The Disconnect Between Physical Gold Demand And The Paper Gold Price
Anyone who’s been following the gold story lately probably has noticed something doesn’t seem right. Specifically, I’m talking about the disconnect between physical gold demand versus the paper gold price. I’ve been hearing a lot of stories of how recent demand for the physical metal has been absolutely on fire in the United States and elsewhere, especially with the chaos taking place throughout the financial system. From NumisMaster’s Patrick A. Heller on October 7:
Gold and silver coins and ingots are almost non-existent anywhere in North America, Europe, the Far East and Australia. Premiums on what merchandise can be had are far higher than commodity market prices.
Banks in Europe, if they can find any, are willing to pay 10 percent to 15 percent over gold spot to buy Krugerrands or sovereigns. In the United States on Monday, some dealers were bidding well over 30 percent over intrinsic value to purchase immediate delivery silver coins or ingots. There are many reports of retail buyers paying more than double silver value to acquire U.S. silver American
Eagles in recent days.Partly in response to the lack of availability of gold bullion-priced coins and ingots, several buyers are purchasing common-date U.S. $20 and $10 gold coins in all grades. Prices are up sharply in the past few weeks, as much as 25 percent to 30 percent in some instances, with supplies dwindling rapidly.
With all this going on, I find it strange the paper gold price hasn’t reflected these circumstances. In fact, after falling off a cliff near the end of July, the Comex gold price has resembled a sickening roller-coaster ride ever since.
So what gives? Why isn’t the paper price of gold going up in an environment of strong physical demand and financial uncertainty? Here are two insights into this phenomenon. Alex Wallenwein, editor and publisher of the EURO vs. DOLLAR & GOLD MONITOR, wrote on The Market Oracle (UK) website yesterday:
Why is gold dropping right now when anyone in their sane mind would expect it to rise? The simple answer to this question is, “because Comex-gold isn’t gold” – and because it deceptively pretends to be ‘the’ price-setter for real gold.
Gold is gold, paper is paper, and “Comex gold” is nothing but paper masquerading as gold while simultaneously pretending to be the price-setting medium for actual gold in the world. Now, finally, Comex-gold is in the process of being unmasked.
The real supply and demand determinants for Comex gold are not actual gold investors but fund managers. Fund managers are inextricably intertwined with the world of contract-based credit instruments. They use bet on Comex gold contracts to hedge their other (currently horrendously losing) bets with something they all, in their in-bred belief in paper markets, believe will ‘go up’ in value while everything else is going down.
However, these very same fund managers and their paper-bound investment psychology are the exclusive reason why Comex gold is dropping in these times when everyone (including fund managers) expects gold to rise. As already stated, though, and as they now finally realize to their own dismay, Comex-gold just isn’t gold – and that causes even further selling.
Fund managers’ other bets are losing money fast, now, so they need to raise cash to keep up the overall value of their respective funds, so they can earn their management bonuses and avoid getting booted for lack of relative performance. Guess what they cash in on? The very same Comex paper-gold they mistakenly bought as a ‘hedge’, of course.
Meanwhile, real investors in real gold are enjoying their shopping spree – except that the spree turned into a treasure hunt as the shelves and display cases of gold dealers look more and more like the supermarket shelves in the old Soviet Union – bare.
This is the only ‘bare-market’ in real gold the world will see for a long, long time to come.
With this split, this disconnect, between Comex illusion and gold reality, one thing or the other will have to give, and it won’t be physical gold that gives.
Also discussing the paper gold price physical gold demand disconnect yesterday was Tony Allison, a registered representative for the PFS Group. He wrote on the Financial Sense website:
Gold has been known throughout history as a safe haven during troubled times. Sure enough, there is now unprecedented demand world-wide for physical gold and silver. There are shortages and high premiums from the US to Europe, from the Middle East to Asia. In some areas, delivery times are running into the two month range or longer. Other dealers are simply not selling, as they are unsure of obtaining any supply.
At the same time the paper gold price, set on the Globex world-wide trading system (dominated by the NY Comex) has gyrated wildly. It moved sharply lower during last Friday’s chaos on Wall Street, causing analysts to dismiss gold’s value in a crisis atmosphere. It is logical that the world’s central banks would want a lower gold price to calm the jittery markets. Paper gold traded on the Comex appears to be dancing like a puppet to a tune emanating from Washington. That tune may continue until the crisis has calmed. But sooner or later the global rush to physical gold and silver will reconnect precious metals prices to the reality of supply and demand.
William Fleckenstein of Fleckenstein Capital had some interesting thoughts on this “disconnect” recently.
“What I haven’t talked about is gold lease rates have gone through the roof. That appears to be because central banks are becoming credit-adverse and not lending out their gold as they once did. I’ve also heard rumblings about some large holders of gold futures deciding to take delivery, since they’re having trouble buying physical gold in sufficient size. If that’s the case, it could cause a mad scramble at the Comex, because there’s not enough gold to meet the open interest. It looks like physical gold, as compared to paper gold, is rapidly becoming the flavor of the day; meaning that a huge price move may lie just in front of us.”
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Sources:
“Physical Gold Demand Bids Up Prices of Common $10 and $20 Coins”
Patrick A. Heller
NumisMaster.com, October 7, 2008
“Why Gold Is Dropping When It Should Be Rising”
Allen Wallenwein
The Market Oracle (UK), October 13, 2008
“The World Is Not Ending”
Tony Allison
FinancialSense.com, October 13, 2008
October 15th, 2008 at 2:49 pm
Called NW Territorial Mint a number of times on Monday to order some more Gold. Could not get through – got a message saying ther were busy but would respond to messages and emails.
So I both emailed and left a phone message…still haven’t heard back from them yet.
Yes indeed – there is quite a disconnect between paper vs. the real stuff!
October 15th, 2008 at 3:30 pm
I’ve been wondering about the disconnect between demand and the ‘price of gold’.
October 15th, 2008 at 3:38 pm
I have put up a chart showing the disparity over the past few days. Will extend back in time to see how the spread widened over time.
http://pricewatcher.blogspot.com/2008/10/physical-gold-vs-paper-gold-oct-2008.html
October 15th, 2008 at 5:49 pm
Update – finally got through on the phone this afternoon. When I asked whether the majority of their business these days was buying or selling, the reply was “everybody is buying. There is some manipulation going on.”
So there you have it – straight from the Gold dealer’s mouth. Oh yeah, the wait time for 1-oz Maple Leafs is 12 – 14 weeks.
October 15th, 2008 at 5:54 pm
And the premium (for a 10-oz purchase) is $50/oz, $55/oz for 5-9 oz.
And if you are in the market for less than 5 oz, they don’t want to bother talking with you.
October 16th, 2008 at 9:04 pm
Mammoth, thanks for that update on the physical gold market. As I expected…
October 16th, 2008 at 9:05 pm
Thanks for the comment Chris.
October 16th, 2008 at 9:06 pm
Paul, thanks for sharing that chart with everyone!
October 29th, 2008 at 11:53 pm
Can the term Fiat Gold be used to expalin the paper market?
October 30th, 2008 at 8:23 am
Thanks for the comment Rick. I like the term “fiat gold.” It highlights Wallenwein’s argument that “gold is gold, paper is paper, and ‘Comex gold’ is nothing but paper masquerading as gold.”
November 9th, 2008 at 10:55 am
What a load of total nonsense. It is unbelievable how these people twist the facts. If you want the “retail” price of gold based on what the retail investor can buy, then gold coin prices reflect this. If you want the price of gold based on tens of millions of $, then COMEX is the valid price. Now why then are banks buying gold coins? Because their retail clients want to buy them….. and given there is a shortage of coins due to retail demand, then the premium is high. When the mints create enough new coins, watch the premium fall.
November 10th, 2008 at 9:26 am
Thanks for the comment phil.
December 27th, 2008 at 1:34 am
The Jews come in and change our monetary system from gold to paper. Then, they start stealing all the gold. Or, they start stealing all the money (as in the Madoff case…..there were no losers here…you can bet your bottom dollar) to change into gold. Now that they have all the gold, they crash the system through stealing even more money. Now, the dumb-dumb people of the world will revert back to using the gold standard? NO! Suppose we do NOT accept that and instead use a different form of money. Some cultures use cocoa beans, coffee beans, and even sea shells. Why can’t we? Gold is only as valuable as the PEOPLE say it is! If I and everyone else chooses only to sell our food for buttons, well then you’d better have some buttons or else you’ll be eating the gold since it’s all you’ve got!!
January 7th, 2009 at 11:07 pm
Thanks for the comment Ducky.
“The Jews come in and change our monetary system from gold to paper…”
The Jews did do this… along with WASPs, Catholics, and a number of other individuals from various ethnic/religious backgrounds. The common denominator here? The people responsible were influential members of the U.S. banking establishment, the Federal Reserve, and the U.S. government. Why did they do it? They hate gold, and for the following reasons:
-Bankers detest the yellow metal because it doesn’t allow for fractional reserve banking.
-The Fed hates gold because it’s also in the profitable business of manufacturing— U.S. dollars.
-The government, or to be more, precise, American politicians, dislike the precious metal because, to quote Dan Denning of The Daily Reckoning in a piece entitled “Why the Fed and bankers hate Gold”:
February 26th, 2009 at 2:40 pm
I enjoy the various articles and viewpoints on this site. I am a recently ‘downsized’ real estate finance executive in california who has been a gold prospecting hobbyist and historian for twenty years. Good jobs are in short supply in Sacramento California (for my skillset), and I’m contemplating taking the next two years and mining placer gold on a small scale, yielding 30-50 troy ounces once refined over the next 18 months…based on the state of the physical gold demand level and the international economic outlook, do you see a sustained or increasing premium for physical gold over the next twenty four months? I have a masters in econ and have accurately predicted the economy for quite a while on a macro level….I cannot, however, find my comfort level on whether gold will drop sharply in lieu of ‘basic survival commodities’…wheat, gasoline, etc. if the global recession deepens, more sharply depressing america due to our less nimble structure at this point. Your view??
February 27th, 2009 at 1:19 pm
Thanks for the question david hunter.
“do you see a sustained or increasing premium for physical gold over the next twenty four months?”
Similar to whay I told lil’ Al, even though I’ve been actively following precious metals, especially gold, for some years now, I’m not in a position to give advice. That being said, you might want to keep in mind what Marc Faber is saying about the short-term price of gold. From an Investorazzi.com post today:
April 21st, 2009 at 11:21 pm
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