on the shorting of gold shares

  1. 374 Posts.
    Farfel ( 1/30/03; 04:16:41MT - usagold.com msg#: 96245 )
    The Jim Sinclair Thesis Re-examined ( A Corollary )
    I remain skeptical of Jim Sinclair's thesis that Wall Street hedge funds in toto are long gold, short gold stocks. As I stated in a previous essay, OTC activity lends credence to the idea that foreign specs via US-based proxies are acting as a major trigger to higher bullion prices, NOT domestic specs. From all appearances, large foreign specs are challenging the commercials and succeeding to date in raising gold prices. Moreover, given the physical short position in gold accumulated by major Wall Street houses over the past decade via the gold carry trade, it is not in their best interests to be long anything with the word "gold" ( or "silver" ) attached to it.

    However, for the sake of argument, let us grant Mr. Sinclair the benefit of the doubt. In the end analysis, it does not really matter because such a hedge strategy as he describes is categorically doomed to failure in the intermediate term.

    The central problem revolves around the ongoing revaluation of gold mining companies' reserves. As the gold price marches higher, unhedged gold reserves increase in value. All the shorting in the world cannot preclude that fact.

    At a certain point in time, the suppression of gold stock values via short selling will lead to a substantive difference between market value and real value. In other words, irrational, excessive short selling of gold stocks depresses gold stock values even as the actual gold price marches upward. Excessive irrational short selling of gold stocks creates an unsustainable disequilibrium in gold stock values.

    The resultant revaluation of unhedged gold reserves in real terms will lead inevitably to the following probabilities:

    1 ) A hostile takeover attempt by one gold producer aimed against the other, since the acquisitor will recognize the market's undervaluation of real reserves in the target company.

    2 ) A hostile takeover attempt by a spec financial consortium aimed against the undervalued, unhedged gold producer, since the acquistor will recognize the market's undervaluation of real reserves in the target company.

    3 ) A potential leveraged buyout by gold management interests ( or their proxies ) since nobody is in a better position to recognize the market's undervaluation of unhedged reserves than management itself.

    Bottom line: a hedge strategy only makes sense when you counterbalance an entity rising in price against one falling in price. Yet as the gold price rises, in a normal and logical world, unhedged gold producers MUST rise in value too. Anybody attempting to disrupt this equation throws a whole market into disequlibrium.

    In an ultimately efficient market, the disequilibrium will be recognized by speculators and they will act in order to maximize their gains and take advantage of the discrepancy between low market value and the higher real value of unhedged reserves.

    The patent illogic of trying to go long gold bullion while shorting gold stocks sows the seeds of its own destruction in the intermediate term.

    That is essentially why I place little credibility in Mr. Sinclair's analysis. Rather, from my perspective, the excessive shorting of gold stocks is more an imitation of a "scorched Earth policy" adopted by the gold short funds. Recognizing that another year of triple digit percentage returns in the gold mining sector will trigger a tremendous liquidation in bubble financial sectors ( stocks, bonds, real estate ) in order to target monies into the far more rewarding gold stocks, the major Wall Street players are throwing every available dollar and credit at their disposal in order to cap artificially the gold mining stocks ( very much analogous to the strategy adopted in the gold carry trade whereby the commercials continued to utilize the gold carry trade to short gold long after the real rate of return had turned negative. However, they continued to maintain the gold carry trade since the accumulated physical short position over the years had become so large ( and essentially uncoverable ) so as to leave them no other choice but to maintain the gold carry trade as a vehicle of mere gold price suppression rather than a means of achieving profits ) . The only area in which Sinclair and I are in agreement pertains to his belief that a good deal of the excessive shorting is occuring on a NAKED basis.

    The huge acceleration of gold/gold stock shorting over the past month is nothing less than "Custer's Last Stand," as Wall Street digs in its heels and tries to stop gold/gold stocks in their path before they threaten to suck liquidity from bubble markets ( stocks, bonds, real estate ) in much the same way that internet stocks captured liquidity from every capital corner in America during the late Nineties.

    However, if history is any judge, gold and gold stocks will win.....and in a manner that will astonish even the most optimistic goldbugs.

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