Gold (20 page)

Criterion
:
The asset cannot be an instrument issued by the institution holding it as a buffer.

Gold
:
No one “issues” gold. Its value is not tied to anybody's credit. Therefore it has no credit risk.

Criterion
:
The asset's price should be easy to calculate from public information.

Gold
:
Gold is probably the best known asset price in the world.

Criterion
:
The asset must be tradable in markets with a large number of participants, a high trading volume, and market breadth and depth.

Gold
:
The London gold market alone was trading $240 billion a day.

It's worth repeating that the true size of London bullion trading had surprised even those who'd uncovered it, the London Bullion Market Association. It was the first time in sixteen years they'd polled their members about trading. They'd conducted the exercise in their own interest. If regulators accepted gold as a liquidity buffer, sales to banks would increase. If liquidity was the measure of a buffer, the LBMA survey revealed, gold met it. The liquidity was a function of the intensity of trading. If volume was the standard, Dempster said,
it was easier to sell gold than government bonds. There were always buyers—the definition of liquidity.

Because the need for bigger liquidity buffers stemmed from the problems banks had faced when money got tight, Dempster reviewed gold's performance during the crisis. She contended that the bullion market stayed robust while other markets faltered. A graph showed interest rates spiking as banks stopped lending to each other. The bullion market stayed liquid. Many other markets “assumed to be deep and liquid proved to be the exact opposite,” she wrote in a supporting document, “and assets could only be sold at a large discount. This was even true of some AAA-rated assets: credit ratings proved to be no guide to liquidity.”

In Dempster's view, gold also benefited from a pricing floor. “What happens to gold is that the structural demand of the jewelry market exists under it,” she said. “What happened during Lehman's failure is that suddenly, as gold fell, industrial and jewelry demand cut in and put a floor under it. So it's not about gold never falling, but that when you are liquidating it the price is never going to fall out of bed. This is one of the most important points. People from the jewelry and technology sectors have a completely different perspective. When gold goes down in price, they
want
it.”

Central bank gold buying is another box that gold advocates like to tick, and Dempster ticked it. The Chinese central bank had been expanding gold reserves by about a hundred tons a year, and Mexico, Russia, and South Korea had all bought large amounts. Now European central banks seemed to be changing their position on bullion. They had been sellers for more than a decade, shedding about 400 tons a year. That trend had stopped. They had become net buyers.

In pitching European regulators, Dempster and the WGC were
trying to change decisions already made by the Basel Committee of G20 finance ministers. The committee had already considered including gold as a liquidity buffer, but had rejected the idea, mainly, a spokesman for the British Treasury told me in an email, “due to the volatility of its price.” Moreover, he added, the Basel Committee's recommendations were global. European regulators were supposed to be transposing them into law, not “watering them down” in any way.

In the end they did not water them down. It was the wrong time to be recommending gold as any kind of pillar. Volatility was roiling the bullion market. September 2011 was a chaotic month for the gold price, with sharp swings up and down. Whatever winds were blowing blew the gold price. Gold did not behave like any kind of safe haven. It behaved like what it had become—just another derivative. It was a construct that could be attacked, and someone attacked it.

T
HE GOLD PRICE WAS VULNERABLE
because it was easy to manipulate. Gold traders understand that liquidity is a sea with different depths. When the London market opens, a lot of gold is available to trade. When it's closed, much less. If you want to sell a lot of gold in an orderly way that will not disrupt the price, you sell when London is open. But what if you
do
want to move the price? Then it makes sense to pick a time when the trading is thin.

Large miners watch the markets like hawks, because they sell their gold there. They understand to a fine degree the consequences of trading in a thin market.
Barrick Gold's research department once determined, for example, that 100,000 ounces offered during London market hours would move the gold price down $4. That same
100,000 ounces sold when London was closed, would depress it $10 to $15. When half a million ounces dropped like a bomb on September 7, 2011, into the thin market before the London opening, then, it was no accident.

The attack took place during a period of volatility. In the chaotic month of September 2011, the gold price dashed up and down the chart seeking a consensus that it could not find. Into this jittery milieu, on September 7, during lunch-hour trading in Shanghai, hours before the great gold blotter of the London market opened, someone dumped 500,000 ounces.
The gold price dropped like a shot crow.

Suspicion turned to Libya, where the regime of Muammar Gaddafi was disintegrating in a bloody rebellion. A former Libyan central bank governor warned that the dictator had possession of the country's gold reserves. As it turned out, Gaddafi's gold sale had already come and gone. He had cashed in some thirty tons of bullion the previous April, selling it for a reported $1 billion to dealers who had gone to Libya to transact the deal. Gold traders in Tripoli's Old City, near the Libyan central bank, said that the regime had started the selling with a trickle of 22-carat coins and then increased to twenty-six-pound bars as its crumbling army demanded pay. But that was five months before the Shanghai sale.

To see what might have caused a bullion seller to make a move so harmful to the price, I spoke to Jim Mavor, an eighteen-year veteran of Barrick's gold trading operations. Mavor has since become vice president of finance at Detour Gold Corporation, but when we spoke he was still Barrick's treasurer.

“Well,” he said, “somebody with 500,000 ounces of gold worth [at the time] $900 million, may be assumed to be somebody who knows what's what. So it's fair to wonder why he performed a trade guaranteed to drive the gold price down. It fell $50. In trying to understand
what happened, it's useful to construct a scenario in which the person causing the event to happen made money out of it.”

Such a scenario, in Mavor's view, could work this way: Let's say the seller of the gold also owned a certain kind of option called a put. The owner of a put option has the right to sell the underlying asset—in this case gold—at a stipulated price. Let's make the price $1,800 an ounce. If the put owner also happens to own bullion, in addition to owning the right to sell it, then the $1,800 put has placed a floor beneath his possible losses. He knows he can always exercise the put at $1,800 no matter how far the price drops.

But in the scenario we're envisioning, gold has not dropped, but risen. It has reached $1,825. The owner of the gold has made money on his bullion, but in the process his puts have become useless. There is no value in a right to sell gold for $1,800 when the price is $1,825. The puts, then, represent a loss, because the owner paid money to buy them. The only way his puts can regain value is if the gold price falls. If the put owner decides to drive the price down to revive the value of his options, the best time to do it is in the low-liquidity doldrums before the London opening. The only math required to make his attack on the price appealing is if our hypothetical gold player can make more money from selling the puts into an alarmed market than he will lose from the depressed value of his bullion. We must suppose he can do the math. The likely trader, in Mavor's estimation, was a hedge fund, where aggressive tactics and large sums come together.

If the September 7 bullion dumpers meant to spook the market, they picked the right time. It was already spooked.
Europe was in danger of unraveling in what
The Economist
called “the greatest crisis to befall the European project in its history”—the dilapidated euro. In the United States, the contest between parties over what to do about the national debt had become a war of religion. In one view
the economy would founder without government action, including a tax hike on the rich; in the other, such interference amounted to the destruction of the republic.
Meanwhile, American stocks lost $1.1 trillion in a four-day rout. The U.S. government was about to run out of money.
Bitter partisans haggled in the Congress. Into this reaper of despair went the gold price.
In a single week it lost $200.

Confidence in gold was crumbling in its biggest market, futures. With futures, investors bet on where the price will be at a stipulated forward date. To open the contract, the buyer must deposit with the commodity exchange a certain percentage of the contract's value. This collateral gives the exchange something to seize if the market turns against the player and he is tempted to abandon his contract.
In the face of increased volatility in the gold price at the end of September, CME Group, formerly the Chicago Mercantile Exchange, the world's biggest commodities market, raised its collateral demand for gold by 21 percent. It was Chicago's third margin hike for gold in a matter of weeks.
The aggregate increase, according to a client note from one large bank, was
90 percent
, forcing investors who couldn't post that much collateral to liquidate their gold positions. The liquidations were depressing the price.

Also preying on the gold price were suspicions about ETFs. The gold market plays in a skeptical arena. Gold bugs are habitually suspicious: mostly of paper money and governments, but anyone will do. You don't have to search far to uncover doubts about whether gold ETFs actually possess the physical gold they are supposed to. Perhaps it is only natural for a product such as the Spider to attract suspicion, given its spectacular success. Before the market turned against gold, the Spider was the biggest ETF of any kind.

In September 2011 the fund owned 1,232 metric tons, or about 40 million ounces. All of it was stored in the London gold vault of
the fund's custodian, HSBC Bank. Since the ETF was ultimately a creature of gold miners, you could say it had simplified the flow of gold from one underground space to another. Or could you? Was the gold at the end of the stream as real as the gold at the beginning? That question troubled some people's minds.

Online at
spdrgoldshares.com
, a visitor can navigate to a photo said to show the bars held in the Spider's account. The Spider says that its shares represent real bullion in a real vault. Such gold is said to be “allocated.” In an allocated account, the asset is not merely produced when the account holder asks for it, like money in a bank account, but stays in its repository all the time, unused by anyone else. It is as if you deposited cash in a bank, and the bank put that actual cash into a separate box and kept it just for you, separate from the cash of every other depositor. No matter what happened to the other deposits,
your
deposit would be intact. When the Spider fund says that its gold is allocated, it means that the custodian keeps it separate from any other gold. It is always and only the Spider's gold.

The Spider's site also gives a list of every bar in the ETF's account, with each bar's unique number, its gross weight, and its “fine” weight—the actual weight of gold that it contains. The bars are said to be refined to London Good Delivery standards—a trade definition that specifies a purity of at least 995 parts per 1,000. But rumors persist, about gold ETFs in general, that they do not hold enough gold to redeem all shares. In this view, a surge in redemption demands would collapse the funds, as they would not have the bullion to meet the calls. These rumors, said the client note referred to above, were also helping to push down the gold price.

“The biggest gold and silver funds are now on the defensive,” wrote a commentator in a piece appended to the note, “as they may soon face mass investor exits on the back of heavy discounts to the
precious metal spot prices [i.e., a falling market] and doubts about the levels of physical gold they actually hold.”

September 2011 closed with words like “bruising,” “brutal,” “turbulent”—and those were all in the same piece. In the worst quarter in three years, the markets had turned into a kind of
Friday the 13th
: you got chopped just for being there. If gold was a safe-haven asset, the sound we should have heard was the vault door slamming shut as investors sealed themselves in with the bullion. Instead, the mood of alarm did not drive frightened money into gold, but into that paper shelter scorned by gold bugs—the U.S. dollar.

G
OLD LOST ITS STRUCTURAL BALLAST
when it lost its formal relationship to money. Now it tosses on the same sea of events as other assets. It doesn't occupy a special asset class ordained by history: all you can say is that it did.

In 150 years the world supply has grown from 10,000 metric tons to 170,000, from a modest cube six feet a side to a dazzling block that would cover the infield at Yankee Stadium. Every three years we pack as much fresh gold onto the block as our ancestors mined in 6,000 years. We trade it like men possessed. Every quarter an amount of gold equal to twice the amount ever mined flies back and forth in London in a storm of trades. And that's just the metal. Trading alongside it is an even thicker blizzard of derivatives. Yet even though the gold trade has accelerated to the hyper-speed of modern commerce, its folkways are as secretive as ever, less like a business than a court intrigue.