I seldom comment on anything having to do with precious metals
because, well, the subject tends to bring out, how to say it?,
er, enthusiasts. Monomaniacal enthusiasts. But I feel somewhat
compelled to do so, because Adrian Douglas, a board member of the
Gold Anti-Trust Action Committee ((
structured his comments to the CFTC about metals
position limits around one of my older writings on
(Douglas's comments are all over the web-that's just one link.) (
delivered some impromptu testimony at the CFTC hearings on the
Douglas starts out all nice and stuff:
I recently read some of the work of Craig Pirrong, a
recognized expert on commodity markets and market
But then says:
Despite Pirrong's alleged [thanks!] expertise in commodity
markets, he considers that manipulation is mainly instigated by
the "long" market participants in what is colloquially called a
"corner." He writes:
Other speculative activities sometimes called manipulative
are far more ephemeral than corners, and are of dubious
practical relevance. For example, farm interests and farm state
legislators frequently assert that large short sales of futures
contracts by speculators are manipulative, and cause prices to
fall below their 'true' value.
Such 'bear raids' are profitable for the raiders only under
very restrictive conditions. In order to realize a profit, it
is necessary to sell high and buy low - that is, the short
seller must eventually buy back his positions at a price which
is lower than the price at which he initially sold. Since the
number of contracts sold is equal to the number of contracts
subsequently bought, this can happen if, and only if, the
futures price responds asymmetrically to the speculator's
purchases and sales. That is, the price decline caused by the
speculator's sales must exceed the price rise caused by his
There is no credible evidence that such an asymmetry exists
or has existed in futures markets. Moreover, it is even
difficult to construct a theoretical model that exhibits this
property. As a result, it is highly unlikely that short
manipulations of the type that is criticized so vigorously by
the opponents of futures markets are a practical concern.
Indeed, futures industry experts have been nonplussed by the
allegations of widespread 'downward' manipulation as far back
as 1921, when there was no regulation; most recognized the real
danger of squeezes and corners, but were deeply skeptical of
the possibility of short manipulations.
Nonetheless, the primary impetus behind the regulation of
futures markets in the early 1920s was the collapse in
agricultural prices after the end of World War I. Despite the
skepticism of the industry witnesses, the promoters of the
legislation regulating futures markets, such as Senator Capper
and Representative Tincher, both of Kansas, were convinced that
short-selling speculators were largely responsible for this
collapse. As a result, Congress was intent upon preventing
manipulative short selling. However, since it could not
distinguish legitimate short selling for hedging purposes, for
instance, from illegitimate short selling, Congress simply
proscribed 'manipulation' and passed the buck to exchanges by
requiring them to prevent what Congress could not define - or
face the closure of their markets."
I find it astonishing that an alleged expert could make such
a claim. In the futures market there has to always be a buyer
and a seller for every contract; that is, a "long" for every
"short." This means that there are as many longs as shorts.
Whatever model can be proposed for long-side manipulation must,
by symmetry, be possible for the short side. If one can drive
prices up by buying a large amount of contracts, one can also
drive the market down by selling a lot of contracts.
The prejudice that manipulation cannot be effectively
carried out on the short side is a fundamental barrier to any
intelligent and productive discussion of manipulation of the
precious metals markets.
What the right hand giveth, the left hand taketh away.
Although Douglas then goes on to use other things I wrote in that
article to support his arguments for a crackdown on manipulation
in the gold market, which suggests that I'm not all bad. (Some
friendly advice, Adrian: Citing me is probably not the best way
to persuade Gary Gensler and Bart Chilton. Just sayin'.)
Mr. Douglas needs to read a little further, and a little more
carefully. I was addressing one type of short manipulation that
was commonly alleged in the 1870s-1930s; the "bear raid," in
which a manipulator drives down prices by selling large
quantities of futures and then profits by . . .
Well, that's the problem. It's hard to see how this could be
profitable, because the manipulator has to buy back the
contracts. If selling contracts drives down the price, why
wouldn't buying them back at the end of the manipulation drive up
prices? And given the frictions (bid-ask spread, etc.) wouldn't
transactions costs make this unprofitable? That's why I said that
there has to be some (unexplained) source of asymmetry in price
impact to make such a strategy profitable.
I would agree that if such a strategy is profitable for a
short, then the mirror image strategy would be profitable too.
The problem is, I don't see either strategy being profitable, as
I don't see reliable evidence of the necessary asymmetry.
Manipulation can work by driving down prices in one market can
enhance the profitability of other contracts with prices tied to
that price. (Again, the same thing can work in reverse.) But
that's different than what I describe in what Douglas quotes.
Moreover, both large longs and shorts can sometimes manipulate
by exercizing market power in the "delivery end game." A long
manipulation of that type-a corner-is what I focus on in the
article Douglas quotes, and what is undoubtedly the most
empirically important kind of manipulation.
And contrary to what Douglas claims, I did show in my 1993 hat
J. of Business piece (and in a related chapter in my
manipulation book) there IS asymmetry in market power
manipulation. The conditions that make long market power
manipulation profitable (inelastic supply and elastic demand of
the deliverable commodity) tend to make short manipulation
unprofitable. Therefore, one kind of manipulation should
predominate in a particular market. Short market power
manipulation is usually found in perishable commodities, such as
potatoes and onions. Perishability makes the demand for these
commodities very inelastic in the short run, which makes driving
down the price relatively easy. (Historical aside: frequent short
manipulations led to a federal ban of trading futures on onions,
the only commodity so honored. There's the answer to your
Now, about gold
Since gold (and, to a lesser degree silver) are held as stores
of value (investments), their demand should be relatively
elastic, making short market power manipulation very difficult
Ironically, in the testimony before the CFTC, the main scare
story the gold bugs told related to long manipulation. Noting
that the open interest in gold derivatives exceeds the physical
gold available for delivery, they said that there would be
extreme price disruptions if there was demand for delivery on a
large number of contracts. But this would be a long market power
manipulation that drives prices UP, not a short manipulation that
drives prices down, and which GATA claims has happened for
And that's another problem. GATA alleges that central banks,
in cahoots with bullion dealers, have manipulated gold prices
down for years. But most manipulations are very short term
affairs that have relatively short-lived effects on prices.
The GATA story of how manipulation works also doesn't make
much sense. GATA was most exercised in the 1990s and early-2000s,
when gold producer hedging was quite common. Producers would
short gold forward to bullion dealers. The dealers would cover
this long position by borrowing gold from central banks, and then
selling it. GATA interpreted the gold sales as an additional flow
of gold onto the market that depressed prices.
This is mistaken on many levels. The stock of gold remained
unchanged by these transactions, and the price of gold is
determined by the size of the stock, and the demand for the
stock.* Moreover, just mechanically, a gold loan is a
simultaneous sale and future repurchase, not an outright sale;
the sale and subsequent purchase are essentially a wash.
If anything, the gold loan mechanism, and the resulting
possibility that a single firm can accumulate a long position
that exceeds readily deliverable supplies, can make long market
power manipulations possible. There is some evidence in gold
lease rate data that such long manipulations have occurred in
recent years. (This is analogous to the repo squeezes that occur
in the Treasury market, and which were rife in the mid-2000s.)
But these have the opposite effect on prices than GATA alleges,
and these effects tend to be temporary.
If gold hedging affects prices, it does so indirectly, and in
a non-manipulative way. By permitting producers to manage risks
more effectively, hedging presumably allows them to increase
output (e.g., it permits them to obtain financing on better terms
to expand mines.) This would tend to reduce prices, by increasing
the rate of growth in gold stocks. But this is not manipulative.
It represents a socially beneficial reduction in the costs
associated with financial frictions. This cost reduction is
welfare enhancing, whereas true manipulation is welfare
So, the GATA story doesn't wash with me. It is just a repeat
of the same allegations that have been directed at commodity
derivatives markets for years, and suffers from the same
fundamental misunderstandings of the ways these markets work. The
GATA allegations are made more lurid by the involvement of
central banks, and the secrecy with which these institutions
operate. But at the end of the day, there's nothing to see here
folks, so just move along. Not that the gold bugs ever will. But
I hope that having written this, I can.
* GATA and other gold bugs have chronic difficulties
distinguishing between stocks and flows. They point to the fact
that the volume of trades in gold exceeds actual gold stocks. The
aptly-named (since it is high variance) ZeroHedge breathlessly
repeats such things, claiming that this is evidence of a Ponzi
scheme. Did these guys just fall of the turnip truck?: this is
true for virtually every major commodity market. For a variety of
reasons, the number of transactions, and frequently the open
interest, is a multiple of the underlying deliverable supply.
Douglas states that this has developed slowly over many
The futures markets were conceived to allow commodity
producers to reduce risk by being able to contract to sell
their yet-to-be-produced commodity at some time in the future.
By the same token, it allowed commodity users to reduce risk by
being able to contract to buy a yet-to-be-produced commodity in
the future. The futures markets also served to perform the
function of price discovery by matching future demand with
future supply at a market-clearing price.
However, gradualism has resulted in the futures markets
morphing into giant casinos where less than 5 percent of
contracts get settled with a physical commodity delivery. The
futures markets are now totally divorced from their intended
function. The futures markets have become such a farce that the
delivery of physical commodities has become an inconvenience
that hinders speculation and market manipulation.
Uhm, not exactly. The facts that the volume of trades, and
open interest, exceed deliverable supply, and that very few
contracts are settled by delivery, have characterized commodity
markets since the birth of futures markets in the late-1860s.
They have been the subject of comment and frequent criticism
since that time. This is not, contrary to what Douglas says, a
'Bubblemania': Market Valuation in Historical