held in vault storage, to gauge their
potential exposures on gold loans or gold derivatives, or to
measure their compliance with any parts of the Washington

Extrapolating from the gold loans reported by the Swiss National
Bank at the end of 1999 (see commentary on Swiss gold sales), I
calculated that if all EA central banks had loaned 10 percent of
their official gold reserves, total gold loans for the group
would be approximately 1,250 tonnes. Further support for this 10
percent estimate can be found in "The 1998 Gold Book Annual,"
where Frank Veneroso reports (p. 27) a statement by the
Bundesbank suggesting that "it has lent perhaps 10 percent of its
3,700 tonnes of gold." From 1995 through 1998, total reductions
in foreign earmarked gold at the New York Fed amounted to 1,245
tonnes. Taking Fed Chairman Alan Greenspan at his word regarding
the observed purposes for which foreign central banks lease gold,
I suggested the possibility that these outflows reflected leased
gold fed into the market to cap rallies in the price.

Perhaps the reappearance of the 1,250-1,300 tonnes figure in
these three contexts -- Swiss gold sales, EA central bank gold
loans, and outflows of foreign earmarked gold from the Fed -- is
coincidence. But it is also consistent with the hypothesis
elaborated in some of these commentaries: a coordinated official
scheme to control the gold price originating in 1995 as part of a
larger plan by the major industrial nations for the economic
rescue of Japan. (See "Two Bills: Scandal and Opportunity in
Gold" and "War against Gold: Central Banks Fight for Japan.") For
the Europeans, this plan would have had the added attraction of
maintaining relatively calm international monetary conditions for
the introduction of the euro on Jan. 1, 1999, when the scheme
could be wound down and gold allowed to run free.

The whole idea of Swiss gold sales seems to have originated in
1996 with former Fed Chairman Paul Volcker's efforts to mediate
the Holocaust claims against Swiss banks. As one Swiss citizen
told me recently: "The Swiss National Bank was talked into
selling gold by Volcker, who likes neither gold nor the Swiss."
Thus, the timing fits as well as the amounts. What is more, after
the Swiss by popular referendum rejected joining the European
Union, they had far greater incentive to go along with gold sales
plan if it would buy them, in addition to a settlement for their
banks, effective inclusion in the European Union while remaining
formally outside it.

From a European perspective, then, the successful introduction of
the euro in January 1999, coupled with increasing doubts about
the continued efficacy of Japan's zero interest rate policy and
rising concern over too much distortion in the gold market,
dictated an end to coordinated official efforts to cap the gold
price. Accordingly, as the chart above shows, outflows of gold --
leased or otherwise -- from the foreign earmarked accounts at the
New York Fed ceased. Indeed, in the fall of 1998 during the
Russian default and the Long-Term Capital Management debacle,
these outflows for the first time in several years fell
considerably short of almost fully covering a spike in U.S. gold

But if the Europeans were ready to free the gold market, the
Americans and British were not. First they pushed for
International Monetary Fund gold sales, against considerable
European resistance, particularly from Germany, making the German
banks' activities in the gold market all the more peculiar. As
the IMF's plan ran into trouble and gold rallied early in May
1999, the British Treasury on May 7 announced its wholly
unanticipated program of gold sales. All these developments have
been discussed in detail in prior commentaries (see especially
"The ESF and Gold: Past as Prologue"), as has the European
response: the ironically named Washington Agreement of Sept. 26,

It took nearly five months for the Europeans to react effectively
to the British announcement, during which time the bullion banks
engaged in an orgy of derivatives writing predicated on the
prospect of ever-lower gold prices. What is more, it now appears
from available numbers that the original plan to control gold
prices had already by January 1999 created a dangerously large
short gold position, far greater than that apparently anticipated
by planned Swiss gold sales. In any event, when the turn came as
a result of the Washington Agreement and the gold price rallied
far more sharply than almost anyone expected, many were caught
very wrong-footed and the full contours of the gold shortage
began to emerge.

So far the only apparent strategy for dealing with this
desperately short gold market is to throw ever larger amounts of
gold derivatives at it. Since these derivatives are coming in
huge volumes from the largest and best-connected American and
German bullion banks, all under the direct supervisory
jurisdiction of the Fed or the Bundesbank, it is very hard to
believe that this explosion in paper gold does not have some type
of official imprimatur.

Still, it is even more difficult to think that this approach can
lead to anything but a very bad end.

Nor does it appear coincidental under the circumstances that the
banks writing these gold derivatives are based in the two
countries -- the United States and Germany -- having the largest
official gold reserves. Ultimately, if there is significant
physical gold backing this deluge of paper, it resides in an
implicit promise of access to these countries' gold reserves. But
neither country has yet done anything to prepare its citizens for
the possibility that their national gold reserves may be called
upon to bail out the bullion banks, many of which got into
trouble initially by trying to profit from inside knowledge of
official efforts to manipulate gold prices.

My guess is that when the European central banks announced the
Washington Agreement, they were quite unprepared for either the
strength of the ensuing gold price rally or the magnitude of the
short gold position that it revealed. Probably they had in mind
only short positions obvious from looking at their own books or
contemplated in their original plan. What they may have failed to
appreciate, or at least not fully, was the extent to which the
bullion banks had taken advantage of their knowledge or
perception of a rigged market to write gold derivatives for their
own profit. Too late, the signatories to the Washington Agreement
may have realized that some of their own gold loans were in
jeopardy of default, and that in allowing the bullion banks to
operate without either effective regulation or appropriate
reporting geared specifically to gold banking, they had made a
grievous error.

Thus, setting out to con the gold market, the central bankers may
have ended up conning themselves. In the process, the ECB and EA
central banks may also have unintentionally stymied effective use
of their gold reserves to support the euro. The causes of its
recent weakness are the subject of considerable debate, but to
some extent the problem is more an overly strong dollar than an
intrinsically weak euro. One solution for the ECB would be to
sell dollars, which it has in abundance -- not for euros, which
it can create almost at will, but for gold. By announcing through
practical action that gold rather than the U.S. dollar is the
ultimate benchmark for the euro, the ECB would likely strengthen
the euro's foreign exchange value and win popular plaudits in
Europe for the new currency. But it would also risk setting off
an even stronger rally in gold than did the Washington Agreement.

The very danger of that rally now seems to stand not just as the
chief barrier to effective mobilization of the EA's gold, but as
a potential springboard into the unknown, including quite
possibly complete collapse of the dollar-based international
payments system jury-rigged on the ashes of Bretton Woods out of
unlimited fiat money and floating exchange rates.

Gold was a hard master. But no master may turn out to be far

Central bankers no more lack for money or brains than Bill Gates
does. Nor do their considerable resources confer any greater
exemption from basic laws of the market place and human nature.
If GATA's Bill Murphy's putting out the truth about the gold
market on the Internet does not start the central bankers
sweating, perhaps Ed Murphy will. He is the American engineer who
coined in the 20th-century the principle known as Murphy's Law,
given milder but more eloquent form two centuries earlier by the
Scottish poet Robert Burns in "To a Mouse (On Turning Her Up in
Her Nest with the Plough)":

The best laid schemes o' mice an' men
Gang aft a-gley,

An' lea'e us nought but grief an' pain
For promis'd joy.