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Falling Gold And Silver Prices Being Driven By Market Makers And Traders Not Fundamentals

By Doug EberhardtMarket OverviewNov 17, 2011 08:00AM ET
Falling Gold And Silver Prices Being Driven By Market Makers And Traders Not Fundamentals
By Doug Eberhardt   |  Nov 17, 2011 08:00AM ET
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Every time we get a run up in the price of gold and silver of late, we seem to get it pushed right back down again like today when we see falling gold and silver prices. Sure, news of what’s going on in Europe or Japan can have some short term effects on the price of gold and silver, or even the movement of the Dollar Index, but some of the time the fall in the price of gold and silver has nothing to do with news at all. While a fall in the price of gold or silver is a cause for concern for some people it isn’t for me. Not because I sell gold and silver for a living, where some may point out I might be biased, or “always bullish,” but because I have been around long enough to know what market makers are capable of when they throw enough money at something.

Market Makers Do What They Do Best: Manipulate Price

When I first traded stocks back in the days of scalping a 1/16, 1/8 or a 1/4 point for a quick profit, and before the digital era we are in today, I became painfully aware of oddities when I decided to buy shares of thinly traded stocks. All of a sudden, the stock would take off in the opposite direction of my trade and squeeze me out of my trade. In this case, market makers, those who put the bid and ask price as live prices for each stock, or in particular, a market maker known as the “ax”  would see someone buying or shorting the stock they follow and throw money at the stock to move the price in the opposite direction of the individual or institution who dared try to play their stock.

Market makers get compensated on manipulating the market to try and make a profit for their company. These market makers consist of professional traders who sit in front of their desk and watch their multiple computer screens and trade news, rumors or they just get bored and make the news by pushing a stock down or up, hopefully catching the other players who trade the stock off guard as they’re out to lunch or took the day off early. Heck, even Kevin Spacey’s latest move, Margin Call, had one large company take just one side of the trade, “to save the company.” Investors be damned!

And the little guy thinks they have a chance to profit against these professionals? Well, the truth is, they do. But how?

The Market Makers In Action

Everyone knows who the players are in the field (the Ax for example) and they can easily be followed on what’s called a Level II screen that shows each wholesaler or market participant for each stock or ETF who places their out of market or in market bid or ask price. You will see the Level II screen below which shows some of the players of the stock Microsoft (MSFT), like Goldman Sachs (GSCO), Morgan Stanley and Company (MSCO) and UBS Securities LLC (UBSS) to name a few.

Sometimes, on these thinly traded stocks, the losses can amount to the $1,000′s for retail investors (the Mom and Pop traders who like to trade their own accounts thinking they can outsmart the professionals. You will see their trades come through via a retail broker like Etrade (ETRD), or via ECN’s like ARCX to execute the bid/ask (buy/sell order). The market maker tries to get them to cry uncle and sell or cover a short so the market maker can make their profit. They get the investor to chicken out and sell/cover while they move the stock a few points against you, possibly in just a few minutes (like with thinly traded stocks. I know. It’s happened to me…in the early days. A good explanation of the players involved can be found here. While one can profit from this type of trading, it’s not for everyone. I am not condoning it, but allowing you so see how the markets work and how the big boys make money.

What Does All This Have To Do With Gold and Silver Prices?

Most people know that trading in stocks or ETFs is not the same as trading in the actual physical metal, at least for the retail investor. But the big boys get to play the physical metals in the Over The Counter (OTC) market.

From WIKI:

Internationally, gold is traded primarily via over-the-counter (OTC) transactions with limited amounts trading on the New York Mercantile Exchange (NYMEX) and Tokyo Commodity Exchange (TOCOM). These forward contracts are known as gold futures contracts. Spot gold is traded for settlement two business days following the trade date.

The spot fix price for gold is set by the London Bullion Market Association (LBMA).  ”There is a brief conference call among the five members of the London Gold Pool (Scotia-Mocatta, Barclays Capital, Deutsche Bank, HSBC and Société Générale). The London spot fix price is the price fixed at the moment when the conference call terminates.

According to Wiki again:

Although the physical market for gold and silver is distributed globally, most wholesale OTC trades are cleared through London. The average daily volume of gold and silver cleared at the London Bullion Market Association (LBMA) in November 2008 was 18.3 million ounces (worth $13.9 billion) and 107.6 million ounces (worth $1.1 billion) respectively.

This means that an amount equal to the annual gold mine production was cleared at the LBMA every 4.4 days, and to the annual silver production every 6.2 days according to IFSL research out of London. Please note that this could not be done without the ability to trade the metals via fractional reserve methods. Meaning, they trade unallocated accounts that are only partially backed by physical gold (or silver). Is it any wonder that these traders can cause falling gold and silver prices even when the fundamentals point to higher prices?

What Good Does the CFTC Do?

Like the rating companies that gave good ratings to bad investment products, what good does a regulator do when they don’t do their job? The Commodity Futures Trading Commission – CFTC was set up by the U.S. Commodity Futures Trading Commission Act of 1974. The primary mission of the CFTC is to guard market participants against price manipulation, abusive trade practices, and fraud for those who participate in the metals market.

While the CFTC was set up with good intentions, if it were true that they wanted to “guard market participants against manipulation, abusive trade practices and fraud,” then why doesn’t the CFTC crack down on these traders when they do this? Isn’t the fact they trade unallocated accounts with no metal backing them considered fraud to begin with? According to the Wiki article on this issue; Similarly to a bank run this makes LBMA unallocated gold accounts susceptible to loss if a sufficient number of market participants request delivery of physical bullion.

Gold and Silver Traders Are Not Held Accountable

And herein lies the key. These OTC traders don’t take delivery of the metals, so no one has to “pay up.” I remember about 30 years ago when I was in college I worked at the Chicago Mercantile Exchange (CME). There were traders at the CME who at the end of the day would have this down and out look sometimes because they for example as one trader told me, “lost big today” in the grain market. This means they were on the wrong side of the trade. You see, he felt the effect of the bad decision he made for the trade and had to personally account for it. He either had to pay for the trade one way or the other, either by dollars or by movement of grain. Farmers do this all the time when they wait for the price of say corn to rise in the future while they store it at grain elevators. They hedge their bet through a put option just in case the price falls. If the farmer brought the grain to the elevator and sold that day, he might take some of the proceeds and buy a futures contract to capitalize on any potential rise in price.  But with farmers, they can provide the product to cover a trade or take delivery on the other side of the trade. You don’t see that with gold and silver bullion traders. They can go short for as long as they want without having to pay up the metal.

That’s why, as the IFSL report referenced above states, “this means that an amount equal to the annual gold mine production was cleared at the LBMA every 4.4 days, and to the annual silver production every 6.2 days.” The logical conclusion thus is, if only a few participants take delivery, it exposes the ponzi scheme.

Banking System Similarities

Just look at the banks that lend out multiples of their deposits. Once the 2008 financial crisis hit (actually well before this), the bad loans started to hit the banks. The banks don’t have enough cash on hand to cover the write-down on the assets, so they got the Financial Accounting Standards Board (FASB) to give them permission to mark to fantasy (2006/2007) values the real estate they have on the books instead of marking the properties to market price (today’s values). The FASB is an independent, private sector organization that sets accounting and reporting standards for both public entities (which issue securities that trade in public markets) and nonpublic entities (which include private companies and not-for-profit organizations). How can anyone take the FASB seriously when they allow the banks to get away with this?

This blessing of the FASB bestowed on the nations troubled banks would help improve the banks reserve ratios and keep the FDIC from knocking on their doors. Today, banks still don’t mark to market their assets, the FDIC is $8 billion in the hole and the FASB is complicit in the scheme. But who will come to the rescue of those who bet wrong on the gold and silver trades? Who exactly is trading heavily in this market? Look no further than the nations top banks. Look no further than the banks that play the derivatives markets. Look no further than the banks that are custodians to the gold and silver held by the major gold and silver ETFs. I will be writing more on this connection in a forthcoming article.

Making Connections

You never see me mention anything on the Buy Gold and Silver Safely site about price manipulation until today. While there are others who do write about it, I haven’t seen the correlation to banks not marking to market their assets with the full blessing of the FASB. I haven’t seen the connection to what market makers do every day with the stocks traded on the NYSE.

But it is easy for one to draw a conclusion about price manipulation. They need look no further than the example above of the thinly traded stock where the “Ax” gets involved when they see someone messing with their stock (buying or shorting it). Market Makers don’t like to be messed with. If a player comes in and tries to take money from their pockets, you can bet they will try and punish them by moving the market away from their trade. While it is illegal for these firms to conspire and talk to each other about the way they want to move a stock (or in the case of big banks manipulate the price of gold or silver), they can jump on the same bandwagon in figuring out what the other is up to. This isn’t rocket science. But it is a game that the little guy, especially if they are on margin, can get creamed. That’s why the best way to invest in gold and silver is to buy the physical metal and just sit tight and wait for things to implode. Dollar cost averaging into a position and practicing a little patience is what I preach. This is the tortoise vs. the hare and because of this potential for manipulation, you don’t want to get caught jumping in too soon with all your allocation to gold or silver. Patience will be rewarded along with good money management where you actually are ok with the price of gold and silver falling.

Today, with the likes of J.P. Morgan and Goldman Sachs becoming holding banks, and the already well connected banks who play the gold and silver markets, there is an opportunity for these traders to try and manipulate the gold and silver markets, as well as other markets. Whether or not the Fed is actually involved behind the scenes with some of these companies is pure speculation. But there is the new Fed mandate of regulating systemic risk and preserving financial stability. This gives the Fed even more power thanks to both sides of Congress who gave them this power. Heck, Congress is complicit even further in this financially rigged game as they even gave money to the IMF to help bailout other countries.  Don’t think for a second the Fed doesn’t want to see falling gold and silver prices. And since the Fed is never audited, except for the one time audit brought about by the Financial Reform Act of 2010, which didn’t go far enough in auditing the Fed, one will never really know what they’re up to.

Keep one thing in mind. Do you really think the same group of intellectuals that got us into this mess can magically keep the cracks in this Humpty Dumpty economy from getting bigger before things get worse?

Along with the deteriorating fundamentals I constantly mention in my articles, it will eventually all come down to the banking system as I mentioned in Chapter 4 of my book, Buy Gold and Silver Safely. This is the chapter that provides the road map of what’s to come. What happened recently with MF Global is only a small sample of what occurs when bets go against you. The nations top 5 banks are on shaky grounds with similar type games they are playing.

The Humpty Dumpty Banks

The U.S. banks sat on a wall,
The U.S. banks had a great fall.
All the Fed’s horses,
And all the Fed’s men
Couldn’t put the U.S. banks together again!

Stay tuned for more…and just know…falling gold and silver prices should be welcomed as more investors are able to buy gold and silver at lower prices. Congress, the Fed and the decisions made by the banking industry will see to the future appreciation of the precious metals.

Falling Gold And Silver Prices Being Driven By Market Makers And Traders Not Fundamentals
Falling Gold And Silver Prices Being Driven By Market Makers And Traders Not Fundamentals

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