Gold vs Gold (Paper vs Physical)

Confusing paper trading with real physical delivery can be very misleading. And here's why.

There has been a huge drop in the price of gold (and many other commodities) for the past few weeks and gold has declined from $1,000 per troy ounce to about $750 (so a decline of about 25%).

The reasons of this drop remain to be found, here are some possible explanations (not mine):
  • Government and Central Bank manipulation
  • Bank manipulation
  • Raise (huge rally) of the US Dollar
  • Lack of momentum and interest from investors
  • Decline in demand due to high prices ('Demand destruction')
  • Sell off by commodities Hedge Funds to meet their margin requirements
My opinion is that the latter explanation might be the right one, and if you add some downward momentum to be exploited by speculators, you probably would reach the current levels.

The reason I reached that conclusion are twofold:
1) Gold futures market (paper gold)
One futures contract for gold has a notional of 100 troy ounces and on a typical day, more than 100,000 contracts are exchanged. What does it mean? That every single trading day, about 10 million ounces or 300 metric tonnes of gold for future delivery are exchanged. This is an unbelievably huge amount if you compare it to the to gold production of 2007: about 2400 tonnes or 80 million ounces. So basically, every single trading day, 15% of the yearly gold production changes hand, and obviously, in the end, a very small fraction of this is actually settled with physical delivery.

2) In the meantime, in the real world (physical market), there is a major shortage of gold available for investors:
Kitco Precious Metal Store (probably the biggest store worldwide):
The following products have been temporarily removed from our Precious Metal Store until further notice due to production and delivery delays that retailers are currently facing:
  • 1 oz Gold bars,
  • 1 oz Kitco Gold bars,
  • 10 oz Gold bars,
  • 1 oz Silver Eagles,
  • 1 oz Silver Maples,
  • 100 oz Silver bars,
  • 1 oz Palladium Maples.

Basically, they've sold out of everything!!! Except the 1000 oz silver bars and the 1kg and 400 oz of gold. Not many private investor that I know can afford to pay between 14 k$ to 350k$ one shot.

Getting delivery of the physical in private-investor friendly way is becoming almost impossible. So you can tell me that I can always buy a futures contract and take delivery for it, but you would be being just a sophist. A single contract being for delivery of 100 troy ounces, it would mean $75,000 at current prices.

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