Selling Low and Buying High

Today is Presidents’ Day, which means the markets are taking a rare break. Hopefully, you’ve been able to enjoy the long weekend, too.

Today I’d like to share an old trading tale I think you’ll enjoy. It’s a true story. (Seems like the best ones always are.) I first wrote it up in April of 2007, along with some extended thoughts on gold. The story is still fresh and the gold thoughts still apply. So without further ado, here it is.

Ed. Note: this piece was originally written in April of 2007. At that time gold was $200 to $300 lower, the dollar was 5-10% higher, and Gordon Brown was not yet prime minister. Also, subprime woes had not yet materialized like a skunk at the garden party. Other than that, all arguments still apply -- perhaps now more than ever.

Memorable birthday presents are always nice. One of the best presents your humble editor ever received came from European central bankers.

In late summer 1999, nearly eight years ago now, yours truly and a friend put some money in a special joint trading account. The plan was to speculate a little in the precious metals and perhaps turn a profit from the Y2K complications ahead.

Gold was about as down in the dumps as it had ever been. Stocks like CMGI and Qualcomm were all the rage. It was almost the total reverse of what we have now. “Dot com” was a heroic and inspirational suffix, rather than the punch line to a joke. Hard assets were seen as the musty leftovers of an antiquated age.

With gold in the $260-$280 range, and volatility having ticked down to nothing, my trading partner and I felt that things were seriously out of whack.

Confident that something would have to give, the joint trading account was loaded up with call options on gold futures. We bought super-cheap call options at a strike price of $330 -- more than $50 out of the money in a low volatility market -- with an expiration date nine to 12 months out.

We were prepared to wait. But as it turns out, we didn’t have to wait too long.

In September of 1999 -- within days of the aforementioned birthday -- more than a dozen European central banks announced a moratorium on future gold sales. The signatories agreed to limit their gold sales to a maximum 400 tons per year over the next five years.
The news hit the gold pit like scalding hot water on a sleeping cat. The yellow metal exploded, posting the biggest single-day rally in 20 years. The joint futures trading account went from $10,000 to $60,000 (give or take) in the space of a week.

No, you don’t see birthday presents like that one very often. Fifty grand rarely comes so easy.

But that’s not the most curious part of the story. The intriguing question is how gold had gotten so low in the first place.

Earlier that same year (1999), gold had been languishing a bit below $300. The yellow metal had been stuck in a sideways funk for more than a year, after steadily trekking downward from its 1996 peak. It seemed things were gloomy as could be for gold bugs… but they were about to get much worse.

In May of 1999, the British government announced plans to sell half of its existing gold reserves. Proceeds from the sale were to be invested in government bonds (issued by the U.S., Europe and Japan).

It was an awfully timed surprise for gold. What’s worse, the auction-style plan for selling the reserves seemed the height of idiocy.

When you have a large quantity of anything to sell on the open market, you normally do it as quietly as possible so as not to run the price down if you are selling (or up if you are buying). It was almost as if the British government wanted to hammer gold through the floor, rather than seeking the best price possible for Her Majesty’s assets.

Gold futures gapped down huge on news of Britain’s plan. All hope seemed lost. Central bankers had apparently gone insane, and they were going to sell all the gold they owned for nothing.

The yellow metal relentlessly down-ticked from that point on, to its ultimate bottom in the fall of 1999. Shortly after that the timely (and lucky) purchase of $330 call options ensued, and Europe’s non-British bankers did the rest.

More ancient history. But now the question becomes more pointed. Why, oh why did Britain do something so foolish?

We now have an answer of sorts: Because Gordon Brown is an idiot.

Gordon Brown is Britain’s all-but-anointed prime minister in waiting, for those who don’t follow British politics (and who can blame you). Back in ‘99, Brown was displaying a taste for boneheadedness in his job running the UK treasury. It is only now that the full scope of things comes to light.

In a long-overdue expose titled “Goldfinger Brown’s £2 billion blunder in the bullion market,” the Sunday Times tells the tale:

GATHERED around a table in one of the Bank of England’s grand meeting rooms, the select group of Britain’s top gold traders could not believe what they were being told.

Gordon Brown had decided to sell off more than half of the country’s centuries-old gold reserves and the chancellor was intending to announce his plan later that day.

It was May 1999 and the gold price had stagnated for much of the decade. The traders present — including senior executives from at least two big investment banks — warned that Brown, who was not at the meeting, could barely have chosen a worse moment.

…“The timing of the decision was ludicrous.

We told them you are going to push the gold price down before you sell,” said Peter Fava, then head of precious metal dealing at HSBC who was present at the meeting. “We thought it was a disastrous decision; we couldn’t understand it. We brought up a lot of potential problems at the meeting.”

…The decision to sell 400 tons of gold is seen in City circles as a financial bungle on the scale of the Tories’ “Black Wednesday” that cost the taxpayer £3.3 billion, according to Treasury estimates.

Dominic Hall, a former gold dealer who now runs thebulliondesk.com, a website for the gold market, said: “Brown was keen to throw mud at the opposition over Black Wednesday but this was a financial disaster on a similar scale.”

Fascinating. Based on these and other details, it appears that the decision to dump half of Britain’s reserves -- ultimately at the cost of billions -- was made by a single uninformed dolt and his group of doltish cronies. The Sunday Times adds more to the story:

According to other sources… Bank of England officials told those present they had “little say” about what was going to happen and that they were “doing what they were told.” This was a decision made by Brown and his inner circle, who appeared uninterested in their expert advice.

It’s the classic libertarian’s lament: What can you do with government? You’re damned if you do, damned if you don’t.

It is highly unsettling to realize that momentous decisions are taken by pigheaded men -- and it is still mostly men -- with far more arrogance than sense. Sadly, the thought of government by committee is no less appalling. Many a terrible plan has arisen from gutless, mealy-mouthed consensus.

Unfortunately, as long as there are men like Gordon Brown in government -- and the world is rife with them, for they are the type attracted to public service in the first place -- governments will continue to do exceedingly dumb things.

It is a natural temptation to respect the trappings of power -- or, at the very least, to respect the logistical decision-making mechanisms of power. This may be a mistake. Many first-world countries, it seems, are run with less regard for logic and common sense than your average corner grocery.

Here is the moneymaking part of the equation, at least as far as gold goes.
By deciding to dump gold at the worst possible time, Gordon “Goldfinger” Brown has shown us how spectacularly stupid governments can be at selling low. When push comes to shove, we may find that governments are equally spectacular at buying high.

Consider the lay of the land in terms of dollars and gold reserves. The asset boom we are experiencing right now [circa April 2007], the rising tide of liquidity that has fueled a buyout mania and lifted so many boats, is being fueled by dollars. Dollars, dollars, dollars.