The precious metals market is but a fraction of the size of the either the stock or bond market and so if even a small portion of either of these markets were to move into precious metals i.e. Gold, Silver or Platinum it could move that market drastically. Many investment advisers recommend having 5-10% of your investment portfolio in precious metals as they tend to move independently of either of the other markets, thus lending stability to the overall portfolio. Traders tend to prefer paper versions of gold such as a Gold ETF or Gold Mutual fund because it is easy to switch into and out of the investment from other paper based assets and it doesn’t require physical storage and assay costs etc.
The Disconnect Between Physical Gold and Paper Gold
Long term investors, on the other hand or those who view gold as a hedge against catastrophe may prefer physical gold in the form of coins or bullion such as Credit Suisse gold bars. But the recent collapse in the price of gold highlighted an interesting disconnect that is developing between the paper gold and the physical gold market. During the April crash a single sell order for 400 tons of gold on the futures market triggered massive selling taking out a cascade of “sell stops” and causing the gold market price to collapse. But simultaneously, physical gold buyers, recognizing an bargain sale, rushed to their dealers to take advantage of the falling price and buy physical gold. So dealers began jacking up the premium (the difference between the paper gold price and the price the dealers charge their customers). Thus the actual price to obtain physical metals was much higher than the paper price quoted. By watching only the quoted price, this two tiered pricing system might lead a trader to believe that the demand for gold was falling and that he should be exiting the market, while the demand for physical gold was actually rising and the only thing that was falling was the demand for paper gold.
It is quite possible that at some point there will be other cracks in the link between paper gold and physical gold. If for instance it is found that ETFs and other fiduciaries who claim to be holding “X” number of ounces of physical gold as reserves for their clients turn out to not actually have the gold they claim to. It won’t be the first time this has happened. Throughout history gold storage facilities have been tempted to sell the same gold to multiple buyers and it isn’t until physical delivery is demanded that the owners realize that the facility has over-promised.
This would cause the price of that particular ETF or Bullion company to fall drastically (possibly dragging down related funds as well) while simultaneously boosting the price of the physical metal as that ETF would have to go to the physical market and make up the shortfall.
So the key for any trader or investor is to understand the risks and realize that if you are trading in paper gold it is not the same as holding physical gold and may actually be quite the opposite. Even though theoretically the price of a Gold ETF is supposed to track the price of gold, using an ETF or other paper substitute may also involve leverage which can multiply your gains or losses, while holding physical gold itself as a hedge is the exact opposite and is designed for safety rather than speculation.
- Physical Gold vs. Paper Gold
- The Greatest Wealth Transfer in History
- NY Times Says End for Gold
- A Rare Opportunity to Make Serious Money on Gold’s Rebound
- Is This the End for Gold?
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