Some comments on the storm over the Blanchard lawsuit

Daan Joubert
daanj@kingsley.co.za
(c) 2002 All rights reserved

Hoo, boy. All this dust being raised by Tim Wood’s article on the Blanchard-Barrick-JPM lawsuit! One would think that the dispute of whether gold is being manipulated by a nest of conspirators has been settled a long time ago, with the pro and con camps withdrawing into their own circles so that each of them can tell their converted that they have WON!

And then Blanchard comes along to light the fuse again!

One can imagine much the same kind of abuse being thrown at each other in the days long ago when the people were divided over the relative positions and motions of the sun and the earth and later also whether the earth was flat or a ball. Then, as now with this conspiracy thing, the opposing camps were violently casting all kinds of philosophical arguments at each other, with little effect to convince, when all they had to do was to wait until improved knowledge and more detailed understanding of reality solved the dispute in an objective manner, to find that a round earth was orbiting around the sun.

Interestingly, though, that when I searched Miningweb today so that I could examine the original article by Tim Wood and the long list of responses to it, from a wide range of luminaries in the world of gold (including the fringes, as some might say), I could not find it. Perhaps a case of ignorance and finger problems on my part??

Nevertheless, seeing that it appears to be a season for asking questions, I would like to ask some of my own; hopefully, to stimulate less subjective and parochial thoughts on the matter of gold, rather than to receive a host of responses covering the full gamut from vilification to full throated cheering – or perhaps Tim Wood may want to run a poll.

To begin with, I state a few assumptions that, of course, are open to challenge:

1. The gold price, like those of (other?) commodities, responds to supply and demand as per basic economic theory.

2. Central Banks take seriously their mandate to manage the reserves of the country in a prudent and diligent manner. In support of this assumption we have the stated reason for Central Banks leasing gold – to earn an income (estimated to be about $3 - $4/oz p.a. in terms of lease rates and the price of gold) on a ‘dead’ asset, thereby to increase reserves by some small amount, depending on how much of the gold is leased.

3. Central Banks have economists who understand the ramifications of the law of supply and demand, as this applies to the gold market, even if central bankers do not

4. It is a fact that after the bull market of 1993, the gold price spent all of 1994 and 1995 in a horizontal band, mostly between $380 and $390. In terms of supply and demand we can assume that the market was effectively in balance during this period. Then, in early 1996, gold rose to $415, but suddenly reversed trend and started the steady slide that finally took the price to $250 almost 30 months later. This too is fact. Therefore we can assume that during this latter period – from early 1996 to mid 1999 – supply of bullion consistently exceeded demand by quite some margin.

5. Most sources for supply and demand data for gold agree, in principle, if not in detail, that at least from the latter half of the 90’s and through to today overall demand for gold exceeded natural supply from producers and from scrap. It seems to be generally accepted that at least some if not the majority of the excess supply that is directly or indirectly responsible for the decline in the gold price, originated from the vaults of one or perhaps a number of the Central Banks. After all, their vaults are, or perhaps were, the main repositories for most of the free bullion in the world.

Interlude:

It would appear that by the mid-90’s demand for gold had outgrown supply and the gold price had reacted as expected, by rising to above the $400 psychological resistance. At that time, supply suddenly increased and remained at elevated levels, well above demand, to result in a consistent decline in the price of gold over some 30 months.

Now picture the situation in February of 1996 when the price of gold rose above $400. If the above assumptions are not too far off the mark, it must have been at about this time that one or more Central Banks decided that they have had enough of holding a ‘dead’ asset with no return on it, to begin leasing it in quantity. One may argue whether this was a pro-active measure by the Banks in order to earn an income on the gold, or whether it was in response to demand for leased gold, presumably from bullion banks, who saw profit in obtaining cheap funds at a cost of around 1% on which they then could earn 6% or more. In the final analysis, though, this is of no consequence, as the key decision to lease always was that of the Banks.

Of course, one may ask whether the central bankers did not consider the effect of a fresh supply on the price of gold before they started to lease in quantity. Perhaps whether they did not listen to their economists, if the latter had anything of significance to contribute as to what will happen to the price when supply started to exceed demand. But that question becomes irrelevant by July 1996 when the price had collapsed from $415 to $380.

Let us return to our assumptions:

6. One can assume that within 4 months or so from starting to lease in quantity, it must have been evident even to central bankers that their attempt to earn an income (of say $4/oz p.a.) on a relatively small portion of their gold, was not having a good effect on the value of the bullion that remained in their vaults, the latter having lost $35/oz in just 4 months. In other words, that mainly due to their action, the value of the reserves for which they had responsibility was taking a real beating.

7. A further assumption – perhaps with less confidence than most of the preceding – is that the central bankers were sufficiently concerned about the damage that was being done to the reserves to sit down and discuss the matter. If they did, the decision quite clearly was that they could see no reason to curtail their practice of leasing gold in quantity, as the gold price continued to decline under the excess supply from central bank vaults, to fall by another $128; losing all of $163/oz over a period of 28 months.

8. In this post Enron world, we are seeing a spate of law suits in the US where brokers and others are being sued by people who have lost money due to the actions or lack of action of these parties. Let us then assume that there is a universal ruling that owners of assets can seek reparation from parties who have had a mandate to manage these assets on behalf of the owners and who failed to act prudently and diligently, judged in terms of the then available facts, so that significant value was irredeemably lost.

There can be little doubt, if the bulk of these assumptions are not too far off the mark, that the decision of the central bankers to lease their gold in quantity for less than $4/oz p.a. and to continue to do so for at least 28 months during which the value of the bullion reserves fell by $163/oz from $415 to $252 (while earning, at best, $10/oz on just a portion of the reserves during this time), can only be due to two reasons:

• Massive, sustained stupidity by central bankers in the face of day to day evidence, to reveal a near criminal negligence of their mandated responsibilities

• A hidden agenda that was more important to them than the effect of their decisions and actions on the value of the bullion reserves in their care

Observe that except in so far as there is reference to a possible "hidden agenda" for the decisions of the central bankers, there is no mention of conspiracy or manipulation in this essay. So please do not impute support for a ‘conspiracy’ theory to what is written here. The whole essay hinges purely on the wisdom (some might say ‘sanity’) of these central bankers in respect of their decision to sell and lease gold in quantity (a decision generally accepted as fact). Also on the fact they kept on doing so, even when they were clearly shooting themselves in both feet at the same time, at least in terms of their mandate to The People, the proper owners of the national reserves.

This brings us to the final assumption:

1. Assume that you, the reader, is the Judge in a matter where ‘The People’ sue their central bankers for the latter’s negligent management of the country’s gold reserves during the period February 1996 to July 1999; when the value of the bullion declined by $163/oz and the gold leases at best earned 10$/oz on a (small?) portion of these reserves. The People now seek either reparation or punishment, or both.

In the light of the above assumptions, all you have to decide, really, is whether the central bankers, in a climate of excess natural demand, did in fact lease gold in such quantity as to depress the price. Nothing more and nothing less. That is the crux of the matter.
On the basis of how you find the facts in the case, you have to rule:

a. In favour of the Plaintiffs: Central Bank activities did depress the price
b. In favour of the Defendants: Central Banks did nothing to depress the price

Irrespective whether it was crass stupidity or having a hidden agenda.

Conclusions

The above is written a little tongue in cheek, and in a manner to fit the format of recent communications on the matter of the Blanchard law suit.

Finally, though, this essay boils down to just one question – would you, as a judge, rule the central bankers Guilty or Not Guilty on the charge of acting in a manner that had the effect of reducing the value of the national reserves, contrary to what is expected of them in terms of their mandate to be prudent and diligent. No if’s and no but’s – a simple question: did the central bankers act in a manner contrary to fulfilling their mandate.

A simple question, but a Guilty verdict would lead to a mare’s nest of other questions and suppositions that are not touched upon here, including, perhaps, mitigating circumstances in that these central bankers were pursuing other objectives critical to their function. But that would be supplementary to their guilt on the main charge.

Yet the ramifications do not end with a guilty verdict, if you do so find. For example, if, subsequent to early 2001 after the gold price had started off on the current bull trend, the central bankers and other parties also short of gold discovered (belatedly?):

i. that their short positions could not be covered and
ii. that the rising gold price presented most severe complications for them all

Would you, now acting the role of a central banker, be willing to do all that is necessary to deal with the problem and attempt to avert what threatens to be a financial disaster of such magnitude as to cause major havoc in all the global financial markets?

In other words, would you use all possible measures, including disinformation and active manipulation of the gold market, including entering into active conspiracy with the other vulnerable parties, if that is what is required, with the objective of keeping the gold price in check? Or would you sit back passively and wait for the inevitable?

A simple choice is all that is needed to this question:

a. Yes, I would try all possible avenues to avert the disaster
b. No, I would simply let happen what must happen

Of course, you may still rule the Defendants ’Not Guilty’ – that they had nothing to with the decline in the gold price, despite the economic law of supply and demand.

Then, do not feel alone: when Copernicus and others presented overwhelming evidence of a heliocentric solar system and Magellan circumnavigated the globe, there were still many people who lived and died convinced that the sun orbited around a flat earth.
However, in this matter, as in many other things, history will still have the last word.

Compliments of the season.

May peace and goodwill permeate the world.

PS You ask what is the relevance of all this to Blanchard? Simple; if you had found that the central bankers had behaved in a manner contrary to their mandate, it is unlikely this was due to crass stupidity. So, if they had acted in pursuit of a hidden agenda, they would welcome all allies in their effort – which might just include JPM and Barrick.