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The Anatomy of Brown’s Gold Bottom – Keith Weiner

by Keith Weiner, Sprott Money:

As most in the gold community know, the UK Chancellor of the Exchequer Gordon Brown announced on 7 May, 1999 that HM Treasury planned to sell gold. The dollar began to rise, from about 110mg gold to 120mg on 6 July, the day of the first sale. This translates into dollarish as: gold went down, from $282 to $258. It makes sense, as the UK was selling a lot of gold… or does it?

We won’t get into the theories of his motivation. However, we note that if he wanted to—pardon the dollarish— push down gold, he was not particular effective. He squandered half of Britain’s gold to get the price to drop 8.5%. That lasted but a few months. By the end of September, the price was not only back up to $282 but rising rapidly on its way past $320. Then it came down with volatility, rose, slowly fell to just under $260 about two years later. The price bottom just about coincides with the end of his selling.

This is history, and it’s been discussed and analyzed many times. What has not been seen until now is a look at the gold basis and cobasis during this time. Was gold becoming abundant due to selling? Or did something else happen?

Here is a graph showing the continuous gold basis and cobasis, overlaid with the price of the dollar.

Several features are noteworthy:

1. The basis begins to fall on the announcement, but not a lot yet. The cobasis may be arguably said to begin to rise. Both appear to change character.

2. The dollar begins rising immediately (i.e. the price of gold falls), but nothing alarming happens in the basis yet. Almost the entire initial price move occurs, with little move in the basis.

We believe this confirms our view that there is a lot of gold out there. This was as clear a case of short selling as can be. Brown wasn’t even selling yet, and the market price was driven down 8.5%. Actually, the market price began falling before the announcement, which suggests that privileged information may have leaked. Yet the market makers handled this with aplomb. The basis moved, but not that much.

3. Once he began the actual selling, the price did not move much further. Notably, the basis and cobasis begin much larger moves. Gold became significantly scarcer.

4. Three months later, we see a wicked backwardation. That is no small number, like the many little temporary backwardations of today. That was a cobasis of +1.95%. And not a near-month contract cobasis, but the continuous cobasis. This is big, albeit only one day.

Wait… Brown is selling large quantities of gold and yet gold is become less abundant and scarcer, peaking at significant scarcity indeed? Selling physical metal should—all else being equal—cause it to become more abundant. But it didn’t.

It’s appropriate to quote Sir Arthur Conan Doyle here (doubly so, as Keith is in London at the moment). “When you have eliminated the impossible, whatever remains, however improbable, must be the truth.”

Those fool speculators thought they could short gold with impunity. After all, the price dropped. A major country was selling in quantity. We assume the charts painted a bearish picture. Even some gold bugs may have thought that with major governments against them, the price could be driven down even further. This was the end of a long period of a falling gold price. Sentiment must have been in the pits.

5. Gold could become scarcer for a while, and to a point.

6. But when the shorts push it past the breaking point, the price of gold snaps violently to the upside.

If you were watching the basis, you would have seen this move coming. Here is a graph of our fundamental price, zoomed in to show just a small window around the price explosion.

Read More @ SprottMoney.com

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