Wednesday, September 2, 2009

Paper Gold During a Paper Promise Collapse?

I know many are excited about today's Gold, silver, and Gold and silver mining action today. It was an explosive move, to be sure, but before breaking out the champagne glasses, let's see what the move looks like in a few weeks. Remember, buy on weakness, not strength. Don't chase prices higher. If you bought precious metal investments a while ago, enjoy! If not, don't let fear of "missing out on THE big move" make you buy high only to find out in a week it was just da big boyz trying to lure you in before a big drop.

Long-term investors are just that. Traders are just that. When trying to trade, we all look for low-risk entry points to maximize our chances of success. I don't trade physical Gold, I own it. I look to buy more on weakness, not strength. I do trade the Gold miners and have had some success doing so. I would not consider adding new money to Gold miner positions here.

Anyway, rather than talk about the more obvious Gold and Silver price spikes along with the respective miner spikes, I would like to talk about paper instruments as a substitute for physical Gold. I don't like them and I think they are designed to trap the unwary. You see, Gold is the antithesis of Wall Street. Don't get me wrong, Wall Street traders are happy to trade any market they can move and make money in.

But Gold has no growth prospects, pays no dividends and really never changes. The world around Gold changes. Investing in Gold is a vote of "no confidence" in Wall Street and their sales pitches. Taking delivery of actual physical Gold rather than just buying the GLD ETF or other paper substitute is seen as "kooky."

People think it's risky to hold physical Gold but they will trust their life savings to Madoff, Goldmun Suchs or Citibank (aka Shittibank). The "paper" guarantees of the FDIC and SPIC are certainly likely to hold up for a while longer. But when it comes to Gold, you are basically betting on contraction, hard times, monetary storms and government instability. These are not rosy investment themes.

That doesn't mean these are incorrect themes for the current investment climate - actually, they are dead on accurate. What it means is that how you invest in Gold may end up being just as important as whether or not you do at all. I bring this up due to recent rumblings by the apparatchiks that commodity speculation has gotten out of hand.

The apparatchiks may be right, they are just a year late. New regulations on commodity limits have caused a double bullish ETF on oil (ticker: DXO) to be closed (here's a link with the story). I think now is a terrible time to be long commodities (Gold is not a commodity, it is money, but Gold is viewed as a commodity by those ignorant of such things like apparatchiks). However, I respect anyone's right to trade any instrument and they may end up making lots of money and I may be totally wrong about oil. My point is that DXO closed down just over 7% today while oil was flat. Not performing as advertised, eh?

Why did this anomaly happen? Because the DXO ETF is being shut down. The apparatchiks have put Deutsche Bank (the proprietors of DXO) in a position where it didn't make sense for them and/or would be illegal to keep this ETF going.

Such rule-changing actions taken unilaterally by regulators who have little to no knowledge of the markets they regulate and how they function hurt U.S. financial market credibility (as if our markets needed another blow!). These specific actions also hurt liquidity in the commodity patch, as retail investors traditionally shy away from the commodities futures markets due to leverage but were "all in" on commodities these past few years due to these new ETF-type instruments. Now, those against speculating in commodities may have some valid arguments, but it's a little late for that discussion, eh?

If Gold starts doing well while other financial products like stocks, corporate bonds and even government bonds do poorly, look out! Paper Gold is ripe for attack and "forced redemption" to be paid out in paper dollars at a discount to the "street value" of physical Gold, not a premium. Those who think they are insured may instead end up losing more than 7% on a day when Gold is flat or up - they may lose the most important part of their investment. That part is the insurance physical Gold provides against broken paper promises.

You can't eat Gold and I don't think you can have sex with it (I've never tried...), but you can hoard it as a means to preserve wealth and purchasing power. I'm not talking end-of-the-world scenarios here - not even close. I'm talking about more and more promises being broken as this credit contraction and economic depression grinds on (we're in the 1st inning here, folks!). Make sure you secure at least a little physical Gold once the price drops again if you haven't already (buy on weakness, not strength).

I love to speculate in paper, but one must be cognizant of where we are in the long-term cycle - a Kondratieff Winter is no laughing matter. As the Dow to Gold ratio continues to creep towards parity, more and more paper promises will be broken. Those who hold paper Gold don't hold Gold, they hold paper. And paper Gold is suspect right now, especially when one looks at the actual firms backing paper Gold products like the GLD ETF. Don't make the right bet and find that you are unable to collect on your winnings.

Actual physical Gold confiscation threats are unnecessary, as Wall Street and its siren song have convinced people to trust them with their paper products instead. With stocks, there is little choice - almost all the action is in the casino and even those who have secured physical stock certificates are still holding only a paper claim. But with physical Gold, you're able to keep at least a few toes outside the casino in case it catches on fire.

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