The Phantom Cartel Part II

By: Mark Taylor | Sat, Mar 11, 2006
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In part one of The Phantom Cartel; we discussed the possibility of manipulation within the gold market. An in-depth look at the historical Commitment of Traders reports conclusively revealed that there had been no suppression of prices in the gold market during the timeframe discussed. It became evident that the rise and fall in prices from March 1993 through October 1993 was a matter of speculative behavior on the part of both the Non-commercial and Non-Reportable Traders in the COMEX gold market. As these two groups of Traders accumulated a record-breaking level of long positions, the Commercial Traders seemed fearless in their willingness to take on an ever increasing number of short positions. It has been suggested by many that amassing these extensive short positions eventually serves as a mechanism to cause a decline in prices. At the same time, these same Commentators insist that the short positions will also lead to what is commonly referred to as a short squeeze. It is absurd to conclude that such an unbalanced stance in a market could have two opposite effects.

To understand the reasoning behind a continued build-up of short positions as prices rise to ever higher levels, one must first properly define who the Commercials are. As expressed by the CFTC, a Commercial is "an entity involved in the production, processing, or merchandizing of a commodity". To be listed as a Commercial it is required that the Commercial be "engaged in business activities hedged by the use of the futures or option markets." It is therefore extremely important that one realize these Entities are in fact, Commercial Hedgers that are "taking a position in a futures market opposite to a position held in the cash market to minimize the risk of financial loss from an adverse price change; or a purchase or sale of futures as a temporary substitute for a cash transaction that will occur later."

There are two ways to hedge price risk, one can hedge either a long cash market position (e.g., one owns the cash commodity) or a short cash market position (e.g., one plans on buying the cash commodity in the future). Hedging a long cash position is accomplished by selling short the market while hedging a short cash position is achieved by holding long positions at COMEX.

An example of a Producer's selling hedge is as follows; ABC Mining operates an open pit mine from which it extracts gold ore. The company produces 10,000 ounces of gold each month at their site. Today gold is selling at a 15 year high of $500 per ounce. ABC has determined the new high in prices is an excellent price at which to sell. ABC would like to secure the new selling price for 6 months of gold production or 60,000 ounces. The objective is to guarantee ABC will have a gross income of $30,000,000 by the end of the 2nd quarter. On January 10th, ABC determines that January and February's production will be available for delivery during the current active (February) contract. ABC immediately sells short the COMEX market 200 contracts or 20,000 ounces. They then sell 400 contracts (40,000 ounces) in the June contract. There are two possible scenarios; Assume by the time they are to sell the first two month's production, gold is selling for $450. The physical sale of 20,000 ounces at $450 nets a sale price of $9,000,000, however with the COMEX selling hedge; ABC has a gain in that market as well. The short sell has produced a $50 per ounce profit to net a gain of $1,000,000. The total net gain between both the physical and COMEX market is $10,000,000.

The second scenario would be that gold prices have risen during the period to $550. The outcome is the same as scenario number one; ABC sells its 20,000 ounces into the market at $550 per ounce, for a net gain of $11,000,000. In the COMEX market, ABC has suffered a loss on its short position of $50 an ounce or $1,000,000, the total gain is $10,000,000.

The end result for the sales in June will be the same, regardless of prevailing market prices; ABC will have a net gain of $20,000,000 with the combined sale of physical gold and the loss or gain in the COMEX market. The total from the February and June sales will be $30,000,000, just as estimated on January 10th.

Understanding this age old principle is an absolute must when one takes notice of an ever increasing Commercial short position in the COMEX gold market. As mentioned, these Commercial short positions are accumulated as prices are rising in the gold market. Our fictitious Mining Company will provide us with more information on the subject. When ABC Mining realized that gold prices were in a steady uptrend back in January, they decided to increase production by 20 percent. By March when gold prices increased to $550, ABC had estimated their increased production would amount to an additional 12,000 ounces by the end of June. They immediately take on an additional 120 short positions at $550 in the June contract. They have thereby locked in the price regardless whether prices rise or fall. This is an example as to why Commercial short positions increase as prices rise.

ABC Mining is not the only Mining Company on the planet nor are they alone in the proper utilization of the Seller's hedge. All Sellers of gold be they Producer, Processor, or Merchandiser, must lock in rising prices in an effort to be competitive and increase profit potential. It is no less important that the hedge be exercised to avoid the risk of falling prices.

This returns us to the assertion that the Commercials are suppressing the price of gold. If it were the intent to cause gold prices to fall, why do the Commercials use the Seller's hedge to lock in higher prices? As prices rise ever higher, why do they lock in again and again? It would serve them much better if they were to sell into a declining market and continually lock in lower prices. This however has not been the case at any time since the alleged price suppression began. Certainly the suppression of prices did not commence in August, 1993 so we must now consider the group that insists it all started in 1996.

In part 3 of The Phantom Cartel, we will investigate many price levels at which price intervention supposedly occurred. We will also look into several specific comments commonly repeated to reinforce the conspiracy theory of manipulation.

GATA go, Zorro

Many readers of this series may wonder what the point of all this is. At we often look at the possibility of both trading and owning gold. With that possibility in mind, it is of utmost importance we are not biased in our decisions. Repeated and growing declarations of a controlled market may lead many Traders and potential gold Investors to believe they will gain huge returns on the theoretical "day of reckoning". It is equally possible that many will simply ignore the tremendous opportunity currently existing in the gold market for fear a "rigged" market. At the Dow Theory Project, we trade reality.....not phantoms.


Mark Taylor

Author: Mark Taylor

Mark Taylor aka Zorro

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