comment posted on my article "Gold Stocks Are Undervalued - For Good Reason," published on Seeking Alpha June 20th, 2012
* * *
I was home, enjoying a quiet day, working on a piece for Seeking Alpha - one of my standard articles about a small-cap value stock - when my phone rang.
"Hello," I said.
"It's Ben Bernanke."
The Chairman of the Federal Reserve, I thought. What could he possibly want from me?
"Mr. Bernanke, good to talk with you. What can I do for you?"
"I need you to write a piece bashing gold mining stocks."
"Excuse me?" I was stunned.
"We've launched a coordinated media blitz. We need to keep the price of gold - and gold stocks - low."
The chairman paused. "Well, Rupert Murdoch and Steve Forbes wouldn't play ball. They're both Republicans."
"So am I."
"But, Vince, we need you. You've got almost 400 followers."
"That hardly compares to the reach of Forbes or Barron's or The Wall Street Journal."
Bernanke laughed. "We're starting small."
"Well, what do I get for this?"
"How about a thousand dollars?" the chairman asked.
"A thousand dollars?" I repeated. "A thousand dollars? You can't possibly pay me in fiat currency. I want gold."
"We don't have any."
"What's in Fort Knox?" I demanded.
"Pyrite," Bernanke replied. "We're fond of irony."
"Amusing. But I don't want paper currency."
"How about a copy of Obama's Kenyan birth certificate?"
"Very funny," I replied.
"OK, two thousand dollars," Bernanke said after a moment.
"It's still paper, Ben," I said in frustration. "Fiat currency. Backed by words." I considered a counter-offer.
"Just answer me one question, Mr. Chairman, and I'll write the piece."
"That's the deal?"
"That's the deal," I replied. "If you're trying so hard to manipulate the price of gold, why has gold nearly tripled since you took office?"
Bernanke considered the question. "Well, I didn't say we were any good at it."
* * *
Obviously, I'm exaggerating for effect; but the constant conspiracy theories surrounding the supposed manipulation of gold rely on similarly far-fetched discussions. The fact remains that when Ben Bernanke, the chairman of the Federal Reserve, took office on February 1, 2006, gold traded at $568.25 per ounce. The spot market closed Friday at $1,582.20, up 178 percent in six and a half years.
In fact, many of Bernanke's actions have been positive for the price of gold. The expansion of the money supply under Bernanke has helped gold's strong bull run. The negative real interest rates ensured by Fed policies - including Operation Twist - have lowered the "cost of storage" for gold (theoretically equivalent to that real interest rate), which should also be bullish for the price of gold.
Nor has Bernanke spoken publicly about the price of gold, or appeared to make any attempt to use his bully pulpit to affect gold prices. The chairman has publicly opposed a return to the gold standard; but his opposition can be more readily explained by his economic views (or, more cynically, professional self-interest) than a wide-ranging conspiracy to manipulate the price of gold.
There are a number of theories through which investors attempt to attach a proper price to gold, from an inverse relationship to real interest rates, to the ratio of the supply of gold to the worldwide monetary supply, to the more traditional attachment to gold as a hedge against political turmoil and economic disaster. Goldbugs point to the continuing debasement of paper currency and the ongoing fiscal crises across the West as a reason to buy gold; skeptics point to the relatively limited industrial value of the metal and the signs of a bubble in the gold market.
Educated, intelligent, investors can - and have - made arguments on either side; as of late, the conflict over the "true" price of the metal has largely been a draw, as seen by the tug-of-war in the price of gold over the past eleven months. A mild increase in economic optimism, profit-taking, fears of weakening Chinese demand due to the possibility of a so-called "hard landing": these are all valid reasons for being bearish on gold in the near-term. For gold equities, increasing costs and worldwide regulatory concerns both explain at least some of the divergence between the value of the miners and the value of the metal they produce, as I noted last month. On the long side, the continuing turmoil in Europe and the possibility (probability?) of a "QE3" in the US would seem to augur a further rise in the price of a gold.
But the idea of a Federal Reserve-led conspiracy to depress price in the gold market is simply not part of the investing equation. Does anyone truly believe that such a conspiracy - which includes, in some tellings, not just government officials but the media at large - can possibly exist silently? Reuters has spent months investigating the personal behaviors of a single CEO of a natural gas company in Oklahoma. Yet the rest of the media is content to look the other way while a multi-billion dollar market is manipulated? Aaron Regent, the CEO of Barrick Gold (ABX), was fired last month due to the underperformance of his company's stock. Yet Regent - who is losing untold millions in potential compensation - sits quietly as the alleged Fed manipulation costs him his job?
The idea that the price of gold and/or gold miner equities are being depressed by a massive conspiracy is simply too fanciful to accept. By these tellings, hundreds of people - from Fed officials to congressmen to financial analysts and writers - are engaged in a decades-long plot to undermine the plot of gold. Clearly, this plot has failed for the better part of a decade; yet there is no evidence to assert that the conspirators have changed their ways, and no explanation as to why a plot backed by the most powerful people in the world has failed to manipulate the opaque and relatively small (by worldwide financial standards) market in gold.
The actual evidence is clear; far from suppressing the price of gold, the actions of the Fed under Ben Bernanke have been a catalyst for gold's impressive run. Gold has risen by an average of 17% per year since Bernanke took office, out-performing nearly every other asset class. It may even have further to rise; the conditions that set up the metal's bull run, from currency debasement to the lingering fears of another "Lehman moment," still exist in the market, and continue to be driven by Fed policies, among other factors. But gold's move going forward will be, for the most part, based on the standard dynamics of supply, demand, and the physical and futures market.
Let me note that I do not believe that the gold market is pure as the driven snow. Market manipulation no doubt occurs -- perhaps on a daily basis. Given recent news on the Libor scandal, the disclosures of questionable, even illegal, activity during the housing bubble of the last decade, and the manipulation in power markets by Enron and (allegedly) JP Morgan Chase (JPM), to name just a few instances, an investor would have to be willfully naive -- at best -- to assume that all participants in a market are acting ethically.
But it is a long leap from bear raids and interest rate manipulation to the allegedly massive, targeted, coordinated -- and illegal -- influencing of the price of gold. And it is equally naive to posit that the gold market faces pressures unknown to other markets. Equity markets worldwide have been targeted by high frequency traders, who use scalping techniques to effectively increase spreads for longer-term investors. Fixed-income markets remain opaque, explaining their value to investment banks, who use their informational advantage to maintain spreads and gain huge profits. The commodity markets retain exceptional volatility; witness the drop in natural gas, which fell from $13 per million BTU in 2008 to nearly $2 in 2012, before rebounding sharply as of late. Individual investors face disadvantages entering any market; this is likely as true in the gold market as it is for any other asset class.
But advocates of the gold suppression conspiracy allege a massive, decades-long plot, which can only be resolved through a massive spike in gold, leaving investors with massively outsized expectations. These proponents, such as Bill Murphy, chairman of the Gold Anti-Trust Action Committee (known as GATA), often posit that gold's "true value" is between $3,000 and $5,000 per ounce, double or triple the current price.
The belief in a coordinated manipulation of gold -- which is destined to fail as its predecessor the London Gold Pool did, and result in massive short-covering and a exponential increase in gold prices -- is erroneous, and dangerous. It creates expectations which most likely cannot be met, resulting in an overattachment to gold (and gold miner equities) and, potentially, dangerously ill-conceived portfolio allocation.
Whether investing in physical gold, or through ETFs such as the SPDR Gold Trust (GLD) -- another target of manipulation theories -- or in mining stocks through the Market Vectors Gold Miners (GDX) or Junior Gold Miners (GDXJ), or individual purchases, investors must understand that gold is a historically volatile, emotionally driven, and complex market. There is a bull case for gold, and a bear case for gold; but neither involves greedy bankers and evil government officials in a worldwide cabal to fleece the common man. Tomorrow, in Part II, I will review the supposed evidence of a gold manipulation plot most often proffered by believers, most notably GATA. There's not nearly as much there as many claim.
Additional disclosure: My household owns a small amount of physical gold in the form of jewelry, totaling substantially less than one troy ounce of gold.