17 May 2013

Paper Gold, Metal Gold - When Worlds Diverge

"Price discovery is not a sexy function of markets, but it is critical to the efficient allocation of scarce capital and resources, and to the preservation of the long term wealth of investors and the economy as a whole. If price discovery is compromised by manipulation, then we will all be gradually impoverished and the economy will be imbalanced and unstable."

London Banker, Lies, Damn Lies, and Libor

There are a number of ways to account for it, but this divergence between 'market prices' and real world supply and demand fundamentals is at the heart of a problem that is called 'the mispricing of risk.'  

That same sort of mispricing of risk is what led to the recent financial crisis, as the values placed on Collateralized Debt Obligations began to plummet from their artificially high levels, abetted by a credit bubble caused by the Fed policies, control frauds, and lax regulation.  The mispricing of risk was also at the heart of the LIBOR rigging scandal, and the gaming of the energy markets by both Enron and more recently JPM, as it is alleged.  These paper games always have real world consequences, and they are rarely beneficial except for a few.

While there are some differences between the gold and silver ETFs that purport to own specific amount of gold, and tracking products that own no shares or none of the underlying commodity, there is little doubt in my mind that the pricing mechanisms of the US and UK markets, at the least, have become perversely detached from real world fundamentals once again.

Such detachment is inherently unstable, and increases systemic fragility.

This includes not only the metals markets, but other commodities, stocks, and certainly bonds as well.  The divergence is justified with the notion that the central bank and its associates makes of the market what they will.  Perhaps we should start calling this 'Crowley-nomics' after England's 'the whole of the law is do what thou will' bad boy.

People do not like to stand up and say so when this sort of divergence happens, because rising markets tend to make such warnings look foolish. And economists can find a rationalization for almost anything in the manner of lawyers and other breeds of sophists.

These things run on momentum and bad behavior by some fairly powerful institutions and individuals. And there is a great deal of money to be made in the meanwhile, and a status quo to be protected.  Timing is problematic when trying to determine when a somewhat opaque control fraud is going to be forced to unwind.  They can remain pathological longer than you can remain solvent, to borrow a phrasing.

There will be a reckoning no doubt, and they always take their shenanigans a step too far.  But try not to jump in front of their boots as they have their way in the short term, since it would seem they operate with semi-official sanctions, and plenty of easy money.

My suspicion is that some portion of this market operation we are seeing today is tied to making a point in the ongoing debate about the suitability of precious metals as reserve assets, and their inclusion in the new reserve currency. There is quite a bit of tension abroad amongst the financial groupings of nations, which I have referred to as 'the currency wars.' Perhaps the model of nations is misleading. It may resemble competing crime families amongst oligarchies more closely.

I do also think that some entity or entities were deeply in trouble on the wrong side of some trades that caused the monetary authorities to 'stare into the abyss' once again. Only time will reveal the truth.

But I agree with David, that there will be a 'closing of the gap' between paper and reality once again, most likely triggered by some 'black swan event' that simply no one could see coming.  Except those that the financiers have worked so hard to silence and discredit. 

And then there will be a thunderclap of convergences, and a recognition that we have been led down the same garden path by the irresponsibles once again. 

This is the continuing story of the will to power and the rule of law,  and the rights of individuals to protection of property and liberty against the incursions of powerful moneyed interests.  In history this is marked by an ebb and flow of lessons learned and forgotten.

Related: A Bull Market In Physical Metal - Maguire

Paper gold, Metal gold – When Worlds Diverge

The price of gold is going down. That is what the charts, newspapers and pundits are all saying. What I think they are deliberately not saying is that the value and desirability, as opposed to the price of gold, is going up and will go up further.

Make no sense?  Well I think it does if you remember there are two types of ‘gold’ for sale. One is metal, the other is paper. It is paper gold that is being dumped not the metal. The metal is being bought at a fair old rate. But because there is so much paper gold around and the major sellers and market makers in paper gold prefer metal and paper to be confused, even thought to be identical (their trade depends on this confusion), no one seems to be pointing out the very different dynamic happening in paper and  metal gold.

Paper gold is being sold. And those selling it are the likes of Soros Fund Management LLC and BlackRock Inc. As Bloomberg reports today,
Filings showed Soros Fund Management LLC and BlackRock Inc. (BLK) were among funds that cut stakes in the SPDR Gold Trust, the biggest gold ETP, in the first quarter.
Does that say Soros and BlackRock no longer want gold? No it does not. It says they don’t want paper gold. They don’t want paper claims of gold. For those that don’t know ETPs (Exchange Traded Products) are very similar to ETF’s (Exchange Traded Funds) and both a paper claims on something rather than the thing itself.

If you buy a gold tracking ETP you are NOT buying gold.  If you by an ETF based on bank shares, for example, you do not own any bank shares. In both cases you own a piece of paper which says it will match the price of the gold or bank shares. It is these paper claims that big players seem to be selling as fast as they can without it looking like they are going for the exit. In fact, I think that is exactly what they are doing.

The fact is there is a vast pyramid of paper claims on gold which dwarfs the amount of actual gold available. Since the trade in gold ETFs took off we have been living in a fiat gold world. There are as many claims on gold as there are bits of paper on which to print them. And this fact confuses a great deal of the punditry about gold as a safe haven.

In the Bloomberg piece we find Mr. James Moore, an analyst at FastMarkets Ltd. in London saying,
The reasons for holding safe-haven assets have abated…Investors are looking again at stronger growth assets.”
I think he is wrong. 180 degrees wrong. I think the reason Soros and BlackRock are selling paper gold is because they know paper claims are not safe. Bits of paper with the word gold printed on them are not gold themselves and their claims in the metal are not safe. I suspect we will find they have sold paper and bought metal.

I think Soros and BlackRock have sold paper gold because, contrary to Moore, the reasons for holding safe haven assets have not abated but are getting stronger. I am not saying ‘buy gold’. I do not offer investing advice. I am not saying gold will save you. I am also not saying that people are not looking for higher yielding investments. Because they are. They are caught in a nasty trap of really needing yield in a world they can also see is getting more volatile and less safe. What is a thrusting city boy to do? Answer, invest other people’s money in risk and keep quiet about what you are investing in yourself.

Of course you cannot get around the fact that the price of gold is going down. Which would seem to make my argument ridiculous. But it doesn’t. The confusion is that the price and value of Gold backed ETF’s not only ‘tracks’ the value of gold but impinges heavily on it. ETF’s are sold as a way of ‘tracking’ the value of a kind of share or commodity of ‘getting exposure to it’. But the whole family of Exchange Traded products has become so large, in some cases much larger than the size of the underlying market they are just supposed to be passively tracking, that they are not longer just tracking they are having a decisive  influence upon it.

Thus as people sell gold ETF paper, that is causing the price of not only paper gold but metal gold to decline as well. And what I think this is doing is creating a buyers paradise – if you have the pockets to take the risk. With one hand you sell paper claims on gold, let people confuse paper and metal and talk about how the price and desire for ‘gold’ is declining, and then with the other hand buy the metal.

End result the amount of paper gold declines but along side that decline some people sell real gold which you buy. You end up, if the game holds together, being able to buy real metal as the price declines, knowing that the price of paper and metal will diverge, at some point, rather drastically.

While Soros and BlackRock have been selling paper gold China, Russia, India and Iran have all been buying it. Last year alone (2012) China bought more than 500 tons of gold which is more than the ECB owns.

I continue to believe as I have for several years now that China and Russia along with India, Japan, Venezuela and Iran are looking seriously at sharing a new reserve currency and have planned to be able to advertise it as being significantly backed by gold. In that article I linked to a series of articles I have written looking at various aspects of the idea. I think the idea looks more and more likely.

For those who wish I have written about ETFs as being the Next accident waiting to happen and a part two in which I looked at the inherent instabilities of the ETF markets just waiting to blossom, especially as they grow larger than the market they are ‘tracking’.

Originally posted today at Golem XIV by David Malone, author of Debt Generation.