John Embry: Last Call to Board Gold Train at Under US$1,000


As economic and financial conditions lurch from bad to worse, the central banks and their allies have become even more brazen in their attempts to manage the gold and silver markets. The current effort to convey the message that everything is fine reached a crescendo in the aftermath of the Bear Stearns fiasco.

As economic and financial conditions lurch from bad to worse, the central banks and their allies have become even more brazen in their attempts to manage the gold and silver markets. The current effort to convey the message that everything is fine reached a crescendo in the aftermath of the Bear Stearns fiasco.

Purely and simple, the Bear was rescued by J.E Morgan Chase to prevent a derivatives-driven systemic meltdown, and gold and silver were hammered as part of the exercise. Gold reached an intra-day high of US$1,031 per ounce as the gravity of the situation sunk in, and then was driven down under US$900 in a two-week period before the recovery process began.

The price action in silver was even more egregious with the price collapsing more than 20% in the same time frame. In the past, when there were large speculative positions in both metals on the Comex, these sorts of violent corrections were seen as business as usual with the speculators routinely having their clocks cleaned by the commercials (i.e. the bullion banks). However, this time the breakdown occurred when open interest in both metals was falling sharply, implying that speculative exposure was far from extended. This suggests that short selling and nefarious derivative activity had to be employed to a far greater degree to achieve the desired outcome.

This shouldn't have come as a large surprise to anybody who has been playing close attention because, as I said last month, I believe the central banks will defend the US$1,000-per-ounce level to the best of their ability. With the IMF recently calling the current financial maelstrom the worst since the Great Depression, their motives are obvious. The brilliant Australian Bill Buckler succinctly described this in a recent edition of his publication The Privateer when he wrote: "Gold is mankind's historical money and the silent sentinel on the hill guarding the personal wealth of millions of individual men and women. It is always able to be used as money and has in fact reacted to events by climbing from about US$250 to above US$1,000 per ounce over the past six years. Gold is the immortal challenger to paper money AND credit money. But when credit money systems have their backs to the wall, as they do today on a global basis, the official monetary powers react by trying to repress [the price] of gold. This is now happening again."

I would add that it is happening for about the umpteenth time this cycle although any attempt at subtlety is now being abandoned. It is an unfortunate, irritating reality but it will be coming to an end fairly shortly when western central bank inventories are essentially exhausted. I strongly believe that the current episode will represent the last serious opportunity to acquire a sizable position in physical gold for less than US$1,000 per ounce.

As part of the establishment's current attack on gold, the International Monetary Fund (IMF) once again proposed to sell 403.3 tons of its alleged vast gold holdings as part of a wide-ranging financial reform of this failing organization.

Beyond Tiresome

This supposed threat has been utilized so many times that it has become beyond tiresome. It was only a couple of months ago that some U.S. undersecretary announced, with great fanfare, that the U.S. would finally approve an IMF-gold sale after years of vetoing it. What went largely unremarked at the time was the fact that this initiative requires Congressional approval that will take many months, if not years, if it is even forthcoming at all.

However, that is not the only issue. The IMF's gold does not actually belong to the organization, as it has been allocated to the IMF by many nations who are the real owners. There has always been a question, which has never been satisfactorily addressed, as to whether the 3,200 tons that the IMF supposedly owns is being double-counted because the donors really consider it as their gold also.

This raises the possibility that the proposed sale may be just a book entry closing out a previous lease transaction, in which the gold was loaned and subsequently sold by the borrower and is not coming back to the original owner. To top it off, the IMF acknowledged that the sale will occur under the auspices of the Washington Agreement and will therefore not be additional supply, as it will just replace absent European central bank sales.

In my opinion, if the IMF is really serious about selling 403 tons for roughly US$11 billion, I can think of a number of eastern central banks that could purchase it with their walking around money. In fact, this is such a pittance that less than one week of the U.S. current account deficit would more than cover it. This has to be one of the greatest red herrings of all time but virtually every time the sale is proposed, the anti-gold cartel uses it as cover to take the gold price down.

Adding fuel to the fire, GFMS Ltd. (formerly known as Gold Fields Mineral Services), an organization that has, in my opinion, made inaccurate statements about the true state of the gold market, recently issued a report containing observations I question.

While suggesting gold may go higher in the near term due to continued investor interest, GFMS then stated that gold is vulnerable because the equilibrium price is in the US$600-US$700 range, as estimated mining costs in the fourth quarter were US$518 per ounce. My response to this fiction is that if the economics of gold mining are so robust that a US$600 - US$700 price is deemed appropriate, why is mine production relentlessly falling in most areas of the world outside China as the gold price trades between US$900-US$1,000 per ounce.

This same organization has continually predicted that future production will be essentially flat at worst while being constantly contradicted by the facts. Mine production has been falling and will continue to fall for the foreseeable future, irrespective of the level of the gold price, for a long laundry list of reasons: uncooperative governments, permitting delays, exploding capital and operating costs, and a critical shortage of competent personnel, to name but a few.

However, I believe GFMS truly moved into fantasyland when it referred to the gold market currently experiencing an element of "irrational exuberance" with positive sentiment at a similar extreme to that of negative sentiment back in 1999. That point of view is flat out wrong in my opinion.

The average citizen is blithely unaware of the merits of gold, the mainstream press takes every op¬portunity to pan the yellow metal and the anti-gold cartel works the market over every time an opening is presented.

This latter activity is specifically directed at keeping the public away from the sector, and when one looks at the decimated state of the junior gold-share market, the strategy appears to be working. Therefore, to suggest that sentiment is at a positive extreme is both disingenuous and beyond laughable.

The critical error that I believe many investors and GFMS are making is failing to recognize that investment demand is going to continue to accelerate as greater concerns emerge about the future viability of financial assets and, for that matter, paper money in general. As I have said many times in the past, all great gold bull markets are driven by this phenomenon, and the current episode is about as bad as it gets.

The more than twenty-fold move in the gold price in the'70s was a direct result of people abandoning paper money m the face of runaway inflation, and I can virtually guarantee that financial and economic conditions will prove to be materially worse this time around. GFMS also emphasized that falling jewelry demand will take a toll on the gold price, failing to realize that while jewelry demand is important in setting the floor price for gold, it becomes essentially irrelevant in an investment-driven price rise of the sort that we are now experiencing.

Another questionable piece of advice on the subject of gold has recently emanated from two prestigious brokerage houses, one in Canada and one south of the border. They both recommended selling gold and gold shares in the near future because of upcoming seasonal influences.

To be fair, in the past there has been a distinct seasonal pattern to the demand for gold, with the late spring and early summer being a particularly slow period. A rational explanation for that was the dominant role that jewelry demand, which was predominantly in the northern hemisphere, played in overall demand. The sharp summer slowdown in the jewelry business led to an obvious diminution in gold demand. However, we're now in the midst of a financial meltdown, and I doubt very much that the resulting burgeoning investment demand will pay much attention to what time of the year it is. In addition, with the market having been blitzed recently by the anti-gold gang, to sell one's insurance against financial upheaval at this point in time doesn't seem like a terrific idea to me.

John Embry is chief investment strategist at Sprott Asset Management. Views expressed are those solely of the author and should not be considered an indication of trading intent of any investment funds managed by Sprott Asset Management Inc.

Copyright 2008 by MPL Communications Inc., reproduced by permission of Investor's Digest of Canada.

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