04-27-07
Memorable birthday presents are always nice. One of the best presents your Macro Musings editor ever received came from European central bankers.
In late summer 1999 (nearly eight years ago now), yours truly and a friend put some money in a special joint trading account. The plan was to speculate a little in the precious metals, and perhaps turn a profit from the Y2K complications ahead.
Gold was about as down in the dumps as it had ever been. Stocks like CMGI and Qualcomm were all the rage. It was almost the total reverse of what we have now: “dot com” was a heroic and inspirational suffix, rather than the punch line to a joke. Hard assets were derided as the musty leftovers of an antiquated age.
With gold in the $260-$280 range, and volatility having ticked down to nothing, we felt that things were ridiculously out of whack. Confident that something would have to give, the joint trading account was loaded up with call options on gold futures: $330 strike price, expiration date nine to twelve months out.
We were prepared to wait. But as it turns out, we didn’t have to wait too long. In September of 1999—within days of the forementioned birthday—more than a dozen European central banks announced a moratorium on future gold sales. The signatories agreed to limit their gold sales to 400 tons a year over the next five years.
The news hit the market like scalding hot water on a sleeping cat. Gold exploded, posting the biggest single-day rally in twenty years; the joint trading account went from $10,000 to $60,000 (give or take) in the space of a week.
No, you don’t see birthday presents like that one very often.
But that’s not the most curious part of the story. The intriguing question is how gold had gotten so low in the first place.
Earlier that same year, gold had been languishing in the $280-$300 range. The yellow metal had been stuck in a sideways funk for more than a year, after steadily trekking downward from its 1996 peak. It seemed things were as gloomy as they could get for gold bugs… but it was about to get much worse.
In May of 1999, completely out of left field, the British government announced plans to sell half of its existing gold reserves. Proceeds from the sale were to be invested in government bonds (US, Europe and Japan).
The timing was clearly terrible. What’s worse, the auction-style plan for selling the reserves seemed the height of idiocy. When you have a large quantity of something to sell on the open market, you normally do it as quietly as possible, so as not to run the price down (or run it up if you are buying). It was almost as if the Brits wanted to hammer gold through the floor, rather than discreetly seeking the best price for her majesty’s assets.
Gold futures gapped down huge on news of Britain’s plan, all hope lost. Central bankers, it seemed, had gone insane, and they were going to sell all the gold they owned for nothing. The yellow metal relentlessly downticked from that point on, to its ultimate bottom in the fall of 1999. Shortly after which the heroic purchase of $330 call options ensued, and Europe’s non-British bankers did the rest.
More ancient history. But now the question becomes more pointed. Why, oh why did Britain do something so foolish?
We now have an answer of sorts: because Gordon Brown is a moron.
Gordon Brown is Britain’s all-but-anointed prime minister in waiting, for those who do not follow British politics. (And who can blame you?) Back in ‘99, Brown showed his first flash of greatness—er, make that boneheadedness—as Treasury Minister. It is only now that the full scope comes to light.
In a long overdue expose titled “Goldfinger Brown’s £2 billion blunder in the bullion market,” the Sunday Times spills the beans:
GATHERED around a table in one of the Bank of England’s grand meeting rooms, the select group of Britain’s top gold traders could not believe what they were being told.
Gordon Brown had decided to sell off more than half of the country’s centuries-old gold reserves and the chancellor was intending to announce his plan later that day.
It was May 1999 and the gold price had stagnated for much of the decade. The traders present — including senior executives from at least two big investment banks — warned that Brown, who was not at the meeting, could barely have chosen a worse moment.
…“The timing of the decision was ludicrous. We told them you are going to push the gold price down before you sell,” said Peter Fava, then head of precious metal dealing at HSBC who was present at the meeting. “We thought it was a disastrous decision; we couldn’t understand it. We brought up a lot of potential problems at the meeting.”
…The decision to sell 400 tons of gold is seen in City circles as a financial bungle on the scale of the Tories’ “Black Wednesday” that cost the taxpayer £3.3 billion, according to Treasury estimates.
Dominic Hall, a former gold dealer who now runs thebulliondesk.com, a website for the gold market, said: “Brown was keen to throw mud at the opposition over Black Wednesday but this was a financial disaster on a similar scale.”
Fascinating. Based on these and other details, it appears the decision to dump half of Britain’s reserves—ultimately at the cost of billions—was made by a dubiously informed politician and his group of cronies. As the Sunday Times further recounts,
According to other sources… Bank of England officials told those present they had “little say” about what was going to happen and that they were “doing what they were told”. This was a decision made by Brown and his inner circle, who appeared uninterested in their expert advice.
It’s the classic libertarian’s lament: what can you do with government? You’re damned if you do, damned if you don’t. It is highly unsettling to think that momentous, gigantic decisions are ultimately taken by pigheaded men (and it is still mostly men) with far more arrogance than sense. Sadly, the thought of government by committee is no less appalling. Many a terrible plan has arisen from gutless, mealy-mouthed consensus.
As long as there are men like Gordon Brown in government (and the world is surely rife with them), governments will continue to do exceedingly stupid things. It is a natural temptation to respect the trappings of power; or, at the very least, to respect the decision-making mechanisms of power. This is a mistake. Most countries, it seems, are run with less regard for logic and common sense than your average corner grocery.
Okay, libertarian rant over. Here is the money-making part of the equation.
By deciding to dump gold at the worst possible time, Gordon “goldfinger” Brown has shown us how spectacularly stupid governments can be when it comes to selling low. When push comes to shove, we may find that governments are equally spectacular at buying high.
Consider the lay of the land in terms of dollars and gold reserves. The asset boom we are experiencing right now, the rising tide of liquidity that has fueled a buyout mania and lifted so many boats, is being fueled by dollars. Dollars, dollars, dollars.
The Federal Reserve prints reams of dollars via their magical electronic press. Consumers and businesses spend these dollars, gorging on credit. Investors multiply these dollars, bidding up everything with leverage. Asia and the commodity-exporting / oil-exporting countries rake these dollars in by the truckload… and then print truckloads of their own local currency in return, to keep exchange rates favorable.
It used to be said that China was exporting deflation, via the proliferation of lower cost goods in the world. But now, as wages and costs in China and India rise, it is more accurate to say that emerging market countries are importing inflation from the West, both directly and indirectly, as paper floods their economies and investors bid up assets with abandon.
China and her emerging market brethren are sitting on a mountain of dollars… a veritable Everest that grows by the day, if not the hour. For instance, it is estimated that China "absorbed" more than $136 billion worth of surplus greenbacks in the first quarter of 2007 alone. (Just more paper to throw on the $1.2 trillion pile.)
At present levels, the dollar is flirting with twelve year lows. When the downside rush accelerates, the bagholders, er, dollar-holders will experience tremendous pain. (Imagine having a trillion bucks invested in tech and telecom stocks circa 2001. Get the picture?)
Gold is the ultimate safe haven in all this—the other side of the “debt liquidation trade,” as we have written before. It is the ultimate safeguard against fiscal collapse and inflationary outbreak.
Unfortunately for them, the BRIC countries (Brazil, Russia, India, China) are all “dollar-heavy” and “gold light” to an insane degree. They don’t have anywhere near enough gold in their coffers to offset the dollar debacle that is coming. And they know this.
Consider: according to recent statistics from the World Gold Council, China has just 1.2% of its total reserves invested in gold (600 tons). Contrast that with the strong likelihood that two thirds or more of China’s pile is tied up in dollar-denominated assets.
Russia is a little bit better off. They have approximately 2.8% of their total reserves invested in gold. India is at 4.1%. And Brazil? A laughable 0.3%.
All those numbers are laughable of course. And those are only four countries. Most of the world’s up and coming economies (and oil exporters too) have immense dollar risk linked to miniscule holdings of gold. It is the equivalent of owning a multi-million dollar home and only insuring the mailbox.
With a situation this dire, where do you think gold is going to go? We already know where the dollar is going to go. The playbook has all but been spelled out. Is anything going to change? Yes… it is going to change for the worse.
Things don’t get much simpler than supply and demand. When central bankers really get their selling low and buying high groove on, you are going to see gold trading at thousands of dollars per ounce. That is an absolute, double-riveted, lead-pipe cinch. The only way this doesn't happen is if human nature changes, or some absolute miracle otherwise intervenes, and more than five centuries worth of economic and political history is repealed.
This is why your editor remains unconcerned by the recent weakness in gold. It doesn’t much matter that the yellow metal is taking its sweet time below $700, or that gold stocks are looking beat-up and sluggish once again, or that whispers of a new era are coming back around. When you have underlying conditions on your side, you can afford to be relaxed. Let the other guys chase and sweat. Better to be a little early and do things with style.
Most everyone in the market right now is crowded around the punch-bowl. Investors are in a high-fiving, back-slapping, self-congratulatory mood… yet few of them are thinking about what’s coming down the road. When it comes time for governments to buy high—buy gold that is—they’ll have to do it on a scale never before seen. As the great J.J. Cale (and Clapton too) once sang: After midnight, we’re gonna let it all hang out.
