Cornering Gold: True or False?

Karl Denninger submits:

Janet Tavakoli has written an interesting piece over at Huffington Post related to the gold market and a potential cornering attempt:

First, let your greed overcome all regard for the stability of the global market, and overcome your aversion to illegal activities.

Pump up the gold story. Get your friends to tell retail investors to buy some gold every month. Get your buddies in the financial business to offer exchange traded gold funds (ETFs) that claim to buy physical gold. This will sound safe to retail investors, but in fact, the ETFs are very risky. This will serve your purpose when you are ready to start a panic. These particular ETFs will allow the “gold” to be commingled with the custodian’s gold, and the custodian can lease out the gold. Moreover, the “gold” custodian can give it to a sub custodian that the manager doesn’t know. The sub custodian can give it to yet another sub custodian unknown to the original custodian. The manager will never audit the gold, and the gold is not “allocated” to a particular investor. Since this is an “exchange traded” gold fund, investors will probably assume the gold is regulated by the Commodities Futures Trading Commission (CFTC), but it isn’t. By the time investors wake up to the probability that there is very little actual gold backing their investment, your plan will be ready to execute.

That could be a problem, right?

Zero Hedge has run a piece on alleged manipulation of the market (specifically, selling short an insane number of contracts – which would obligate you to deliver – when you have no possible way to do so.) This, however, isn’t necessarily manipulation per se, nor is the assertion that these are “financial” (that is, we trade ‘em for money, not to actually buy or sell physical gold) assets false. They in fact are; if I sell short a S&P 500 Futures Contract I can assure you that I do not deliver a basket of 500 stocks to the buyer if I’m right (or wrong!)

However, the elements of a scam – which could be the intended outcome – are indeed present. The person buying or selling a futures contract can have either the intent of actually taking (or making) physical delivery or they can be a pure speculator on price, intending to execute the opposite trade prior to expiration (and thus pocketing either a profit or a loss thereupon.) So long as the person executing a futures trade is required to post margin on all underwater positions nightly (and provided the market is honest, they are) the “pressure” on them as the market moves the wrong way tends to force correction toward the mean – and is counter-cyclical against imbalances.

But the buyer of an ETF is likely in a different circumstance. Unlike the sophisticated speculator (like me) who buys and sells futures contracts on things like the S&P 500, currencies, gold and even oil without the intent to take delivery of a thousand barrels of crude in my driveway (that would be kinda messy, especially if the barrels were not included – and they’re not!) many if not most ETF purchasers are under the belief that they are buyingactual physical gold or silver that someone is holding for them in a vault somewhere.

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