Paper Gold is not the same as Physical Gold

by JDH on April 27, 2013

So government spending is at levels unseen in human history, and yet the ultimate store of value, gold, was trading earlier this month at the same level it was at in October, 2010? How is that possible?

The obvious answer is that the price of gold is determined on the paper markets, so it’s not a real number.

Mark McHugh at Across the Street offers an interesting perspective in his post titled Jamie Dimon Has Issues (or Meet The Idiot Selling Gold).  It would appear that JP Morgan, aka “The Morgue”, was responsible for 99.3% of physical gold sales at the COMEX in the last three months.

Since February 1 The Morgue has sold almost 2 million Troy ounces of gold.  That’s a big number (74% more than US mint gold Eagle sales in all of 2012).

On February 1 gold was trading at around $1,675 per ounce, before falling to $1,350 by mid April.  Perhaps JP Morgan are brilliant, beginning to unload gold at $1,675 as it fell all the way down to $1,350.

Or not.  Their net sales were 7,028 contracts (at 100 ounces per contract) in February, followed by 4,020 in March and a further 8,612 in April, so they have actually sold more at the lower April prices than they did at the higher February prices.  If  they were that smart all of the selling would have occurred in February, or earlier.  Time will tell.  If they make large purchases at these depressed prices in early May they may be geniuses.  Continued selling all the way to the bottom will prove they are not doing this as wise investors.

Could they have other motives?  Of course.  Perhaps the US Mint wanted a lot of gold to make more Eagles, and The Morgue is buying it for them.  Or perhaps they want to crash the gold market to make the US dollar look better.  I have no idea.

Tyler Durden pointed out that JPMorgan’s eligible gold decreased by 65% in 24 hours to an all time low, which is somewhat scary.  It’s a “run on the vault”, just like a “run on the bank”, and if enough paper gold customers start asking for physical delivery, the gig is up.

I’ve searched the web, and here are some theories.  First, from sidewinder on the BHSH Forum:

Something’s going on, for sure. Don’t know what as I’m not in the inner sanctum but something IS going on. Could have something to do with japan I don’t know. More than likely someone with the “juice” is taking their physical. The paper market is part of the problem. I mean they are selling shit they don’t have and can’t deliver never intend to and never did. All these schemes work until …. they don’t. At some point it has to disconnect and that’s what all these guys are saying. problem is …. it could take 50 years. I know where I’ll be by then. I mean, it’s the same game that started as the paper currency. They sell 10-100 time more than they have and as soon as people start demanding delivery the game falls apart. People think they are sophisticated investors and in reality just suckers driven by greed and set up by crooks.

IMO physical is the only real value and the price discovery won’t happen until the current mess finally collapses. Could be next month, two years out or even 20, depends on how the money folks handle it.

Can’t disagree with that assessment.

Onlooker on the Forum referenced Jim Sinclair’s MineSet, and in particular his commentary that we will never see $1,300 gold again.  He is of the view that gold bounces up to an intermediate top on May 2 and 3, with a pullback bottom occurring on May 10 to 13.

Here’s my take: perhaps.  As I said last week, my strategy is:

First, hold. If we are near a bottom, now is not the time to sell…

Second, line up your cash. A drop to the the 2008 low of $700 is theoretically possible. That would probably be the greatest buying opportunity of a generation. $1,300 may be the low, also representing a great buying opportunity. You can only buy if you have cash, so start accumulating cash.

Third, watch for a retest of the lows. Once gold stops falling, it will probably go up, and then go back down to test the $1,300 level. If that test holds, significant buying may be in order.

It would appear that I am of the same view as Mr. Sinclair: some form of retest of the newly established lows is necessary before we can move decisively higher.  I have no idea whether that low will happen on May 10, or 13 or six months from now.  How anyone can predict the future that accurately and not be a billionaire already is a mystery to me.  However, I do believe the direction, long term, is much higher for gold.

I have my cash at the ready, and I plan to do some buying in May, particularly if we have a few down days.

My only decision now: bullion, or precious metals stocks?  I haven’t decided yet, but I suspect that with prices on some shares down over 50%, the high-risk-high-reward leverage play will be stocks.  Of course that somewhat goes against the “paper gold is not the same as physical gold” premise, since stocks are, in essence, paper, which is why I am still pondering my next move.

More next week.  Thanks for reading.