By Eric Sepanek,
Long-term market watchers and analysts are raising concerns that an interesting element of supply and demand could soon create a large spike in gold prices. They trace this potential price rise to the role of ETFs in today’s gold markets.
Many new buyers of gold and novice investors in the yellow metal are surprised to learn about the “paper gold” markets. For over a decade there has been a major growth in what is called the Gold Exchange Traded Funds, or ETFs. Today, contracts for the sale or purchase of gold may exceed the actual physical gold available by a hundredfold.
Creating a Large Demand for a Non-Existent Product
When the gold market started to see significant growth after the floor that was reached in 2001, there was a challenge to owning physical gold bullion. Outside of a limited supply of coins and certified investment bars, the primary market was in Good Delivery Bars. These bars of at least 350 ounces are quite expensive and difficult to store for individual investors.
The creating of ETFs, on the other hand, allows traders and speculators to buy and sell contracts representing gold, creating an entire market that moved with the price of physical gold. Normally, the contracts for the sale of gold regularly roll over and are settled for paper currency, not the gold the contract represents.
The real effect of this real versus paper supply of gold is that at any given time, a market shift or other situation could create an exceptionally large demand for physical gold rather than accepting a paper money settlement.
This is where the power of great demand against an inadequate supply creates upward pressure on prices – in the extreme, a super-spike in those prices. Some analysts, such as James Rickards, see that spike potentially in the thousands of dollars an ounce.
ETFs Could Spur a Domino Effect
Rickards and others have noted the impact of the Brexit vote and other factors on the ETF market. They note that the ongoing global economic malaise has created something of a potential perfect storm for a major crisis for ETF investors.
The strength of the U.S. dollar is a major factor in ETF market movement, as it affects the cost of gold to such countries as China. A weaker dollar allows for a greater demand from those gold buyers who see a bargain. In turn, that demand drives the price higher.
ETFs have a multiplier effect on gold prices, driving them higher as the market rises, and lower when there is a softening. For this reason, any movement of the market due to the numerous bullish factors will accentuate any potential price spike.
How High Can Gold Go?
These realities have the analysts looking closely at the actual movements of physical gold, as this will play a large part in determining how large a price increase occurs. According to Rickards, the Swiss report they have been exporting more gold than they import for at least four months. Switzerland plays a unique role in the gold market, as they do not produce gold, but rather refine the bars and scrap from other suppliers. They are also quite open about the monthly movement of gold, an important piece of information for those who buy gold.
On the other hand, countries such as China are very close-to-the-vest about their gold transactions and holdings. While China produces more than 450 tons of the yellow metal annually, they are large net buyers of gold. The lack of insight into their actual inventory is a major factor in trying to correctly assess global supply and demand.
The fall of any one of the dominos of a currency war, weaker dollar, major economic crisis, increased demand, surprises from China or India, or several other factors, could create that ETF crisis that would show that there is less than one percent of the physical gold available to meet the demands that would be made. That would certainly lend credibility to the idea of increase in the price of gold well in excess of 100 percent to 200 percent.