Physical vs. Paper: The Real War

Mon, Apr 16, 2012 - 9:04am

Kathy Derbes, CEO of KDerbes Precious Metals, is a bullion dealer offering services to a broad range of clients from individual investors to hedge funds

Paper Pricing Fuels Volatility, Physical Buying Takes Advantage

After experiencing years of steady price increases in precious metals followed by swift declines, we are not strangers to volatile markets. Many of us have become "seasoned" to exceptional price swings even though their frequency and magnitude can be wearing. The same can be said about any battle. Right now we are in the middle of a monetary war to return to a sound monetary system. The paper gold pricing system vs. the physical holders are on the front lines.

Here's another truth: what doesn't kill us makes us stronger. Physical gold is in and going into strong hands. On waterfall price declines in the paper market, physical purchases accelerate. We see virtually no selling of physical during times like this. Further, in our daily conversations we hear absolute resolve of physical gold owners to stay the course until we are once again is a sound monetary system. Collectively our belief in gold as the antidote to a failing fiat monetary system is stronger than ever, even though precious metals prices seem to take the steps up and the elevator down. As Jim Grant has said (paraphrasing) "gold is for the weary, not necessarily the frightened.

Big Hat, No Cattle

After trillions of dollars in monetary stimulus we have low economic growth and very little improvement in unemployment. If statistics were available to assess the quality of jobs being created we would likely see a deterioration in actual wages earned on a per-job basis. Many are working multiple jobs just to maintain a prior earnings level. The quality of one job is simply not equal to every other job. We all believe if we work hard and smart we'll get ahead financially. That of course is the case, unless the money you're working for is dying.

The unintended consequences of money printing have been steadily showing up in higher prices for what we need in our daily lives (food, energy). We are getting squeezed between the two (less income, higher prices) and our quality of life is declining. Our current precarious economic environment has been reaped upon us courtesy of the Federal Reserve. For decades they have been meddling in the free market system, muting the business cycle thereby promoting massive miss-allocation of capital, QE+ and a myriad of other money printing (currency destructive) programs.

Because the real world doesn't march to the tune of academic models, the Fed cannot control the economy the way they thought they could. Trillions of newly printed dollars have produced volatile markets, a barely stable housing environment, a difficult lending environment, higher unemployment and an enormous debt burden. Because what they have done has failed by most metrics, all they have left is the perception of credibility. This explains their intensified jawbone method to try to convince the public that their high wire economic balancing act will eventually stabilize the economy and and produce prosperity. When the Fed's veil of credibility is pierced and the majority no longer believe they can "save" us from the pain of over-indebtedness and a myriad of other structural economic issues, they have a huge problem. That point in time appears to be swiftly approaching (when the bond market takes the printing press away from them). The point is, as economic reality reveals the truth, the Fed's jawbone attempts to defend its fiat monetary system come alive. Remember, it's all about perception. The Fed's credibility hangs in the balance.

Talk is Cheap: Watch What They Do, Not What They Say

Statements from Fed members trying to thread the perception of a not too hot, not too cold economy continue to whipsaw equity, fixed income and commodity markets. High frequency and other day traders focused solely on price change course suddenly when short-term economic numbers indicate QE is imminent, delayed or "not necessary". In this roller coaster environment we must remember that the Fed will continue to do what they always have done, print money. More QE is coming. The one market they fear the most is the bond market so watch it closely for clues. The Fed simply cannot let interest rates rise or servicing our enormous debt will be like climbing up a mudslide. Remember, the truth lives in what they do. It tells us far more about our financial future than what they say.

Cheap talk, market reactions and a dying monetary system worldwide have also caused enormous volatility in the price-setting paper metals markets. Most of the violence seems to come on the downside as the price takes ten strokes forward and gets hit with a title wave of selling. There are reports of thousands of gold futures contracts sold in minutes causing huge price setbacks (and running stops) - obviously without the intent to maximize profit. On these waterfall declines when the fractional paper market runs the gold price down, the fully accounted for physical market soaks it up at lower levels.

Strong Hands

There are reports of tonnes of physical gold being bought at lower levels, literally tonnes, presumably by sovereign entities. The west is likely losing tonnes of physical gold to the east. On the individual level we see participation in the physical gold market broadening and getting deeper as they too add to their collection on any break in price. At the same time there are virtually no sellers. This tells us physical gold is in strong hands and going into strong hands as the paper setting market facilitates the trade.

This is all happening at a point in time when the overall individual participation in the metals markets, at least in the U.S., is still extremely low. How many people do you know who own even one ounce of gold? Current holders are positioned perfectly, ahead of the point in time when more and more people understand their financial future depends on a sound monetary system. Physical gold and silver are the basis of a sound monetary system. And because they are in strong hands they are not likely to be re-offered again anytime soon, eventually only changing hands at much higher prices.

How Many Tonnes Does It Take?

The fiat paper monetary system is dying. The silent army of strong gold owners and their collections are growing. More debasement of our dollar will hasten the arrival of the day when the physical market is in control and the paper market can only respond to physical demand. How many tonnes will it take? No one knows of course but we are on the path to find out.

Stay the course and focus on the truth. A sound monetary system will prevail.