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Friday, November 14, 2008

Is a Gold Short Squeeze Coming?

I liked this post, via Yahoo Finance. It's about the possibility of a short squeeze in gold. It's interesting to see such an article on a "mainstream" news source. (Does Yahoo Finance count as "mainstream media"?)

Even though the FRN-denominated price of gold has declined this year, the S&P 500 has declined by a greater percentage. Gold is still a better investment than stocks! The value of gold itself has not decreased. The price decline is the result of a deflationary recession/depression, due to the Compound Interest Paradox.

When you see "the price of gold" quoted on TV or in newspapers, they usually are referring to the "spot price" or "futures contract nearest expiration". When that contract expires, they switch to the next month's contract.

There is a discrepancy between the "official" price of gold and the "free market" price of gold. The "official" price of gold is cheap, but many gold dealers have no inventory. They either are holding out until market prices rise, or they are only willing to sell at higher prices. For example, the official price of gold is $750/oz, but if you go into a coin store and buy gold immediately and pay cash, you might pay $900/oz.

It isn't immoral for a gold dealer who bought gold at $1000/oz to refuse to sell at current prices. Inflation is guaranteed, and the FRN-denominated price of gold should rise again soon. These dealers say they aren't able to buy at the current spot price, so why should they sell at the current spot price?

It is possible to arbitrage the discrepancy between the "official" price of gold and the "free market" price of gold. You can buy a gold future, pay the full price, and take physical delivery. Some gold dealers have bought gold futures, and plan to take delivery.

This could lead to a massive short squeeze. If "people owning gold futures expecting delivery" exceeds "supply of gold", then there could be a massive price spike. The world's central banks have nearly exhausted their gold reserves, which limits their ability to sell/lease gold to keep down the price.

I read that a "failure to deliver" occurred on a foreign gold futures exchange recently. In the USA, a gold futures clearing default would practically be the equivalent of complete collapse of the US monetary system. That would mean that nobody owning gold is willing to sell it for Federal Reserve Notes, no matter what the price.

That article suggests the possibility of a massive spike in the price of gold. The gold market could enter backwardation, which means that the December futures price is greater than the January price. For oil, backwardation is reasonable, because you need to buy oil to use now; a June futures contract is useless for heating your home in March. The primary demand for gold is monetary demand. For this reason, the gold market should *NEVER* suffer backwardation. If you believe that the economic system and gold market won't completely collapse, a June future and a December future are equivalent.

If the gold market enters backwardation, that's a symptom of complete economic collapse. It's an indication that gold traders anticipate a clearing default by the gold exchange, due to a greater demand for physical gold than available gold. If traders trusted the gold market, and backwardation occurred, then they would merely sell their short-term contract and replace them with longer-term contracts. Customers are demanding physical gold *NOW*, because they're losing trust in the financial system, and customers are concerned about higher inflation and hyperinflation.

The GLD ETF lends out its gold for short selling. In the event of a default, the GLD ETF might lose on its short sales. The GLD shareholders would be forced to take a loss. For this reason, I consider the GLD ETF to be inferior to actual physical gold in your possession.

I consider the price of gold to be the most reliable measure of inflation. In the short term, it is manipulated, but over 5+ years, this should be an accurate measure of inflation. The financial industry will probably be able to prevent a gold clearing default this time. An eventual default is guaranteed as people lose trust in the financial system and the final collapse approaches.


Anonymous said...

As an alternative to GLD, what do you think of the Central Fund of Canada (CEF)?

Anonymous said...

-The reason for PM stocks not going up is this: Calculate the worth of your mine stock after the nationalization of that mine. So, facing collapse, one expects revolutions and nationalizations from a commie government. This isn't a favorable forecast to buy paper ownership!

-December Futures Gold price would be equal to a January futures price, ONLY assuming that real inflation is accounted for. Therefore, within a fraudulent system that is using fiat paper for money, far away price is expected to be higher than a closer one.

Absent deflation in money, which isn't possible under fiat system, backwardation then signals a vanishing trust in the system, as you correctly noticed.

Anonymous said...

Elsewhere in the news on Nov 20 2008: - "...While many gold and silver stock investors have had enough and want out at any price, those buying in this selloff are picking up stocks of companies trading at less than ONE! times earnings or cash flow and as little as 30% of the cash companies have in the bank. I don’t know if there has ever been a time in history where a group of stocks has traded so cheaply while their operations have performed so strongly ..."

I ask you, gentlemen, what is it that the market knows that we fail to realize? I see only two outcomes, in which the price for gold goes higher and higher but the benefits of owning shares of a gold mine diminish further and further.

1. Government declares central plan for economy (communism), and nationalizes gold mines so as to stop the windfall profits to greedy capitalists.

2. US is forced to accept new world reserve currency, which is tied to gold. US is confiscating it's citizens' gold and nationalizes its gold mines in an effort to stave-off revolts (keep imports flowing by any means necessary) and keep it's government rich and alive.

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