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Gold's War Between Physical And Paper

Published 08/07/2015, 07:40 AM
Updated 05/14/2017, 06:45 AM

Gold Vs. Silver

Gold and silver traded in a tight range this week on low futures volumes.

Last Friday the gold price rallied from $1,080 to $1,101, last night it closed at $1,089. Silver also traded in a narrow range though both are slightly firmer in early European trade this morning.

The market background is extraordinary. Last week gold's open interest fell sharply, suggesting that some of the oversold conditions were being unwound: not a bit of it, it was only spread positions being closed, and for the second week in a row the Managed Money category's net short position increased to an extreme condition previously unrecorded. This is shown in the next chart.

Managed Contracts

Isolating the short side is even more remarkable.

Gold Shorts

Since the date of the last data input (28 July), open interest has fallen by only 4,000 contracts, suggesting the speculative money is still very short. It would be remarkable if these market conditions are not followed by a massive bear squeeze.

Investors in gold ETFs such as (ARCA:GLD) are liquidating dismayed by the negative trend. Some of the gold released is simply migrating east, but this is small in comparison to the increase in demand from value buyers around the world. In the week ending 24 July, the Shanghai Gold Exchange delivered 73.3 tonnes into public hands, and India has also reported a substantial increase in gold imports in recent months as well. And that's only the public in two countries. Recent reports suggest a global revival in physical demand from South Korea to Europe. British gold sovereigns are in short supply at some dealers suggesting demand has picked up in the UK. Coin dealers in the US are also reporting high demand.

How much all this amounts to one can only guess, but a figure of between two and three times mining output seems likely. The balance must be coming out of vault storage, as has been the case since April 2013. At these prices scrappage must have declined.

There is evidence that shortages of deliverable gold are also developing on Comex, where registered gold, in other words gold in Comex vaults available for delivery, fell to a very low 362,000 ounces. This is at the same time holders of the August contract have been standing for delivery, creating potential difficulties. The short term problem appears to have been partially resolved with a transfer in JPMorgan's (NYSE:JPM) vault of 276,000 ounces on Tuesday from the eligible category, or gold held in safe custody. Whether or not this is JPM acting out of charitable feelings towards the market or on behalf of a government agency to create deliverable liquidity we can only guess. Either way, it should be observed that if "the establishment" is prepared to bail out the market, Comex could become an easy source of physical gold for large buyers, given shortages and delays in delivery are common elsewhere.

It is hard to see that being permitted for long. Considering all these factors the odds favour a price recovery from current levels, if only to call a halt to the underlying redistribution of bullion.

Latest comments

The GLD prospectus fails to specify around how much of GLD's gold is insured but it does give you this clause "The Custodian maintains insurance with regard to its business on such terms and conditions as it considers appropriate which does not cover the full amount of gold held in custody." As I wanted clarification on this subject, I called GLD's info line. The GLD representative acted as if he didn't know and said they were just the "marketing agent" for GLD. What kind of marketing agent doesn't know such basic information about a product they are marketing?. . I also recall there was a well documented visit by CNBC's Bob Pisani to GLD's vault. This visit was organized by the management behind GLD to prove the existence of GLD's physical. However, the gold bar held up by Mr. Pisani had the serial number ZJ6752 which did not show up on the bar list dated at that time. It was later discovered that this "GLD" bar was actually owned by ETF Securities.
Thank you for this very well written and informative piece. I've always found paper gold funds like GLD to be highly questionable from the start. Paper gold GLD claims to be fully backed by physical gold bullion but yet it refuses to give retail investors the right to redeem for any of these ‘claimed’ gold bullion. This fact alone would mean GLD shares are nothing more than paper at the end of the day. Furthermore, GLD’s prospectus is chalk full of weasel clauses and legal loopholes that allows the fund to get away without the full physical gold backing. One good example of this is the clause that states GLD has no right to audit subcustodial gold holdings. To this day, I have not heard of a single good reason for the existence of this audit loophole.
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