The New Robber Barons Read online

  Time for Reform is Overdue

  More than a year has passed since former Treasury Secretary Henry Paulson went to Congress in September 2008 to plead for special powers and TARP money to bail out U.S. financial institutions. Yet there has been no meaningful financial reform.*

  Lehman was not alone in fudging its accounting and over-borrowing. All of our legacy investment banks: Lehman Brothers, Goldman Sachs, Morgan Stanley, Bear Stearns, and Merrill Lynch had borrowed too much money, all of them used gimmicks to disguise debt, and all of them--including Goldman Sachs--would have gone under in 2008 without the bailouts.

  World leaders should not be surprised that many countries also disguise debt and fudge their accounting. A good first step to reform of the financial system is to take away financial instruments that are ripe for abuse, starting with a ban on all sovereign credit default swaps.

  How to Corner the Gold Market

  March 30, 2010

  First, let your greed overcome all regard for the stability of the global market, and overcome your aversion to illegal activities. Stay away from people like me, and fly under the radar, because I’d like to see you thrown in jail. Most Washington officials, regulators, and Wall Street managers are probably safe to hang around, especially if you cut them in for a piece of the action or give them vague promises of a future lucrative job.

  Next, cultivate relationships—or plant someone—on as many as the gold exchanges as possible in London, New York, Chicago, Hong Kong, Sydney, and Dubai. Get to know key people at one or more of the bullion banks: JPMorgan Chase, UBS AG, ScotiaMocatta, Barclays Bank, and Deutsche Bank AG. Get to know as many mine producers as possible (China has been buying gold mines), and watch the sales of mines, particularly to China. Get to know all of the refiners.

  Set up some new offshore corporations, subsidiaries of existing corporations, and a hedge fund or two of your own to engage in some gold trading.

  Get to know as many hedge fund buyers as possible, and encourage everyone to buy physical gold. Remove the gold from custodian banks, and stash it in a vault solely under the control of the hedge fund. Use your network of people with net worth of $1 billion or more to get them to buy gold, too. Then work on the “small” investors with only $100 million or more net worth. Keep the key decision making group as small as possible to make it harder for anyone in your group to try to back out.

  Pump up the gold story. Get your friends to tell retail investors to buy some gold every month. Get your buddies in the financial business to offer exchange traded gold funds (ETFs) that claim to buy physical gold. This will sound safe to retail suckers investors, but in fact, the ETFs are very risky. This will serve your purpose when you are ready to start a panic. These particular ETFs will allow the “gold” to be commingled with the custodian’s gold, and the custodian can lease out the gold. Moreover, the “gold” custodian can give it to a sub custodian that the manager doesn’t know. The sub custodian can give it to yet another sub custodian unknown to the original custodian.

  The manager will never audit the gold, and the gold is not “allocated” to a particular investor. Since this is an “exchange traded” gold fund, investors will probably assume the gold is regulated by the Commodities Futures Trading Commission (CFTC), but it isn’t. By the time investors wake up to the probability that there is very little actual gold backing their investment, your plan will be ready to execute.

  Locate the naked shorts, the bullion dealers whose short positions are greater than their long positions. After you complete your plan, the naked shorts will have to pay whatever you can squeeze out of them to cover the contracts they have with you.

  Now you are ready to execute your plan.*

  Step 1: Let everyone in the futures markets know you are buying gold, speculating in gold, and want to take physical delivery. It helps that China openly announced it wants to increase its gold reserves; the market isn’t looking too hard at you. At first, act like you’re naïve. Buy on margin and pyramid up by reinvesting your profits when you have them. This part is legal, but you don’t want to draw too much attention to yourself. Your buddies in the market will distract attention from you by buying gold and putting on straddles (selling the near months and buying in future months). No one will suspect collusion.

  Step 2: Get the banks to let you finance your gold. They will lend you most of the value of your gold, especially if you do not argue about the interest rates they charge. Since they are borrowing from the Fed or another Central Bank at nearly zero, they consider the difference they get from you (backed by your gold) as gravy. As the price of gold rises, they will lend you more, and you can add to your gold position.

  Be careful with the loans, though. In March, 1980, Paul Volcker was Chairman of the Federal Reserve. As the Hunts tried to corner the silver market, Volcker inadvertently ruined their plans. Volcker raised interest rates to fight inflation and issued a special credit restraint to banks admonishing banks not to provide financing for speculators in gold and silver. Borrowing costs rose, while silver prices dropped. The former billionaires were bankrupted by Volcker’s prudence. Fraud is not for sissies. But don’t worry too much. No one in Washington is really listening to Paul Volcker today. They just trot him out for a photo-op, and then dilute any “rules” he suggests to render them totally ineffective.

  Step 3: Book up all of the space at gold refiners, so that no one else can do it. Buy as many gold mines as possible, and do not hedge (sell gold forward). Since the price of gold is going up, persuade other mines to keep as much of new production as possible off the market, while you execute your plan to push up prices. Keep the part about your attempt to manipulate gold prices a secret. You won’t be 100% successful with all the mines, but you don’t have to be, and every bit helps. Besides, if these other mines insist on hedging (by selling gold forward), your plan may drive them into bankruptcy, and then you can buy them cheap.

  Step 4: Create credit derivatives contracts that give you the option to ask for your pay-off in gold. Make the reference credit the United States or the United Kingdom and create extra triggers like credit downgrades or other events that make it easier for you to demand payment in gold. The steps you use here to manipulate the gold market can be adapted to the credit derivatives market, so even if you can’t trigger the event, you can make the spreads move in your favor and demand collateral in gold. Hide the credit default swap contract from the eyes of the clearing exchanges by embedding them in a securitization, a credit-linked note, or a sovereign fund product. The suckers investors that invest in these products never read the documentation, so when you trigger the event, they won’t realize they are caught in a short squeeze—scrambling for your gold at the high prices you set—until it is too late.

  Step 5: Pick the future month to make your big move. You will go long gold futures and demand physical delivery. Your buddies will all go long, too. Mix it up a little by buying some straddles to make it appear you are just a regular speculator, and throw everyone off the scent. Balance your straddle so it is relatively neutral, and the initial long position continues to apply pressure. When the long side of your straddle becomes due, demand physical delivery (this will be before your other long position) to keep up the pressure.

  Step 6: Secretly and habitually start making some large early purchases in non-U.S. markets. That way, when the U.S. markets open, gold should follow the upward trend. Create chaos by doing as many as the following as possible in the shortest time possible. Move any remaining gold you have in trading depositories to private storage. Get some banks to issue research reports on how the bullion banks don’t have enough gold to cover their massive short positions, and talk about the tight gold supplies. Trigger some of those credit default swaps. Inform the suckers investors in non-allocated “paper” gold ETF’s just how stupid it is to give their money to a “manager” that doesn’t audit the gold, insure the gold, prevent leasing of the gold, allocate the gold, or otherwise prove the gold is backing the fund.r />
  Step 7: The bullion banks and dealers that have over-hedged their physical gold with short positions will now be squeezed and have to meet margin calls. You and all of your speculator friends will look bad, so now is the time to use a ruse. Offer to cancel some of your forward contracts in exchange for early delivery of gold. This will temporarily relieve the bullion dealers’ pain on their short positions, and give you control over even more of the gold supply.

  Step 8: You and you friends have pinched off the gold supply and control most of the free gold supply having locked it up in your own vaults and warehouses. You are all long a lot of futures contracts, and you will all demand physical delivery. You now have the naked shorts exactly where you want them.

  Step 9: Rely on bankruptcy and bailouts to get what you want. Normally, you would be afraid that you would never get paid, because your demands would bankrupt the naked shorts. But the naked shorts are likely to be unwary hedge funds or other sophisticated investors, and no one cares if you bankrupt them. Other naked shorts are likely to be the bullion banks, and they are all being bailed out by the Central Banks who will lend them what little gold they have left and then beg the IMF for whatever they have. In lieu of that, you can set a very high cash price and take cash. In the gold feeding frenzy you have created, you can gradually unload some of your physical gold. If you managed to bankrupt any gold mines, circle back and see if you can scoop them up for a song.

  China is a wild card. If it is not part of your scheme and decides to lend its gold, it could dampen your profits or even upset your short squeeze. But China may not want to help out your victims. Why should they? If China buys enough gold mines and increases its reserves enough, it may be in its interest to befriend you. Your combined ownership will have made the futures markets irrelevant. Together you will not only have cornered the gold market, you will have cornered gold.

  * The Hunt Brothers used a similar earlier strategy in an attempt to corner the silver market in 1979-80 as recounted by Stephen Fay in The Great Silver Bubble (Coronet, 1982).

  Gold Game Changer: J.P. Morgan Accepts Bullion as Money

  February 7, 2011

  J.P. Morgan Chase & Co. announced on February 7, 2011 that it will accept physical gold as collateral for investors that want to make short-term borrowings of cash or securities.

  Presenting gold to satisfy demands for performance bond collateral has been allowed on the London CME in a limited way since October 2009. As of November 22, 2010, the Intercontinental Exchange Inc. (ICE) has accepted gold bullion as collateral on all credit default swaps and energy transactions.

  I don't recall the G-20 declaring gold a new currency. Yet JPMorgan Chase and a couple of financial market exchanges have effectively declared that gold is an alternative currency.

  In other words, gold is money.

  Abolish Credit Default Swaps on Sovereign Debt

  In an earlier post, I wrote that Congress should act immediately to abolish credit default swaps on the United States, because these derivatives will foment distortions in global currencies and gold. Credit defaults swaps on the United States currently settle in euros, but there is talk of creating new contracts calling for settlement in gold. Congress should immediately ban all credit derivatives on the United States, since the opportunities for mischief making outweigh the hedging value.

  Most traders in U.S. credit default swaps don't think the U.S. will default as long as we have money printing presses, so they are speculating on price movements in U.S. Treasury bonds due to potential increases in interest rates. If speculators manage to get contracts to settle in gold, speculators on the winning side of a price move will demand collateral paid in gold.

  Destruction of the Volcker Bubble Deflator

  In 1979/1980 the Hunt brothers tried to corner the silver market. In March 1980, Paul Volcker (who was then Chairman of the Federal Reserve) went to DEFCON 1 and directed banks to cut off funding to precious metals speculators. That directive included billionaires like the Hunt brothers. The Hunts couldn't borrow money against their long silver positions to meet their margin calls. Volcker popped the silver bubble and the Hunt brothers were bankrupted.

  Since gold is now accepted collateral, there will always be a way to borrow against one's gold position, so speculators that create leveraged long gold positions can always find a way to fund margin calls. The Volcker bubble deflator is no longer relevant.

  Trifecta of Absent Financial Regulation: CDS, Currencies, Commodities

  How much mayhem could "creative" minds generate in the credit default swap markets, the currency markets, and the gold market? Quite a bit, since customized credit default swaps can be embedded in all manner of financial investments, and they can be written to offload unexpected risks on naïve investors.

  The Dodd-Frank "financial reform" bill doesn't address customized over-the-counter credit default swaps, and the bill doesn't do anything at all to reign in speculation in the currency markets or the commodities markets.

  Disclosure: I currently own some long positions in precious metals including gold. This is not an offer or solicitation for purchase or sale of any security and is not an investment recommendation of any kind and should not be construed as such. These comments reflect my views as of February 7, 2011, and are subject to change at any time based on market and other conditions.

  Today’s Silver Scandal

  May 5, 2011

  Under-30 silver traders weren't alive to see the billionaire Hunt Brothers bankrupted by silver trades, and those under-45 years old probably never read about it. The Hunts' silver debacle occurred after the "soybean caper," but before the CFTC fined them $500,000 in a July 1981 out of court settlement for blatant violation of commodities laws in their attempt to corner beans. The Hunts had borrowed money to buy silver and leveraged themselves in silver futures in an attempt to corner the market.

  On March 14, 1980, the CFTC staff reported to their commissioners that the Hunt Brothers could handle their short-term losses as silver prices fell, because "they bought at low prices." The CFTC was right about the low purchase prices (around $15 on average), but it was wrong when it thought the Hunt brothers could handle the losses.

  Simultaneously, then Fed Chairman Paul Volcker instituted a new directive to U.S. banks as part of his anti-inflation policy. It was a "special restraint" on lending to speculators with holdings in commodities or precious metals. The banks knew better than to mess with Volcker, and they immediately closed the lending spigot to speculators in gold and silver.

  Within three days, the Hunt brothers' cash had nearly run out, and they couldn't meet a margin call. Two days later, they had to deliver silver instead of cash in order to meet the margin call. Other speculators were having trouble raising cash against their silver, and prices dropped like a stone.

  Back to the Future

  Some believe the recent general commodities pullback was triggered by the series of CME margin hikes on silver within the past week, after the recent exponential run-up in silver prices. Whether or not that is true, holders of leveraged long commodities positions should have warily watched the action in the silver market. Some silver speculators may not have seen the margin hike as a constraint on lending, but it should have been a red flag for any speculator with a leveraged long position. Moreover, after silver markets closed, silver prices were getting "banged" lower in what looked like suspicious market manipulation.

  Speculators rushed in as prices recently soared and rumors swirled that there will be a delivery default at the CME including one of the TBTF banks with a huge short position that it cannot cover. Are the rumors true? I don't know since those in charge of investigating these matters haven't put evidence in the public domain, even after a senior member of the CFTC claimed there was blatant silver manipulation.

  The fastest way to collapse a recent run up in prices is to choke off the ability of those with leveraged long paper positions to raise cash. Another way is to rapidly hike margins; those with in
sufficient ready cash will be forced to liquidate. As they liquidate to meet margin calls, prices fall, and it creates a cycle which feeds on itself. I have no explanation for the recent ramp up in silver prices any more than I have an idea of where spot silver prices eventually hit bottom.

  This isn't the first time there has been extreme price action and volatility in the silver futures markets, and it will not be the last. If anyone thinks that the Commodity Futures Trading Commission (CFTC) has the right stuff to regulate the commodities markets, look no further than its failure to check manipulation in the silver market.

  The CFTC has the mandate to "regulate" tens of trillions of dollars in credit derivatives, but it is actually in the business of anti-regulation.

  Price Manipulation: Look for Motive

  January 19, 2012

  Regulators haven't been able to keep up with price manipulation in the commodities markets or any other market. Why do games persist? The short answer is because they can, and because they can be very profitable in the short run.

  If you've Googled gold or silver, you've probably come across sites that are breathless about the possibility of manipulation of metals prices. The problem with the Internet is that it's new, too new to capture the rich history of the financial markets. Manipulation of metals prices -- and the prices of many other commodities -- is an old tradition. Here's one example adapted from An Alchemists Road: My transition from medicine to business, by Dr. Henry Jarecki (Dr. Jarecki is currently Chairman of Gresham Investment Management LLC.), October, 1989. This publication is not available on the Internet.