A Response to Toby Connor’s Thesis about the Gold Bear Raid

The “gold bear raid” was driven by the TBTF banks in an attempt to amplify their earnings. This is according to a  Toby Connor article on Resource Investor. In short, his thesis was that the TBTFs drove the price down so they could buy lower now so they could sell higher later. stack-of-gold-bullion-coins

Though I do not disagree with Connor’s technical analysis, I think his explanation for why the price of gold plummeted is just too damn complicated. Occams Razor tells us to look for the simplest explanation, and I think there are much simpler explanations than his.

First, the context: the price of gold fell from ~$1800 last October to less than $1300 in June. It’s recovered a bit of that price since then but is still down over 30% from October.  The fundamentals for gold haven’t changed.

In general, the main driver of gold’s price – at least in the West – is the expectation of monetary inflation. The main driver in Asia is simple demand .

Since the Fed is still creating $85B in brand new money every month, there is no change in the expectation that the new money won’t end up sloshing into the marketplace. Asians are still demanding gold in quantities that far outstrips supply, so there is no change from that perspective that would drive the price of gold down.

I think Connor overlooks at least two situations that serve as a better explanation for the drop in the price of gold.

In no particular order, they are:

  1. The disconnect between paper gold and physical gold
  2. Margin calls on big players

Its well-known that the supply of physical gold implied by the volume of “gold-backed” ETFs far exceeds the actual supply of physical. Nevertheless, paper gold has tracked the price of physical since it was introduced. If a big holder of paper deciding that the spread between implied supply and actual supply was just too big to justify, he might just decide to dump his paper. That could start a drop, which could then be exacerbated by other holders getting margin calls.

Suppose some of those getting margin calls were large holders of gold. Cyprus was proof that the Eurocrats will stop at nothing to keep the big banks afloat. Suppose some big hedge fund was massively short the Euro and massively long gold and found themselves on the wrong side of both those trades when the ECB decided to bail-in Cyprus? Or Portugal? Or Spain? Or Italy?

The amount of gold that was dumped on the market tends to argue that someone was reacting in “panic liquidation” mode, not coolly choosing to manipulate the price lower so they could buy a lot more so they could sell it a lot higher. That’s a cool theory, but it’s just too damn complicated to be believed. I’d put my money on forced liquidation due to margin calls.

2 thoughts on “A Response to Toby Connor’s Thesis about the Gold Bear Raid”

  1. Jack – you have not succeeded in making your argument which apparently is that it is too complicated to believe that TBTFs drove the price of gold down so they could buy gold lower and sell higher in the future.

    What exactly is your argument? Do you think these folks sit around baking cookies all day – wondering which charity to send them to? Or do you think TBTFs have actually succeeded in their business by paying exceedingly close attention to market dynamics and using their impressive resources to any advantage presented to them?

    I guess if we assume they are into baking cookies then the 500 tons of paper gold dropped onto the pre NYSE market was just as shocking to them as to you or I. Heck, even Goldman Sachs should have been shocked as just the day before they told the world to short gold. What kind of cookies were they baking that day, I wonder?

    Don’t feel bad about being naive Jack. Those of us who do not have the financial resources of the TBTFs have no or little clue what it is like to be in their shoes. But my hunch is that it is like a Major League ball player going up against a 12 year old kid. You may not give the Major League ball player much credit for being a Major League ball player, but when he hits the kid’s fast ball up your ass and over the center field fence you better wake up and pay attention when he offers to hit another pitch.

    1. I am actually deeply cynical about our financial markets and believe that Goldman & Co are willing to do almost anything. I can believe they dropped 500 tons of paper with the intention of driving the price down. I can believe they wanted to eventually buy at a lower price. But even I have trouble believing they did all that HOPING that after dumping and buying, they would drive the price of physical to $3000 and sell again. That’s just too complex and too risky even for the TBTFs. Maybe I’m wrong, but to me it seems much more likely that someone had delivery demands on leased gold, and TBTF helped ’em out in a mutual back-scratching session.

      Thanks for the comment.

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