Market Talk #2 – Why Gold and Silver are not going up

Posted by Tokyo MadHatter on January 09, 2009

It is the Tokyo MadHatter back from last time, I hope we didn’t put you off following financial matters too much. A lot of financial commentators are told to make things sound good, especially the paid ones, well I prefer to tell it as it is.

So, to cap off the last blog, I will admit it, I did recommend Gold and Silver. Everyone knows, or at least everyone knows that during a crisis, people sell other “risky” assets, and try to buy less risky assets, ie the famous “flight-to-quality”. Now, as we non-North Americans also know, US Treasury bonds used to be considered the best “less risky asset” and were always the beneficiary of any flight to quality movement.

For the US investor, that is still true. But, for the Rest Of The World (ROTW) that has all finished. The ROTW can all see that the US government can’t be trusted anymore and they want real assets, not worthless IOUs, which in effect anything denominated in US dollars should be viewed as these days. The ROTW have decided that Gold is the asset of choice and to a lesser extent Silver too.

Now, let’s take a brief break here while I explain why buying gold is not so easy. Obviously the price is known, hey, it is quoted every day. Equally obviously, there is a limited quantity, so the amount you can sell is also limited. Thus, the incentive to sell it is limited. As it happens, there is very little money to be made in selling gold. Now compare that to say selling shares in a company, or selling units of a fund. A company can issue unlimited numbers of shares, equally a fund can raise unlimited amounts of money by issuing unlimited number of units.

What is the difference?

One is paper, one is real. The real one is not a liability. If you own gold it has intrinsic value that does not rely on anyone paying you back. So, since the early 70’s when the Nixon government finally broke the link between the US dollar and gold by refusing to exchange dollars for gold, the financial industry has gradually done a fantastic job of convincing us that paper has more value. And to a great extent it did. This spurred a lot of technological innovation, but as empires go, and the US dollar and US empire has followed, bad money chases out good, so, what began as a positive influence in global finance, ultimately ended up corrupting it, and unfortunately we are now seeing the cumulative effect of all this coming together in one major crisis.

Now, so the price of gold has actually fallen while the crisis got worse. How can this be? Well, what price are we talking about? We are only referring here to the price of paper gold, because the financial innovators long ago created a paper gold that could be traded along with all the other paper assets.

How can you believe this?

Go down to the local gold merchants, yes they even exist in Japan and find out how much gold you can buy. Good luck, there is hardly any physical gold available to be purchased at the moment.

What has happened? Well, if the price of gold is a market signal, there is a lot more demand for physical gold that there is physical supply. Ok, thanks MadHatter, anyone who has done economics 101 knows that in cases like this the supply will increase to meet demand, particularly if the price has gone up a lot recently. Well, yes and no, and no particularly because of the laws of physics. There isn’t enough gold for sale because global gold production actually fell last year, and some of the more popular places to buy gold, like the PerthMint have actually has to suspend deliveries because of supply.

Ah, I hear you say, the price should go up. Yes, it should and it does. Again, if you are familiar, there is a little thing called a premium. So, if you walk into a gold shop anywhere in the western world, you’ll actually pay $200-300 dollars more for the physical gold that the “paper” gold price that is quoted as the “official” gold price.

How long is this going to go for? That is a good question. I don’t have an answer, but, I would say that there is an old Wall Street theory. Everything is a theory if someone wants to argue with it, but maybe over time this will be renamed as the old Wall Street truism. The theory states that a price of an ounce of gold can and sometimes is greater than the price of the Dow Jones Index. Let’s see, the Dow is around $8,500, gold is $768. Can it happen again? It happened in the thirties, gold was $32 or so, the Dow went below that level. I leave this one up to your judgement

Tags: gold, silver, Stock Market, the market

Filed in Personal Finance