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Peter Crabb: Gold is overpriced, so be wary of those ads to buy it

The long and short of it is never mind. It’s just not that simple.

Participants in the financial markets use the terms “long’ and “short” to describe the position investors or traders have taken in a stock, bond, or commodity investment. “Long” means the trader owns the asset and hopes the price will rise. Short means the trader has sold the financial asset or futures contract and hopes the price will fall so he or she may buy it back at some later point and profit from the drop in price.

To be “short” in stocks or bonds traders often borrow the asset, paying interest to the lender until the asset is returned. The trader sells this borrowed asset in the market today, then buys it back some time in the future, hoping to make a profit, but losing on the investment if prices rise.

Futures markets, like the Chicago Board of Trade (CBOT) or Commodity Exchange (COMEX), allow traders to short stocks, bonds, or commodities without borrowing. When you sell a futures contract (an agreement to make delivery of the underlying asset at some point in the future), you do not have to actually have the underlying asset. You are simply agreeing today on what price you will sell at when you will make the sale in the future. If prices are lower on this future date the contract will be valuable.

Futures markets therefore make it easy for investors and traders to take what some would call a negative position in the market.

These days there is a lot of buzz in investment newsletters and across the Internet that someone is manipulating the price of gold and silver with a concentrated short position. This so called “short-seller” is pushing prices down below what many believe is the true value of the metals.

Newsletters like the James Cook Market Update and others contain stories about large short positions on the COMEX, a New York-based futures exchange specializing in metals now owned and operated by CME Group. The story goes that JP Morgan Chase or some other large investment bank is manipulating the price of silver low with a large number of sell, or short positions, in the silver futures contract.

It may be true that a bank has future contracts obligating it to sell many ounces of silver. But as is often the case, that is not the end of the story.

The largest group selling futures contracts for delivery of silver are silver mining companies. Idaho-based Hecla Mining Co. and Coeur D’Alene Mines Corp., for example, use derivative contracts, like futures, to hedge the risk of falling prices.

An even more common way for mining firms to hedge their risk is in a forward contract. Forwards work just like futures but do not trade on exchanges such as the COMEX. A forward is a customized agreement to sell a stock, bond, or commodity in the future.

The other party to a forward transaction is often a bank. The bank acts in this market in the same manner it does in the stock market, as a broker. So banks may have heavy short positions in futures contracts, but also large long, or buy, positions in forward contracts. On net, the banks may not be long or short — they are just acting as a dealer.

The newsletters and other writers pushing this story are probably using scare tactics to pump up sales of gold or silver. These stories are coming out at the same time television advertisements from gold and silver sellers are proliferating.

The stories and ads appear to be working well, pushing gold above its true value as an inflation hedge.

The price of gold reached a record high this week and is up 20 percent in the last year. Silver prices have nearly doubled.

This doesn’t mean inflation is imminent. Precious metal prices may be higher, but the many other indicators of inflation are unchanged or predicting deflation. The yield spread (the difference between 2-year and 10-year Treasury notes) remains at just over 2 percent, where it has been for most of the year. Broad commodity indexes like the Dow Jones – UBS index are also unchanged for the year. Rather than falling when inflation picks up, the dollar has risen by more than 5 percent against other major currencies over the past year.

They are telling you, “Short sellers are manipulating the market and inflation is just around the corner. So buy gold and silver.”

The long and short of it is – “it’s not that simple.”

Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.