For February’s issue of Markets at a Glance, Eric Sprott discusses BaFin’s statement that precious metals prices were manipulated worse than LIBOR. He breaks it down how obvious the manipulation has been in physical gold markets in 2013, where demand far exceeded mine supply. Now that silver and gold have broken its downtrends, what does this mean for the market?
Don't Miss This Golden Opportunity,
By Eric Sprott
Gold declined from $1,900 in September 2011 to $1,188 on December, 19, 2013. Silver declined from $48.50 to $18.50 over approximately the same time frame. Precious metal equities declined by approximately 70% over this period.1 This move down played out exactly as was scripted. However, let us review the causes of this decline. We start out with the most important words ever written by a regulator: BaFin, the German equivalent of the SEC, said that precious metals prices were manipulated worse than LIBOR.2 What are we to read into this, particularly the word “worse”? Obviously, worse than LIBOR could not mean that more money was fraudulently earned since the LIBOR markets are many orders of magnitude larger than the precious metals markets. Then it must mean that the egregiousness of the pricing dysfunction was materially larger in precious metals.
The chronology goes as follows:
- November 27, 2013, BaFin announces an inquiry into precious metals manipulation on the London Bullion Market Association (LBMA).3
- Mid-December 2013, BaFin is reported to have seized documents from Deutsche Bank (DB).4
- January 17, 2014, BaFin announces that the manipulation is “worse” than LIBOR.1 On the same day, DB also announces its withdrawal from the LBMA gold and silver price fixings.5
Let’s imagine how this played out. Our guess is that BaFin, having reviewed DB’s trading practices, reported their findings to DB’s senior management. They are horrified at the findings (cough, cough) and decide a retreat from LBMA is required. This seems logical to us.
Let’s now discuss why bank traders get involved in price manipulation. In the most simple of all analyses, they don’t do it for the bank, but they do it to fraudulently receive higher bonuses. Otherwise, why take such personal risk? If we assume that manipulation of precious metal prices was the reality, as a bonus seeking trader, when do you want the price to be the most favorable? The answer is simple: by year-end and mid-year periods, when bonuses are calculated.
Figure 1: Gold Price Bottoms at Mid-Year and Year-End
Source: Bloomberg, Sprott Asset Management LP
If we look at what happened in 2013, the two lowest gold prices were on June 27th and December 19th (Figure 1).
Perfect! And perfectly obvious…
Now let’s deal with some reality in the real physical gold market in 2013. As we discussed in 2013, the supply/demand data suggests to us that physical demand was overwhelmingly greater than mine supply (Figure 2. See Markets at a Glance January 2014, October 2013, July 2013, May 2013 and February 2013 for more information on the shortage of physical gold).
Figure 2: World Gold Supply and Demand 2013, in Tonnes6
It is obvious to us that precious metals markets were manipulated in 2013. It is also obvious that demand far exceeded annual mine supply. Now let’s analyze what should happen, going forward, with these revelations. If gold prices are back on their long-term trend, ex-manipulation, a linear progression of the gold chart from 2000 to 2014 would suggest a price of ,100 now (62% higher than the current ,300 level) and ,400 by year-end (Figure 3).
Figure 3: Gold Price is far from its Long-Term Linear Trend
Source: Bloomberg and Sprott Estimates
Figure 4 shows estimates of cash flow per share (CFPS) for different sized gold miners under gold prices at both ,300 and a ,000 per ounce. As you will note, the potential returns vary from 180% for the lumbering seniors to 420% for some of the smaller producers.
Figure 4: Upside Scenarios For Different Types of Gold Miners
Assumed Cash Flow multiple: 10. All Figures in US dollars. Estimates are for FY2014. Source: Sprott Estimates and RBC Capital Markets. lllustrative purposes only, Eric Sprott and/or Sprott Asset Management Funds beneficially (directly or indirectly) may own in excess of 1% of one or more classes of the issued and outstanding securities of the above issuer).
Are these gains likely to materialize? So far in 2014, the senior miners are up 27%1, while the junior miners are up 42%7. Not a bad year. But, we are only seven weeks into the year.
Gold and silver have broken their downtrends and have surpassed their 200 day moving averages. The golden cross (i.e. the fifty day rising through the 200 day) still awaits, but it is most likely to happen within weeks.
When was the last time that an obvious reversal of an anomalous, yet explicable market dysfunction allowed you to imagine that you could expect multi-hundred per cent returns over a short time period?
Again, don’t miss this Golden Opportunity!
1 NYSE Arca Gold Miners Index.
6 GFMS data comes from the WGC’s “Gold Demand Trends” publications for 2013 Q1, Q2, Q3 & Q4. Chinese mine supply comes from the China Gold Association for 2013. Russian mine supply comes from the Union of Gold Producers and is up to 2013 Q4. Chinese data is taken from the Hong Kong Census and Statistics Department and covers the period Jan.-Dec. 2013. Changes in Central Bank gold reserves are taken from the IMF’s International Financial Statistics, as published on the World Gold Council’s website for 2013 Q1, Q2, Q3 & Q4 and include all international organizations as well as all central banks. Net imports for Thailand, Turkey and India come from the UN Comtrade database and include gold coins, scrap, powder, jewellery and other items made of gold. The data is for 2013. ETFs data comes from GFMS as well.
7 MV Junior Gold Miners Index.