Lately there has been a lot of talk in the mainstream media about the end of the Gold and Silver bull market. Mainstream media often tends to concentrate on the paper price of silver and does not pay much attention to the physical price of Gold and Silver or factors that affect price action.
In this post I would like to take a look at the difference between paper and the physical gold and silver markets and some of the factors that are impacting on physical metal prices.
Gold in Backwardation.
Evidence that investors are losing faith in the paper Gold and Silver investment market can be seen when Gold trades in backwardation. Gold trades in backwardation when there is either a physical shortage of Gold for spot delivery or the market has concerns about the exchanges ability to deliver the metals when futures contracts expire.
Backwardation : When the spot gold price trades at a higher price than Comex futures prices. (Paper gold and Silver)
Prices are set by supply and demand. There is an infinite supply of paper Gold but a finite amount of physical Gold and Silver. Many people believe that the recent price of gold has been manipulated lower by the selling of large amounts of Gold into the paper futures market. The strong demand for physical Gold can be seen by looking at the divergence between paper and physical Gold and Silver prices. We have also seen record US Mint sales and massive premiums to spot prices being paid by investors looking to take physical delivery of either Gold or Silver.
Fractional Reserve Gold Leasing
Fractional Reserve Banking is when only a fraction of all deposits need to be kept in reserve by a bank. Most of the the deposited funds are loaned out keeping only a fraction in reserve. In the event that all clients attempted to withdraw funds simultaneously reserves would be exhausted and the bank would collapse. In practice this system of lending results in multiple claims on the same asset.
Western central banks have adopted a similar strategy to offset Gold holding storage costs. Central banks lease their Gold holdings to Bullion Banks, who in turn sell this Gold into the spot market and reinvest the proceeds in other high yielding assets. As in the fractional reserve banking example above this can result in a situation where there are multiple claims on the same asset and could result in an old fashioned “bank run” with all the associated negative consequences. This would also put a great deal of upward pressure on Gold as Bullion Banks will be forced to buy physical gold in the open market to return borrowed gold to the the central banks. Evidence of the cracks forming in the system can be seen in the way the Fed has handled the Bundesbank gold repatriation request. See the video report from RT below.
Conclusion.
Traditionally investors in paper Gold very seldom take delivery or their Gold investments. The majority of this paper Gold and Silver is not backed by physical Gold or Silver so if more of these investors demand delivery of their physical precious metals or opt to invest in physical metal, prices could rise sharply as supply outstrips demand.
There is a shift away from investing in paper bullion as seen by the premium investors are prepared to pay to hold the physical metal. We believe that this trend will continue as long as governments continue to stimulate their economies with quantitative easing.
