January 17, 2006
Are There Any Central Banks Still Standing At the Ready?
Or why Greenspan’s ‘wrongly interpreted’ quote is threatening to tarnish his farewell party
By Brady Willett

14-sessions ago the price of gold was trading below $500 an ounce. Yesterday you got the feeling that the price of gold could bust above $600 an ounce at any moment.  What has happened since December 22, 2005 until today to spark one of the most powerful gold rushes in recent memory? China hinted, and later recanted, that it was looking to diversify reserves away from US dollars, and Iran broke the seals at its Natanz facility.

Beyond investor reaction to these two events it is difficult to rationalize why the latest move in gold has come to pass (i.e. the move lower in USD has not been as strong as the move up in gold). As for the COT statistics, they have been rendered meaningless for nearly two-months and anyone who has tried to trade historical tendencies in the data has been burned, including the commercials.  Since 2002 you could have pinpointed every major turning point in the price of gold by monitoring the commercial net short position (futures & options).  This is no longer the case.


Probably the only argument that makes sense is that a rising price of gold has attracted more buyers; buyers that are undoubtedly in search of a quick Iran or event focused trade rather than a long-term investment.  This is reason enough to expect a sharp pull back when the momentum stops.

With that said, if under the worst scenario the Iran issue continues to boil and/or other financial markets start to come under pressure because of investor apprehension over Iran/oil, the price of gold may not pause until the bombs start dropping.

Is Greenspan Watching Gold Yet?

Weeks away from retirement one of Greenspan’s most famous gold related quotes is threatening to make the rounds:

"To be sure, there are a limited number of OTC derivative contracts that apply to nonfinancial underlying assets. There is a significant business in oil-based derivatives, for example. But unlike farm crops, especially near the end of a crop season, private counterparties in oil contracts have virtually no ability to restrict the worldwide supply of this commodity. Even OPEC has been less than successful over the years. Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over- the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise.” July 24, 1998  Greenspan

In response to questions from the GATA to Joseph L. Lieberman, Greenspan later said that the above statement was ‘wrongly interpreted’. Greenspan added:

“The observation simply describes the limited capacity of private parties to influence the gold market by restricting the supply of gold, given the observed willingness of some foreign central banks -- not the Federal Reserve -- to lease gold in response to price increases.” Dear Senator...

Well Mr. Greenspan, with the price of gold almost double what it was in December 1999 do you still observe a willingness of some foreign central banks to lease gold in response to price increases?  For that matter, do you still abide by your steadfast belief that the OTC derivatives market should forever remain unregulated even though the size of the OTC market has increased by nearly 300% to $270 Trillion (notional) since your 1998 Testimony? (the ‘Gross Market’ value of the OTC market is around $11 trillion, or nearly 400% more than the level in 2000 ~ BIS)

Suffice to say, Greenspan had better hope that the next major default or hedge fund collapse can be contained as orderly as LTCM.  After all, despite flat lease rates, central banks today do not exactly seem united in the pursuit to keep gold under pressure…if they were the last 14-trading sessions in precious metals would not have been allowed to happen.

Why is it important that the next LTCM is quickly contained? Because while it is indeed “impossible to corner a market for financial futures where the underlying asset or its equivalent is in essentially unlimited supply” (Greenspan) it is not impossible for a run on gold to trigger cascading defaults and/or a run out of the dollar. In other words, and this is what Greenspan didn’t give any credence to during his tenure, ‘What if investors just want out?’

If gold regains its status as the only real safe haven choice for investors no Fed Chairman would be able to do anything during times of crisis, save trying to unite all central bankers to keep the monetary system together.

Melodrama aside, before the price of gold embarks upon an even more powerful rally (or before US dollar hegemony is put to it most severe test) it should be remembered that the odds suggest that another serious sell off will materialize first. There is a lot of hot money chasing gold today, and it would be surprising if the Fed has not already started to feel the heat.  In other words, if Greenspan leaves his post with the price of gold surging uncontrollably higher his tenure of non-regulation, gold suppression (or low inflation), and seemingly magical crisis containment skills could be in jeopardy.

Make some phone calls and grease some players Greenspan…you’ve got a couple of weeks. 

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