Urban Legends and Gold

by Bob Moriarty
321 Gold

There are urban legends that have been around for years. Most gold bugs accept them without the least question. The most endearing and enduring is the mythical “GOLD SHORT” position, first of Long Term Capital Management and now of JP Morgan.

Bill Murphy lost a lot of money in copper and was without employment and came up with a brilliant idea back in 1999. He would start two websites. One would champion the GOLD IS MANIPULATED theory and was the base for GATA. That was a public service site. He had a companion paid website called La Metropole Café where he will share his wit and wisdom with you for a mere $299 per year.

Basic to his loudly proclaimed theory that the world faced an imminent GOLD DERIVATIVES TIME BOMB that could go off at any moment was his claim that he was in Central Park in New York in mid-1998 and overheard someone talking about a 400 ton gold short position held by LTCM and that’s why the company went bankrupt and collapsed in September of 1998 after the Russian Financial Crisis.

Recently a variation of the same urban legend has emerged but now it’s Thomas Pascoe of the Telegraph mumbling on about how JP Morgan was short some mythical two tons of gold in early 1999 and that’s why the Bank of England sold their 400 tons of gold, to bail out the mythical short position of two tons.

“One of the most popular trading plays of the late 1990s was the carry trade, particularly the gold carry trade.

In this a bank would borrow gold from another financial institution for a set period, and pay a token sum relative to the overall value of that gold for the privilege.

Once control of the gold had been passed over, the bank would then immediately sell it for its full market value. The proceeds would be invested in an alternative product which was predicted to generate a better return over the period than gold which was enduring a spell of relative price stability, even decline.

At the end of the allotted period, the bank would sell its investment and use the proceeds to buy back the amount of gold it had originally borrowed. This gold would be returned to the lender. The borrowing bank would trouser the difference between the two prices.

This plan worked brilliantly when gold fell and the other asset – for the bank at the heart of this case, yen-backed securities – rose. When the prices moved the other way, the banks were in trouble.

This is what had happened on an enormous scale by early 1999. One globally significant US bank in particular is understood to have been heavily short on two tonnes of gold, enough to call into question its solvency if redemption occurred at the prevailing price.”

You have to wonder why Pascoe would be worried about JP Morgan and any $20 million dollar investment. That’s all a couple of tons of gold was worth in 1999. $20 million is what JP Morgan tips the shoeshine boy; they don’t get the BOE dumping hundreds of tons of gold on their behalf. I’m not even sure how anyone can be “heavily short.” You are either short or long; you can’t be a little short or a lot short. JP Morgan doesn’t give a rat’s ass about any $20 million dollar investment.

Unfortunately and this is going to make me really unpopular, it’s simply not true that either LTCM or JP Morgan was hurt by a gold short position. If they held a gold short position either in September of 1998 for LTCM or early 1999 for JP Morgan the positions would have had to be profitable. For whatever reason the BOE sold gold, it had nothing at all to do with JP Morgan in a money losing gold short position.

It’s an urban legend. No one that I know of besides me ever worked out the math or even thought about it and that includes some of the biggest names in the business. Being gold short in Sept of 1999 or early 1999 mathematically had to have been profitable in any time frame from 1985 on. Actually it would have been profitable for any timeframe from 1980.

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July 16, 2012

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