What might happen to gold if the apparent 'short' position of US banks is curtailed...?

FOR A DECADE AND MORE, J.P.Morgan Chase, Citigroup, Bank of America and Goldman Sachs have been accused by groups like GATA and others of holding wide and huge short positions against gold and silver, writes Julian Phillips of the GoldForecaster.com.

In the United States these four banks control over 90% of the derivatives market. They too will be subject to "substantial supervision and regulations", including conservative capital requirements and strong business conduct standards. The US Treasury secretary, Timothy Geithner, is set to propose giving securities and futures regulators authority to police the over-the-counter derivatives market. Discussions on these regulations begin in August.

Oil market regulation is the first target so as to keep oil prices free from speculatively higher prices. Other markets, including gold and silver, are being targeted for regulation at the same time. The Treasury secretary is moving to address these accusations and ensure that the markets involved are managed in an orderly, regulated manner.

On the surface it appears that these regulations will simply affect the markets from the day of the enforcement of the regulations and thereafter. But is it more likely that actions to clean up these markets will start much earlier if there has been market manipulation?
 
Mr. Geithner stated, "Our plan will help prevent market manipulation, fraud and other abuses by providing full information to regulators about activity in the OTC derivative markets." The Securities and Exchange Commission, which oversees securities, and the Commodity Futures Trading Commission, which supervises futures markets, would have authority to impose recordkeeping and reporting requirements on the derivatives. This plan is geared toward removing counterparty risks by requiring greater use of central counterparties and imposing stricter capital standards on participants. If Mr. Geithner's staff succeeds in bringing true transparency to these markets, either the charges of manipulation will be dropped or the manipulation will be halted!

The sheer size of the derivatives market is enormous, but this is not too much of a concern in itself, provided the great majority of positions match each other or stock is held against the 'open' positions. In other words, for example, where someone sells a futures contract, there will be someone who buys it. This would 'match' the position and remove risk from the overall exchange position.

However, where there were sales of the commodity that were not 'matched' – and where there is none of the product to deliver into the contract – one would be left with an exposed position with no real counterparty. This is called going 'short'. Going 'long' is the other way, but also involves a seller. The buyer must buy from some counterparty that should be able to supply the item on the date of maturity of the contract. If he can't, then the position of the overall exchange is 'short' and can't deliver stock to the buyer. Once it has stock, the seller must go into the market to buy the item so he can deliver to the buyer thereby 'close' the position.

The exchange on which the transaction is dealt is responsible for ensuring that all contracted items can be delivered on the date of maturity of the contract. The exchange itself should hold the physical amount of the item in its own warehouse that needs to be delivered to the buyers whose position is not 'matched'. This ensures an orderly market.

The accusations that have attended the four banks are that they cannot deliver the physical item because they are heavily 'short' to the extent that prices are heavily manipulated. The closing and subsequent opening again, of these positions, on due date, enables the 'short' position to be perpetuated for as long as the bank wants to, despite the potential losses or gains sitting in the contract over time. Provided the new regulations are efficient such exposed positions will be highlighted, bringing the wrath of the government and the public on these institutions once more.

Imagine yourself holding huge short positions that are carrying massive losses, what would you do? The charges made by bodies like GATA are made by intelligent, convinced men who tell us they have indisputable proof of long-term manipulation of the gold and silver markets.

If they are correct, what will happen? As it is, the Commodity Futures Trading Commission will continue holding public hearings in August to consider position limits in oil and gas markets. But that is not all. A member of that Commission, Mr. Chilton, has said he daily hears concerns about large positions being held in metals, particularly in silver and gold. Since last September, the CFTC's enforcement division has joined other federal and international regulators in an investigation into potential manipulation and concentration of positions in the silver market.

Chilton said he is unsure whether his fellow commissioners would support position limits on metals, but is hopeful the idea will gain momentum during the hearings on oil and gas.

The next few months will see, we hope, GATA's work bear fruit in the correcting of market manipulation. We would hope that new regulations do just what Mr. Geithner promised they would do, to resolve current manipulation and to prevent future market manipulation. And what will happen to the gold market if the banks' apparent short position is curtailed?