I often talk about physical gold vs. paper gold, so this week I thought I would spend some time expanding on this subject. In our “instant” world that we live in today, it is often difficult to separate the real from the virtual. What is actual and what is imitation will make all the difference going forward when it comes to the subject of gold.
Let me begin with the real or the physical subject of gold. Gold is a basic element and cannot be manufactured. Gold is a heavy metal. When you lift it, you can feel its weight. It stacks quite nicely and neatly and it stays put! It is also a scarce element and generally difficult to mine; human beings have used it as money for centuries. When you own physical gold it must be stored and insured against loss or theft because like any other physical possession, when it is out of your control, your ownership of it can be questioned.
Next we enter the world of paper gold. Paper gold consists of all those virtual gold products that exist as some sort of derivative of physical gold. A short summary of these would include swaps, warrants, options, futures and exchange traded funds. The derivative market in gold is roughly 100 times larger than the actual physical market. Translated, this means that the paper market in gold is 100 times larger than the physical market. This tends to have a tremendous influence on the price of gold on a short term basis. Leverage and debt can become enmeshed within the market and the price discovery mechanism can become blurred.
The truth is that without the physical, the paper has zero value. Physical gold holds value and stores wealth; paper gold carries counter party risk. Should circumstances arise when the paper market breaks down, the only winners will be those nations, banks, institutions and INDIVIDUALS who actually own physical gold. Most likely the price of gold in fiat currency terms will skyrocket at that time.
So, prepare now. Get that insurance policy and store a bit of gold away for a rainy day.