Why The Gold Price Is So Well-Behaved
For now…
The chat transcript shown to the court read:
“Tell Gregg to wake up.”
Gregg obeyed. We know because every message sent over a Bloomberg terminal is timestamped and archived. What happened seconds later had his fingerprints all over it.
At the time, Gregg was a top gold trader at JPMorgan. Early next year he’ll begin serving a brief prison sentence.
The client who sent the message to Gregg will not join him in prison. In fact, what looks like a pattern of consistently treating the gold market like a cash machine got little attention in the case. Gregg is merely the fall guy.
The client had 90,000 ounces of gold to unload that morning. At today’s price that’s ~$172 million worth of metal. He expected a better than market price on the trade. Gregg delivered.
For reasons we’ll never know, Gregg wanted to please the client. So much so he frantically entered a string of buy orders in the gold market. One after another, his orders populated on trading screens around the world. The logical conclusion of any trader paying attention would be, there’s a whale buying gold this morning, maybe I should too.
But Gregg had no intention of buying. The plan was, create the impression of surging demand for gold, as the price shot up, unload his client’s 90,000 ounces at an above market price.
He wanted to show the client he got them a better outcome than they’d get selling into the real market.
This went on for several years. Prosecutors called it “spoofing.” The trades that sent Gregg to prison happened in 2011-2012. After years of using the technique to fix the gold price, a few traders got a slap on the wrist. JPMorgan itself paid a record $920 million fine to end the investigation into its “spoofing” activities. There is no way to estimate total losses incurred by traders on the other side of these deceptive, bogus orders.
As for the clients, no mention of accountability.
So Fast His Hands Cramped Up
A surge of orders gives the impression of buying or selling. Unlike a regular market made up of actual buyers and sellers, trading the movements of gold only generated losses. Time after time, the surge of orders vanished. That sent prices quickly in the opposite direction.
Gregg, our soon-to-be incarcerated gold trader was the top “spoofer” on his desk. He spoofed so effectively, so rapidly, colleagues worried his hands may cramp up.
To understand how this works there are a few key details.
For starters, these traders rarely deal in physical gold. Instead, they trade speculative contracts. Pieces of paper which entitle the holder to a specific price of gold on a future date.
It’s not much different from spectators placing prop bets from a luxury box at a football game. What’s different here is they placed so many fake bets it looked like the odds turned. That changed how other betters made decisions. The tail wagged the dog. It surely affected the outcome of the game.
Each one of these speculative paper contracts represents the price of 100 ounces of gold. That contract becomes more valuable as gold moves up, less valuable as gold moves down.
Huge Leverage
In addition to rarely seeing an ounce of physical gold, contract buyers pay a fraction of the gold price.
Each 100-ounce contract tied to the future price of gold costs a buyer $8,300 today. That means a trader, like the one commanding Gregg, only pays $83/ounce for gold exposure.
“Exposure” means a bet on the movement of gold. It’s a highly leveraged bet. If gold moves, the contract pays off big.
Gregg’s client could place that massive gold trade today without ever touching an ounce of gold. He’d only pay $7.47 million to control $172 million worth of gold.
That means with a small amount of money, you could send the gold price running one way or another.
It’s a Reality Theory
This might sound like the stuff of conspiracy. After all, who’d want to control the gold market?
Plenty of people spotted this odd action around the start of the 2010s. A group called GATA was one of the most notable. They shouted until they were out of breath. Nobody seemed to care. Worse yet, people laughed at them, called them conspiracy theorists, sometimes worse.
Turns out, they were right. But it’s too late. Spoofing duped traders into buying or selling when they otherwise would have done the opposite. A $1 billion fine and a few low-level traders spending a few months in jail ends the chapter.
Now there’s a new chapter.
My guess is people won’t believe it until the year 2030 when some lowly computer programmer faces charges of corrupt trading. They won’t seem capable of pulling off what people connected to gold see happening today.
Like clockwork, the gold market makes a violent move around 8:30 AM EST on random days.
This person, or entity, shows up with a truck load of gold to sell. The red circle at the bottom of the screen shows the time. The red circle at the top of the screen shows the volume. 88,036 contracts. At 100 ounces each that’s 8.8 million ounces traded in one session.
For reference, all the gold mined in 2022 amounted to ~116 million ounces. That means about 5% of a year’s worth of mining changed hands in this one session. And that’s nothing…
In February of 2022 Russia invaded Ukraine sending the gold price up near a record high. It’s circled in red on the price chart below.
After that high, gold settled back into a manageable price range. It’s so well-behaved it sits at roughly the same price today.
However, it didn’t go there on its own. As the price surged to new highs on the outbreak of war, paper contract trading exploded. Notice below, circled in red, there were 447,651 of these paper contracts traded on one day in early March 2022. That means ~45 million ounces changed hands. That’s almost half a year’s worth of mine supply traded in one day.
Remember, few of these paper contracts ever touches an ounce of physical gold. These are bets on the price, settled out typically in cash payments when the contracts expire.
Well-Behaved…. For Now
A runaway gold price is bad news for central planners.
The name of the game is to keep you believing in the system. If you started to question things, you’d look for a way out.
People are remarkably complacent. They expect mortgage rates to “come back down.” They complain of inflation personally but agree with headlines that say it’s under control. What if things are not under control?
The Fed shoved a record amount of cash into the financial system in 2020-2021. The San Francisco branch of the Fed estimates more than ~$2 trillion of cash piled up as a result.
That cash is on the way out. As the Fed drains the pool, there will be casualties.
Think back to 2020. Try to remember your impression of these hot stocks. Novice traders, flush with government handouts, flooded the market with fresh cash:
· Peloton – Down 97% from 1.13.21 high
· AMC Entertainment – Down 97% from 6.2.21 high
· GameStop – Down 80% from 1.27.21 high
· Wheels Up – Down 99% from 7.14.21 high
· WeWork – Down 99% from 4.5.21 high (pre-merger)
The list goes on. That huge flood of cash shot life into otherwise worthless investments. That’s not to say these companies are worthless. It was the equity value that shot far beyond reality.
Someone bought shares at those highs. As those equity values come back to earth, people take serious write downs.
Even the brightest investors in the world funded startups at peak valuations. Instacart is set to trade in the coming weeks. Investment funds valued the company at $39 billion in 2021 only to fund it again at $13 billion late last year.
The point is, without vast new sources of fresh cash, many assets aren’t worth what the owners think.
If the Fed keeps draining the pool, those asset owners face a harsh reality. It won’t be pretty.
However, if an angry mob of broke credit junkies decides it’s had enough, the Fed may reverse course. If it returns to goosing the “free market” with fresh cash, it might be a good idea to own a few ounces of gold. And not the paper kind bought with borrowed money… (See the bottom of the Trustee Portfolio for more details)
Our Newest Indicator
There’s plenty of fuse left to burn for the Fed. Here’s a good example. It’ll be our newest indicator to keep an eye on.
This is the Rolex GMT Master II. As configured on the Rolex website the MSRP is $10,900.
If you can get your hands on one, eBay buyers will pay double for it. In fact, the owner of the watch pictured below held on to it for 9 months before selling it this month for $19,300. This is not a listing; it is a record of a recently completed sale.
There is a vibrant “grey market” for Rolex watches these days. Rolex only sells new watches through an authorized dealer network. Buyers turn around and flip them on internet auction sites.
I can’t imagine buying a used watch on an auction site. For starters, it might not fit. Then there’s question of authenticity, warranty registration, and sensible concerns like wiring double the retail price to an anonymous eBay seller. The whole thing makes no sense to me.
Further, I have several Rolex watches. I feel like I got a good deal on all of them. Buying overseas avoided sales tax and the $1,000 surcharge Rolex USA placed on the same watch once imported. Those days are over.
In each case, I had lots of time to deliberate. Sales clerks offered me champaign, and other things I didn’t want, like financing. They don’t do any of that now.
While I’m not in the market for another watch, I do stop by Rolex stores when traveling. Even with a substantial purchase history, the sales clerks treat me like I showed up to fix the toilet.
Something’s off here. Rolex makes more than 1 million watches each year. It’s nice to have one as an everyday watch. But it’s not an heirloom.
This list of buyers waiting in line for a Rolex is a lagging indicator. My bet is most of them can’t afford the watch. Without the prospect of flipping, the list might disappear overnight.
If we keep an eye on this wait list, we’ll get a sense of how much fluff is left in the system.
Lance Will Keep Us Up to Date
It came to my attention that TTL subscriber Lance A. is on the Rolex wait list at his local authorized dealer.