Long Gold for the Long Term

Long Gold for the Long Term

Jim Clark


Dollar Strength, the Euro and Gold

All eyes are on the US Dollar in recent weeks. The strong USD has put pressure on gold and silver prices late this week. The strength of the dollar reflects the uncertainty in the negotiations of the repayment of Greek debt to the International Monetary Fund (IMF). The potential of a Greek default has significantly weakened the Euro against the dollar for the past two weeks until Monday when positive reports on negotiations coming from the ECB and the Finance Minister of Greece supported a rally in the Euro.

Greece did not meet the repayment deadline of Friday last week, but in the world of government finance however, this is not a default. How is that?

Stand Back- This is how they do it downtown

As reported in The Economist this past week, “Despite a delayed payment to the IMF, a deal between Greece and its creditors remains in sight. In an abrupt change of plan, Greece will no longer make a €300m ($340m) payment due to the International Monetary Fund (IMF) on Friday. However, this does not constitute a default.”

“The Greek coalition government…will avail itself of a rarely used concession whereby all the payments of principal in any one month can be bundled together into one payment at the end of the month. The plan is to combine the money due on June 5th and three other payments due by June 19th into one overall payment of €1.6 billion, to be made by the end of June.”

Let’s make sure we understand this. In the logic of government finance, quadrupling a defaulted payment increases the chances that the payment will be made.  So, instead of defaulting on one payment, Greece now has the opportunity to default on four payments. How much farther down the road can they kick the can?

In anticipation of a pending disaster for the Euro, as reported in last week’s blog, demand for physical gold in Europe has increased significantly among all members of the EU. In Germany, the strongest economy in Europe, perhaps the world, gold buying has increased by 20% in the first quarter alone. In other words, those who can afford gold are buying for the safe haven of the yellow metal.

The Developing Shortage of Physical Gold

The COMEX does not have enough gold to meet its June delivery obligations. There are 375,000 registered ounces in COMEX warehouses against 550,000 ounces of required delivery claims. These delivery claims must be met with physical gold, not dollars or gold contracts. This is a shortfall of 175,000 ounces. There is not enough COMEX gold to meet the demand for physical delivery. A shortfall of this magnitude has never happened before in COMEX history.

This means the clearing members of the COMEX must source the gold elsewhere in international markets to make delivery to the owners of COMEX contracts to buy gold. (A “clearing member” is the financial company that guarantees the contract performance of the traders.)  Industry analysts have long suspected that gold futures (paper gold) prices are artificially suppressed in delivery months to reduce the cost to clearing members of sourcing physical gold in international markets to make “good delivery” of physical gold.

Paper Prices and Physical Gold

The COMEX is the world’s standard setting exchange for gold prices. Any widespread default by clearing members would cause the COMEX to lose its status as the international standard for gold pricing. Any default would send gold prices soaring and put at risk hundreds of billions of dollars in off- exchange traded gold derivatives contracts.

Despite the price of paper gold drifting lower, the supplies of physical gold are increasingly tight and the owners of physical gold are holding on to it. That is why the stock of gold in COMEX warehouses is at historic lows. This is a serious liquidity problem.

UBS (formerly Union Bank of Switzerland) published a report last week in which they said, ““The reality is that gold holdings have increased over the past decade or so and, even taking into account the cleanout in 2013, the market is still longer than it was in the previous decade,” A decade in which the price of gold increased by almost 300%.

The key takeaway from this unprecedented shortfall of physical gold at the COMEX is that a situation of significantly tightening physical supplies and lower paper prices cannot continue. The paper price of gold must rise to reflect real world demand for physical gold. Otherwise, there will be more and larger shortfalls and default risk for COMEX gold.

With gold trading below the average cost of mine production and the international supply of gold rapidly shrinking, we have never seen a better opportunity to buy gold.

“I’ll be keeping a sharp eye on the market and I encourage you to do the same!”