For months we have witnessing a worldwide paradoxical phenomenon which the press has widely reported. Because of the crisis investors fled most categories of assets (real estate, stock market, currencies, comodities) and many of them have invested a portion of their portfolios in gold, even causing shortages of coins or bars in many markets. Yet, and this is the paradox, the price of gold is not taking off its average price of 900 USD / ounce.

As a first step, in the second half of 2008, the commonly accepted explanation was that margin calls due to massive losses in other asset classes had required significant sales of gold by their holders, offsetting growing demand and this was probably the case. But since early 2009, the paradox remains and this explanation is no longer be sufficient to explain the status of the price of the yellow metal.

LEAP/E2020, therefore, tried to understand the "why" of this paradox and draw conclusions for GEAB subscribers. Let's keep in mind that the analysis of gold market is particularly complex because it blends several phenomena that obfuscate its actual operation:

1. It is simultaneously a highly speculative market where information of all sorts is circulated to serve any particular market trend and a market for an industrial raw material (namely the jewellery trade)

2. It is a market driven by investors particularly convinced, sometimes ideologically, of the 'uniqueness' of gold as the only legitimate basis of an economy and a healthy currency

3. It is a market under the close supervision of central banks and states which, in times of crisis, regard it, on the one hand, as a potential danger to fiat money and, on the other hand, as an asset of « last resort » which can be subject to seizure when the crisis becomes uncontrollable (1)

4. Finally, it is a market that deals with a metal identified as wealth for at least five millennia, known to make people go crazy!

So, to try to understand what is happening currently in this market, caution is required. However, in the many shadowy areas of the international gold market, a darker area than others seems to provide an explanation of the current gold price and from which at the same time, useful recommendations can be drawn for GEAB subscribers. It is the difference between the two types of market for the yellow metal:

1. The physical market, which requires real transactions of yellow metal. It sells and buys real coins and bars that one must then stored oneself (in a bank safe, in one's garden or under one's mattress (2))

2. The paper-gold market. It buys and sells certificates that guarantee the possession of a quantity of gold (coins or bullion), which the seller agrees to provide the buyer physically if required.

The practical aspect of the paper gold market is obvious. It avoids the complex problems of transport and storage for buyers of large quantities of gold and facilitates all transactions, increasing liquidity in the gold world market. However, it requires absolute trust in two types of operators in the heart of this market:

. Sellers
. Regulators

The first have to be above any suspicion and respect the rules that require them, in general, to possess physical gold equivalent to 90% of the certificates that they negotiate. The latter must be even more legitimate because they must ensure that all sellers of paper gold comply with the regulations.

However, the performance of global financial institutions and regulators of the major international financial centers over the past two years does not inspire great optimism. The first acted (and still act) as top-level crooks and the latter as the accomplices of the former, especially on Wall Street and the City ... which, coincidentally, are the international centers of the gold market (3).

LEAP/E2020 believes that because of the current struggle for survival of major financial institutions and of the crisis in the international monetary system, it would be very naive to assume that the regulators of the gold market play fair, in so far as this would be, first, to the detriment of the Dollar, the British Pound and most fiat money and, second, to the detriment of the balance sheets of major financial institutions, already seriously weakened. We therefore believe that the paper gold market no longer operates by the regulations and that many operators in this market do not respect the requirement to hold 90% physical gold as collateral. It is impossible to know precisely at what collateral they hold but it is likely to be very low, at least at a level that would pose a serious problem if tomorrow more than half the buyers demanded conversion of their certificates into physical gold (4).

For the record, the United States acted, to all intents and purposes in the same manner when a manipulation when, in 1971, President Nixon suddenly announced that the dollar was no longer convertible into gold. Before 1971 the Dollar was equivalent to a certificate on gold and the United States a seller of paper gold which forgot to comlply the constraints of coverage of its certificates, and eventually had to acknowledge that it could no longer honor its contracts (5).

Evolution 2004-2009 of gold sales by the central banks of France (red), Switzerland (blue), The Netherlands (green) and the rest of the world (orange) - Source : World Gold Council / VM Group, 02/2009

Of course, the gold market is also affected by the supply of precious metal. These sources are mainly mining (which is basically stable), central banks’ sales or sales by international institutions like the IMF (6). By massive sales (public or discrete) states can easily alter the gold price (7). Currently, the level of central banks’ gold sales has hardly changed. For many European states, which, because of the Euro, can no longer rely on the direct income of gold sales because they only receive the interest (the capital is in the hands of central banks), the relevance of sales is now marginal. The monetary storm coming by the end of summer 2009 may encourage governments to exchange their foreign currency reserves, particularly U.S. dollars, for gold. As far as the United States is concerned, its gold reserves, even valued at the current market price (about 300 billion USD (8)), represent only a small fraction of the exorbitant amount committed by the US under the current crisis (and there is great uncertainty about the exact amount of current U.S. gold reserves (9)). However this LEAP/E2020 analysis and recommendations does not pass judgment on an evolution of gold price, but on the safety of the investment. That in the end the buyer of gold has physical gold in the hand instead of a piece of worthless paper.

In conclusion, our team recommends that its subscribers who do not want to speculate (and therefore face the risk of losing their entire investment (10)) must stop investing in paper gold and should limit themselves to physical transactions (11). It This may be difficult in some cases, but as we get closer to the breakdown of the international monetary system in the summer of 2009, we believe that there is now a major risk that owners of paper gold will end up losing all their investment when sellers recognize that they cannot honour their contracts because they are unable to supply the physical gold they contracted to.

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Notes:

(1) Many countries had policies prohibiting private possession of gold and / or setting up forced sales to the State at ridiculous prices. The United States and Germany have experienced such situations in the twentieth century. The United States also maintained a ban on private possession of gold from 1934 to 1974. That is why, for the last two years LEAP/E2020, has regularly reminded its subscribers that one must be wary of the gold market and closely monitor the attitude of public authorities in this area. Although currently it is useful to diversify up to 30% of one’s assets into precious metals (gold, silver, platinum).

(2) The last option is safer but more uncomfortable.

(3) Sources: TraderTech; Quid

(4) Avery Goodman has published two interesting articles on the subject referring to two cases invoking the possibility that the New York Stock COMEX is already out of stocks of gold for certain product categories and that the European Central Bank has intervened discreetly to avoid a problem of coverage in the same market. Sources : SeekingAlpha, 03/27/2009 ; SeekingAlpha, 04/02/2009

(5) The United Kingdom did the same in 1931 because of the economic crisis.

(6) The latter announced a sale of 400 tons of gold last year as part of its reorganization. The recent statements of the G20 summit in London on IMF gold sales are not clear at all. Are they the planned 400 tons or additional quantities? A mystery, and, anyway, it is the general assembly of the IMF which will decide. Source : Reuters, 04/02/2009

(7) For an inventory of world gold reserves: Wikipedia.

(8) Source: Watoday, 03/09/2009

(9) In recent years, frequent changes of the wording in the classification of the various components of the gold reserves of the United States have generated a series of questions about the exact quantity of the country’s gold reserves. Their use by the ESF (Exchange Stabilization Fund, whose interventions on the foreign exchange market in the summer of 2008, which LEAP/E2020 has already described, is suspected to have greatly reduced the country’s gold reserves contrary to official statistics. Source: MarketOracle, 01/31/2007

(10) We take this opportunity to remind subscribers that our analysis and recommendations are never intended for speculation purposes. Anyone who uses them for such purposes takes the risk any speculator should assume: losing his entire bet.

(11) And convert their current certificates, if any, into physical gold immediately.