Who is going to buy gold?

Vitaliy Katsenelson's picture

This is the first in a series of what some may consider as “gold bashing” articles. I am not short gold in any shape or form. I have no axe to grind against gold bugs. I am simply presenting the other side of the argument in response to what I deem to be dishonest, gold-pimping commercials (e.g., “If gold prices went up to $5,000 this pile of gold would be worth $300,000”) that we are subjected to all day long on TV. I may be wrong, but I am honest.

Here is a trivia question for you: what country is the seventh largest holder of gold, ahead of China, Japan, and Switzerland? Well, it was a trick question: the seventh largest holder of gold is not a country, it is an exchange-traded fund, GLD. Yes, a fund that is not even five years old is the seventh largest holder of physical gold in the whole world, even ahead of mighty China.

When investors buy GLD, GLD in turn has to go out and buy gold, driving up the price. This raises a little question: who will be buying this gold from GLD when investors decide to sell it? Gold is one of those weird assets where nobody knows what it is really worth. You cannot run discounted cash-flow analysis to value it – it has no cash flows. It is an asset where perception and reality are deeply intertwined.

Investors buying the gold ETF (GLD) are influencing the price of gold, which is fair for the most part, as otherwise they’d be buying the real thing. The ease of buying GLD creates a higher, artificial demand – but GLD is still fair game.

The violent selloff in GLD will be caused by factors that are hard to predict today (e.g., hedge-fund liquidations) but that will drive the price of gold down dramatically unless a real buyer steps in (like another government sick of owning the US debt, for instance), and the gold price could get cut in half overnight. Suddenly, perception of not being a store of value will create the reality of gold not being a store of value. The gold game will be over.

Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo.  He is the author of "Active Value Investing: Making Money in Range-Bound Markets" (Wiley 2007).  To receive Vitaliy's future articles by email, click here.

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dcb's picture

gold is a hedge against the unknown. considering I know what central bankers are doing I consider it a good thing to own some. The idea that these folks are actually going to reign in the money supply (at least in dollrs) flies in the face of everything I have seen since 1982.

E Thomas St.'s picture

Then how does the price of gold from 1982 to 2002 figure into your analysis?

Anonymous's picture

If any are still reading comments...this guy is a schill...probably had lunch w BSB!

GO HERE....read his archives....he's a lawyer and disects the "prospectus" and has constantly ripped that kevin paid-for propagator of false informatin a new a**hole!
www.runtogold.com
and
www.drschoon.com
He interviews Fakete

Anonymous's picture

India/Indians had been buying gold for 30 years (largest importer) for 30 years and a 5 year old fund had highest amount of gold. You must get your facts checked before you post them.

As for who will buy gold when the prices are low ? once again go ask Indians !!

Anonymous's picture

India just bought 200 tons of gold, rumor has it - they are planning to buy another 200 tons of gold from IMF. Prices are all time high and lot more people are buying gold now then, when the prices were low.

--Gold Bashing - You MORON.

Anonymous's picture

India just bought 200 tons of gold, rumor has it - they are planning to buy another 200 tons of gold from IMF. Prices are all time high and lot more people are buying gold now then, when the prices were low.

--Gold Bashing - You MORON.

Anonymous's picture

Interesting article that raises some good points. However the claim that "The gold game will be over" is ridiculous. It's been around for 6000 years. Nuff said.

Mr. Mandelbrot's picture

I'd like to attempt to answer the author's question:  "Who's Going to Buy Gold?"  I think that as long as there are still human beings on this planet that choose to store their wealth in something real, there will be buyers for gold.  I cannot think of one other substance that I see signs advertising that it will be bought.  My local pawn shops don't advertise "WE BUY SOYBEANS," or "WE BUY COFFEE."   I like to imagine the bewilderment the intelligentsia of prior generations would experience if they were brought into our present where our preferred method of wealth preservation consists of speculation in abstract bits of information -- abstract claims to something abstract.

lookma's picture

When investors buy SPY, SPY in turn has to go out and buy shares of S&P500 companies, driving up the price. This raises a little question: who will be buying this shares of S&P500 companies from SPY when investors decide to sell it? Shares of the S&P500 companies are one of those weird assets where nobody knows what it is really worth. You can run discounted cash-flow analysis to value it – but the value of that cash (i.e. fiat currency) is rapidly depreciating. It is an asset where perception and reality are deeply intertwined.

Investors buying the S&P 500 (SPY) are influencing the price of shares of S&P500 companies, which is fair for the most part, as otherwise they’d be buying the real thing. The ease of buying SPY creates a higher, artificial demand – but SPY is still fair game.

The violent selloff in SPY will be caused by factors that are hard to predict today (e.g., hedge-fund liquidations) but that will drive the price of shares of S&P500 companies down dramatically unless a real buyer steps in (like another government sick of owning the US debt, for instance), and the shares of S&P500 companies price could get cut in half overnight. Suddenly, perception of not being a store of value will create the reality of shares of S&P500 companies not being a store of value. The shares of S&P500 companies game will be over.

===================

Maybe not an exact fit but you get the idea.

Where is any meaningful analysis?  Ignoring the elephant in the room - GLD as a proxy for physical gold, amongst a litany of other issues, I see an argument that the price is going up because people are buying it (appears you could substitue any investment in for the word "it"), but when the "violent selloff" comes (assumes a "selloff" that will be "violent" because of undisclosed, hard to predict factors), who will buy it? 

 

Josey Wales's picture

"Gold is one of those assets where no one really knows what it is worth".  Yup, that is why I think we should all stick to assets that are accurately priced in free and effecient markets; like bank stocks and REITs and maybe a few CMBS or CDOs to reduce systemic risk.  Just buy and hold and wait for those green shoots to take us right up to the goose that lays the OTC derivative eggs!

Anonymous's picture

Being long of Gold ( sounds like D. Gartman no?) I work with many professional money mgrs and the ones who use ps's in their holdings are suspicious of GLD and other ETF's. The same cannot be said of Canada's Central Fund. As a close observer of the pm's markets, one glaring question stands out about GLD's activities. Considering the weekly reports on it's holding, on what exchange or what gold market does GLD move it's ### tonnes? Not on any gold market I know on this planet. Those things are easily seen and accounted for based on the volume GLD claims. Sop how does GLD or other ETF's buy all the pm? Paper or OTC

Wake up, how do you think this whole Quadrillion plus derivative bubble works!

Anonymous's picture

GLD is a derivative...it is NOT convertible to gold, but is valued at the current price of Gold in US dollars. It supposedly is backed by physical gold, but gold held by banks is levered in the same way that all their other assets are.
Banks don't even actually own the gold, they lease it from the Fed.
Like all derivatives GLD is subject to counterparty risk and a run on the bank (people taking physical possession of gold). If the US dollar were to collapse due to runs on banks, GLD would be worthless.
It is a speculative tool, but is not a store of value.

i.knoknot's picture

i recall that you could take delivery of physical from GLD IF you were some special banking entity and you would take it in large chunks. Oddly, it seemed easier to sell your shares and head over to CRIMEX and buy a bar or two at the window... with fries.

 

Bron Suchecki's picture

The statements that COMEX futures contracts can be settled with GLD ETF shares is wrong.

That misinterpretation came from a GATA article talking about the announcement that GLD shares could be used in Exchange of Futures for Physical (EFP) transactions. It has nothing to do with physical settlement of a COMEX futures contract. I checked COMEX rule 113.02 and there is no mention of ETFs being allowed - only physical is allowed. See also seekingalpha.com/user/...

The issue with EFPs is explained better by Tom Szabo (silveraxis.com/todayin.../). His key point is that an EFP is an "exchange" and there is no change in the number of futures at the end of the transaction - so an EFP done with an ETF  does not "settle" a COMEX futures contract.

Anonymous's picture

GLD is a derivative...it is NOT convertible to gold, but is valued at the current price of Gold in US dollars. It supposedly is backed by physical gold, but gold held by banks is levered in the same way that all their other assets are.
Banks don't even actually own the gold, they lease it from the Fed.
Like all derivatives GLD is subject to counterparty risk and a run on the bank (people taking physical possession of gold). If the US dollar were to collapse due to runs on banks, GLD would be worthless.
It is a speculative tool, but is not a store of value.

dubaican's picture

I agree gold infomercials are irritating. They cheapen the investment and make it feel like a scam. However, i don't see a lack of buyers in the near future. Look at it this way would you rather own gold or the euro and sterling? Clearly there is an element of reserve diversifcation going on. Gold will benefit for as long as this period of fiat skepticims persists.

Mediocritas's picture

Wading into the paper PM debate. People do understand that we're talking about unallocated bullion right? (Just read the prospectus for GLD or SLV if you don't believe me). If you were to demand full allocation, or audit their 'holdings' then the chance of booked ounces matching physical ounces is exactly the same chance as me being the reincarnation of Michael Jackson.

I don't understand why anyone would want to take a long position in these ETFs. Risk after risk after risk with no reward bar simplicity. Best of all, your 'physical' holdings actually decrease over time due to the fee design of these funds. Perhaps the biggest smack in the face is that with allocated metal being such a small percentage of net 'holdings', your long position, in reality, can translate into a short, or worse, naked short position, thereby having the exact opposite effect on price that you would expect. I'm not saying that it necessarily will be, I'm just saying that the design of the fund means that it *can* be.

Call me a consiracy nut if you want but if you wanted to maintain or build a large short position on precious metals, what better way is there to do it than to run a paper ETF backed by unallocated bullion that makes it impossible for participants to take delivery and trigger a squeeze? I consider it a tad suspicious that when Bear Stearns went down, silver didn't squeeze big even though Bear held the single largest commercial short position, and perhaps the single largest % short position on any commodity in history (according to Ted Butler).

Bear Stearns was acquired by JPM which, instead of liquidating that insane position (a relic of hunting the Hunts), proceeded to add to it. Guess who the custodian for SLV is? Yes, none other than JPM. Similar story for HSBC and GLD.

From every angle this smells like a scam, which explains why many big names strongly suggest you stay away and take physical delivery.

Vitaliy may, or may not, be correct in suggesting that GLD influences gold prices. Once you understand how these ETFs actually work then you can see how the link between PM ETFs and real metal prices is not so easy to predict.

Pay close attention to China and Russia. If they demand full allocation and soak up physical from here on in with tulip-mania induced amonst the peons, then eventually these ETFs will break. As I've said before, I'm ready for the counter-intuitive long physical, short ETF play.

I wouldn't be me if I didn't end with the usual cynicism....those hoping for the BRICs to bust the decades long uber-short should consider that the BRICs are simply wanting in on the game and causing a little friction to get what they want. If the BRICs take physical and then launch their own paper ETFs then PM prices are going nowhere, just a brief pop while people change chairs then back to suppression as usual.

There is a glimmer of hope though that the BRICs are honest and are going to bust the scam open. How ironic to be depending on China and Russia to return 'free' to free market.

aus_punter's picture

Maybe Mr T was onto something all those years ago

Anonymous's picture

the worst analysis of the gold market i have ever read

Anonymous's picture

Anyone who is able/willing to read the GLD prospect and fully understand all the legal stuff involved, and concludes that they have the gold they claim, and believes that UK government (unlike US) will never confiscate gold, and .... may confidently buy it instead of the real thing.
All others should buy physical gold.

Anonymous's picture

The Elements of Deflation - John Mauldin's Weekly E-Letter

Next week, we will look at money supply and the velocity of money, savings, consumer demand, and more as we further explore the complex molecule that is deflation.

But one last thought, as I have had a lot of questions on gold recently. "Isn't gold telling us that inflation is coming back?" The answer is no. Since the early '80s the correlation between gold and inflation has dropped to zero. Gold has had very little to say in the last 30 years about inflation.

But what it may be saying is that paper currencies are a problem. Gold is going up not only in dollar terms, but in euros, pounds, yen, and more. My view is that gold should be seen as a neutral currency. The dollar is the worst currency in the world, except for all the others. Is it possible the Fed will not respond and print more money next year? Sure. And the dollar could rise as deflation kicks in. The only time we saw the purchasing power of the dollar rise in a sustained manner was during deflation, in the last century.

The race is not always to the swiftest or the fight to the strongest, but that's the way to bet. And right now, my bet is the Fed will print money to fight a double-dip recession and deflation. And gold would be one way to play that bet.

Sabibaby's picture

The commercials for Gold in America really don’t matter because America isn’t a player anymore. It’s about what the rest of the world is doing. America isn’t the driving force behind gold, it’s everyone else –the other 95% of the population.

flaxpin's picture

I think you present a fair view of the argument against.  But it's a large logical jump with your statement:

>> Suddenly, perception of not being a store of value will create the reality of gold not being a store of value. The gold game will be over.

Gold's perception of value can't be overridden, it's inate.  While the levels of perception can change, it won't ever go to zero.

 

luckylee's picture

I think people who are betting on paper gold will lose money. I am not buying GLD, I am adding more physical gold as soon as there is a correction.

Anonymous's picture

Question from a gold neophyte: Is it really worth paying a premium for bullion coins (i.e. premium over the spot price for the metal). Is there a better way to get physical gold without paying this premium?

Do you goldbugs feel you're getting ripped paying more for an ounce coin than an ounce is trading for? Or is it just the price of doing business?

Anonymous's picture

Take a look at the short interest in the gold and silver eft's. It's nonexistant - less than a day. And the weekly volume on GLD topped out in Sept '08 with big up volume while SLV's topped in Feb '09 on big down volume.

Anonymous's picture

Take a look at the short interest in the gold and silver eft's. It's nonexistant - less than a day. And the weekly volume on GLD topped out in Sept '08 with big up volume while SLV's topped in Feb '09 on big down volume.

Sqworl's picture

Im sticking to my diamonds...gold is not pure and to gamed into speculation...:-)

Anonymous's picture

Wow, if you like bid/ask spreads THAT much, perhaps you'd like trading eight months' out FXE options "at market".

Diamonds are lovely, but with DeBeers still controlling 80% of the market, things are not really in your hands. Unless you are buying bulk, either at the mine or in Antwerp, the spread is fifty percent minimum, more likely 100%.

Go to a local diamond dealer and try to sell him a 1 carat, D-IF fine make. He'll quote you 40 off Rap, while you probably paid, at best, Rap plus 20%.

Anonymous's picture

Vitaliy Katsenelson? Gold commentary? What is this a joke?
Click here to subscribe to future reports? This man actually manages OPM? CFA no less? LMAO

Pull-eaze ... no more jokes

Stuart's picture

He's a CFA!  Kool Aid drinkers society bar no equal.  'Nuff said.  Run as fast as you can away...

Anonymous's picture

Therefore, I PITY THE FOOL who does not get himself some GOLD bling. :-)

Anonymous's picture

Correction. If you had put your savings into gold 10 years ago, you would now have 286.5% more. (rather than 14.5% more)

Anonymous's picture

If you had put your savings into the Standard & Poor 500 stocks 10 years ago, you would now have 24.5% less. If you had put your savings into gold 10 years ago, you would now have 14.5% more. So why would anyone call it "nutty" to put savings into gold?

E Thomas St.'s picture

Shifting the timeframe to reference doesn't make the investment any better.

 

 

Anonymous's picture

30 years ago 2 silver dollar coins worth two dollars got you a full tank of gas; 2 silver dollars today worth around $40 do the same job....gold and silver don't go up or down in price; it's worthless paper fiat coupon currency that does....figure that out, and you'll change your entire perspective on stocks, bonds, derivatives, CDSs, etc etc fraught with counterparty risk....oh, and the goofball that warned about goldbugs going nuts over this stupid article, remember this, you will eat those words. Gold has gone up for the past decade for a reason: central banks are running out of gold and many of them are trying to buy it back. Now why in the hell would they want to store gold bricks in their vaults???? LOL. Ah, finance people, economists, bankers, politicians....poor bastards; the fiat empire is running out of steem; can't you smell the smoke coming out of the back of your nearest investment bank?

i.knoknot's picture

re: silver vs tank of gas: with tongue in cheek, i ask if a manipulated metals market cancels a manipulated oil market...

i'm with you otherwise.

 

gookempucky's picture

+ 100

Try using something other than wikepedia--GLD nothing but a paper chase. Countries rank as follows;

US-8100 tons (doubtful)

Ger-3400

France-2480

Italy-2451-swaps with UBS=probably tapped out

China-1054

Swiss-1040-sellers

Japan-843

Russia-523

England-piss poor

Have a great labor day all

Rollerball's picture

Lead, backed by gun powder wrapped in copper, trumps gold.

Disclosure:  long granite futures.

waterdog's picture

Fools are going to buy gold. I own gold, I am a fool. GLD will be required to prove it's holding of gold at the end of October. There is a good possibility that the SEC will stop trading if it does not, same for SLV. GLD does not hold the amount of gold it claims to have. Gold will be $ 980/once at the end of 2009, 2010,2011. But, you will be able to buy it from the government much cheaper. If gold is going to $ 2,500/ounce sometime in our lifetime, then what is the difference if I bought gold at $850/ounce or $400/ounce? Gold makes for a great story. Just like the story of my $ 90,000 house being worth $180,000 seven years after I bought it. If it was not for fools, we would all be broke.

i.knoknot's picture

please substantiate the GLD audit. imagine what would happen to the price of gold if GLD were proven NOT to have the claimed metal. wow.

that jump could buy a few beers (per oz of real gold...)

i look at the pictures on the GLD website and can't help but think hollywood and gold-coated plaster ingots. i guess that's how skeptical i've become. i can't help it when i look at the power structures and their agendas... consider the timeless 'wag the dog' flick.

wild world we live in.

michigan independant's picture

To many forget some lessons. Read gen. chapter 47 about value and the law of marginal utility since problems can exist and nobody with a sense can forget the ratio of production. Ask a question where do you get your food? Some say from the market. This is true but I was raised on a farm. Never forget your point a to b is not my point a to b and the farm is where I will retire. I think it is prudent to plan for your grandchildren's inheritance if they are worthy and accountable only. I received a gift from my father in a tax exempt structure. A gift is defined generational in our family. I will consider some metals but this spike may or could subside. Check mining chemicals which processes copper zinc etc its ticking up. Value in others household is not ours. Gold is a utility question to put you at ease in what time? Some Gold could never hurt.

Anonymous's picture

quite hilarious
feel ok to buy gold, but you could as well try to find a good phichcanalyst as well for your nightmares
the goldbugs expect the world as we know it to collapse
might happen
but not tomorrow
seems like people who gave up the the dream of getting rich by trading, and now buy stuff (gold) for the long run.
good luck
the establishment (here represented by mr kastelsohn) gave you tonite a hint

actually I'm doing the same, but with lithim, and related

Anonymous's picture

What is the best way to buy physical gold?

Anonymous's picture

gold is held because people are worried about currency collapse. plain and simple. these worries are probably overblown. however, even if there is a 1% chance that the u.s. dollar might collapse to 50% of its current value in the next 10 years, that chance of doom is enough to get people to buy gold, guns, and more guns.

maybe it's a 1% chance, but that's what people say in hind sight about the collapse and subsequent bailout of the banks.

the fact that the global net worth of the top ten gold holdings is less than the market cap of a few of americas largest banks , amidst a massive credit deflation which may well sink another one of the big banks (C or BAC?) is further support for people and countries that are increasing their metal and prescious metal holdings.

gold is a commodity, it just has a lower consumption/destruction rate than most. but then, it is also much more rare and costly to produce than most.