The paper market primarily drives the price of precious metals. The paper market is options, futures/forwards, and ETFs. Three major exchanges and a handful of smaller exchanges dictate the price. The three largest and most significant price-setting exchanges are the New York-based Commodity Exchange (COMEX), London Bullion Market, and the Shanghai Future and Gold Exchange. Other important but significantly smaller markets are Dubai, Japan, India, Singapore, and Hong Kong.
London primarily sets prices, and COMEX is the primary clearinghouse (intermediary) for precious metals. The CME Group owns COMEX and states that COMEX executes more than 400,000 futures and options contracts daily. Futures and options contracts are sophisticated hedging strategies, so most contracts do not result in the physical delivery of precious metals. Usually, around 1% of contracts end with the buyer taking delivery. Since delivery usually does not happen, the paper market’s price is subject to heavy and frequent manipulation.
For example, one of the seven market maker banks setting the price in London, JP Morgan Chase, was fined $920 million. JP Morgan Chase was caught manipulating the price of silver 1000’s times over eight years. JP Morgan Chase’s Global Chief of Precious Metals was just convicted of 13 felony counts of attempted price manipulation, commodities fraud, wire fraud, and spoofing precious metals prices connected to the fines paid.
The three main paper assets are future/forward contracts, options contracts, and ETFs.
What is a Future/Forward Contract?
Gold futures are like other future contracts in some ways and very different in others. A futures contract is a legal agreement to buy or sell something at a future date at an agreed-upon price. Futures contracts are speculation about future prices. A gold futures contract is for 100 Troy ounces, which costs $171,975 per contract currently. Gold futures contracts will expire sometime in the expiration month, and delivery will happen at a future date known as the settlement day. However, unlike a traditional futures contract, no gold delivery takes place most of the time. The seller, not the buyer, chooses whether to deliver the gold or buy out the contract. Around 99% of the time, the contract is bought out instead of delivered. Futures contracts are a zero-sum game. One side of the trade wins, and one side loses. Here are the Futures Contract Specifications required by the COMEX. Futures contracts carry an unlimited risk for both parties if the market swings wildly up or down before the expiration.
What is an Options Contract?
Gold options contracts are derivatives of future contracts. Options give the right, but not the obligation, to exercise a trade. The underlying asset is the 100 Troy ounce futures contracts. Think of options contracts as a bet on the outcome of a bet. If the future contract is the bet on which way the price will go, then the option contract is the bet on whether the investor chose correctly. Buyers of options need to pay an upfront premium to buy an option. Still, they are not required to complete the transaction if the market moves unfavorably. The buyer only risks the premium paid. However, the seller of an option has unlimited risk. Suppose you buy a “call” option. The higher the price of gold goes, the more money you make. However, the higher the price, the person who sold the “call” option loses money. Buying options is less risky than futures but rarely results in physical deliveries like futures.
What is an ETF?
ETFs (Exchange Traded Funds) are paper assets traded on exchanges tracking an index. The price of ETFs constantly fluctuates like a stock. Precious metal ETFs are connected to the price of the metal and are like owning shares of a bar of gold or silver. A Trust holds the metals. The price of GLD (gold ETF) is based on the price of 1/10th of an ounce of gold. In theory, owning ten shares should entitle a claim to one ounce of gold.
Despite convoluted and frequently repeated marketing from the financial industry, investors can’t redeem ETFs for precious metals. According to the SEC, only the Trust’s Authorized Participants, APs, are the only entities permitted to create or redeem GLD shares. Redemption and creation must be done in blocks of 100,000 shares. Even if you have the money invested, the SEC clearly states, “Only APs, not individual shareholders, can redeem shares from the Trust.” Today’s price would cost around $17.21 million to have a seat at the table and be one of about 12 banks to be able to redeem any gold.
The gold held in GLD has been decreasing. In June 2020, GLD held approximately 36.49 million ounces. Today, there are 31.39 ounces in the fund. Of the 5.1 million ounces removed, 4.17 million have been removed since May 1, 2022. Banks hold approximately 14% more physical gold on their balance sheets now than in 2020 and 11.7% more gold since May. The more gold in the fund represents more leverage and money the issuing bank can make.
Banks foresaw our current problems, sold their paper, and brought physical gold to their storehouses at unprecedented rates. It is very revealing that the banks believe the economy is in trouble when banks prefer holding physical metal over making money. Bank behavior tends to follow greed, but they are playing defense. What do they know? If banks thought the economy would improve soon, they would send more gold to be leveraged and sold as ETF shares. Instead, they are bringing it into their vaults at a record pace.
Don’t trust a cook that won’t eat their own cooking. If the largest banks on earth are moving away from the paper they created into physical metals, what should you do?
Call the U.S. Gold Bureau for your free consultation.