In Ted Butler's Archive


(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

This past week, Barrick Gold reported its financial results for the first quarter of 2007. Since I have written several articles on them in the past, I thought it appropriate to comment on their results.

Barrick is the largest gold miner in the world and, traditionally, the largest gold short seller, via forward sales of future production. They pioneered the practice of short selling gold borrowed from central banks (through dealers), more than a decade ago. In the early years, Barrick’s short selling strategy worked well for them, because the price of gold was stagnant or declining through 2001. But since then, gold prices have boomed and their short selling strategy has hurt them, as revealed in their newest earnings report.

For the quarter, ended March 31, Barrick incurred a net loss of $159 million, due to a $557 million charge on the closeout of gold short sales. They also announced a further $68 million loss on short closeouts after March 31. Barrick has incurred realized losses of more than $3 billion through its gold short buy backs in recent years.

For public relations purposes, Barrick has chosen to present their recent short covering as proof they’ve put the issue behind them. That might be true in public relations terms, but not in actual financial terms. They still have an open short position of 9.5 million ounces, more than a full year’s of Barrick gold mining production. This open short position has a current unrealized loss of $3.5 billion that’s in addition to the already realized $3 billion loss. For those who expect gold to move substantially higher in the years ahead, Barrick’s loss on their open short gold position will increase by roughly $1 billion for every $100 increase in the price of an ounce of gold.

About a year ago, I commented that Barrick had the largest derivatives’ loss in financial history, which also exceeded the cumulative profits for the entire existence of the company. Then along came the hedge fund Amaranth, who shattered the record with a $6 billion loss, and Barrick appeared to be in second place. Sadly, Barrick is number one again. The final tallying of their loss is yet to be determined since the short position is still open.

The purpose of this article is not solely to highlight the epic management blunder at Barrick. It will be far more instructive in terms of what it means for the gold mining industry and the price of gold. Now that the true impact of this ill-conceived financial experiment has become obvious, it behooves you to factor it into your investment thinking.

Ten years ago, I began a public campaign to expose what I termed was fraud and manipulation through gold and silver leasing and forward selling. It started with a letter to the Chairman of the Federal Reserve and Treasury Secretary of the United States, in April 1997.

To my knowledge, I was the first to publicly attack these manipulative and destructive short sales. I genuinely believed that once understood, these short sales would be immediately discontinued. I was sadly mistaken and quite naïve. The authorities dismissed my warnings and allegations and the practitioners of these short sales not only continued, but intensified the practice for another four years. Short selling reached a peak in 2001.

But not everyone dismissed my allegations and explanations. Some truly astute gold people like John Hathaway, James Sinclair, Richard Pomboy, Reg Howe and others began to expose and write about the practice of gold leasing and forward selling. An organization designed to fight the gold manipulation (the Gold Anti-Trust Action Committee (GATA) was formed in 1999. Subsequent events and gold price movements proved that metals leasing/forward selling were manipulative to the price of gold.

Originally, leasing was perceived as a way for mining companies to hedge themselves against the risk of a price decline on future production. It was also a way for central banks to earn interest on gold and silver inventories. In essence, the central banks’ loaned gold that would be returned, with interest, from the miners’ future production. It sounded good at first blush; a win-win for all parties (especially for the dealers who arranged everything). After all, hedging against risk is considered a legitimate economic activity and who could fault the central banks for earning a bit extra on what were “fallow” assets? These loans/forward sales were enthusiastically embraced, reaching 120 million ounces, or 3700 tons, of gold at their peak.

However, when you step back from the initial impression and break these transactions down into simple terms, a different, very ugly, picture emerges. The miners weren’t hedging against downside risk; they were actually making a very big bet that gold would decline in price. This is an absurd bet for a resource producer. It puts them at odds with their shareholders, who, to the very last man and woman, are shareholders because they expect the price of gold to rise. No one is going to invest in a gold mining company if they expect the price of gold to decline. So the big short sale bet by many mining companies put them on the opposite side of their shareholders’ expectations. Talk about a conflict of interest.

Much worse, the very act of short selling with borrowed central bank gold caused (or manipulated) the price of gold lower, because thousands of tons of physical gold were dumped on the market. These were not just paper short sales, but involved real metal being dumped on the market. Remember, we are talking about an amount of gold (over 120 million ounces) that’s much greater than all the gold produced in the world in a year (80 million ounces). I asked many times what would the effect of dumping more than an entire year’s worth of global production have on the price of any commodity? It would destroy the price.

The whole concept of hedging, which is defined as the transfer of risk from a producer or consumer to a speculator, was turned upside down with these leasing/forward selling transactions. This is an important concept to grasp. It lies at the very heart of the economic justification for futures trading. Futures trading does not exist in order to allow everyone to gamble; like a casino, even if it is perceived that way. The reason we have commodity futures trading and laws and regulations is to facilitate the transference of risk from commercial producers and consumers to willing speculators. This is what gives the commodity futures market its economic legitimacy.

But the way that metals leasing/forward selling was practiced violated the basic premises of commodity law. First, it was never intended that physical material would be sold short or purchased in order to hedge (like the gold and silver forward sales). It was intended to be paper contracts (with a physical delivery option). The framers of commodity regulation never anticipated that any producer would be so stupid to borrow and sell short the actual physical commodity they produced since that would flood the market with extra real supply and drive down the price of what they produced. Second, it was never intended that any producer would be reckless enough to sell more than one year’s full production, because it was impossible to look out longer than a year. Such a sale would uneconomically impact prices on the futures market. This principal is at the heart of position limits.

Precious metals leasing/forward selling brought about two unwanted results; the dumping of physical material and dumping in quantities that amounted to years of production for many mining companies. No commodity, other than gold and silver, ever had to experience this market perversion. I have a background and experience in the supply and demand fundamentals of commodities. I am most sensitive to factors greatly impacting the physical supply and demand of a commodity, especially if those factors can be factually verified and documented. Gold forward sales could be easily documented because they were initiated by publicly held mining companies and had to be reported in financial statements. That’s what first drew me to the leasing and forward selling in precious metals.

The sheer amounts of metal involved in these forward sales (and subsequent buy backs) had to impact the price of gold. First it was down, then up. After all, at the peak frenzy of the gold forward selling, in the third quarter of 2001, the amount of cumulative gold dumped on the market reached 120 million ounces (source Mitsui). That coincides with the important low in the price of gold at $260 ounce. Then, forward selling stopped and the buy backs began. Since then, almost 80 million ounces of forward sold gold have been bought back, sending the price of gold up to $700.

This is not complicated. Over 120 million ounces of central bank gold were borrowed and sold on the market, causing the gold price to collapse to its low in 2001. Then the buy backs commenced, causing prices to soar. Please put this physical amount of gold into perspective – 120 million ounces of gold is more than 5 times the total amount of gold in all the world’s gold ETFs. To me, that makes the price impact of gold lending and forward sales 5 times the impact of all the gold ETFs combined. Ten years ago, I didn’t know when the short selling of central bank gold would stop, only that it would stop. I knew when it did stop prices would rise dramatically.

Now we have the benefit of hindsight. We can look at the price performance of gold and the public documentation of forward short selling and subsequent buy backs. Look at this chart and decide for yourself. The arrow shows where we achieved the maximum amount of gold shorting in 2001. What you should conclude is that gold prices broadly declined into this date, as massive amounts of gold were dumped on the market. Then prices rose consistently and dramatically as these shorts were bought back. If that’s not manipulation, I don’t know what is.


Ten years ago I predicted that losses would be horrendous. Since 2001, the total hedging loss to those companies that sold the 120 million ounces of gold short is close to $25 billion (realized and unrealized). This is much more than these companies made on gold mining operations over the past 5 years. The real owners of these companies, the shareholders, were deprived of $25 billion that would have flowed to the bottom line if these companies never hedged. How much more the shareholders wealth would have increased by virtue of share price appreciation absent the drag of this $25 billion short sale loss is incalculable.

The ultimate irony (more like a kick in the teeth) is that shareholders were universal in their unease and distaste with this metal short selling scheme from the start. Many managements pretended to know better than the real owners and persisted in the folly. I think it’s safe to say that this ill-conceived and cockeyed short selling scheme was the biggest management financial blunder in the history of the mining, or any, industry. What is truly remarkable is how it has evolved gradually, much like a slow-motion train wreck.

Most remarkable of all, is that I have yet to hear one public utterance by any of those involved in this ongoing debacle as to what a dumb and true disaster this whole scheme was. No one in mining, central banking, investment banking or establishment research circles has ever publicly acknowledged what a screw up this whole thing has been. I’m sure it is acknowledged plenty in private, but never in public. And it probably never will be acknowledged publicly by those involved. If it weren’t for independent analysts, it wouldn’t be discussed at all, in my opinion. (Editors note – only Mr. Butler’s analysis we might add.)

So, what’s the message to investors in general? The financial world can be a dangerous place for your money. Sometimes, seemingly popular trends emerge that are not what they are really cracked up to be. While you can never completely guarantee yourself against loss, thinking things through carefully and relying on your common sense is usually the best approach. Someone who took the time to study the precious metals leasing/forward selling scheme in the past would have reached only two possible conclusions. One, gold and silver were artificially depressed by this short selling and therefore the metal was a great buy. Two, if you were going to buy mining shares, avoid the short-selling miners.

Ten years ago I began to question the merit and legitimacy of metals leasing/forward selling. In retrospect, it is hard to believe just how accurate this turned out to be, especially considering that the mainstream metal establishment dismissed my concerns. The same thing is happening today with the concentrated short position on COMEX silver.

Yes, there is a clear parallel between the issues of metals leasing/forward selling and the unique concentrated net short position presently in COMEX silver. In fact, it’s kind of like déjà vu. We’re talking about a common theme – short selling in such great quantities so as to be manipulative. I approached it the same way. I tried to take the high road in both cases. I first wrote to every regulatory official I could think of in both my leasing/forward selling and concentrated silver short position campaigns. I tried to give them a head’s up and a chance to address the problems. In both cases, they refused to lift a finger. But it didn’t matter in the long run that the regulators stood by, doing nothing. The same thing will happen with the concentrated short position in COMEX silver, namely, the market will prevail.

Importantly, both forward selling and the concentrated short silver position depressed the price of both metals. This is precisely what has created the great opportunity for investors. It’s not just some esoteric discussion about whether a market is manipulated. It’s the lifetime opportunity. Gold was close to $250 and silver near $4 a while back, thanks to a manipulation. Those that recognized that prices were artificially depressed and took action did much better than those who assumed the market was free and fair.

There are also a number of differences between leasing and the silver concentrated short position. For one thing, leasing didn’t fall neatly under any one regulator’s jurisdiction. That why I wrote to everyone – the SEC, the CFTC, the companies involved, as well as their auditors. I even remember writing the Federal Trade Commission. I was convinced leasing/forward selling was thinly disguised dumping. This was a new phenomenon and there was no existing body of law to deal with it.

With the concentrated silver short position on the COMEX, there exists concrete CFTC law. There’s no jurisdictional question, nor any disagreement that concentration is mandatory for manipulation. That’s why the CFTC tracks concentration data. Unfortunately, tracking is all they do when they should be moving to terminate the concentrated short position.

The main difference between leasing/forward selling and the concentrated silver short position is that forward selling is being unwound. Already, two-thirds of the leasing/forward gold short selling position has been bought back, with a clear and obvious impact on price. The concentrated short position in COMEX silver is still near its historic peak. In fact, it’s much bigger than it was when I complained to the CFTC a year ago. There is a chance that this concentrated short position can be reduced somewhat on one final sell-off in silver, but the bulk must someday be covered to the upside. This is one big reason why I favor silver over gold for the long term – there’s been significant resolution in the gold forward selling manipulation, while there has been no resolution in the silver concentrated short position.

Everyone must look at the facts and decide what’s best for them and for their families’ financial security. Unless you think it was just blind luck that my campaign, ten years ago, about leasing/forward selling turned out the way it did, I would suggest that you get positioned to take advantage of what lies ahead for silver as the huge short position in silver is bought back and covered. I believe it will have a much greater impact on the price of silver than anyone now imagines.

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