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Market Manipulation and its Effects

"Now that leasing scams and hedging have run their course, a new scam has to pick up the ball -- EXCHANGE RATE MANIPULATION. Your charts are very interesting, but the fact remains that the silent forces of the world evil TRULY control all market rallies and plunges. GET IT THROUGH YOUR HEAD!!! YOUR CHARTS ARE MEANINGLESS. Go predict rain in the rain forest!" -- E-mail from a disgruntled manipulation junkie

Every now and then it becomes vogue to talk of market manipulation and how the insiders have "rigged" the market to favor themselves and to fleece the average investor. Such a time we are now witnessing with the recent yo-yo precious metals market environment. Peruse the message boards of any of the precious metals web sites and you're bound to hear of talk of "those darned manipulators!"

This is nothing new, really. It happens every time gold fails to carry on a sustained rally and can't seem to get any traction. You may recall that manipulation was the talk of the town back in the late 1990s among gold bugs. This was at a time when gold was near its 20-year bear market low and every time gold tried to mount a run at the psychological $300 resistance it seemed to fail. That's when the Internet's version of the town criers would come out with talk of a "market cap" at $300 that would never be overcome. I can remember receiving several sneering e-mails around that time from those who were dead certain the gold market manipulators would NEVER allow gold to rise much above $300. When gold finally did overcome $300 in 2002 only to never look back, I never heard another word from those doubters again...until now.

It seems the Doubting Thomases among us have emerged from a 2-year hibernation and are once again starting up the hue and cry about the gold market being manipulated so that new highs will be impossible...or worse, a return to the low levels of the late 1990s. Another common argument espoused by these manipulation junkies goes something like this: "Since the market is under constant manipulation, there is no use in trying to guess where the trend of prices is headed. This manipulation also renders chart reading and other forms of technical analysis totally worthless!" If they are to be believed then why are we even wasting our time following the gold market and visiting gold-related web sites such as this one? And why in the world would we ever consider investing in the yellow metal? (For that matter, if the "market-is-being-manipulated" crowd truly believes its own propaganda then why do they even bother visiting this web site and frequenting the message boards of other gold-related web sites?)

Let's break down this fallacy. If we assume that the presence of market manipulation makes impossible the forecasting price trends (or at least makes impossible the ability to follow basic trends through a reasoned investment strategy) then we have to assume that investment in ANY asset category is a waste of time and money and should be completely avoided. Why is this true? Because any asset worth investing in at any given time is under manipulation. That's right -- manipulation is actually a normal phenomenon without which a smooth-functioning, trending market environment would be impossible!

The proof? Here's a little experiment you can do to prove to yourself that if markets were left alone by "manipulators" there would be no market worth following. Get a random number generator (or simply cut up little pieces of paper with each paper containing a number 1-100). Randomly pick out numbers in sequential order and list those numbers on a piece of graph paper in the form a price graph. In most cases you'll see totally random, non-linear movement -- herky-jerky movement of the numbers without rhyme or reason. This is what a "normal," non-manipulated market looks like. You can also see this phenomenon of irregular price patterns with no definable trend in certain thinly traded stock issues (mostly in the penny stock category). These thinly traded, non-manipulated markets aren't worth trading which is why investors typically shun them.

Below is an example of this experiment in random number generation. Do you see any discernable pattern in this chart? Can you draw any trend lines on it? Would you like to invest in this hypothetical stock or commodity? No moving average could possibly smooth out this mess!

Now to show you what a manipulated market looks like, pick out a chart of any actively traded stock or commodity -- it can be IBM, Barrick Gold, corn futures, or whatever. I'm not trying to single out any one stock or commodity because any one of them worth trading is being manipulated at the present time. This is not to cast aspersion on these stocks or commodities; indeed, the presence of organized manipulation is actually desirable up to a point. You see, the whole cycle of bull market followed by bear market is nothing but a continuously repeating pattern of manipulation. Bull markets in stocks and commodities happen because shrewd and well-monied groups of insiders decide that a certain asset (say for instance shares of XYZ Corp.) are depressed and have declined too low. Moreover, this coterie decides that XYZ is worth accumulating at the current low prices because the outlook for this company is promising and the group believes that XYZ shares can sell for much higher prices at some point in the future. So an attempt at absorbing all the excess shares of XYZ begins and the campaign of market manipulation is underway. After a long period of quietly picking up shares of XYZ, a new bull market campaign commences with the insiders advertising XYZ to the general public in various ways, which causes the public to demand shares of XYZ. A bidding war ensues with the public grabbing the bait laid forth by the manipulators and a new uptrend in the price of XYZ gets underway. Eventually, the shares of XYZ reach unsustainable levels and by that time the manipulators have long since sold all their shares to the public. So a bear market cycle follows and XYZ declines in price again. That, in a nutshell, is the cycle of manipulation.

Would the price of XYZ shares ever start a sustained uptrend and make higher highs without the presence of organized market operations (read manipulation)? Likely not. It takes organization from behind the scenes by professional manipulators to build bull markets, which in turn give way to bear markets - these things could never happen if trading in stocks and commodities was left to the unorganized public alone. So manipulation, far from being undesirable, is actually a necessary element to the smooth functioning of the financial markets. Without manipulation, there could be no following of the trends (since there would be no trends). Moving averages wouldn't work since price movement would be extremely erratic (see the above chart example). Chart patterns would be unreadable since by definition there would be no recognizable price patterns. Even fundamentals would be of little use if none of the well-heeled, behind-the-scenes manipulators felt that a given asset wasn't worth operating in.

Liquid markets that are under the influence of organized manipulation (which would include virtually all tradeable commodities and most listed stocks) have what is known as "market makers." Every stock of a well-capitalized company whose shares are heavily traded by the public employs someone to make sure the market for its shares is in relatively good working order. That means that whenever things look shaky this paid professional will step in and support the market at critical price levels to prevent an all-out break in prices. Or, to give another example, when an accumulation campaign is underway near the bottom of a bear market, this professional will make sure that no undue attention will be attracted to the stock of said company (in order to keep the general public away from the stock until the appointed time). This might properly be said to be another form of manipulation, but a very necessary one from the standpoint of the company and of the stock market as a whole. After all, if the public was allowed to madly rush into the market of any given stock at the same time, it would create a huge spike in the share price that would quickly be followed by a completely retracement right back to where the price was before the public entered the fray. (We've all seen this happen time and again with the penny junior mining stocks in years past when there was no professional support for a given stock. A "hot tip" from the Internet would cause thousands of traders to all buy the said stock at the same time, resulting in a massive rally in one or two days, which inevitably failed and left the stock right back where it started. This is what happens when there is no organized manipulation).

(Note: For further reading on the subject of the presence and desirability of manipulation in the stock market I suggest reading the classic 1933 work "The Business of Trading in Stocks" by John Durand and A.T. Miller (Fraser Publishing, Burlington, VT). The authors devote two in-depth chapters to the discussion of manipulation and describe in detail a complete manipulation campaign from start to finish).

Now I realize there is another form of manipulation which is particularly odious to even well-meaning market observers, which is mistakenly called "manipulation" by many. Actually, the correct term to use for this form of market operation would be "intervention." This is typically carried out by large entities such as the government. For instance, many traders speak of "manipulation of interest rates" or the manipulation of the dollar by the U.S. government. What they really mean is that at certain times (or perhaps at all times) there is an ongoing effort by the feds at keeping the value of the dollar low or high relative to other currencies. Or in the case of interest rates, that there is an active attempt by the Fed at keeping rates extremely low in order to keep the economy stable. Be this as it may, does the presence of the Federal Reserve or the Treasury Department mean that we have no way of trading the markets without always coming out on the losing end? Does government manipulation of the markets render price patterns meaningless and technical analysis of no value?

Of course the answer to these questions is an emphatic "no!" There are two underlying assumptions in the technical approach to financial markets: the first is that all known information about a given stock or commodity is factored into its price well in advance by all market participants (including especially the insiders); and secondly, that even when a large entity (such as the government) is about to step into a market tends to show its hand before the actual market intervention takes place. This can be seen by observing price and volume behavior and other technical data too numerous to discuss here. There is a science to reading the market, whether you call it "tape reading" or chart analysis, or anything else. And the basis to these forms of market reading is that the insiders who control each market tend to act on their knowledge in the securities they operate in before the information (or event) reaches the public. So, for example, if persons within the government with lots of money knew that there would be official intervention in the currency market next Tuesday, you can be assured they will act on this advance knowledge by staking a position in the market that will be discernable to those who follow the market closely. Of course, manipulation can't always be known in advance but more often than not the manipulators simply cannot contain themselves and will tip their hand by staking an early position in the market.

"But," someone protests, "aren't there instances where large manipulators (including governments) will enter the market all of a sudden, acting on an impulse and without fore-planning?" Possibly, but this is extremely doubtful due to the size of the markets and the enormity of the stakes. Do you think, for instance, the Treasury Department could intervene in a given stock or commodity without informing certain large financial interests of their intention? Would the government dare to intervene in a market without telling any of the major banks and financial institutions involved in this particular market? Could the government afford to betray the trust of its associates in the financial markets (and after all, the government is based on nothing if not trust)? Doubtful in the highest. We can only assume that official intervention and other forms of federal manipulation are planned well in advance and that parties too numerous to mention are informed of these intentions so that they can prepare. Along the way, some of this info leaks out to outside sources and eventually finds its way into the tape.

Others of the belief that the gold market is being manipulated by central banks and governments will maintain that there is a market cap on the price of gold that the manipulators absolutely will not allow gold to reach. They used to say it was around $300. Now some of them are saying $430-$450. Others believe gold can climb to no higher than $500. To this I can only respond by an appeal to history. Get out a chart book showing price history of any major commodity over the past 25-50 years (one such chart book is available from Commodity Price Charts, 250 S. Wacker Dr., Suite 1150, Chicago, IL 60606). Can you find a single commodity that has been contained within a narrow price band for longer than 25 years? Can you look at these charts and honestly say that any one of them is under the strict control of the feds for a long period of time? Certainly not, for there are dozens of instances of massive, uncontainable rallies in each of these commodities over the years.

In fact, the lesson of history teaches us that whenever governments or banks try to contain prices there is always an explosive upside movement of price at some point since the inexorable natural forces of supply and demand (especially with commodities) cannot be suppressed for very long. One analogy would be trying to hold back the water of a creek or river by building a dam without making allowance for some of the water to pass underneath the dam, thereby alleviating some of the natural tension. If you tried to build a dam against a flowing body of water, regardless of how small the stream, eventually the natural force of the water would simply overpower your dam - even if you made it as big and as strong as you possibly could.

There are limits to human intervention in the natural realm and this applies especially to the commodities market. That's the lesson of history with regard to manipulation. True, manipulation will always exist as long as there are stocks and commodities to trade. To a degree, manipulation is even desirable. But even when taken to undesirable extremes, the natural forces of supply and demand ultimately keep the manipulators in check.

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