Did the ECB Save COMEX from Gold Default?

On Tuesday morning, gold derivatives dealers, who had sold short in the face of a fast rising gold price, faced a serious predicament. Some 27,000 + contracts, representing about 15% of the April COMEX gold futures contracts remained open. Technically, short sellers are required to give “notice” of delivery to long buyers. However, in reality, buyers are the ones who control the amount of gold to be delivered. They “demand” delivery of physical gold by holding futures contracts past the expiration date. This time, long buyers were demanding in droves.

In normal times, very few people do this. Only about 1% or less of gold contracts must be delivered. The lack of delivery demand allows the casino-like world of paper gold futures contracts to operate. Very few short sellers actually expect or intend to deliver real gold. They are, mostly, merely playing with paper. It was amazing, therefore, when March 30, 2009 came and passed, and so many people stood for delivery, refusing to part with their long gold futures positions.

On Tuesday, March 31^st, Deutsche Bank (DB) amazed everyone even more, by delivering a massive 850,000 ounces, or 8500 contracts worth of the yellow metal. By the close of business, even after this massive delivery, about 15,050 April contracts, or 1.5 million ounces, still remained to be delivered. Most of these, of course, are unlikely to be the obligations of Deutsche Bank. But, the fact that this particular bank turned out to be one of the biggest short sellers of gold, is a surprise. Most people presumed that the big COMEX gold short sellers are HSBC (HBC) and/or JP Morgan Chase (JPM). That may be true. However, it is abundantly clear that they are not the only game in town.

Closely connected institutions, it seems, do not have to worry about acting irresponsibly, in taking on more obligations than they can fulfill. Mysteriously, on the very same day that gold was due to be delivered to COMEX long buyers, at almost the very same moment that Deutsche Bank was giving notice of its deliveries, the ECB happened to have “sold” 35.5 tons, or a total of 1,141,351 ounces of gold, on March 31, 2009. Convenient, isn’t it? Deutsche Bank had to deliver 850,000 ounces of physical gold on that day, and miraculously, the gold appeared out of nowhere.

The announcement of the ECB sale was made, as usual, dryly, without further comment. There was little more than a notation of a sale, as if it were a meaningless blip in the daily activity of the central bank. But, it was anything but meaningless. It may have saved a major clearing member of the COMEX futures exchange from defaulting on a huge derivatives position. We don’t know who the buyer(s) was, but we don’t leave our common sense at home. The ECB simply states that 35.5 tons were sold, and doesn’t name any names. Common sense, logic and reason tells us that the buyer was Deutsche Bank, and that the European Central Bank probably saved the bank and COMEX from a huge problem. What about the balance, above 850,000 ounces? What will happen to that? I am willing to bet that Deutsche Bank will use it, in June, to close out remaining short positions, or that it will be sold into the market, at an opportune time, if it hasn’t already been sold on Tuesday, to try to control the inevitable rise of the price of gold.

Circumstantial evidence has always been a powerful force in the law. It allows police, investigators, lawyers and judges to ferret out the truth. Circumstantial evidence is admissible in any court of law to prove a fact. It is used all the time, both when we initiate investigations, and once we seek indictments and convictions. We do this because we deal in a corrupt world, filled with suspicious actions and lies, and the circumstances are often suspicious enough to give rise to a strong inference that something is amiss. Most of the time, when the direct evidence is insufficient to prove a case beyond a reasonable doubt, or even by a preponderance of direct evidence, circumstantial evidence fills the void, and gives us the conviction. We even admit evidence of the circumstances to prove murder cases. In light of that, it certainly seems appropriate to use circumstantial evidence in evaluating possible regulatory violations. The size and timing of the delivery of Deutsche Bank’s COMEX obligation is suspicious, to say the least, when taken in conjunction with the size and timing of the ECB’s gold sale. It is circumstantial evidence that the gold used by Deutsche Bank to deliver and fulfill its COMEX obligations, came directly or indirectly, from the ECB.

I’d sure like to know what the ECB’s “alibi” is. If I were an investigator for the Commodities Futures Trading Commission (CFTC), assigned to determine whether or not gold short sellers are knowingly violating the 90% cover rule, I’d be questioning the hell out of the ECB staffers, as well as employees in the futures trading division of Deutsche Bank. There is certainly enough evidence to raise “reasonable suspicion”. Reasonable suspicion is all that one needs to start a criminal investigation. It should be more than sufficient to prompt the CFTC, as well as European market regulators, to start a commercial investigation of the potential violation of regulatory rules by both the ECB and one of the world’s major banking institutions. That is, of course, if and only if, the CFTC staff really wants to regulate, rather than simply position themselves for more lucrative jobs inside the industry they are supposed to be regulating, after they leave government service.

It is quite important to determine whether or not Deutsche Bank was bailed out by the ECB because that will answer a lot of questions about allegations of naked short selling on the COMEX. If the ECB knew that its gold would be used as post ipso facto “cover” for uncovered shorting, staffers at the central bank might be co-conspirators. At any rate, if the German bank did sell short on futures contracts without having enough vaulted gold it sold a naked short. It also means that the ECB has facilitated a major rule violation in a jurisdiction (the USA) with which Europe is supposed to have extensive joint regulatory agreements, any number of which may have been violated by this action of the ECB. At the very least, naked short selling is a blatant violation of CFTC regulations, which require 90% cover of all deliverable metals contracts. If the delivered gold came directly, or indirectly, from the ECB, it means that Deutsche Bank’s gold short contracts were “naked” at the time they were entered into.

The 90% cover rule is very old rule, designed to prevent fraud on the futures markets. Its origin dates back into the 19^th century. Farmers, in that simpler age, were complaining that big bank speculators were downwardly manipulating grain prices on the futures exchanges. Nowadays, the CFTC has a predilection toward categorizing banks as so-called “commercials” or “hedgers”, rather than as the speculators that they really are. Traditionally, only miners and gold dealers whose business involves a majority of PHYSICAL trade in gold should qualify as commercials. However, the CFTC has ignored this for a long time, and qualified numerous banks and other financial institutions, whose main gold business is derivatives, as “commercial” entities, immunizing them from position limits and other constraints. As a result, just like the farmers of the 19^th century, today’s gold “cartel” conspiracy theorists revolve their theory around an allegation of downward manipulation, and heavy short selling concentration.

Manipulation can only take place when there is a disconnect between supply, demand, and trading activity on the futures exchanges. The 90% cover rule attempts to force a direct tie between the futures market and the availability of particular commodities, so that supply and demand become primary even on paper based futures markets, just as it is in trading the real commodity. Unfortunately, the modern CFTC has ignored or misinterpreted the purpose of the 90% cover rule for a very long time. This regulatory failure has allowed the current free-for-all “casino-like” atmosphere that now prevails at futures exchanges.

It would be helpful if some of my colleagues, within the public prosecutor and securities regulatory offices, in Europe, as well as the CFTC in America, filed complaints for discovery, to ferret out the truth. In the interest of transparent markets, the ECB should be forced to disclose who purchased the gold they sold in the morning of March 31, 2008 and why the sale was timed in a way that corresponded to the exact moment in time that Deutsche Bank had a desperate need for gold bullion.

Was it yet another bank bailout? Has another bank sucked up precious resources belonging, in this case, to the people of Europe? Gold is needed to bring confidence to the Euro currency, as often noted by Germany’s Bundesbank, which seems to be less kind to German banks than the ECB. Why should the ECB be permitted to sell gold to closely connected derivatives dealers, if the primary purpose is to save those dealers from the bad decisions they have made, and the end result is to reinforce moral hazard? Should banks like Deutsche Bank be allowed to take on more derivative risk than they can afford without involving publicly owned assets? Did Deutsche Bank issue naked short positions? Have innocent European citizens now had their currency placed at more risk, and some of their gold stolen from them, simply to enrich private hands? All of these questions are begging for answers.

European regulators are quick to condemn the Federal Reserve for its incestuous relationship to client “primary dealer” banks, special treatment of favored institutions at the expense of other non-favored institutions, propensity toward injecting dollars to artificially stimulate the stock market, seemingly endless bailouts of closely connected banks, and, now, the seemingly unlimited printing of new dollars. I’ll not attempt to excuse the Fed for its failures. Indeed, I believe that it is in the best interest of the American people to close down that malevolent institution, permanently. However, if any of the questions I have posed are answered in the positive, people might begin to understand that special favors, nepotism, corruption, and a failure to properly regulate are not confined to America. The real estate bubble, for example, was allowed to become much bigger in the U.K., Ireland, Spain, and eastern Europe, than it ever was in the USA. The collapse of real estate, in those countries, is going to be more severe, even though it is more recent in origin than the pullback in the USA. America happened to be the first nation affected, but it did not cause the world economic collapse. That was caused by the joint irresponsible policies in almost every major nation in the world.

Those who rely on the good faith of Angela Merkel, to keep the Euro inviolate, certainly have a right to get answers from the ECB and from Deutsche Bank. The answers will tell us a lot about the real proclivities of the ECB. As the U.S. dollar is progressively debased, in coming years, will the Euro be any better? Is the ECB merely a European copy of the Federal Reserve “slush fund”, utilized by well connected European banks, for the purpose of private financial gain, much as the Federal Reserve’s assets are utilized by its primary dealers? If the ECB is willing to bail out a major trading institution from the mismanagement of its derivatives operations, who could honestly claim that it would hesitate to competitively debase the Euro against the dollar? Having the answers to the questions I have posed would give everyone the knowledge needed to make important decisions. That is exactly the reason that, in all likelihood, we will never get these answers. Maybe, Europeans and others ought to be dumping Euros just as fast as they are now dumping dollars, and buy gold and silver, instead.

Aside from the regulatory issues, if we did discover that Deutsche Bank got its gold from the ECB, one glaringly strong inference arises. When a major derivatives dealer goes begging for gold, to the ECB, it is very strong circumstantial evidence that not enough physical gold is available for purchase on the OTC wholesale market. Up until now, bearish gold commentators have steadfastly denied that wholesale gold shortages exist. Instead, they have insisted that all shortages are confined to retail forms of gold. Now, when combined with the circumstantial evidence, however, common sense tells us that they are wrong.

Decision: There is sufficient evidence for this case to go to a full scale investigation. The CFTC and similar securities regulators in Europe need to properly investigate the gold conspiracy allegations. That has never been done to date. They must determine who is buying central bank gold and whether or not it is simply being sold into the open market, or channeled into the hands of favored financial institutions who then use it to cover naked short selling. The investigation must include detailed vault audits and explore all paper trails.

Disclosure: Long on gold.

Comments

[Alan von Altendorf]

Thank you. Forwarding this pronto.

2009 Apr 02 08:28 AM

[daveddawg]

All western CBs are shorting gold because a rise in price would threaten their fiats. Taking delivery will eventually exhaust the vaults at least to the point where CBs will stop bailing out their buddies. Delivery will continue by the arabs and asians as they no longer trust the western fiats. Can you say short squeeze.

Those shorties better settle soon in cheap fiat.

To the author--An excellently written, meaningful and accurate article. Good Job! Going in watchlist.

2009 Apr 02 09:02 AM

[tjhorton]

If governments are knowingly involved, what can you really do? Expose and express outrage, perhaps find someone with political power that can make mileage out of it, but don't expect government to punish itself.

2009 Apr 02 09:03 AM

[yellowhoard]

There will not be any serious investigation in the near future. Who do you think put the politicians in power in the first place?

The inevitable investigation will only come after the house of cards collapses. Then we will see "outrage" from the political class. Probably show trials and public executions.

Kind of like Russia about 100 years ago.

2009 Apr 02 09:19 AM

[Ed Zimmer]

This is only the tip of the golden iceberg. In the March Bank Participation report of the CFTC, 21 Non-US banks held a total short position of 58,900 contracts, an increase in short positions of 16,565 contracts over the February position, with two fewer non-us banks. If you are only referring to 850 contracts settled, there is a massive short non-US bank position still out there. The massive increase in the short position has to be supressing the price of gold.

When you add the 3, US Bank short positions of 109,091 contracts, the evidence of price manipulation downward is apparently clear to everyone but the CFTC.

CFTC numbers show that these 24 total banks, control 46 percent of the short contracts in CMX Gold and only offset this position with just over 10 percent long positions. Anyone think that net shorting 130 million ounces of gold you don't have is a good thing?

One stiff month of delivery demand is going to bring this house of cards tumbling in on itself.

2009 Apr 02 09:22 AM

[Cesato]

Nobody saved anything, it is how the markets works. As soon as you understand market cycles you will be buying at the right time, selling timely and buying back near bottoms. Big players (real winners, not losers like already broken investment Banks) in Gold are diversified in their portfolios and constantly keeping a balance between those assets. It's been more than a year since the manipulation theory (inexistent by the way) has been discussed in order to justify losses from uneducated investors who don't realize that following the trend and identifying the corrections associated with other assets' moves makes you a winner. I really got tired of that manipulation discussion, buy low sell high and add to breakouts either if you are long or short, it does not get any simpler that that. If you were making money you would not waste your time digging into theories but explaining why the market does what it does without taking you off-guard. Remember that physical Gold can be bought and sold for a profit as well, you don't have to keep it under the mattress just for pride, it is a way to make money and still have physical on your net worth long term, playing paper Gold as a hedge is another means to make some money short-term if you are in love with the physical stuff. For now the trend in Gold continues and will continue down for a while.

2009 Apr 02 09:45 AM

[FoxV]

tjhorton: "If governments are knowingly involved, what can you really do?"

buy physical Gold and don't play their games. The sooner people realize the importance of the age old wisdom "5-10% of savings should be in precious metals" the sooner the CB's and governments will be forced to admit that paper is only paper.

And here are other age old wisdoms that people seem to have forgotten "A bird in the hand is worth 2 in the bush" and "Don't count your chickens before they hatch". These old truths came about for a reason. It would be in everyone's best interest to consider those reasons and evaluate the situation they, and we, are in.

2009 Apr 02 09:58 AM

[kohalakid]

"Naked shorting" is a violation of absolutely no regulation in the commodity market. What is this knucklehead talking about? If Deutsche Bank needed to get out of this position because they didn't have physical gold to deliver, they could have bought back the amount they were short or simply done a Apr/June switch to roll the position forward. The market certainly had the liquidity before first notice day to accomodate either move.
But fear and conspiracy makes for a better article, right??

2009 Apr 02 10:03 AM

[GMiki1]

Like the CFTC will do anything. Look at Ted Butler's comments on the silver market manipulation. The CFTC hears no evil, sees no evil and speaks no evil. I did noticed the ECB sale and was surprised and knew that a nice number of longs were taking physical possession for April, but didn't put the two facts together. Great explanation. The precious metals were certainly hammered down today. I think that's bullish for them.

2009 Apr 02 10:53 AM

[Avery Goodman]

Kohalakid,

Obviously, you have no knowledge, whatsoever, of the rules that govern the markets in the United States, or anywhere else. Before we get more deeply into that, let me point out what 17 CFR 31.8 says, and leave it at that.

"...(a)(1) Each leverage transaction merchant must at all times maintain cover of at least 90 percent of the amount of physical commodities subject to open long leverage contracts entered into with leverage customers, and must at all times also maintain cover of at least 90 percent of the amount of physical commodities subject to open short leverage contracts entered into with leverage customers..."

Vault audits would tell us whether the alleged paper "cover" that is presented to the CFTC, and which is never questioned by them, to my knowledge, is actually valid. Most COMEX dealers are probably presenting OTC derivatives contracts to claim that they have the required "cover", and are not naked shorts.

However, the veracity of those paper OTC contracts are in question, if big banks like Deutsche Bank, are forced to go "hat in hand" to a sovereign gold vault, like the ECB, to get enough gold (8500 contracts worth) to deliver on their obligations at COMEX.

Vault audits are necessary, at this point, in order to determine the truth or falsity of the claim to possession of real metal. If OTC contracts are just supported by other OTC contracts, which, in turn, are supported by yet other paper contracts, and so on and so forth, ad infinitum, then the whole game is a fraud. In that event, the gold conspiracy theorists, from Ted Butler to Jim Sinclair, are telling us the truth. On the other hand, if the underlying metal really does exist, the conspiracy theorists are wrong, and everyone can feel much more comfortable in the quiet knowledge that our markets are honest and true.

Keep in mind that it is not the individual investor who sells a "naked" short. It is his broker/dealer, and his broker/dealer's clearing broker, who end up doing that. Many of the broker/dealers and certainly the people on the bottom of the totem poll, like you, me, the line brokers and so on, are simply honestly relying upon paper promises. But, if the underlying metal doesn't exist, then, someone, probably the biggest players, at the highest levels, are committing fraud.

The recent sale of such a suspicious amount of gold into the market, just at the moment of Deutsche Bank's need, justifies a full investigation of the gold market, either to help assure us that it is clean or to help start the cleansing process.

2009 Apr 02 10:57 AM

[Vuke]

Cesato, I like your explanation. As I understand it, everyone wants gold but the trends make it go down.

Ah, the "magic hand" of the market once again appears. The trend will make gold more affordable so we shouldn't surprised if the IMF decides to sell a little in the future.

======================...
On Apr 02 09:45 AM Cesato wrote:

>>> Nobody saved anything, it is how the markets works. As soon as you understand market cycles you will be buying at the right time, selling timely and buying back near bottoms.<<<

2009 Apr 02 11:08 AM

[Maxe Paul]

In my dealings with the gold market i have accepted that it is controlled by government and large bank selling, and bought by fear mongers who hawk its rise at every opportunity.

Some people honestly believe that one day.....soon, they will walk into a supermarket and pay for their food with gold as everyone else on the street starves, because they are not smart like them because they bought gold with all their money!

If i read another story of $5,000 gold coming very very soon im going to laugh my head off.

2009 Apr 02 11:09 AM

[Avery Goodman]

Kohalakid,

One more thing...the gold market is NOT sufficiently liquid to absorb the sudden liquidation of 8500 gold contracts, representing almost a billion dollars worth of gold. A few months ago, a few large long players liquidated about 10,500 contracts, over a period of a week. That liquidation temporarily dropped gold by $120 per ounce. In the inverse, a short side liquidation of 8500 contracts would probably cause the price of gold to go from $920 to $1,020 or something in that vicinity.

2009 Apr 02 11:22 AM

[kohalakid]

Avery, I think you are confusing a "leverage transaction merchant" with a "futures commision merchant". They are very different animals with very different regulations.
See 17 CFR 31.22.
I don't think Deutsche Bank is a "leverage transaction merchant".

2009 Apr 02 11:32 AM

[kohalakid]

Avery, I was watching the Apr/June gold switch on the couple of days preceeding first notice as I had contracts to roll. The bid and ask sizes on the spreads were in the 2500-3000 contract ranges. It would have not been difficult to roll 8500 lots over in a period of a couple days.

2009 Apr 02 11:35 AM

[psig]

I am not much for conspiracies but I do believe in manipulation. If there is any hanky panky going on the physical gold market demand will eventually expose it within a few years or less if the economies of the world continue in the crapper. If economies recover or at least don't get much worse then everyone can continue to play the "I've got a boat load of gold on paper" game and no one will know the difference and gold price can be controlled at >1000 range.

2009 Apr 02 12:05 PM

[Avery Goodman]

Kohalakid,

Thank you. You may be correct. Technically speaking, Deutsche Bank is probably not acting as a "registered leveraged transactions merchant" per se, with respect to these particular transactions. It seems to me that you have hit on the reason that CFTC has managed to look the other way. But, "nab" them the authorities should, nonetheless.

The fact that they may not be covered under this explicit rule, requiring 90% cover, does not diminish, but, rather, amplifies the need to do vault audits. The potential for wrongdoing is far greater if the majority of the big dealers on COMEX are not covered by the rule. No wonder silver has been selling in backwardation for so long. Many people justifiably do not trust the futures markets, and must want their silver immediately.

This makes me more concerned, not less. It is further circumstantial evidence that most of the alleged "gold" and "silver", supposedly "bought" and "sold" on futures markets "for delivery" may not actually exist. Dealers who allow short selling, without gold to back thousands of contracts, not only court financial disaster for themselves and their customers, but, also, commit fraud upon the market. Selling naked short positions is fraud upon the market because the specifications of the COMEX gold contract specifically state that the seller and the exchange warrant "delivery" of physical metal. If there is really no gold to deliver and the seller is really depending solely upon the transient politics of a central bank, he commits fraud upon the long buyer.

17 CFR § 31.3 states, in pertinent part that:

"...it shall be unlawful for any person...directly or indirectly...(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person...in connection with (1) ...a transaction for the purchase, sale or delivery of silver bullion, gold bullion, bulk silver coins, bulk gold coins...pursuant to a standardized contract commonly known to the trade as a margin account, margin contract, leverage account, or leverage contract..."

2009 Apr 02 12:45 PM

[Avery Goodman]

You see, it would be one thing if they admitted to the truth -- that the contracts are intended as cash settled instruments that "track" the price of gold. But, in order to influence market prices, apparently, they are not doing that. They are claiming that these gold and silver contracts are settled by physical delivery, and, if their gold vaults are not full enough to make those deliveries, it is a fraudulent claim.

2009 Apr 02 12:52 PM

[Zapf]

Being outraged by government manipulation is pointless-they own most of the liquidity anyway. They can sell whatever they want because it's not a "recognized" currency and a dumb rock in the ground. They "own it" and can "sell it."The outrage is that the government can sell US taxpayer assets at depressed prices and there is no recourse or regulation. In the end this will all come and bite them in the tushska-like Britain selling gold at 200 an ounce. You can always trust the government to sell low and buy high. When Russia and China go on some sort of gold-based commodity standard, the USG and the banks will have to buy their previously owned property back at higher price because they need gold as a reserve against dollar revulsion. The benefactors-anyone who is buying gold now. The first country to get to a reasonable gold standard or basket of commodities standard will be the world reserve currency because its backed by a real object. Heck, if the currency was backed by Weber BBQ's it would be better than the "backed by confidence" game the Euro and the Dollar play.

2009 Apr 02 12:58 PM

[hartgeld]

Sorry guys to disrupt but the question arises wheteher it is 850,000 ounces or "just" 850 contracts - as written in the article above.
One contract usually ressembles 100 ounces, so 850 contracts would be 85,000 ounces

Yours, Ludwig

2009 Apr 02 01:04 PM