There is no other leveraged commodity market where short sellers increase their positions, materially, as the price rises, and increase them even more when prices are exploding, except gold and silver. The reason traders don’t normally do that is that it exposes short sellers to unlimited liability and risk. Yet, in both March and July 2008, and on countless occasions over the past 21 years, vast numbers of new gold and silver short positions were temporarily opened up, with the position holders seemingly unconcerned about the fact that precious metals had just risen exponentially, and that there was a very real potential they would bankrupt themselves with unlimited upside potential. Normal traders would not expose themselves to such unlimited risks.

I conclude, therefore, that over the last 21 years or so, “fake” precious metals supply in the form of promises of future delivery have habitually been increased when prices increase until increased “supply” managed to overwhelm increased demand, leading to a temporary price collapse. This is compounded by the fact that the futures prices on COMEX tend to dictate the “official” report price for the precious metals elsewhere.

The SEC banned short selling at 3 am, on Friday morning, propping up the share price of a long list of financial stocks, including Citigroup, Wachovia, WaMu, Morgan Stanley, Goldman Sachs, and about 794 others.  This rule will expire on October 2, 2008.  Christopher Cox, Chairman of the Securities & Exchange Commission, came out with a statement:

The commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets.  The emergency order temporarily banning short-selling of financial stocks will restore equilibrium to markets.

Many people are convinced that it is OK for the government to bail out failing private companies like Bear Stearns, Fannie Mae (FNM), Freddie Mac (FRE), and, now, Lehman Brothers (LEH). Hank Paulson, our Treasury Secretary, argues that we should put these debts onto the backs of innocent taxpayers because if we don’t do it, we will have “systemic risk.”  

Let’s drill down to the reality. There is always systemic risk whenever a large company fails.   There were also systemic risks to the energy markets when Enron, a huge energy trader, went bankrupt, but we got through that. That is what Chapter 11 bankruptcy exists to do. There is nothing that differentiates Lehman Brothers from any other big company except the fact that its debt, including a lot of counter party debt arising out of various derivatives, is held, mostly, by other Wall Street players.

When I listen to so many innocent people talking about the renewed “strength” of the U.S. dollar, I cannot help but chuckle a bit, even though it is upsetting to see that they are so easily fooled. It would be nice to believe democracy works, but how can you when people are so gullible? Here is a chart of the ICE U.S. dollar futures index. You can create your own variations by going to: www.fxstreet.com.

Those who bought shares in GLD, SLV, as well as interests in other inflation hedge investments, have been confused by recent reports which predict so-called “deflation”. Some claim that the world is “deleveraging” and this will cause the dollar to rise in relation to other currencies, and the price of virtually everything else to drop. Many of these pundits point to an alleged “drop” in the M3 money supply, in August, to support such allegations.

In these prognostications, however, they ignore the $750 billion dollar per year U.S. current account deficit, and a combination of public and private foreign debt which now amounts to over $9 trillion U.S. dollars. Both the current account deficit and the overall foreign debt will rise now that the dollar has been increased in value in relation to other currencies. The reduction in the nation’s oil bill is a relatively small part of the current account deficit, and cannot make up the difference, as ever more financially strapped Americans buy more and more from deep discounters, like Wal-Mart (WMT) and Costco (COST), who stock their stores with cheap foreign imports. Indeed, these two were about the only retailers to see increased August sales.

If you are a holder of Powershares dollar bearish fund (UDN), gold (GLD) or silver (SLV), you’ve been taking a beating since late July/early August, as the dollar has powered forward, against all odds, in a bewildering climb against virtually all other currencies. In the past few weeks, after having been on a downward trajectory for years, the dollar suddenly appreciated against the euro, pound sterling, yen, ruble, rupee and almost every other world currency. On September 4, 2008, the U.S. dollar index rose an incredible 48 cents, while the DOW fell by 344 points!

How can the dollar be rising, in the face of overwhelmingly negative fundamentals? Big bank “analysts” are telling us the dollar is going up because Europe is following the U.S.A. into recession. But, this proposition is ridiculous. No other nation has been as adversely affected by the credit crisis than America, where the mess began. Ok, maybe the U.K. also. It shares our language, and most of the big Wall Street players are deeply enmeshed with players on High Street. The Bank of England does somersaults for High Street just as the Federal Reserve does for Wall Street. Both nations have essentially followed an identical path to economic implosion. This is not true of continental Europe, however.

Word on the street is that previously silent victims of precious metal manipulation are now, for the first time, grouping together to do battle in the courts of the United States of America. Class action lawsuits are being planned against the suspected manipulators of the gold and silver markets. What is the basis of the lawsuits? 

About two weeks ago, on August 18, 2008, I published an article titled “The Disconnect Between Supply and Demand in Gold & Silver Markets”. In the article, I explained how relatively small amounts of money can be strategically used to collapse the price of multi-billion dollar commodities markets, such as gold and silver. In short, unscrupulous manipulators can use either fictional silver/gold, or gold “swapped” to them by Central Banks, to create an artificial supply. This fake “supply” can then be strategically used to attack the price, on the futures markets, which, in turn, will profoundly affect the spot price. Collapsing the spot price can, in turn, destroy investor confidence, market stability, and the willingness of more conservative investors to take large permanent positions in precious metals. After collapsing a market, using the techniques described, unscrupulous manipulators can buy back their short contracts, from shell-shocked long position holders, at a profit.  

Yesterday, something interesting happened. Precious metals went up, while the dollar went up. Everyone is amazed. But, the news shouldn't really be surprising, because it is nothing new. Gold and silver have never been tethered to the dollar, or anything other than the principles of supply and demand. When looked at in the long term, they have been rising against a falling dollar, but, also, against a rising euro and pound, for over 8 years now.

All the world’s Central Banks - most notably the Federal Reserve (the Fed), but, also, the European Central Bank [ECB], the Bank of England [BOE], the Bank of China [BOC] and the Bank of Japan [BOJ] - have been heavily printing paper money in the last few years. All have increased their M3 money supplies by staggering percentages (see shadowstats.com). Making matters worse, the central bankers are now accepting mortgage backed paper from their friends at major politically connected banks, as collateral for cash and/or government securities. Problem is, the mortgage backed bonds are suffering high default rates.

I owe thanks to the folks who commented on my previous article (The Disconnect Between Supply and Demand in Gold and Silver Markets), and gave me a lot of new ideas to research.  The input has stimulated more precise calculations.  I am compelled to write a follow up on the issues previously presented.

According to the Wall Street Journal, “the latest bank failure came Friday, when Kansas regulators closed Columbian Bank & Trust Co., of Topeka, Kan. About $46 million of the bank's $622 million in deposits may have exceeded insurance limits...”  In the same article, the Journal notes that a June Gallup poll found that only 32% of Americans say they have a "great deal" or "quite a lot" of confidence in U.S. banks, down from 41% in June 2007 and 49% in June 2006. According to a Gallup poll, taken in July 2008, only 14% of Americans approve of the way Congress is doing its job. 

So, you’ve got some money that you want to invest?  You’ve heard that stock market investing gives better returns that keeping money in the bank?  Besides, you know that banks are reeling from bad loans.  You’ve read stories that some of the smartest economists, like former Chief Economist of the IMF, Kenneth Rogoff, are predicting that at least one of the biggest banks, as well as a lot of small and mid-sized banks, will fail in the next few months.  You decide you don’t want to be invested in banking.  You don’t want to own bank stocks.  You don’t even want to be one of their depositors.  So, what do you do?

You look at the insurance industry.  Not looking good either.  A lot of the big insurers have been caught playing with fire, in the form of credit default insurance on the subprime toxic waste that is plaguing the banks.  AIG (AIG), for example, is in just as much trouble as many of the big banks. 

There is a huge demand for both gold and silver right now in India and North America. North American shops are completely bare of silver.  Indian shops are empty of both silver and gold. Even the Indian banks don't have any gold or silver.  The big western bullion banks, based in New York and London, control both the gold and silver trade.  Reports from India are that they are refusing to extend Indian bank lines of credit, forcing the small banks to deliver to clients, collect money, and pay down lines of credit, before being allowed to take delivery of another gold or silver shipment. This is very abnormal. Normally, if a banker’s bank knows that its customer-bank has firm orders, it would extend the smaller bank a bigger line of credit.  Not now.

By refusing to extend lines of credit, the big bullion banks are essentially rationing a very thin supply.  Most physical silver, for example, is being reserved for industrial and fabrication use, and investors are simply not able to get any, without waiting for months.  Investor oriented shops are bare, and the U.S. Mint has suspended coin production.  All available supply seems to be reserved for industrial users.  You cannot substitute paper claims for real silver, in industrial use, because paper doesn’t have the physical properties of silver.  So, it seems that all available supply is being diverted to industrial users, and, to a lesser extent, aside from the squeeze on lines of credit, also to jewelry fabricators.  But, investors are left out in the cold.  They can accept paper claims, or nothing.  The most interesting mistake that the manipulators have made is in not supplying the U.S. Mint, which has run out of silver, proving that there is a severe shortage.