THE PAPER GOLD TAIL WAGGING THE GOLDEN DOG

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by Egon Von Greyerz, Gold Switzerland:

Investors may hope that the biggest financial experiment and debt bubble in history will last another 100 years. And they can pray that the currency system which has lost 98% of its value in the last 50 years will last another half century.

But that would be investing on a wing and a prayer with extremely poor odds of success.

Since neither the wing nor the prayer is likely to save investors from the greatest economic and financial collapse in global history, the need for protection or insurance is vital.

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We are of course looking at probabilities and not certainties when we evaluate the risk of catastrophe.

With virtually all asset markets – stocks, bonds and property – at all time highs, investors are clearly judging the risk of failure to be nearer zero.

Personally I judge the risk of a collapse of markets and the economy to be between 95% and 99%.

So a risk range from 0% to 99% is quite a spread. An actuary would probably pitch it at 1 to 5 percent risk and sell catastrophe insurance on that basis.

Financial Insurance Dirt Cheap

With both investment markets and the insurance industry evaluating risk as virtually non-existent, that is the time when insurance is really underpriced or in simple terms dirt-cheap.

So what kind of insurance are we looking at here. The conventional investment market will look at hedging financial risk in all kinds of complex financial instruments in the form of derivatives.

What the so called “experts” don’t realize is that they hedge their investments with the same instruments that created the risk in the first place, such as paper gold. This would be a real financial tautology.

Or in other words: RUBBISH IN – RUBBISH OUT.

Financial tautologies are often the demise of investment markets, especially when derivatives are involved. The 2006-9 Great Financial Crisis was caused by a chain of interdependent derivatives that at the end of the day proved totally worthless.

Coming back to insurance there is no better time to buy it than when the market underestimates or doesn’t understand the risk.

It is obvious that it serves no purpose to buy the insurance in the same fake  instruments that in themselves represent the risk. So why buy paper gold?

Insurance That Withstands the Test of Time

Instead of buying insurance protection in the same form as the risk itself, the insurance must be an uncorrelated asset. It must also be an asset that has withstood the test of time and held its value and purchasing power throughout the ages.

physical gold is clearly the best combination of wealth preservation and insurance compared to any alternative and that by a massive margin.

At the beginning of the 2000s we decided to invest in physical gold in a substantial way for our own funds and the investors we advised. Since the 1999 bottom, gold was then stabilising and at the beginning of 2002 we considered that the 20 year correction was over and we bought gold at $300.

Back in 2002, we considered gold to be unloved and undervalued. Gold had gone from $35 in 1971 to $850 in 1980 and then corrected down to $250 in 1999.

At the time, central banks were selling gold, including the bank of England and the Swiss National Bank which both sold a major part of their holdings at the very bottom.

The Paper Gold Tail Wagging The Golden Dog

When the tail wags the dog, the dog is in a state of disequilibrium that is transitory.

This type of imbalance can only last for a limited period or the dog will not survive. There  are two options; either the dog will take control of his tail or shed it. The tail cannot survive without the dog’s body whilst the dog can cope very well without a tail.

Real, unencumbered physical gold does not need the paper gold market to function. The paper market hinders real price discovery. The gold paper market receives a respectability that it doesn’t deserve.

The gold paper market pretends to be backed by physical gold when in effect it is gold in sheep’s clothes.

It is like putting a Rolls Royce badge on an 1950s model Skoda and charging a Rolls price for it.

The Fake Paper Gold Market

So we are looking at paper gold market which is corrupt and fake. It exists for the benefit of central banks, the BIS (Bank of International Settlement) and bullion banks.

In the short term, the paper gold market certainly harms the only genuine gold market which is physical. But artificial markets or instruments have never survived in history. Just look at the fact that every fiat currency in history which has failed.

And so will paper gold. It is only a matter of time.

The sheer volume of paper gold trading reveals the desperate pressure this market is under.

Gold trading by LBMA banks and futures exchanges amounts to $180 billion per day.

This is a staggering 350X the daily gold mine production.

So we ask ourselves how a dog can function properly with a tail that is 350X bigger than his body? The simple answer is that he can’t. I do realise that this is a slight oversimplification but nevertheless it does highlight how absurd the gold market is today.

The only reason why gold trading volumes are totally out of proportion to the actual amount of physical gold available is that 99% of the gross trading activity is in the paper market.

Is 50% of central Bank Physical Gold Lost Forever?

Central banks supposedly hold 34,000 tonnes or $2 trillion of physical gold. Since most central banks never do a full physical audit, verified by external auditors, no one knows how much gold they actually possess.

It is likely that at least half or 17,000 tonnes have been leased to the market or covertly sold. The part which is leased is unlikely to ever come back in physical form. The gold is lent by a central bank to an LBMA bank which in its turn sells it to a buyer in say China or India. The buyer will never return the gold which he now owns outright.

The central bank has an IOU from the bullion bank. But that piece of paper is not worth more than the paper itself. There is more than 100X paper gold issued by the LBMA banks than physical gold held by them.

That kind of imbalance is a recipe for disaster. So when the market asks for physical delivery they will be staring at empty vaults and computers full of zeros representing worthless paper gold.

At some point in the next few years, that will take the paper gold market to zero and physical gold to unimaginable levels. It would also lead to FreeGold which I discussed in my previous article.

Buying Insurance Must Not be Finessed

I don’t know anybody who waits to buy financial insurance until the day before the fire.

Since gold is critical financial insurance, the purchase should not be timed until the risk occurs.

The whole purpose with physical gold is that you buy it and forget about it. You mustn’t try to finesse the buying to get a “good deal”. We have seen many examples of investors waiting for a certain level lower than the market and when the price doesn’t get down there, they miss the boat altogether.

Gold is Much More Than Insurance

In times of high risk in investment markets, gold, as I have explained above, is the best insurance available. But the beauty of gold currently is that it is not just the perfect insurance but also a superb investment.

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