This past week I was approached by a client who told me he was investing heavily into gold future contracts. He said he was out of the market presently because his commodity firm was telling clients Gold was going down. He asked me for my opinion and I gave him more than he bargained for.
I told him that owning gold future contracts was not owning gold at all. I explained that ‘paper gold’ was just paper and not similar at all to physical gold. This is true because paper gold is nothing more than a promise to deliver old at some point in the future which may or may not happen depending on circumstances. In other words it is “Phantom Gold”.
The LME (London Metals Exchange) based in the UK and COMEX (Commodities Exchange) based in New York are the two principal markets for trading gold bullion futures contracts. Frequently the huge volume of trades which take place in these marketplaces are cited as evidence that there is plenty of metal available to easily satisfy all central bank, industrial and investor demand. But is that really the case? How large is the bullion market compared to production? Annual global gold production amounts to about 2,200 metric tonnes which is about the volume traded daily on the (LME) London Metals Exchange.
Associated bullion bank depository warehouse vaults are seemingly as opaque in their reports as are bullion ETF’s. Use of a variety of vague terms to describe the status of holdings such as ‘Registered’ and ‘Eligible’ are part of the problem. Central banks are similarly guilty of obfuscation by using terms such as ‘Bullion Reserve’, ‘Custodial Bullion Reserve’ and ‘Deep Storage’ gold. Nor is there any clarity in terms of how much is leased and from where?
The central point to be derived from an examination of futures trading in gold is that it is principally a paper trading exercise. It is the ultimate in ‘paper gold’ in that less than one percent of all trades are settled by taking delivery of the metal. Since most traders are more than prepared to be paid out in cash, the metals exchanges have good reason not to hold an inventory of the metal since it isn’t needed for the settlement of trades.
Unfortunately, most people not directly involved in the business assume that the vast quantities of paper traded on the COMEX and LME is a proxy for the real deal…gold bullion. Trades are not, and apparently never have been, backed by the physical metal except in relative token fashion. Some analysts may consider this reality an attempt at deception. This writer takes no position on the issue, except to state unequivocally, that the metals exchanges and their associated bullion banks and industry trade groups such as the LMBA (London Bullion Market Association) do not possess any meaningful inventory of gold bullion.
Where’s the Gold!?
Where’s the Gold? Clearly, there isn’t much of it. This is the central question for all of us who consider ourselves investors in precious metals, whether it be the bullion or mining company shares. All of us need to ponder this question if for no other reason than to reflect on the prospects for future capital appreciation.
This writer contends that, given the relative scarcity of gold and silver bullion supply, prices will go parabolic once governments and institutional and private investors realize supply is disarmingly insignificant. As Jim Sinclair is fond of saying:
-Gold is competition to paper currency.
-Gold is not a commodity.
-Gold is a barometer of fear.
-Gold is a barometer of confidence in Government.
-Gold is insurance.
-Insurance is not something to trade.
-Gold is money when money fails.
-Hyperinflation is a currency event, not an economic event.
-Hyperinflation is a currency event described as a loss of confidence in the currency.
-Gold in your hand eliminates counter-party risk.
-Gold is the high ground when the global tsunami hits.
-Gold removes financial agents between you and your assets.