Paper gold has long been heavily criticized by gold bugs, who view the gold ETFs and futures contracts as not representative of the real thing. The reasons for these claims are well documented and hold validity.
The gold crash of the past couple days has opened up quite a large disconnect between the paper gold price and physical gold price. If you attempt to purchase physical gold anywhere, you will be hard pressed to find anywhere that sells close to spot price that is decided in the futures market. When gold is more expensive in the near or present term than it is in the future, this is known as backwardation, and is a major indicator that something is up. Usually this means a concern regarding the availability of gold and hence immediate availability becomes more expensive. But that’s not what we’re seeing as of right now, at least not in terms of price.
Anecdotal evidence from around the globe over the past few days signals that people are flocking to gold shops buying the precious metals hand over fist. This article by ZeroHedge does a fine job showing the demand explosion in gold over in Japan, China, and Australia over the past few days. India, of course, is not letting a firesale on gold pass them by.Silver appears to be sold out for the first time ever in the United States. Most people who head to their local shops clearly notice the empty shelves and the surge in activity. So while the physical gold price hasn’t yet adjusted, the demanded certainly has, with physical gold behaving completely opposite to the market with the ratio of buyers to sellers heavily favoring those with a long position.
It’s a reality that more gold is traded in a single day than the total global supply in a whole year. Usually most of this volume is traded in OTC markets in private deals that don’t affect the futures markets and hence the price of gold. Yet on Monday around 400 tons were sold in a few hours, which set off this crash in the first place. It’s hard to imagine what kind of entity had access to that much gold or funds, but it doesn’t take a genius to know that their intentions weren’t good. Whoever sold knew very well the downward pressure it would create in the price of gold and the stop order triggers it would set off.
So here we stand today with the gold valued at not too far off its marginal costs. Gold retailers are starting to ignore the futures price and charging hefty premiums or not selling at all. If this game goes any longer, we could see a permanent decoupling between paper and physical gold prices. Once that happens, the game played over in paper markets will have been unveiled and the loss of confidence could lead to a mass sell off in the paper markets, as the realization sets in that only a small fraction of the paper being traded actually has any gold behind it. If this happens, then it will be the end of COMEX where most of these shenanigans take place, and physical gold can be free to find its true price unshackled from the manipulation and naked short selling. Some in the community call it ‘free gold’ and it certainly looks like a possibility capable of transpiring.
Regardless of the way this all plays out, it’s becoming ever more clear that paper gold can no longer be regarded as a legitimate substitute to owning real physical gold in your grasp. Unfortunately, by the time this become crystal clear, it will have been too late for any of the involved parties to do anything about it.