The fact that gold fell dramatically is not of as much concern as the fact that there’s no consensus as to why gold fell. If we don’t know the “why” gold fell on Friday, there’s no way of telling what will happen this Monday (April 15th) or on into that week.
Will the price of gold go up, down or sideways? Friday was disconcerting. But without a “why,” Monday and the remainder of this next week could be frightening.
Last Friday, Kitco published an article entitled “Metals Outlook: Views on Gold May Get Reassessed Next Work”. According to that article,
“In the Kitco News Gold Survey, out of 34 participants (bullion dealers, investment banks, futures traders, money managers and technical-chart analysts), 21 responded this week. Of those 21 participants, 10 see prices up, while 10 see prices down, and one sees prices moving sideways or are neutral.
Ohh, that’s just perfect! 10 up. 10 down. 1 sideways. There’s no consensus.
Nobody seems to know why gold fell $84 on Friday. Instead, everyone seems bewildered because Friday’s $84 fall seems irrational. We’ve stumbled into an economic “Twilight Zone”.
More importantly, as I write this article on Saturday, no one has any idea what gold will do next week.
• Groping for a “why,” some said gold fell because the producer price index showed wholesale inflation was lower than expected. Others said inflation had no bearing.
Some blamed “Federal Reserve governors talking about ending quantitative easing on the idea that the U.S. economy will improve later this year.” Bunk. The Fed merely “talked about” ending QE3 in the 4th quarter and gold fell $84? Makes no sense.
Some “economists said a cold snap in March may have trimmed sales” and somehow triggered gold’s price fall. Really? A “cold snap” caused the price of gold to fall $84?
“Energy costs fell.” That makes some sense, but not enough to explain an $84 fall.
Some commentators even opined that the price of gold may have fallen because Cyprus might have to sell some of its gold reserves.
As I’ve explained in a previous article on “Fundamentals,” I’m convinced that fundamental economic forces make it inevitable that the price of gold must rise dramatically in foreseeable future.
On the other hand, I’m also “convinced” that last Friday, gold actually fell under $1,500 an ounce for the first time in nearly two years . That’s the lowest price level since April 2011.
And no one seems to know why.
• The absence of reason troubles most people, but it’s great for commentators like myself.
When no one seems to know why something is happening, we have a kind of intellectual “vacuum”. Commentators abhor intellectual “vacuums” and therefore rush in to fill the void with conjecture and speculation. (C’mon in! The conjecture’s fine!)
Some of our ideas may seem half-baked, but so long as no one else knows for sure what’s happening, who can say we’re wrong?
Therefore, in the spirit of shooting from the hip on “a dark and rainy night,” allow me to offer some of my own conjecture.
• We know that the price of “gold” fell $84 last Friday.
But I’m wondering what kind of “gold” suffered that fall?
There are, after all, two “kinds” of gold being traded at this time:
1) paper gold; and
2) physical gold.
So, when the price of “gold” fell last Friday, did the price of physical gold fall? Or did the price of paper gold fall? Or did both fall equally?
We’ve been conditioned to assume that the prices of paper gold and physical gold are equivalent.
But what if that conditioning is false? What if the paper and physical gold prices are not equivalent?
Clearly, Friday’s $84 loss definitely struck paper gold. But it’s not clear that that loss also struck physical gold in a direct sense. Maybe, the price of physical gold is not actually falling but only seems to be falling as “collateral damage” to the fall in the price of paper gold.
There’s evidence to support this conjecture. It’s reported that there are 99 units of paper gold being sold on COMEX for every 1 unit of physical gold. Given the 99:1 ratio, the COMEX price of gold certainly reflects the price of paper gold, but probably does not reflect the true price of physical gold.
For example, let’s suppose the real price of physical gold were, say, $5,000, while Friday’s price of paper gold is $1,478. Let’s suppose COMEX sold one ounce of physical gold for $5,000 and 99 ounces of paper gold for $1,478. What would the resulting average price for “gold” (both paper and physical) be?
A: (($5,000 x 1 ounce physical) + ($1,478 x 99 “ounces” paper)) divided by 100 total “ounces” sold = COMEX market price of “gold” at $1,513.
That $1,513 would be very close to the paper price of $1,478—but it would be only about 30% of the price of physical gold. (In a sense, the price of paper gold can be seen to be a “derivative” of physical gold.)
Because of the hugely disproportionate, 99:1 ratio of paper gold to physical gold traded on COMEX, the market price of “gold” is primarily the price of paper gold.
Of course, the previous analysis fails because there’s no true, free market for physical gold. No one really knows if the true price of physical gold is $5,000, $3,500, $10,000 or $1,478.
Nevertheless, however hypothetical, the previous analysis illustrates that the relationship between the true price of physical gold and the current price of paper gold are, at best, tenuous and probably illusory. Thus, it’s entirely possible that the real price of physical gold might be much different (and much higher) than the current price of paper gold.
• Unfortunately, there’s little evidence in the current gold market that the prices of physical and paper gold aren’t equivalent. Although common sense makes that conclusion obvious, we can’t prove it because there’s no free market for pure, physical gold.
A true, free market for physical gold would be a market where 100% of the trades were executed in physical, gold. Those who sold gold would sell only physical—not paper—gold. Those who bought gold would take delivery of only physical—never paper—gold. The daily price of physical gold would go up or down according to the prices established by those who actually bought and sold physical gold in the market—not by some group of elitists (as in the London Bullion Market Association) who arbitrarily set the “spot” price of gold each day.
• Is there any evidence that the prices of paper and physical gold are not only different, but diverging?
Yes. Central banks around the world are buying hundreds (even thousands) of tons of physical gold. Why? Because physical gold is being sold for the price of paper gold. That’s a little like selling a new Cadillac for the price of a plastic, model Cadillac.
Central banks—believing the price of paper gold to be markedly below a reasonable price for physical gold—are cashing in their paper dollars to buy physical gold at paper gold prices.
Thus, it appears that the central banks’ push to buy physical gold is evidence that the prices of physical gold and paper really are different, diverging, and likely to continue to diverge in the foreseeable future.
Implication: Central banks must believe that: 1) the price of physical gold will be shown to be much higher than the price of paper gold; and, therefore, 2) if they can buy physical gold, now, at paper gold prices, they should be able to generate significant future profits when the price of paper gold is finally forced to rise to reflect the price of physical gold.
• In fact, given that the COMEX market primarily reflects the price of paper gold, the current fall in the price of “gold” may not be a fall in the price of physical gold, but only a fall in the price of paper gold. If so, Friday’s $84 fall may not be evidence of a retreat form ownership of physical gold, but only evidence of a retreat from paper gold.
I.e., are gold investors giving up their paper gold to buy physical gold? If they’re not doing so already, as the difference between paper gold and physical gold becomes increasingly apparent, they’ll do so in the future.
But if Friday’s $84 fall was only in the price of paper gold—and if the price of “gold” doesn’t bounce back—we should see the supply of physical gold dry up over the course of the next week or two as more sellers refuse to sell their physical gold at paper gold prices. In other words, if sellers refuse to sell their physical gold for paper gold prices, it will confirm that there’s a growing disconnect between paper and physical gold prices.
If the price of gold doesn’t jump up this next week, and if the supply of physical gold shrinks, I think it’ll be a good thing. It may even be worth last Friday’s $84 “hit” if it signals a growing recognition that:
1) The true prices of paper and physical gold aren’t equivalent or even closely related; and
2) The world needs true, free market for physical gold.
Buckle up. This next week should be a very interesting.