Paper Gold
The live price you see of gold is from the futures markets, which covers forward contracts with an expiry where end-of-the-month settlements are made. Generally, around 90-95% of these contracts are cash settled or simply rolled over to the next month, with delivery rarely requested. The simple reason is that gold in its physical state can be unwieldy to move between several parties, financial advisors generally recommend against physical due to simplicity, and traders prefer to take profit rather than delivery.
This allows traders to hold many paper contracts via short or long positions without having the physical collateral to ride the price higher or lower. This is how the derivatives markets work, and in the case of gold, it is estimated that 1oz of physical gold is underpinning 100oz of derivatives. Please bear this in mind for later in the article.
Another way to buy paper Gold includes ETFs, where you are one of many “pooled investors” under one investment vehicle. This however can be very dangerous if the custodian doesn’t have the physical to back the paper contracts which we will draw upon later. Many of these ETF’s use unallocated Gold derivative accounts.
Options in the form of put or call are other ways much the same as how they work for any other stock. It is essentially leveraged bets on the price moving up or down with a short-term expiry period. CFDs are other instruments that can be used which work in the same way as options with greater leverage but without the short term expiry.
With almost all paper trading, however, you are likely to be exposed in some way to swaps, (sometimes called overnight funding) where a broker will charge you a percentage for keep your positions open after exchanges close through the night then open again the next morning. Depending on which country you are trading and how long the position is open, there may also be fluctuations in FX fees.
So in summary, paper trading Gold means you never are guaranteed to own it, you could be one of 100 entities claiming a stake against the same 1oz, (estimates are over 300/1 in silver) and you may incur additional costings in FX or swaps.
Physical Gold
Physical gold, as the name suggests, is where you make a purchase and claim the physical gold in your ownership. This simply means that there is no counterparty risk involved (which there could easily be with paper Gold if an institution has a margin call or suffers financial collapse and 100 people come asking for the 1oz) The only potential issue maybe if it is stored or vaulted outside of your possession and in a crisis it could be difficult to reclaim.
Large-scale examples of this include the US taking seven years to repatriate German gold held in their possession. This poses a question as to whether Germany’s Gold was rehypothecated in a paper Gold scheme without their knowledge. There are countless examples of this.
Physical gold is also money and has been for 5000 years. Russia has been accepting gold as a method of payment since the Ukraine crisis and India has also followed suit.
Why is there a disconnect in price between the two?
There is some science behind this disconnect, which can be distinguished with supply and demand. If we consider silver (which has in history moved in tandem almost exclusively with gold) the physical prices in the UK for a one oz coin sit at near 100% premiums. Gold doesn’t sit at the same premiums as silver, but it is not possible to find prices at the levels the futures markets dictate. Not even close in fact.
The Comex and LBMA claim to be delivery exchanges however they are not set up for distribution of metals, and are far more akin to paper Gold. One day of Gold trading through the LBMA in London alone totals a year’s worth of mining production. This highlights the paper vs physical debate – there isn’t the metal to cover this quantity of contracts. This brings further fuel to the fire of the unallocated Gold trading argument.
Some analysts state reasons why gold is less preferred than say treasuries as the burden of storage costs. When such huge percentages of Gold daily traded is paper, then this argument doesn’t hold water.
Present-day price action and future Gold target price
The paper price of Gold moves against headline news, economic data releases, and Fed decisions, amongst other things including the dollar strength and bond markets. The only way the physical price will influence the paper price is when supply and demand fundamentals come into play, and history has shown us this leads to prolonged bull markets.
Consider a scenario where gold is in high demand from institutions. The internet is awash with rumours of BRICS nations wanting to use gold to back a new currency to rival the US Dollar, as the East wages currency wars against the West. That is just one scenario, as many well respected names in the financial world are adamant the only way that the world’s debt problem can be paid is to revalue gold with figures put on it of $10,000/oz to $50,000/oz.
Whilst these numbers seem brash to say the least, there is every possibility they could be reached if the world decides to revalue gold to back a currency or held in central bank reserves to pay off monetary and fiscal debt. One thing is for sure though, it won’t reach these levels through paper trading on the Comex or by Jerome Powell reducing interest rates. A total overhaul of the monetary system would be needed, and that may not be too far fetched given lifecycles of Fiat currency and a mind blowing world debt to GDP ratio north of 350%.
Money Week still reports that China has well over 20,000 Tonnes of Gold. Other analysts believe this to be a conservative estimate. If this were true, China could easily trigger the revaluation process. An inflated gold price will kill the dollar – it’s as straightforward as that. The US have already stated that a Gold backed digital Yuan designed to rival the dollar would be considered an act of war.
Summary
Paper trading Gold isn’t owning gold, it is simply trading paper receipts based upon the fundamentals of price movements against gold. You never own it and can never be guaranteed when there are as many as 100 claims against 1oz. With central banks net buyers for years, the BIS changing physical gold to a Tier 1 asset, and the anti west BRICS nations colluding, against a back drop of rapid inflation and eye watering debt levels, there is plenty of evidence to suggest a lot of planning has been taking place in the background relating to gold as the solution. Only the physical side should be held.