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 31st, Deutsche Bank (NYSE: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 (NYSE: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 19th 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 19th 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.