16 September 2009
Jim Willie CB,  “the Golden Jackass”

* The OTC Derivative Shock
* Hong Kong Gold Demanded
* Rare Earth Metal Fallout

Special Report
Issue #66


$$$ CHINA MADE THREEMAJOR ANNOUNCEMENTS IN EARLY SEPTEMBER, EACH HIGHLY DISRUPTIVE, ENOUGH TO FURTHER ALONG THE PARADIGM SHIFT. THEIR ACTIONS WRECK THE US-UK SYSTEMS, AND BRING ABOUT A CHANGE IN GLOBAL LEADERSHIP. $$$ The timing of late August and early September for disruptions and onset of instability in a visible manner have not been a disappointment. See the Special Report entitled "China Declares Financial Trade War" for September for much more details.

China has shaken the global system in three key ways, resulting in a grand challenge to the power structure. China announced

  1. permission to selectively dishonor OTC derivative contracts by mean of self-administered Stop-Losses imposed as reneges

  2. Hong Kong demands the return of its London gold bullion held in custodial accounts, as they build an airport vault center (modeled after Zurich)

  3. Mongolian rare earth metals will no longer be exported to the West.

Implications are ominous and potentially enormous. The abrogated OTC contracts for crude oil and metal contracts, ripe with corruption and without benefit of regulation, could kill Goldman Sachs and JPMorgan. Talk is ripe among high level bankers that the wild unregulated OTC arena could backfire and kill the GSax-JPM control tagteam. The demand for return of the Hong Kong gold bullion is more a symbolic threat, adding thrust to what already has begun with other nations. Germany, Switzerland, and the United Arab Emirates have demanded a return of their gold from New York and London, inciting secretive acrimony. The trend puts considerable pressure on the COMEX, which could be killed from lack of underlying metal, as its corruption is exposed. Neither the USGovt nor the USMilitary have built stockpiles in rare earth metals. They are critical for weapons programs, and their absence could put further strain on the over-extended USMilitary whose equipment is being ruined by sand, whose soldiers are suffering from morale and prolonged service, and whose strategy seems hell-bent on self-destruction, all with a blind eye toward a few thousand years of history. Neither Iraq nor Afghanistan have ever been tamed in the annals of history.

The Chinese actions border on extreme, but are part of a grand mosaic of change, if not rebellion amidst a Paradigm Shift. They clearly are a toss of the gauntlet for conflict. The entire foundations will undergo powerful changes. A banker with global reach and three decades of experience commented on these policy transformations from China and more. He said, "Like earthquakes, tsunamis and avalanches, Paradigm Shift constitutes all three rolled into one. The COMEX boys will be driven over the cliff, right into the death pit like in good old Sparta. And it will be silver guys who will kill them." Hi Ho, Silver!!



Financial markets absorbed a sudden shock on Monday August 31st, when an important Beijing regulatory agency issued a stunning statement. The State-owned Assets Supervision & Administration Commission (SASAC), the regulator and nominal shareholder for state owned enterprises (SOEs), told six foreign banks that SOEs reserved the right to default on contracts. A report that Chinese state owned companies will be allowed to walk away from failed commodity derivative trades provoked anger and dismay among investment bankers, even confusion. They fear it could set a damaging precedent. Imagine the entire globe dishonoring such contracts based in the gigantic fraudulent arena. Financial circles from Shanghai to Singapore are bewildered as to the effect on commodity marketers, which would suffer multi-million$ losses, possibly reaching the billion$. The companies holding underwater price hedges could simply renege on the deals. The warning from SASAC follows a series of measures from Beijing this year to crack down on the sale of derivative products by foreign banks to Chinese enterprises, principally big corporate consumers. They bought protection against higher prices last year only to watch the market collapse, saddling them with huge losses.

The commodity markets are a constant playground for corrupt Wall Street machinations. Chinese officials are well aware that Wall Street plays with commodity prices like a cat with a mouse, replete with corruption, with full impunity. For instance, the 70% decline in crude oil last year came from a spearhead initiative to dump oil from the USGovt Strategic Petro Reserve, with a Goldman Sachs front run, a story still denied. Paper contracts were exchanged with Mexican suppliers in order to cover their illicit games. Victims have retaliated. The OTC Derivative market is 9x to 10x larger than the commodity futures exchanges generally. The size is staggering, over $592 trillion in notional value, scattered with tentacles described often as a Daisy Chain. According to the Bank For Intl Settlements, the OTC Derivative market has come down from $1200 trillion a year ago, to almost half that size, but it is still mammoth and dangerously high. The contracts involved are typically custom-made, difficult to enforce on dishonored renege, and are considered the Wild West beyond regulatory oversight. The OTC Derivative contracts have no required margin to post, nothing, whereas the COMEX and other futures exchanges have posted margin and immediate mark-to-market enforcement bearing consequences. This could be an early stage attack designed to severely weaken the COMEX itself. One should also note that the Chinese are primary participants in the planned Access Capacity Barter Exchange program in current formation. We might see a step from the corrupt bank-led OTC Derivative arena into the new Barter Exchange arena that is absent banks!

The contract dishonor topic is highly sensitive, since major losses would be tossed like grenades on the US-UK craftsmen who devise these control-laden contracts. An unnamed Hong Kong-based derivatives analyst said, "I would not be surprised if more state firms emerge with big derivatives trading losses. Otherwise, SASAC would not come out with such a radical move." Another unnamed bank source said, "It is a handful of companies who are being encouraged by regulators to re-negotiate. It is outrageous, but it is China. So everyone is treading very carefully." Response from the victimized bankers is mute. Goldman Sachs and UBS declined comment, and Morgan Stanley and JPMorgan were not immediately available for comment. All are major global providers of commodity risk management. They must gird for major additional losses and court challenges.

This conflict could become dicey, as China might defend itself in an international court by charging Wall Street firms with trillion$ bond fraud related to mortgages and their leveraged products that went sour after exported globally. We are witnessing an escalated financial trade war. China is a major commodity consumer. Price hedge contracts are a standard device for contract protection drawn over time. The danger goes beyond the immediate risk from existing contracts to the longer-term precedent that suggests Chinese companies can simply renege on deals when they wish. The report follows an order from SASAC in July that required all central state owned companies involved in trading derivatives to submit quarterly reports about their investments, including details of holdings and performance. Air China, China Eastern, and shipping giant COSCO, some of the Chinese companies stuck with huge derivatives losses, had issued almost identical renege notices to banks. A certain quote has circulated, capturing much attention. "It is like the father suddenly told the creditors of his debt-ridden son that his son will not pay any of his debt," said a lawyer from the derivatives risks committee of the Beijing Lawyers Assn. Except the Dad is China with a big stick. See the Business World article (CLICK HERE) or the shorter Reuters story (CLICK HERE).


Chinese officials attempted to backpedal in political repair. The report from SASAC to permit OTC Derivative dishonored contracts was misinterpreted, according to an unnamed Chinese Govt source. The source said the warning was only meant to address specific contracts that targeted specific deals deemed too complex for the SOEs to understand. The specific deals or the banks involved have not been named either. See the Chinese Economic Review article (CLICK HERE). This is very difficult to accept as a formal clarification. It seems more like cheap ointment applied to feign mollified feelings, when a shift in policy is afoot.

Some personal reactions, and reactions from some trusted colleagues and contacts. In my view, Beijing just cut the derivative cord of control, used by US bank syndicate centers to control the commodity markets and impose their will upon global corporations. The United States is slowly being isolated, and its levers dismantled. This is utterly huuuuge news !!! This is a lethal development !! Notice is served that the tentacles of US control will be broken in full view. In fact, Goldman Sachs might be lined up to be first for the kill, or at least very powerful financial assaults. Recall that GSax is heavily leveraged, and thus vulnerable. However, they will probably arrange for the USGovt to accept their losses, a contract fraud switch.

Rob Kirby is one of the stellar financial forensic analysts on the gold journals. He discussed the nature of margin consequences. BUT NOTE HIS COMMENT ON THE ALL-IMPORTANT CREDIT DERIVATIVES. He said, "Let's say I buy a large number of wheat futures at 10 per bushel and post the required margin. The price then drops to 8 per bushel. My broker calls and orders that I pony up more cash. If I tell him to go swim, I have a problem. Also there is the sticky wicket of Interest Rate Swaps and Credit Default Swaps, which are also ALL OTC. Often, large payments are due regulary to maintain these contracts. What happens if the counter-party refuses to or is unable to pay? This is what was at the root of AIG's bailout, when $180 billion was handed over by the USGovt so that AIG could settle all of the disastrous bets it had made with the likes of Goldman, JPMorgan, and others. The ramifications of this statement by China could be EXTREMELY far reaching in my opinion." The largest portion of OTC Derivatives pertain to credit derivatives. Interest Rate Swaps are used to push down long-term rates from the more controllable short-term rates, with the aid of USFed central bank policy. The Credit Default Swaps insure against default of asset backed bonds, like from corporations or mortgages. If counter-parties begin to dishonor credit derivatives, then GSax and JPMorgan could be stuck with many trillion$ in losses. Interest rates in the United States would double. Wall Street would suffer a financial bomb akin to Hiroshima. CHINA HAS BEGUN TO STRIKE AT THE WEAKEST FINANCIAL LINKS IN THE US-UK CORRUPT CHAIN OF CONTROL.

Jesse at the Crossroads Café put it well, when he described the 'face rippings' that have befallen Chinese corporations victimized by Wall Street fraudulent management of commodity markets. Jesse wrote, "After one too many face-rippings by the merry Pranksters of Wall Street, China's state-owned companies have run to their government to complain about the fraudulent nature of their derivatives contracts… If the US will not put its house in order, the rest of the world will increasingly start to rein in the the US financial institutions."

Craig McC is a savvy experienced colleague. He concluded, "I would agree that the impact could be significant, but more so to the banks than to the exchanges. The Reuters article is somewhat confusing in its language. The focus is on the potential default by the Chinese on future hedges with banks. This is a default on OTC derivatives which would severely impact the banks. In regards to Exchange Traded Futures, margin is required to protect the brokers and the exchanges. Since the Chinese defaulted once before on soybeans, they are required to post a bond in addition to the margin requirements. It appears that the Chinese are not required to post bonds for energy and/or metals trading. So the brokers and exchanges could take big hits if the Chinese default on say their copper or oil contracts. In either case any such defaults would not be force majeure. Instead the Chinese Govt appears to be giving protection to its SOEs from the blood-sucking OTC derivative-issuing banks. Someday we might say 'Rest In Peace' Goldman Sachs and JPMorgan."

Karl Denninger has some choice words on the brewing battle. He sees it as potentially a game changer, as China has become the new strongarm enforcer. He wrote, "See what lawless behavior gets you folks? You start this crapp, selling worthless paper, intentionally turning a blind eye to fraud, profiting from fraud, screwing consumers and foreigners alike, and guess what? BINGO! A foreign government that runs a command economy [retaliates.] For banks that are hoping to sell more derivatives hedges in China, the world's fastest expanding major economy and top commodities consumer, the danger goes beyond the immediate risk from existing contracts to the longer-term precedent that suggests Chinese companies can simply renege on deals when they like… We reap what we sow, and may the foreign banks get stiffed and stuffed. I have no sympathy, zero, for the investment banks who get burned by this. Now let's see China grow a pair of brass church bells and tell Geithner and company to stick it on their debt sales? Or even better, why not sell? If our government refuses to do the right thing and acts like Tony Soprano, then perhaps we need a bigger, badder, more powerful gang to come smack our government around a bit." See the Market Ticker article (CLICK HERE). Denninger is a bonafide blockhead stooge when it comes to 911 apologists in defense of the official story, but he does great forensic analysis. When worthwhile, his work will continue to be quoted.

The Wall Street Journal suggests that Western Govts might actually seize Chinese assets while engaged in commerce during normal business functions, as they circle the globe. The WSJ wrote, "Foreign banks that entered oil derivative contracts with some Chinese airlines and shippers could find they have little recourse if the companies make good on threats to default on their obligations. The government can still conclude that it is contrary to public policy to enforce complex and unfair contracts, when Chinese companies have made a legitimate claim that they were misled. People close to the banks that received letters said that if China balks at accepting arbitration terms, the firms still could seek a court ruling in Hong Kong, Singapore, the UK, or whichever jurisdiction governs a particular contract. In that case, they may be able to seize overseas assets of the Chinese companies, a Chinese aircraft that touches down in London, for example." This would constitute a grand ratchet up in the trade war. What incredible bluster coming from a corner deeply indebted and totally dependent upon foreign credit supply! This is like an indebted pipsqueak flexes muscles before a bear. China holds many cards at the table. A jet aircraft or a shipping vessel pale by comparison to a high stack of USTreasury Bonds. A more damaging blow would be sale of a stack of USAgency Mortgage Bonds. Compare a hand slap given to China, versus a giant sledge hammer blow given by China potentially in response, with a sale of $20 or $50 or $80 or $100 billion in a mix of USTBonds and USAgencys. The debtor nation never has the edge, except with a powerful military. Look for strange military threats to come, since the United States has very big advantages, and is greatly tempted to use them. See the WSJ Online article (CLICK HERE).


In his almost daily communiques, Sinclair wrote "China Invokes A 'Stop Loss' On OTC Derivatives" on the same day the news broke. Here are some special words. He wrote, "China tells the Wall Street OTC derivative manufacturers and distributors to go straight to hell. China has invoked a 'Stop Loss' on these fraud-ridden instruments. If you create a specific performance contract that you know under even the slightest pressure cannot perform, you have committed fraud… This will have a MAJOR impact on the sociopath US manufacturers and distributors of OTC derivatives like CDSwaps that struck the world over with these weapons of mass financial destruction. This could roil the financial world one more time. Doing the right thing is never easy. Doing the right thing takes character and courage. The Chinese are doing exactly the right thing and exactly what the West should have done years ago when Long-Term Capital flopped. Now the rest of the BRIC nations will follow suit… Here is an example of how China will act with regards to the dollar late this fall… Screw with China and you will get bitten in the ass by a real dragon. China leads the BRIC nations. This will have a MAJOR impact on the sociopath USA manufacturers and distributors of OTC derivatives…, enriching themselves in the process by many trillions." See the JSMineset editorial (CLICK HERE).


Ted Butler has his own theory and interpretation. He regards the Chinese vague denial as confirmation of a serious policy shift toward reneged contracts. Butler wrote, "Even more amazing is that the obligatory follow-up story, in which the threat of default is invariably denied, actually confirms that China is seriously considering defaulting on selected OTC commodity derivatives contracts. If there is going to be a default by China in select OTC commodity derivatives, silver is a prime candidate It points to the extraordinary situation that presently exists in silver, not just from an investment and regulatory perspective, but also from a view that impacts the strategic interests of nations, including, but not limited to, the US and China... There is an unusually large concentrated net short position in COMEX silver futures held by four or fewer traders, documented by CFTC data. There is no unusually large concentrated position on the long side… Correspondence from the CFTC to elected officials identifies JPMorgan as the prime holder of the short position, with Morgan having inherited the position in its takeover of Bear Stearns… Over the past five years, the silver short position has grown more concentrated. About six years ago, based upon input from my friend and mentor, Izzy Friedman, I first speculated that China was the big short behind the COMEX silver short position. Other articles followed on China and this theme."

Butler is not a great forecaster, but he is an excellent silver analyst and expert in this market at revealing important data and factors at work. He believes a potential disaster exists if the foreign backers to the short position in COMEX silver decided to abandon their obligations. The silver price would double rapidly. He regards the silver short position as having the potential to threaten the existence and survival of the NYMEX/COMEX, an important financial institution linked to US national interests. Butler concluded, "If and when these four large traders decide they have had enough of the short side of silver, instead of covering their short positions or delivering actual silver, they could declare force majeure and simply walk away and leave the regulators and NYMEX clearing members holding the bag. Since they are outside the jurisdiction of the Commission, there is, currently, little to prevent this."

My conclusion is slowly forming. China is expert at employing the principles laid out in the "Art of War" by Sun Tzu. They are patient, strong on planning and preparation, but ruthless in execution. They had endured a century of colonial exploitation and harsh treatment, like export to China of opium addiction by England. One must consider the possibility that China entered the ranks of the gold and especially silver paper casino IN ORDER TO DISRUPT THEM at a later date, specifically by design. That disruption would serve as a DEATH BLOW, meted out when Beijing judged the timing to be right, when systems were in place, when the USGovt policy had become irresponsibly corrosive, when trade war called for lethal action. China is a major gold and silver producer. They are accumulating large reserves in each. They hold large quantities of gold bullion and large quantities of raw silver ore. They have positioned themselves to be huge beneficiaries of a precious metal price runup. China might pursue a position where they are in near total control of the silver price for strategic reasons. They could then control the rise in its price to 30-40/oz and then later to $60-70/oz, even higher. Silver is an important metal in USMilitary weaponry, common in electronics, of strategic importance. China could essentially limit the growth or cripple the progress of the USMilitary by using the silver lever. A dishonor of silver contracts would catapult their silver stockpiles into great wealth, and transform their silver production facilities into great wealth engines. Whether this is the Chinese secret long range plan, we will soon find out.

My colleague CraigMcC concluded on metals generally. He said, "You are right. The possibilities are always changing and hence, one must reassess the most probable scenarios. With China being one of the largest gold and silver producers, which is actively working to expand production within its own borders, I continue to think China's options are more focused to being on the long side of the PM casino. Nonetheless, anything is possible. Over decades China gained pricing power in the rare earth markets by predatory pricing. Such metals are critical to the production of sophisticated weaponry. While I seem to recall the US having some good size rare earth reserves, most of those mines have been mothballed or destroyed. Unlike the USSR, the US is a net importer of silver. The best way to hurt a net importer is by increasing prices." Predatory pricing is the practice of winning market share from sales below cost, at a loss, fully planned. It was developed by Rockefeller for Standard Oil over a century ago.



The decision by Hong Kong to demand its gold bullion is somewhat symbolic, and clearly antagonistic. Hong Kong is pulling all its physical gold holdings from depositories in London, transferring them to a high security depository newly built at the city airport. The 3660 square foot depository, located at the main Chek Lap Kok Airport, will serve as a storage facility for local and overseas government institutions. The facility would support their emergence as a Swiss-style trading hub for bullion. Over time, the London status as a key settlement & storage center has lessened, and will continue to shrink. The HK gold vault facility is the first with official government backing in the Asian region. Efforts will be made to convince Asian central banks to transfer their gold reserves to the Hong Kong facility. Efforts will also be made to reach out to commodity exchanges, banks, precious metals refiners, and fund providers.

Sunil Kashyap is from Scotia Capital in Hong Kong. He said, "Having a central government sponsored vault would create a situation where you could conceivably look at Hong Kong as being a hub, where metal could be traded for the region." Other vault locations holding HK gold intend to make transfers from other vaults to the HK depository later this year, according to the Hong Kong Monetary Authority, which functions as the territorial unofficial central bank. The HKMA reported $63 million in physical gold reserves as of July 31st, according to its Intl Reserves & Foreign Currency Liquidity statement. This is a small amount, but symbolically significant in the abandonment of corruption centers like London and New York. Analysts close to the city claim that the new depository facility could also foster new financial products, such as Exchange Traded Funds based on precious metals. Unlike the StreetTracks GLD (gold) and Barclays SLV (silver), the Hong Kong ETFunds will actually have gold and silver bullion held properly. The management firm Value Partners planned to launch an ETF gold fund with Hong Kong storage instead of London as a repository for the gold backing the fund. The Hong Kong Mercantile Exchange has signed an agreement to use the depository for its physical settlement and storage needs. Central banks are increasingly aware of the importance of having gold reserves at a time of financial crisis where massive insolvency is the norm for banks. The Hong Kong gold vault facility should be regarded as a major lift to the legitimate gold funds, collectively certain to pressure the COMEX & LBMA into breakdown. See the Market Watch article (CLICK HERE).

Implications are vast. Imagine more nations demanding a return of custodial gold bullion held in London and New York, and a bandwagon building followers. The negative image would only add to the horrible decline in the USDollar confidence already. Rob Kirby commented about the London Bullion Market Assn and the absence of metal from the leveraged short futures structural position. It is in danger of collapse from rising leverage during the metal collapse removal. Kirby said, "It is the toxicity to the LBMA that raises and curls my eyebrows. I hope everyone realizes how toxic this could be to the LBMA, which sells every ounce in their physical inventory many many times over. So, when the physical inventory contracts, assuming they actually have the goods to deliver to their rightful owners, one might think this could create a substantial ripple effect and force some very serious short covering."

A banker contact with numerous global contacts and vast experience offered a brief commentary about gold vault centers that adds perspective about Russia. He has personal experience inside Russia during the Yeltsin years. He said, "The next gold super-hub to emerge will be Moscow. It is not only about precious metals. It is all about commodity trading, storage, and settlement. You want a sovereign with real power to provide for a robust and sustainable business environment during paradigm change. Washington and London will have the same importance as Rome or Athens not before long. A chapter in the history books, nothing more. Russia's core never collapsed. The entire security apparatus GRU / KGB and all the other agencies remained intact and in good working order. The people working in those organizations are highly educated, top professionals, and do not blink when the boat takes on water. The Russians never allowed anyone from the outside to crack open their security apparatus. They also kept all their high tech complexes totally shielded from the Western raiders. People will be in for a mega-surprise once the global meltdown occurs and the dust settles. The misjudgment and the mistreatment of the Russians by the West go back hundreds of years." He has commented numerous times that Russia is in possession of multiples more in gold bullion than the West realizes, or even the gold community realizes. They are preparing for the next phase after a meltdown. The West anticipates heavy damage to Russia during a meltdown, but it will be the US-UK Sphere that collapses almost totally. Russia will emerge, along with China.


$$$ CHINA RESTRICTS RARE EARTH METAL EXPORT. EFFECTS WILL BE FELT IN THREE IMPORTANT ARENAS. THEY WILL FORM A STRATEGIC RESERVE TO STORE THESE KEY MONGOLIAN RICHES. $$$ China is in command of the world's largest rare earth metal deposits. The actual possession is with Mongolia. The province of Inner Mongolia, which contains 75% of China's deposits, is in talks with the central government to build stockpiles to support prices, according to Zhao Shuanglian, deputy chief of the province. The comments come from Beijing. Inner Mongolia produces 50 thousand metric tonnes of rare earths every year, 6% of which is exported, Zhao claimed. China accounts for more than 90% of global rare earth metal output.

China plans to build a strategic reserve in Inner Mongolia, strengthening its control over materials used in technology ranging from iPods to guided missiles. Inner Mongolia Baotou Steel Rare-Earth Hi-Tech is the main producer in the province. Chinese officials realize the high value of these unusual metals, and strive to block price suppression. They wish to control the shares of such companies. The Batou Steel company will take over smaller rivals in a consolidation of the industry. "The plan of building a national reserve stockpile is part of a government level strategy to protect the resources of rare earths and prevent it from being sold cheaply," said Liu Minda of Huatai Securities. Rare earths range over 15 elements such as scandium and lanthanum, all heavy metals not tied to household conversations. Each contains unique chemical traits. "Rare earths is the most important resource for Inner Mongolia. [China wishes to] attract users of rare earths to set up in Inner Mongolia." Zhao said.

By limiting exports and controlling the supply chain, China intends to to develop crucial manufacturing. China cut 2009 output quotas by 8.1% from a year ago to 119,500 tonnes, according to the Ministry of Industry Information & Technology. China imports most of its iron ore, crude oil, and copper, by contrast. The Chinese decision to cut output quotas on rare earths this year was motivated to ensure sufficient domestic reserves and to halt a decline in prices caused by the global recession. The Chinese Govt has supported commodity companies. This year it bought aluminum and zinc from domestic smelters after metal prices plunged, an initiative that stemmed losses. Certain of their export restrictions drew a complaint from the United States and European Union in June. China was accused of using taxes to discourage the export of metals and chemicals including bauxite, magnesium, manganese, and zinc. See the Bloomberg article (CLICK HERE).

Rare earth metals are critical in applications for hybrid cars, certain electronics like televisions, and many military weapons such as missiles. Some of the minerals are typically consumed by companies including Apple and Toyota Motor. Rare earths are used to make mini hard drives in laptop PCs, to make headphones for Apple iPods, to make catalytic converters in cars, and to make small electric motors in parts such as windscreen wipers and seat adjustors. Chinese officials said supplies of dysprosium and terbium, requirements to make hybrid cars and televisions, are inadequate for its own needs. Dysprosium is popular for usage in permanent magnet motors for hybrid cars like Prius or wind turbines. Demand is fast on the rise globally. From the Periodic Table of the Elements, rare earths refer to a large family of chemical elements consisting of scandium (21), yttrium (39), and 15 elements from lanthanum (57) to lutetium (71), whose atomic numbers are given. They appear as the elements in olive green, in one row and one column. Shortages are cropping up for rare earth metals in hybrid cars and televisions inside China, motivating official reaction.