That "music" is the (wide-spread but unjustified) notion that there will always be enough gold - physical gold - to keep the gold futures trading Ponzi-scheme going indefinitely.

Some well connected people in the world of gold and international finance have warned for years that the paper-gold trading game will end in unforseen (by most) and unexpected ways. They said that some day, the paper market's price determining function for physical gold will stop reflecting the real price for physical gold, and the two markets - paper and physical - will part ways, never to meet again.

Most people do not believe this. Most - even "ideological" - gold bugs (meaning those who like gold for its solid value rather than for its utility as a vehicle for quick paper profits) are still seduced by the siren call of leveraging their potential gains through options and other instruments, i.e., essentially though playing within the arena of the paper-pricing mechanism.

After all, haven't we all grown up and lived our entire lives under the concept of "dollar-pricing" of the things we use and enjoy in life? Haven't we learned to ascribe value to pretty much anything in terms of paper dollars?

Well, just because it has always worked as far as we can remember doesn't mean it will continue to work that way. And the odds of it no longer working that way, at some point, are far greater than the odds of the sun not coming up tomorrow morning.

So, what could bring about the end of this paper pricing mechanism?

Obviously, a physical supply shortage of some kind would do the trick.

The problem is, most people do not believe that such a physical shortage will ever occur, at least not in the foreseeable future.

Well' let's examine the problem, then, and see if it is really so unlikely. What would it take to cause the supply of "physical" into these contract delivery obligations to dry up? There are a number of possibilities:

1. People (gold bugs?) wise up and start taking immediate delivery on anything they buy from now on.



2. People/institutions who own physical refuse to sell gold at current prices because their internal (mental) perception of the actual value of the metal changes relative to the paper-trading induced "price" of gold.



3. Some of the usual suspects in supplying physical at sub-market prices (central banks) no longer agree to participate in the process, i.e., they withdraw their support for artificially low gold prices.



4. The "discounts" at which the paper contracts containing future delivery obligations trade in the paper markets get bigger and bigger as traders' value perceptions change due to paper-gold "inflation" (i.e., excess proliferation of contracts relative to the underlying commodity - gold.)



5. Those central banks remaining "in support" of a low gold price actually run out of metal while the others just refuse to sell more than a pre-determined amount per year.



6. The number of individuals and institutions (tech funds, institutional traders) who want to own - and hold - physical gold increases, driving up demand.



7. Gold producers go broke or "offline" as the price deteriorates, or cannot crank up their production fast enough to satisfy suddenly increased physical demand.



8. Large official former sellers suddenly turn buyers out of desperation, i.e., they find out their economies or their currencies' FOREX value will not survive without sufficient physical gold reserves.



9. A former official gold "enemy" decides it cannot win this battle and suddenly turns gold "friendly" out of sheer desperation, buying gold en masse.

Any one of these potential factors, or a combination of one or more together, can cause the kind of supply shortages discussed.

Now, let's look at the other side of the coin and find out what could suddenly either reduce the demand for physical, or increase the supply so as to make gold cheaper.

Then, we decide which one is more likely to occur in today's political and economic landscape in order to reach our conclusion.

1. The world's central banks and the IMF announce that gold is no longer needed as a reserve asset in the modern world, and enter the markets as massive sellers.



2. The euro countries and ECB decide they made a mistake by valuing gold at market prices and declare they will exclusively hold "National Geographic" magazines in reserve.



3. Geologists find massive, humongous gold deposits somewhere and producers start mining it cheaply, quickly, and efficiently.



4. People, fickle as they are, just stop liking gold, and it goes "out of style."



5. Warren Buffet and George Soros succumb to US military pressure and sell all their gold for thirty cents a pound.



6. Alchemists make a sudden breakthrough and figure out how to inexpensively turn lead into gold.



7. Indian women decide they prefer fashion jewelry "Made in China", rather than heavy, cumbersome gold bracelets.



8. Osama Bin Laden and his entire network of terrorists, including all Palestinians and militant Israelis become "peaceniks" and declare they will never hurt or threaten another human being.



9. North Korea voluntarily turns in its nuclear arsenal and destroys its bomb-making equipment in return for a the US' promise that it will be "nice" in the future.



10. The European Central Bank declares that it is "sorry" for introducing the euro and announces that it will withdraw its currency immediately.

Please forgive the tongue-in-cheek nature of this latter list. Even if one discounts the facetiousness of these remarks, it becomes clear that valid potential reasons for a real, sudden decrease in gold demand or a sudden increase in actual, physical supply are very, very limited, especially when compared to potential reasons for supply shortages..

Finally, we must examine which of the supply-restricting factors are already in existence or are in the process of developing to get an idea of the true future physical gold demand/supply picture. (An attempt has been made to be exhaustive in listing the supply-restricting factors. The author welcomes any additional suggestions.)

Following are the factors again, with comments inserted in bold typeface:

1. People (gold bugs?) wise up and start taking immediate delivery on anything they buy from now on. Not very likely. Some will, but most will hang on to their notions of "leverage" and ride the paper markets all the way down, just like most stock investors refuse to sell until it's too late.



2. People/institutions who own "physical" refuse to sell gold at current prices because their internal (mental) perception of the actual value of the metal changes relative to the paper-trading induced "price" of gold. This is possible, even likely, but will be very gradual and only in response to sustained, successive paper-price rises. However, when it comes to European Central Banks (the members of the "Washington Agreement), an argument could be made that such a revaluation has already occurred in their minds and has formed the impetus for the agreement.



3. Some of the usual suspects in supplying physical at sub-market prices (central banks) no longer agree to participate in the process, i.e., they withdraw their support for artificially low gold prices. This has actually occurred, as is evidenced by the fact that the Washington Agreement came into existence, in the first place.



4. The "discounts" at which the paper contracts containing future delivery obligations trade in the paper markets get bigger and bigger as traders' value perceptions change due to paper-gold "inflation" (i.e., excess proliferation of contracts relative to the underlying commodity - gold.) Possible, but not likely as die-hard paper profit chasers are unlikely to let go of their illusions before a physical shortage forces them to do so.



5. Those (central banks) remaining "in support" of a low gold price actually run out of metal while the others just refuse to sell more than a pre-determined amount per year which will not satisfy demand. Example: Britain after its gold auctions; Portugal after admitting it lost over half of its gold reserves due to leasing; and a host of small countries who suddenly announced without apparent reason they were selling their gold reserves in the lat nineties. The "others" are the WA countries.



6. The number of individuals and institutions (tech funds, institutional traders) who want to own - and hold - physical gold increases, driving up demand. This is bound to happen as a result of consistently rising gold prices. Gold bugs like buying gold when it's expensive, for some weird reason.



7. Gold producers go broke or "offline" as the price deteriorates, or cannot crank up their production fast enough to satisfy suddenly increased physical demand. Has happened during the nineties gold price crunch. It is a current reality the gold world is dealing with, and it will serve to restrict supply for years to come.



8. (A) former large official seller(s) suddenly turn(s) buyer(s) out of desperation, i.e., they find out their economies or currencies' FOREX value will not survive without sufficient physical gold reserves.



9. A former official gold "enemy" decides they cannot win the battle and suddenly turns gold "friendly" out of sheer desperation, buying gold en masse. 8 and 9 belong together. The US may decide that its paper dollar doesn't stand a chance against a gold-supportive and supported euro, and turn buyer, burning the US bullion banks in the process. Possible? Yes. Likely? No. US administrative officials are - and have been - recruited from the upper echelon of bullion banks (Robert Rubin, Clinton's Treasury guy, came from Goldman Sachs, now heads Citigroup; Stephen Friedman, Bush's Larry Lindsey-replacement, is a former co-chairman of Goldman Sachs - etc.)

Gold demand is increasing, supply is diminishing, and former supporters of the US low-gold policy have deserted the camp because they figured gold will help them do the dollar in. Likely outcome? You call it.

When physical shortages hit the paper-gold markets, and when those entitled to receive the gold (on paper) are left holding the bag and go screaming for their team of lawyers, the "price" of gold that is "fixed" by the paper markets will no longer buy the gold necessary to effect delivery.

On that day, the "music" will die. In this game of musical chairs, when the music stops for the last time, hundreds of "gold" traders will try to sit on the only chair left over - physical gold. The price of occupancy of that "chair" will kill their desire to even try and deliver on their obligations.

On that day the entire system will break down - and gold will be free from its former restrictions. It will rise, and rise, and rise in price (especially in depreciating-dollar prices), overshoot its target somewhat, retract a bit, and then stay there, never to return to present levels.

Bye, bye, Mr. anti-American Pie gold trader - and good riddance!

May 27, 2003

Copyright, Alex Wallenwein, 2003

Alex Wallenwein
Editor, Publisher
The EURO vs DOLLAR CURRENCY WAR MONITOR
Moneypulation Watch (FREE E-zine)
www.a1-guide-to-gold-investments.com/euro-vs-dollar.html
Owner,
A1 GUIDE TO GOLD INVESTMENTS
www.a1-guide-to-gold-investments.com