Gold Prepares to Erupt
I first had the pleasure of speaking with Mr. Adam Hamilton in April this year, after reading his most enlightening and well-researched articles over quite awhile. Mr. Hamilton is a most knowledgeable man, with an excellent grip on both history and markets. Our interview “Thoughts from a Contrarian Investor” will be published at Free Market Talk in June this year. Please take the opportunity to visit Mr. Hamilton’s website; www.zealllc.com. Philip Judge
“We also saw the sea sucked away and apparently forced back by the earthquake: at any rate it receded from the shore so that quantities of sea creatures were left stranded on dry sand. On the landward side a fearful black cloud was rent by forked and quivering bursts of flame, and parted to reveal great tongues of fire, like flashes of lightning magnified in size. You could hear the shrieks of women, the wailing of infants, and the shouting of men – there were some who prayed for death in their terror of dying.” – Pliny the Younger, Roman Orator and Statesman, August 24, 79 AD, eyewitness of Mt. Vesuvius annihilating Pompeii. Less than a dozen miles from the modern city of Naples, Italy, the notorious Mount Vesuvius towers today, resting and biding its time.
On August 24, 79 AD a huge earthquake rocked the mountain and its peak split open. A mammoth noxious cloud of ash, fire, and sulfur burst forth from the cataclysm and blotted out the sky. Pompeii’s doomed citizens were deluged with hot ash, lethal stone missiles, and a flood of mud. Pompeii’s sister city of Herculaneum was also destroyed in the legendary natural disaster.
In one of the most fantastic ancient accounts of the fearful and awesome power of the volcano, we are very fortunate that Pliny the Younger was in the area and taking notes. Pliny, merely seventeen at the time, had an interest in the Vesuvius eruption that he witnessed that was far more than academic. He was trying to save his own life and his mother’s, and at the same time searching for his favorite uncle, Pliny the Elder, who was the commander of a naval fleet based about 15 miles away from the doomed city of Pompeii at Misenum.
Pliny the Elder had fearlessly sailed to the aid of his fellow Romans at Pompeii, and he died as his ships moved in to rescue people trapped near the Tyrrhenian seashore by lava flows from the violent volcanic eruption. In his same letter to the famous Roman historian Cornelius Tacitus, Pliny recounts how his uncle’s body was later found in the ashes, looking “intact and uninjured, still fully clothed and looking more like sleep than death.”
From Thira (Santorini) to Vesuvius to Krakatoa (Indonesia) to Mount St. Helens, volcanoes never fail to fascinate humanity.
The titanic forces involved in volcanoes are simply staggering and impossible to comprehend. Deep in the bowels of the earth, molten rock is tormented by unfathomable physical forces and yearns to burst free. The magma is often blocked by cooled, hardened lava from a previous volcanic eruption, however, so it cannot escape. It boils within the earth, the pressure slowly building over many centuries.
Meanwhile, topside, the volcano appears dormant and dead. People have heard stories about past eruptions of these very same mountains, but they scoff at them. They see beautiful often snowcapped mountains that are so calm, peaceful, and idyllic. They build villages in the shadow of the great destructive mountains, clear out farmland, and settle regions previously utterly destroyed by earlier eruptions. On the surface, the scene looks totally normal and unremarkable. Unseen underneath the ground, however, the pressure continues to build and rapidly approaches an explosive climax.
Needless to say, when the volcano at last lets loose and erupts, the foolish people who ignored history and settled on the flanks of a monster often pay the ultimate price for their veneration of the status quo. When an eruption finally arrives, it always seems to be by surprise even though historical precedent suggested it would come. The resulting destruction, mayhem, and anguish is great.
Interestingly, there are sometimes warning signs of an imminent volcanic eruption. Scientists look for anomalous geologic and seismic activity on known volcanic mountains that can precede massive eruptions. Two of the most common signs are a sudden swarm of shallow earthquakes peppering the volcano and a growing bulge in the very rock of the mountain as magma forces its way towards the surface. If the scientists are paying attention and a volcanic mountain begins to exhibit geologic signs of distress, people can sometimes be warned and offered an opportunity to move out of harm’s way before the real fireworks begin.
In many ways, formerly free markets that are subjected to price suppression schemes mirror the behavior of volcanoes rather well.
Free markets operate by using price as the mechanism to clear imbalances and enable aggregate global demand to be exactly offset by aggregate global supply. When demand is higher than supply, the market price moves up to retard demand and entice more supply onto a market. When supply is higher than demand, prices drop in order to increase demand and choke off excess supply. Freely moving prices are the critical lynchpin of free market economies, clearly communicating supply and demand dynamics to all market participants.
Legendary economist Adam Smith’s seminal 1776 masterpiece “An Inquiry into the Nature and Causes of the Wealth of Nations” wonderfully describes this foundational economic principle in detail. When prices are reached by millions of independent decisions made by unrelated market participants in their own self-interests, the free markets work beautifully. Shortages and surpluses alike are very fleeting and quickly and efficiently resolved by the free market as price changes lead to new market-clearing equilibriums.
The bitter nemesis of free markets is price manipulation. During those tragic times in financial history when powerful wealthy people decide they want to immorally abuse their power and rob and sack other market participants rather than engage in mutually beneficial commerce and trade, the market price mechanism can be temporarily mucked up. Prices can be artificially influenced by large private and official sector players fancifully setting prices by fiat decree, and backing those wishes by playing games with supply. They flood the market with supply if they want to bomb a price and drive competition out of business. Once competition is gone, they withhold supply and force prices up to staggering new heights and reap legendary profits.
Like the blistering magma deep in the bowels of the great volcanoes, however, free market forces are immensely powerful and can only be held in check for a limited period of time. When an effort is made to artificially control market prices, great imbalances build behind the new obstruction like magma stealthily swelling within the heart of a volcano. On the surface, artificially manipulated markets often appear uninteresting and peaceful – until they erupt.
The free market forces accumulate behind the artificial price and build and build, and eventually the pressure becomes so great that the free markets shatter the price controlling scheme with a mighty eruption, decimating those foolish enough to try and manage the ultimately unmanageable free markets.
The subsequent volcano-like explosion when free market forces reach uncontainable pressures and reassert themselves is both incredibly dangerous and a tremendous opportunity. If caught on the wrong side of a market that explodes out of a manipulated state, a speculator can lose decades of hard-won capital in mere trading days. Conversely, if one is fortunate enough to be on the right side of a market when it bursts free, enough money can be made in a short period to last a lifetime.
Manipulating markets is the ultimate high-risk financial game, as history is full of examples of schemes imploding and causing great harm. We are not aware of a single macro-example of a market manipulation proving successful over the long-term in all of human history.
As we have pointed out many times in past essays, we firmly believe the evidence is overwhelming that covert and nefarious anti-free market campaigns are currently actively being waged in the global gold markets. For background information on why we strongly believe that the gold manipulation hypothesis is the only viable explanation for gold’s odd price behavior since 1995, please skim some of our earlier essays.
In last summer’s “Gold Shorts DOOMED” series, we explained the gold markets from a purely economic perspective and discussed why market manipulation schemes always fail. In “November Gold”, we discussed an unbelievable gold pricing anomaly late last year where the critical global gold market appeared to miraculously lapse into suspended animation for a whole month. In our “Gold Delta Hedge Trap” series, we offered an explanation of why bullion banks betting against gold with derivatives are in serious trouble. In “Let Slip the Dogs of War”, we marveled at lionheart Reg Howe’s landmark lawsuit challenging the governments and private banks manipulating the gold market.
In “The Raging Gold Info-War” we outlined the current propaganda war underway between the anti-gold and pro-gold forces. In “England Bombs Gold”, we analyzed the scandalous English gold auctions and their implications for the global gold markets. With all this background information available a mere click away on the web, we will waste no time in this essay re-presenting the case for manipulation in the gold markets to the skeptics. When professionals and amateurs alike take their time to do their homework on the gold markets, the vast majority arrives at the same conclusions as GATA and ourselves, that something strange and unnatural is afoot.
Like magma relentlessly building in pressure in the bowels of the earth, we are beginning to see signs that unimaginable pressure is building behind the scenes in the global gold markets. Gold lease rates remain high, indicating a waning of the willingness of central banks to throw away their citizens’ gold for trivial interest rates and a growing tightness in the physical gold market. Like the earth’s crust bulging above a dangerous magma bubble, gold lease rates call our attention to problems behind the scenes in the physical gold world.
Like the swarms of shallow earthquakes heralding an imminent volcanic eruption, gold has experienced some incredible volatility in recent weeks. The gold market has been relatively comatose in recent years, so this is potentially an excellent omen of great things to come. The magnificent recent two-and-a-half hour trading spike of May 18 is readily apparent in our first graph.
On Friday afternoon May 18, mere minutes after the London gold markets closed, gold roared from around $273 to $288 in 150 breath-taking minutes in New York. The $15 rally, 5.5%, is readily apparent on this graph. It is the large vertical spike on the right-hand side.
This awesome gold spike occurred soon after gold broke out of its technical short-term downtrend channel bound by the red lines. The light yellow dotted line marks the precise mathematical trend of this daily gold data series. The white arrow marks the gold price breakout which carried gold far above the trend channel in this short eleven month graph. From its trough of $256 on April 2 to its $288 peak on May 18, both marked with red circles, gold managed a very impressive $32 rally, or 12.5% in six short weeks. As all gold investors and speculators are painfully aware, this is most uncharacteristic of gold in light of its recent lethargic, plodding behavior.
Over the weekend following May 18, many gold market observers speculated on the cause of the huge intraday spike. Some explanations were plausible, and others were merely amusing. One of my favorites was a mainstream analyst who never covers gold in normal conditions. He soberly explained that gold rallied because the Bank of England had reduced its auction size from 25 tonnes to 20 tonnes. He speculated that because the Bank of England was dumping less gold, that explained gold’s spectacular May 18 afternoon rally.
(Chuckle) I had to laugh at that one because the BoE auction schedule and amounts of gold to be dumped on the market are old news, known months in advance by the gold market. In addition, any BoE related rally should have occurred on Tuesday May 15, the day of the BoE auction, NOT four days later AFTER the fellows in London who “fix” (their word, not ours) the price of gold went home for the weekend. As was quite obvious to long-time observers of gold, something fundamentally DIFFERENT happened in those 150 wild minutes in New York on May 18.
In “Gold Shorts DOOMED” and other essays, we have commented on the amazing amount of money that could be made in gold by running the shorts. As large amounts of gold have been sold short by bullion banks, possibly six years worth of the ENTIRE world’s mining production, the banks short gold are increasingly terrified of a major gold rally. If gold rises in price, these banks will be forced to cover their gold shorts, buying physical gold in the open market at huge losses. In several cases of prominent US money-center banks, the losses sustained in even a moderate gold rally would be large enough to totally obliterate shareholder equity carefully built up over generations, pushing some important banks into insolvency.
Due to this stellar risk, the money center banks short gold will almost have to cover early and hard. If they smell a gold rally that cannot be contained by dumping additional gold supply on the fire, one of the shorts will likely break ranks and begin buying aggressively. This will cause the gold price to rise faster, which will force other banks to join the frantic short-covering orgy. Gold will likely leap dramatically in price in this scenario, and a bona fide “gamma spike” is possible (see “Gold Delta Hedge Trap” for an explanation). The short-covering gamma spike rally could easily push gold hundreds of dollars higher in days or weeks. It would be an unmitigated disaster for the gold shorts, who are like citizens of Pompeii brazenly living in the shadow of a slumbering Vesuvius.
The only firewall between the gold shorts’ continuing health and being smashed to bits against a gold gamma spike is the lack of a catalyst. A gold rally is needed that frightens one of the gold shorts into breaking ranks, then the game is over. An initial gold rally of sufficient size, regardless of its cause, could be like the initial small fission explosion that touches off a devastating nuclear fusion bomb.
It has been really surprising to us that no big traders had yet apparently decided to actively engage the anti-gold cartel. With strategic gold purchases of maybe only a few billion dollars, it would be possible to cause a sharp rally in gold. That initial rally in gold would likely spark investment interest and demand, which would push the gold price even higher. At some point, the large gold shorts become so terrified that they have to cover, propelling gold stratospheric and making a fortune for the traders who can run the shorts.
We suspect the blisteringly fast May 18 afternoon rally was an initial shred of evidence that some large trading syndicate has indeed thrown down the gauntlet to the gold shorts. It looks suspiciously like a shot fired off the bow, an initial salvo between big money on both sides of the gold trade. There are a few major arguments supporting this thesis.
First, the gold rally on May 18 was condensed and FAST. That implies that a few big players launched some big money cruise missiles at the gold shorts at the same moment in time – an orchestrated offensive campaign. Gold was aggressively purchased, overwhelming the usual gold counter-measures screen thrown up by the evading gold shorts. A laser-beam of concentrated demand was leveled on the New York Commodities Exchange. If this was just a general market reaction to other gold factors like the Bank of England, there is no reason the gold rally would happen so rapidly. Thousands of small commodity traders did not all suddenly decide to buy gold in the last couple hours of trading on the week. A BIG, powerful, yet still unknown syndicate launched a carefully staged attack on the anti- gold forces.
Buttressing this argument, the rally began INSTANTLY after the London gold market closed for the weekend. That left the short New York gold players exposed, naked, and quivering in the corner for a couple hours when they could not call for backup. The graph below, courtesy of our pro-gold friends at www.kitco.com, shows the anomalous nature of this amazing gold spike. Note the purple bars at the bottom of Kitco’s famous real-time daily gold chart, which show when various world markets are open. The black line of the gold price on May 18 leapt northward immediately after the London close. The odds of this being a mere coincidence are infinitesimal.
Make no mistake, this looks and smells like a concerted big money strategic pro-gold offensive, NOT a quasi-random market event.
Even more provocatively, this rally happened a mere week after GATA gold champions Bill Murphy, Reg Howe, Frank Veneroso, and James Turk showed the gold producers of Africa how the gold market had been strategically bombed by American and European official and private interests. This awesome May 18 gold rally occurred as information was beginning to spill out on the news wires about the GATA presentation and African action plans following the GATA African Gold Summit.
We have been really excited about the GATA African Gold Summit for quite awhile, and we told our clients to watch this closely in Zeal Intelligence on May 1. The week before the gold summit, we published a public essay on the web not surprisingly titled “The GATA African Gold Summit” that attempted to outline just how important in many ways this landmark event would truly prove to be.
The convergence of the GATA revelations going public in a big way on the news wires and a mysterious lightning fast gold rally that appears strategically designed to rattle the cages of the large gold shorts leads us to believe that a consortium of pro-gold traders have locked their sights on the dangerously exposed gold shorts. The amount of money that can be made running the gold shorts is staggering, and it certainly appears some big pro-gold champions have jumped in the ring for a shot at the title.
Meanwhile, gold stocks as represented by the Philadelphia Gold and Silver Index (XAU) have been on a rocketing rally that appears to have been anticipating great things to come in the physical gold price.
The XAU (blue series) leapt out of its downward trend (red lines) once again in early April, marked by the white arrow above. So far this time, unlike the earlier breakout in February and March evident on this graph, the XAU has remained well above its trend channel. It will be very interesting to see how the XAU performs in the coming months, whether it remains strong and well above this eleven month trend or whether it is beaten back down into the descending red trading pipe.
From its trough on November 17 of 41.85 during the odd flat-lined gold doldrums (please see our “November Gold” essay), the XAU roared up an amazing 57% to its peak of 65.79 on May 21. This rally is marked by the red circles above. A 57% boom is a spectacular six month rally in a single sector by any standard. For the legions of diehard NASDAQ zealots out there, we would like you to note that the vaunted NASDAQ Composite Index managed to shed a painful 24% of your capital over that exact same time frame! Maybe the perpetually ignored or ridiculed pro-gold stock folks had a good point back in November, eh?
The anticipatory action of the XAU PRIOR to the incredible short-term gold breakout of May 18 reinforces the hypothesis that there is a growing pool of big money willing to shoot it out with the gold shorts. As gold investors know, price movements of gold can be leveraged tremendously through the purchase of quality gold stocks. Although there are hedging monstrosities that are in deep trouble in a mega-gold rally and a homeless copper company in the XAU, it is still quasi-reflective of general gold stock demand. SOMEONE was dumping a fair amount of money into gold stocks since last November. The capital spigots turned up a notch in early April.
As a commodity move in gold can be leveraged enormously by pre-positioning capital in gold mining companies, the anticipatory rally of the XAU is very intriguing when viewed in the light of the aggressive post-London close May 18 gold rally.
The bandit gold shorts manipulating the world gold market had better watch out, as it looks like a new sheriff is moving into town.
Like the French following World War I, we believe the gold shorts have a line in the sand that they will pull out all stops to defend. The French built the fantastic fortifications of the Maginot Line to keep the ever-warring Germanic peoples from invading France yet again for the umpteenth time. The engineering on the hundreds of miles of fortifications was formidable, and a full frontal assault on the Maginot Line would have been suicidal for even a fierce attacking German army.
The Third Reich Germans starting World War II, once again proving their notorious reputation of invading and bullying their neighbors before the United States gets involved, simply marched to France through Belgium and bypassed the Maginot Line. The fortifications were approached from the soft rear and soon surrendered to the waves of German invaders.
Like the impressive French fortifications, we think that a similar Maginot Line exists in the gold markets. The next epic battle in gold will likely be fought at $325. If the pro-gold forces shatter the $325 line, gold will probably go ballistic. If the anti-gold forces can extort enough additional physical gold out of central bank coffers to defend $325, they may be able to keep the charade going a little longer. $325 is where the gold war will be won and lost. It is easy to see why on the following graph.
The time scale is expanded here relative to our previous graphs, encompassing three and a half years of daily gold closes. The trend channel, bound by the red lines, is obviously down. The spectacular May 18 rally, while a great short-term breakout, just bumped the top of this longer-term trend channel. The $325 Maginot Line for gold is marked by the heavy black dotted line and the stop sign. Note that the two biggest gold rallies of recent years were decimated and repelled at the Maginot Line.
In September 1999 European Central Banks had a rare blinding burst of insight (socialist bureaucrats are never the sharpest tools in the shed!) and realized that their practice of liquidating their citizens’ gold at fire sale prices was not good for the gold market, so they chose to limit gold sales over the next five years. When they made the announcement, gold skyrocketed from 20+ year lows around $250 to $325. Intra-day, gold pushed $340, but on a closing basis it could not sustain $325 for more than a couple days. The Washington Agreement rally partially collapsed and began to consolidate after being repelled at the gold Maginot Line.
Less than six months later in February 2000, an important gold producer actually put on its thinking cap and realized that aggressive industry hedging practices into which profit hungry bullion banks had seduced mining companies were destroying the gold market. An Einsteinian lightbulb appearing over its head, and the company announced that it was cutting back on its gold hedging and forward sales. Once again the gold market was ecstatic on the news and roared into a vertical rally. Unfortunately, however, just as in the Washington Agreement rally, the $325 Maginot Line held fast and gold was viciously beaten back into its trend channel.
With these recent historical technical precedents, we believe $325 gold is the current mega-critical level, the nexus of the struggle to liberate gold from its oppressors.
IF the gold market rises in a controlled, orderly fashion, we suspect that we will need a few weeks or a month of closes above $325 to convince the gold bulls and bears alike that “something IS different this time” and lead to a massive influx of new capital into gold. IF the gold market rises chaotically and rapidly, as on May 18, we believe that we will need to see closes WELL above $325 (say $350 or so) for a few days or a week in order to convince the battered gold bulls and the ever-skeptical gold bears that the rally has legs. Either way, new capital will pour into the gold market ultimately taking gold to heights few today dream possible and slowly and painfully addressing the enormous global gold supply/demand deficit and short position that the anti-gold manipulation scheme has created over the last seven years.
Today, the vibrant Italian city of Naples sits in the shadow of the deadly Mount Vesuvius. Although the volcano has erupted more than 50 times since Pompeii was immolated, two million people choose to live in the immediate vicinity of the mountain of death today. Not even four hundred years ago, in 1631, Vesuvius claimed another 4000 victims. Meanwhile, magma continues to slowly build in pressure underneath the mountain today and everyone knows another eruption is inevitable. Two MILLION people, fully aware of this, choose to tempt fate and live within the deadly embrace of this mountain of fire.
Like a volcano, the long-suppressed global gold market has also been slowly building pressure, trapped beneath the hardened lava dome of a concerted official and elite private effort at gold price manipulation. Also like a volcano, gold has shown over and over through history that it cannot be suppressed for very long. The power of free markets coupled with the innate human lust for real money, gold, ALWAYS, 100% of the time, shatters efforts at obscuring gold’s true value. Just as the titanic earth forces driving a volcano cannot be bottled up forever, neither can the anti-gold forces contain the ever-building pressure behind their manipulated gold market indefinitely.
The May 18 rally, the GATA revelations, the rising gold lease rates, the astoundingly large short position, and the tight physical market are all warning signs. These are the equivalent of swarms of small earthquakes peppering a volcano prior to it letting go.
We are now observing initial pressure-blowoff warning signs in gold, and the great financial lessons of history coupled with the immutable laws of free-market economics ensure gold is preparing for a spectacular price eruption. The gold shorts will be immolated in this eruption as thoroughly as the ancient citizens of Pompeii who dared to live in the shadow of a monster.
Adam Hamilton, CPA, MCSE aka Zelotes 25 May 2001
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Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro- free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.
by Philip Judge