Paper Gold vs Physical Gold – Craig Hemke

Paper Gold vs Physical Gold – Craig Hemke for Sprott Money

The old adage is: “If you don’t hold it, you don’t own it”. While that’s not necessarily true if you’re dealing with trusted storage companies, it is 100% true if you’re dealing with untrustworthy Bullion Banks in London, Zurich, and elsewhere.

As I type this on Tuesday, March 24, we are seeing an unusual confluence of events overwhelm the global gold market:

1. The U.S. Federal Reserve announced yesterday that they will now provide “unlimited quantitative easing” to combat the financial contractions related to the coronavirus. This is what we’ve known was an eventuality for the past decade…QE∞.

2. This news, plus the recent crash in prices, has led to a surge in physical demand.

3. And this comes at a time when refineries are halting production in an effort to fight coronavirus on a local level.

A perfect storm, so to speak. See the anecdotal evidence below:

So what’s going on here? As I type, there is a MAJOR disconnect between the spot price (evidenced as XAU) and the front-month COMEX contract of Apr20. Arbitrageurs have closed the gap today from $70 to the $36 shown below, but there’s still a long way to go.

For the current digital derivative and fractional reserve pricing scheme to keep going, the gap between spot and futures must close—either by Apr20 falling, spot rising, or a combination of both. IF THIS FAILS TO HAPPEN, The Bullion Banks will have a major problem on their hands.

Why?

You’ve no doubt noticed that dealers are swamped as physical demand related to price, virus fears, and QE∞ has emptied physical inventory around the planet. What price do you charge your customers for their new orders? With physical production offline, how are you supposed to know? And how do you hedge your risk if this requires a functioning derivative market?

Digital arbitrageurs may work to close the gap between futures and spot today, but for this to work long-term, you’ll need a fully-functional and trustworthy delivery market. How long before one returns? What if futures contract demand sends the Apr20 (or Jun20) price even higher? Will spot be forced to keep up?

The answers to all of these questions are unknowable as I type.

What we DO KNOW is that, just like The London Gold Pool failed in spectacular fashion in 1968, so will the current COMEX/LBMA Gold Pool fail at some point in the future. Why? Because confidence in the over-leveraged, unallocated, and just-in-time delivery system of “musical chairs” will crack and dissolve in a true physical delivery crisis.

Could this time be upon us? Maybe. It just might be. It’s also possible that The Banks will be able to hold their system together through this crisis. Time will tell. Just be glad you’ve heeded the warning from this space over the years. Only physical gold can truly protect your wealth through the eventual crisis and monetary reset. If you have some…great. If you don’t…you might try to find some before the music stops playing and the scramble for seats begins.

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Sprott Money

Various authors presenting analysis and commentary on the precious metals, economy and precious metals mining markets.