As gold prices continue to pull back in the wake of higher interest rate talk from Janet Yellen and company at the Fed, you would expect some investors might use this as an excuse to cut their yellow metal positions and run. The truth is that certain gold positions have been liquidated in recent weeks while other types have seen an increase in their totals. This is where it becomes important to understand the different kinds of gold assets. Paper gold and gold backed holdings are two of the main categories. They have diverged sharply since the pullback started in May.
What is Paper Gold?
Paper gold is simply described as a position where a the investor owns a piece of paper. In this case we are not talking about a claim on gold, but a holding that merely trades with the price of gold. There is no gold backing up this asset. Another way to put it is that you do not own gold when you have paper gold. In fact you do not have even a promise to obtain physical gold. This makes you a creditor to the group that is providing paper gold accounts or certificates. As a creditor, you take on the various substantial risks of the company failing and filing for bankruptcy. You also become a victim of counter-party risks.
Different types of investors have an interest in paper gold than those who buy products which at least are gold backed. Speculators on short term price movements tend to be most interested in paper gold. This would include hedge funds and other short term players. Physical gold and gold backed positions by contrast attract longer term investors in the precious metal. These are individuals and groups who believe in the long term value of gold as inflation hedge, increasing store of value, and position of security.
Paper gold examples abound, though some individuals who trade them may not realize they are not involved with actual gold backed positions. These include:
• Gold Futures Accounts and Contracts
• Bank or Mint Issued Gold Certificates
• Gold Pool Accounts
• Passbook Gold Accounts
Paper gold serves a function. It does provide gold spot price short term exposure. It does not help you if the party issuing it fails or if the demand for the product declines or disappears. This is because these types of paper gold do not give you the ability to exchange the position for gold bullion, only to sell the paper back. Physical gold and gold backed holdings do not go bankrupt and have no dependence on other organizations keeping their obligations. This is what makes these physical gold holdings superior for anyone interested in any type of position that is longer than a very short time frame.
Physical Backed Gold Stronger than Paper Gold in May
It is an added strength of the physical gold holdings such as the gold backed ETFs that their investors have maintained and added to their positions at the same time that gold prices have pulled back substantially in May. During this time, the speculators have rapidly shed their positions in the paper gold market by over $7 billion. Yet over roughly the same period of time, gold backed position investors have added substantially to their net positions. Since the beginning of May for example, the GLD SPDR Gold Shares have increased their gold reserves to back up additional shares by an impressive 43.72 tons. This represents the largest such boost since back in January.
Even with the media hammering every day about the rising likelihood of a Fed rate increase and gold prices retracing, there have been additions into the various physical gold Exchange Traded Products for each trading day of the first 20 days in May. During that time, purchases by the physical gold backed ETPs have totaled 86.2 tons. These levels are similar to the purchases their investors made in March when gold prices were still rising impressively and compare strongly to the 5.6 tons of gold they bought in April.
In Conclusion
The fact that longer term gold investors have not been spooked by gold price retracements is significant. While speculators are out or headed for the exit doors, those gold investors who believe in the cass for the metal are both buying and holding. It speaks to the strength and superiority of gold backed products like GLD and the other physical ETPs. The ETP investors consider all of the present weakness to be a temporary correction. They are utilizing the price dips as chances to buy more. This is why ABN Amro’s Coordinator for Precious Metals Strategy Georgette Boele believes that the 200 day moving average at $1,163 per ounce will hold. She and the Dutch banking and investing giant also maintains their year end price target for gold at $1,370 per ounce. That is significant motivation for the longer term investors to keep holding on to their gold.
W. D. Crowder is an American published author with decades of experience in financial writing. He specializes in many areas, including: investment, economics, international relations and more.
