The Wall Street Journal recently broke the story that there is evidence of banks attempting to manipulate the prices of gold and other precious metals. In other breaking news, evidence has emerged that the Earth revolves around the sun, that the Pope is Catholic, and that bears sometimes defecate in the woods.

Kid Dynamite is happy that regulators are finally taking note, as he has studiously documented evidence of upward manipulation of the gold price for years, to seemingly no avail. Actually, what he has done is show that the same sorts of price/volume changes in the gold futures market that are routinely put forward to ‘prove’ downward manipulation can also be used to ‘prove’ upward manipulation. By carefully mining the data it is possible to validate almost any theory, even a ridiculous one.

In any case, my purpose in writing this post is not to delve into the murky world of gold-market manipulation theories, but to point out that “manipulation” is often a poorly chosen word. To manipulate is to skillfully influence or change to one’s advantage. As such, manipulation could be a legitimate business practice. In the financial markets, for example, there is generally nothing ethically wrong with a private (meaning: non-government) trader buying or selling with the aim of influencing the price. Trading with the express purpose of driving the price up or down will usually not lead to a profit, but one person’s reasons for buying or selling are not the business of anyone else.

“Manipulation” therefore doesn’t imply “wrong” or “unfair”. Other words must consequently be used to distinguish between the manipulation that could form part of legitimate business practice and the manipulation that involves a violation of property rights and/or a breach of fiduciary duty. Fraud is a good word. For example, if banks siphon money from their customers to themselves by front-running their customers’ orders or by misusing information given to them in confidence by their customers, as was alleged in a lawsuit filed by a jewellery firm last November, then the banks are engaging in fraud, not just manipulation.

Manipulation is not inherently wrong. Fraud, by definition, is.

Last year I noticed an article by Alasdair Macleod containing an estimate that China (meaning: China’s government) had accumulated 25,000 tonnes of gold between 1983 and 2002. I would say that this estimate was based on rank speculation, but that would be doing an injustice to rank speculation. It is more like total guesswork. It is largely based on assumptions that are either obviously wrong or that have no supporting evidence. I bring this up now because it looks like the 25,000-tonne figure that was plucked out of the air by Mr. Macleod last year is on its way to becoming an accepted fact in some quarters. For example, it forms the basis of a new estimate that China’s government now has 30,000 tonnes of gold.

Here’s the supply/demand table from Mr. Macleod’s article. The top section of the table purports to show the total amount of gold supply that was created during 1983-2002 and the bottom part of the table shows guesses on how this supply was distributed around the world. If the top section contains figures that are either based on false logic or completely lacking in evidentiary support, which is definitely the case, then the figures in the bottom section are irrelevant. That’s because the figures in the bottom section have been chosen so that they add up to the figures in the top section.

The most obvious error is the assumption that because gold was in a secular bearish trend during 1983-2002, there was no net buying of gold within the Western world over this entire period. Instead, it is assumed that not a single ounce of the 42,000 tonnes of gold that was produced by the global mining industry during this period was bought by anyone in Europe or North America. It is also assumed that the “West” reduced its collective gold holdings by 15,000 tonnes during the period.

This takes me back to a point I’ve made many times in the past in relation to similar misguided analyses of the gold market. The point is that the quantity of gold (or anything else, for that matter) transferred from sellers to buyers says nothing about price. The corollary is that price says nothing about how much was transferred.

The fact that the price of gold was making lower-highs and lower-lows during 1983-2002 does not imply that less gold was bought in the “West”. In fact, it’s just as likely that the opposite was the case — that sellers, including gold miners, had to lower their asking prices to account for the reduced eagerness to own gold and sell what they wanted to sell. It’s therefore quite possible that there was no net “Western” divestment of gold and that all of the gold produced during 1983-2002 was sold in the “West”.

I’m not claiming that all of the gold produced by the mining industry during 1983-2002 was sold to Western buyers, but such a claim would be no more ridiculous than Mr. Macleod’s guess that none of the newly mined gold was sold to Western buyers.

I’ll end this discussion by reiterating that even if you have enough information to do the additions accurately (which nobody ever will, by the way), there is no point adding up the amounts of gold being transferred between sellers and buyers in different geographical regions or different parts of the market. At least, there’s no point if explanations of past price movements and clues regarding future price movements are what you want. There could, however, be a point if your aim is to find a justification for being bullish no matter what’s happening in the world.

I should probably do a separate blog post titled “Total guesswork regarding China’s gold strategy”.

This post is a slightly-modified excerpt from a recent TSI commentary.

Gold tends to fare relatively poorly during the booms, which are periods when confidence in central banks and the economy rises at the same time as mal-investment is setting the stage for a future period of great hardship, and fare relatively well during the busts, which are periods when the investing mistakes of the past come to the fore. Be aware, though, that the word “relatively” is critical to understanding gold’s relationship to the boom/bust cycle, because the relationship often doesn’t apply to gold’s performance in US$ terms.

To show what I mean I’ll begin with a chart of the US$ gold price covering the past 20 years. There were booms and busts during this period that are not evident on this chart. In particular, 2001-2011 contained huge booms and busts, and yet the gold price trended steadily upward throughout. How could this be?

Armed with the 20/20 vision called hindsight, analysts who did not expect the large 2001-2011 rise in the US$ gold price and who were completely baffled by it while it was happening eventually came up with explanations/rationalisations for it. Some of the most popular explanations involved identifying other things that trended relentlessly upward during the 2001-2011 period and assuming that the rise in this other ‘thing’ caused the rise in the gold price.

For one example, prior to the past two years it was possible to create a chart that demonstrated a strong positive correlation between the gold price and the US federal-debt/GDP ratio, provided that you started your chart in the early-2000s (starting the chart much earlier would reveal that there was actually no consistent relationship between gold and the debt-GDP ratio*). For a second example, prior to the past two years it was also possible to create a chart that demonstrated a strong positive correlation between the gold price and the US Monetary Base, again provided that you started your chart in the early-2000s (as is the case with the supposed relationship between the gold price and the debt/GDP ratio, the relationship between gold and the US Monetary Base disappears when a longer-term view is taken**). For a third example, some analysts belatedly linked the 2001-2011 upward trend and subsequent downward reversal in the gold price to the goings-on in the “emerging” economies. This explanation is a top contender for the “grasping at straws” award, since, unlike the linking of gold to the debt/GDP ratio or the Monetary Base, it has absolutely no logical basis. Not only that, but the net buying of gold by India, China and Russia, the three most important “emerging” markets, was greater when the gold price was trending downward during 2012-2014 than when the gold price was trending upward during 2009-2011.

As intimated in the opening paragraph, the overarching driver of the gold price (the boom/bust cycle) only becomes clear when gold’s RELATIVE performance is viewed. More specifically, understanding why gold did what it did over a long period requires looking at how it performed relative to industrial metals.

The fact is that the gold market is generally weak relative to the industrial metals markets during the boom phase of the inflation-fueled, central-bank-sponsored boom/bust cycle and strong relative to the industrial metals markets during the bust phase of the cycle. In other words, the gold/GYX ratio (gold relative to the Industrial Metals Index) tends to fall during the booms and rise during the busts. This is due to gold’s historical role as a store of purchasing power and a hedge against uncertainty.

By shading the bust periods in grey, I’ve indicated the global booms and busts on the following chart of the gold/GYX ratio. During the 20-year period covered by this chart there were four busts: the multiple crises of 1997-1998 (the Asian financial crisis, the Russian debt default and the LTCM blowup), the recession of 2001-2002 that followed the bursting of the NASDAQ bubble, the global financial crisis and “great recession” of 2007-2009, and the euro-zone sovereign debt and banking crisis of 2011-2012. On a relative basis gold was clearly very strong during the busts and generally drifted lower during the intervening periods when confidence was rising.

Note that monetary-inflation-fueled booms tend to fall apart more quickly than they build up, which is why the rising trends in the gold/GYX ratio tend to be shorter and steeper than the falling trends.

When gold/GYX made a new multi-year low last October it indicated that the global boom was going to extend into 2015, which it has certainly done. However, gold/GYX’s sharp rise from its November-2014 low to its January-2015 high could be an early warning that the boom is on its last legs.

Gold/GYX has pulled back far enough from its January peak that a solid break above that peak would now be a clear signal that the boom has ended or is about to end.

*Refer to https://tsi-blog.com/2014/09/does-the-debtgdp-ratio-drive-the-gold-price/ for additional information

**Refer to https://tsi-blog.com/2014/10/does-the-monetary-base-drive-the-gold-price/ for additional information

Here’s a chart illustrating a relationship I can’t explain. The chart shows that over the past three years, every short-term trend and almost every ripple in Japan iShares (EWJ) has been mimicked by London’s FTSE Index.

I have no idea why there has been such a strong positive correlation between the Japanese stock market’s performance in US$ terms and the UK stock market’s performance in Pound terms. Furthermore, it’s not like the relationship is a peculiarity of the past 3 years, as the following chart shows that it goes back at least 10 years.