A two-man army calling itself GATA has begun to besiege the media attempting to gain a lot of press on the platform that gold is being "manipulated" by a cartel of investment banks.

They constantly point to what they call the huge "carry trade" in gold were there is far more gold sold than exists. The basic tenents of the commodity markets, be it cash or futures, is that every position is offset by an equal and opposite position. There cannot be more outstanding short positions than long positions, yet the total number of positions combined can far exceed the actual supply.

However, the same thing can happen in S&P 500 futures or even US 30-year bond futures. That is the nature of the free markets. Those who own a commodity have the right to sell it, lend it or hedge it to someone else who is willing to take the other side for whatever reason, be it hedging a future use or betting on the next bull market.

Above all – this single misconception has been man’s greatest downfall! For during almost every great financial panic in history, government has launched intrusive investigations seeking to uncover that horrible short position that has manipulated the entire marketplace through its sheer ability to overpower it with size. Every investigation to date has begun with that misguided belief that a short position can be larger than a long position, failing to understand in the process that all positions must balance. In the wake of the Panic of 1907, short selling was declared a criminal act despite the fact that they never found that horrible person who overpowered the marketplace. Fortunately, the US Supreme Court struck down that law against short selling and the free market went on. The true cause of the decline was only finally revealed as a cash flow problem, which in turn gave birth to the Federal Reserve 6 years later.

An investigation was launched following the Crash of 1929 from which the SEC was born. People from all over the country were questioned by Congress and accused, without evidence, of somehow being short behind the scenes. The mere accusation made against people ruined their reputations and provided the basis that launched a thousand lawsuits. When the evidence was finally collected, all the famous names were found to have been long – not short. From Rockefeller on down, they all lost staggering amounts of money. The multimillion-dollar short position never surfaced once again. The same was true following the Crash of 1987. Those who should have been short as a hedge against their stock portfolios were in fact found to have been significantly under hedged. No massive short position ever surfaced from the 1987 investigation and they imposed circuit breakers that needed to be revised in 1997.

The "carry trade" in gold that has been the subject of much discussion is seriously misunderstood. There are those who would like to point to this position as the cause for the decline in gold. They are dead wrong. The "carry trade" in the OTC gold market has been around for years. The Arabs have used gold as a means to earn interest without calling it interest. Islam forbids the lending of money for interest known as the "sin of usury". The Arabs have used the carry trade in gold since the early 1980s. They buy spot and sell forward and collect the "carry" or premium on a back month. This premium is a reflection of the cost to "carry" a gold position. If you buy the current spot and sell the forward, you earn that net difference without being exposed to the price fluctuation of gold itself. In reality, the investment banks can book billions of dollars of such transactions that have NO impact or relevance to the gold market. Technically, the Arabs are not receiving interest but instead they are buying gold today and selling it for a few dollars more 3 months out. These profits are allowed under Islam, whereas normal interest earnings are forbidden.

The Japanese are also involved in the "carry trade" in gold. Public futures funds in Japan are still regulated under the commodity acts even if they trade Nikkei or S&P500 futures. Since the definition of ALL futures funds remains that of a "commodity" fund according to Japanese regulation, there is a strict investment guideline. ALL futures funds must be invested 50% at all times in commodities. Hence, the Japanese futures funds are also using the gold "carry trade" in order to meet the crazy requirement that the fund must be invested 50% in commodities at all times. Again, gold is purchased on the spot and sold forward without risk. Again, this becomes a paper transaction where a bank will certify that there is a trade on their books thus allowing the fund to meet its requirements for being invested 50% in commodities at all times. The balance of the fund then CANNOT be invested in commodities and off they go into the financial futures world trading Nikkei, JGBs, S&P500 and the like.

Of course, the last type of this "carry trade" involves the mining companies. Here, gold is sold forward in order for a company to plan its operating expenses. A budget can be established only if there is some assured return for their production. Others may borrow gold on an interest rate differential. In this case, a gold loan comes with a lower interest rate. The gold is sold on the spot and the loan is repaid from future production. It is a cheap means of acquiring financing. Interest on gold loans tend to be lower because it is a dead asset on the books of its owners since there is no income and often there is storage and insurance costs. Consumers of such loans are typically mining companies or manufacturers. The granter of gold loans are holders including central banks. Holding gold without lending can be very costly, but by lending the gold a holder retains ownership since the borrower is committed to repay the loan in gold plus interest thereby reducing the holding costs.

Gold is no more being manipulated today in some grand conspiracy than it was going into the 1980 high.

(If you agree with our analysis above, you will also agree with Mr. Armstrong's point that gold is not being manipulated. But, this does not mean that gold is at equilibrium. Because of the dynamic factor that we studied above, gold is now far from equilibrium. You can say that gold is under-valued due to the dynamic nature of Gold Carry Trade. However, you can't say that gold is manipulated, UNLESS you can prove that gold lease rates are kept artificially low by the central banks. We won't try to prove that. That's your job if you believe the conspiracy theory.)

(The rest of the article is not essential to the study of Gold Carry Trade -- Some were Mr. Armstrong's forecasting records; some were his price projections on gold on June 10, 1999; and others were simply off topic. Therefore, we won't comment further. One thing, however, caught our attention. Mr. Armstrong wrote: "if one wants to discuss manipulations, the gold standard was the biggest manipulation of all by keeping the value of gold fixed while the supply of money increased. Gold was NOT money; it was merely a store of wealth in which money was expressed. This is why the gold standard collapsed."

Mr. Armstrong also wrote that "Gold was NOT money; it was merely a store of wealth in which money was expressed." Was gold money? We need the definition of money before we can move on. The definition and function of money are: "Money is anything that is widely accepted as a medium of exchange. It serves as a means of payment for almost all goods and services; hence, it reduces the transaction cost of exchange and simplifies the process of exchange." Before Bretton Woods system (1947-1971) collapsed, gold was money, of course. After its collapse, we guess Mr. Armstrong can argue that gold has not been "money" because gold has not been used as a medium of exchange since 1971. (We don't know if this was his intention.) This is "unusual" in human history and it is something new.)