Paper Or Physical Gold Markets: How Pricing Works

There is a difference between paper gold prices and physical gold prices. In the gold industry, there’s a disconnect between physical and paper gold. The narrative of this disconnect or conflict is that physical gold takes a rebellious stance to the powerful empire of the paper gold market. Physical gold fight is stronger and more vicious of the two.

The paper gold market suppresses the price of other precious markets like silver by using derivatives, futures and other techniques to manipulate the outcome. Luckily, for physical gold this manipulation is doomed to fail. When the manipulation is exposed and paper gold collapses, the real market of physical gold comes up, pushing gold prices to the fundamental level that is reflected in the gold price market. This means despite the manipulation of the paper gold market the true or real price of actual physical gold will surface. This narrative makes gold price seem suspicious to potential investors. Investors fail to take informed decisions or react adequately to changes in the market, but they end up waiting and missing out on a lot of opportunities to gain.

The fact that the price of physical gold like bullion coins or bars always lags behind the spot price reinforces the idea of the disconnect between physical and paper markets. The truth is that bullion bars and coins are above the spot price because of the premium charged for refining gold, minting, and selling gold coins and gold bars to retail buyers. Gold dealers quote prices that are higher than those fixed by the London gold market because they bear the bulk of the cost than wholesale gold buyers. They have to add some mark-up to make profit.

The other thing that plays into prices is the limited capacity to produce gold bullion bars and coins that increases the prices. For instance, only the US Mint can mint US bullion coins and only the South African Mint can mint Krugerrands. When the demand for specific bullion bars or coin rises to meet the supply you will have higher prices. To illustrate the point: take how gas stations work. The price of gas goes up faster in response to crude oil price changes. The reason behind this could be a limit on competitive pressure. Gas stations do not immediately cut their price when the price of crude oil goes down. They need to recoup the money already spent to fill their tanks before that reduction of crude oil prices kick in. There is a slight delay in adopting the retail price of crude oil changes. The same can be said for gold dealers. So, gold dealers don’t always adjust their prices when the spot price goes up or down. Dealers wait to cover the cost of the high-priced bullion coins or bars.

When is the best time to buy gold? When the dollar high and spot price weak or the opposite of that. Remember 2013? After 10 years in the bull market, gold suddenly took a dive without provocation from the industry. But people decided to stick their heads in the sand and delude themselves into thinking it was a mere anomaly, that the fundamentals of the depreciating value of currencies will kick in raising gold prices! In April, 2018 the price of gold went up to $1,400 and then levelled out at $1,200. However, investors hoped that it would rise again. The word ‘hope’ is not particularly useful in gold trading and investments. If the price is going to go down, it makes sense to buy more gold.

We have a less than an admirable money system. It is too inflationary. Gold producers and sellers always want to believe that the price of gold will always go up. Logic dictates that if the supply of money increases the currency will depreciate and gold will go up. However, we need to factor in investor sentiment. People react differently to inflation. If inflation goes high, gold will become more expensive, but the US has had a modest inflation rate. Besides, the US dollar is not the only currency that depreciates as we have seen with the Indian Rupee, the Zimbabwean dollar, Venezuela’s Bolivar and others. The demand for the US dollar as an international reserve currency and contained inflation, the dollar is always attractive. Gold is inextricably tied to the dollar.

The moral of the story is that there really is no such thing as a ‘disconnect’ between the physical and paper gold. If there was a disconnect then the price differential would have created huge arbitrage opportunities. There might be a disconnect between physical and paper gold if there is a shortage. The amount of gold on paper would not correlate with the gold that is out there.

Sources:

  1. https://www.bullionstar.com/blogs/bullionstar/what-sets-the-gold-price-is-it-the-paper-market-or-physical-market/
  2. https://www.peakprosperity.com/podcast/81653/spot-price-precious-metals-becoming-irrelevant

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