Price of gold: the paradox is revealed

Price of gold: the paradox is revealed

– Excerpt GEAB N°34 (April 16, 2009) -

For months we have witnessing a worldwide paradoxical phenomenon which the press has widely reported. Because of the crisis investors fled most categories of assets (real estate, stock market, currencies, comodities) and many of them have invested a portion of their portfolios in gold, even causing shortages of coins or bars in many markets. Yet, and this is the paradox, the price of gold is not taking off its average price of 900 USD / ounce.

As a first step, in the second half of 2008, the commonly accepted explanation was that margin calls due to massive losses in other asset classes had required significant sales of gold by their holders, offsetting growing demand and this was probably the case. But since early 2009, the paradox remains and this explanation is no longer be sufficient to explain the status of the price of the yellow metal.

LEAP/E2020, therefore, tried to understand the "why" of this paradox and draw conclusions for GEAB subscribers. Let’s keep in mind that the analysis of gold market is particularly complex because it blends several phenomena that obfuscate its actual operation:

1. It is simultaneously a highly speculative market where information of all sorts is circulated to serve any particular market trend and a market for an industrial raw material (namely the jewellery trade)

2. It is a market driven by investors particularly convinced, sometimes ideologically, of the ’uniqueness’ of gold as the only legitimate basis of an economy and a healthy currency

3. It is a market under the close supervision of central banks and states which, in times of crisis, regard it, on the one hand, as a potential danger to fiat money and, on the other hand, as an asset of « last resort » which can be subject to seizure when the crisis becomes uncontrollable (1)

4. Finally, it is a market that deals with a metal identified as wealth for at least five millennia, known to make people go crazy!

So, to try to understand what is happening currently in this market, caution is required. However, in the many shadowy areas of the international gold market, a darker area than others seems to provide an explanation of the current gold price and from which at the same time, useful recommendations can be drawn for GEAB subscribers. It is the difference between the two types of market for the yellow metal:

1. The physical market, which requires real transactions of yellow metal. It sells and buys real coins and bars that one must then stored oneself (in a bank safe, in one’s garden or under one’s mattress (2))

2. The paper-gold market. It buys and sells certificates that guarantee the possession of a quantity of gold (coins or bullion), which the seller agrees to provide the buyer physically if required.

The practical aspect of the paper gold market is obvious. It avoids the complex problems of transport and storage for buyers of large quantities of gold and facilitates all transactions, increasing liquidity in the gold world market. However, it requires absolute trust in two types of operators in the heart of this market:

. Sellers
. Regulators

The first have to be above any suspicion and respect the rules that require them, in general, to possess physical gold equivalent to 90% of the certificates that they negotiate. The latter must be even more legitimate because they must ensure that all sellers of paper gold comply with the regulations.

However, the performance of global financial institutions and regulators of the major international financial centers over the past two years does not inspire great optimism. The first acted (and still act) as top-level crooks and the latter as the accomplices of the former, especially on Wall Street and the City ... which, coincidentally, are the international centers of the gold market (3).

LEAP/E2020 believes that because of the current struggle for survival of major financial institutions and of the crisis in the international monetary system, it would be very naive to assume that the regulators of the gold market play fair, in so far as this would be, first, to the detriment of the Dollar, the British Pound and most fiat money and, second, to the detriment of the balance sheets of major financial institutions, already seriously weakened. We therefore believe that the paper gold market no longer operates by the regulations and that many operators in this market do not respect the requirement to hold 90% physical gold as collateral. It is impossible to know precisely at what collateral they hold but it is likely to be very low, at least at a level that would pose a serious problem if tomorrow more than half the buyers demanded conversion of their certificates into physical gold (4).

For the record, the United States acted, to all intents and purposes in the same manner when a manipulation when, in 1971, President Nixon suddenly announced that the dollar was no longer convertible into gold. Before 1971 the Dollar was equivalent to a certificate on gold and the United States a seller of paper gold which forgot to comlply the constraints of coverage of its certificates, and eventually had to acknowledge that it could no longer honor its contracts (5).

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