Dont Look, and Dont Tell..Paper Gold Prices have decoupled from Physical Gold Demand and Supply

I was having a chat with several colleagues of mine in the precious metals industry over the last few days, and a few things have become readily apparent.

1. The massive sell off in paper gold contracts has forced the paper price down substantially

2. The majority of this sell off appears to be coming from large financial entities in liquidity crisis, and desperate for some relief and cash flow that are divesting themselves of metals

3. This does not reflect what the common man investor of gold and silver is looking for, as demand at the retail level is many fold higher than it has been in some time, with some of my colleagues completely inundated with buy orders that they cannot keep up with, nor find physical stocks to provide from

4. Physical supply at the retail level has seriously dried up, especially in silver, but now in gold as well, as it seems the US Mint has ceased taking orders for new American Eagle Gold 1oz coins. In addition, throughout the US on a retail level reports of physical shortage are common.

So what gives here? How is it possible that the prices of metals have plummeted, yet there is no metal to be found anywhere at retail?

A few possibilities come to mind:

If hedge funds are divesting themselves of metal, yet individual investors are buying like never before at the retail level, it may not impact the paper gold or silver price at all, except for the downside, because its doubtful that the few options traders are going to be able to meet what hedge funds can dump. A hedge fund that is on emergency life support and demanding liquidity may exit its metal positions at any cost, and not be met by buyers, as most retail investors are buying at coin shops and not the COMEX or NYMEX.

I have a colleague who has informed me that he has personal knowledge of a default of a delivery of metal on COMEX, the contract holder being forced to take Fiat currency instead of the metal because he got “bumped” at the warehouse because an Industrial user took precedence. What does something like this say about our markets if true?

Is it possible we are looking at trading defaults on a larger scale? Will such trades move to other exchanges in London and Asia? Will such defaults cause a London Gold Pool type escalation in valuation as history records of similar events?

Will actual physical prices decouple from the paper spot price? I suspect this is likely, and in fact we are already seeing such premiums at the retail level. It is my opinion this will only continue, and accelerate as we move farther into this bull market.

While the paper markets will continue to see sharp volatility over the next few years as financial institutions require liquidity infusions to offset the massive write-offs that have still not been reported from the credit crisis, mom and pop investors are buying all they can get their hands on, and not reselling back into the market as has been normal for many years.

No, this marks a definate turning point, and while some will only watch the price action and continue to declare gold no more than a commodity and barbarous relic, some will understand the deep fundamental factors in the economy that will force gold to revalue higher over time.

Yes, some of us will be doing quite well as this unfolds. The question now is, will you? Time is running out. You will either be a fool or a prophet.

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Last 5 posts by Alex Stanczyk

• Sprott: US Gov Dead Man Walking - October 21st, 2009
• Bank of England Governer: Regulation can not stop bank failures - October 21st, 2009
• Dollar Dead-Pool - October 15th, 2009
• Barclays: Gold can go to $1500 - October 7th, 2009
• Gold passes $1040 – Silver Passes $17 - October 7th, 2009