What is the real price of gold right now?

At face value, this appears like a simple question with an equally simple answer. If you go online and check the gold spot price, you’d know that gold is roughly $1,725.00/ ounce. Or is it?

When you look at the spot price for gold, the price quoted is for “paper” gold. It is not the price attached to physical gold coins. The gold market is one of the largest markets out there, but it is not as straight forward as purchasing physical metal to hold in your safe at home. In fact, the vast majority of gold trades are represented by ETFs and gold futures, which have little or no correlation to actual physical metal.

Gold futures, for example, give the holder exposure to the spot price, but it does not actually give an investor physical gold or silver. It is a piece of paper that is controlled by the exchange and its own rules. Futures can be subject to discontinuation as well, if the markets were to become disrupted. When a gold future contract expires, the vast majority of contracts are settled in cash or rolled over. It would be very rare to see a delivery of physical metals and you have to be a massive player to get physical delivery.

In fact, the gold market is so heavily “paper” driven that if investors were to demand physical delivery of gold, the vaults would quickly be emptied and the gold exchange would intervene to cash-settle the contracts. Essentially, physical delivery would be denied because there is not enough physical gold to back gold ETFs or gold futures.

So, why do many investors still pursue trading paper gold over the physical holding of the metal?

The key is in leverages. When trading gold futures an investor is only required to put down about a 5% margin in the contract. If an investor were to put down $50,000 on a gold future, it controls roughly $1,000,000 of gold or silver. If the price of gold goes up by 5% you have a 100% return on your investment, so the potential for gains are quite high. However, if the price goes down by 5% he or she then has a 100% loss, so the associated risk is quite high as well. When a margin is called, if an investor failed to meet the margin, the contract would then be terminated and that investor would be banned from any future trade dealings.

The most important thing to recognize when trading gold futures is that there is rarely if ever an exchange of physical metal.

Another paper option is the London Bullion Market Association (LBMA). These contracts are paper contracts for “unallocated” bullion. That is a nice way of referring to a paper investment that does not actually have gold in the bank to back it. If an LBMA bank has only 1 ton of gold in their vault, they could sell over 100 metric tons of gold based on only that single ton of physical gold that they hold. That’s like floating 99 checks and hoping they don’t all cash them in at the same time. If all holders of the 100 tons of hypothetical bullion tried to get a physical delivery of metal, there would simply not be enough metal to fulfill all the contracts. These contracts would then be terminated and cash settled.

Essentially, if you were to invest in a gold future or ETF and wanted to receive physical gold at the end of your contract, you would not be able to receive it, because there isn’t enough physical gold to back the paper contracts.

There is also a third kind of paper gold called the London Gold Fix. This option does involve physical metals and they are sold via a gold auction. However, this option is not available to the general public because it only trades in large sums. While the London Gold Fix does have physical metal to back the paper, there is never actually a transfer of gold. The gold remains in a vault and is traded by transfer of a receipt or a ledger entry.

The biggest problem with paper metal trading is that the market is wrought with fraud and manipulation. When “floating” gold contracts that are in no way backed by physical metal, the temptation to manipulate the market is exceptionally high.

Given the current state of the US dollar and the rapid rate of inflation the best way to protect your wealth is to increase your holdings of gold (and silver) in your portfolio. However, if you are only holding a piece of paper that will settle in cash, you are not getting the wealth protection necessary to combat rising inflation rates. The only solution to this is to hold the physical metal itself.

While the price for actually holding physical metals may seem higher than the spot price, it is essential to recognize that the cost of storing, dealing and handling the physical metal has much more involved with it than the cost of managing a piece of paper gold. Physical gold and silver are significantly scarcer than paper metals and any number of economic circumstances could be just the catalyst to create a buying panic. War, volatility in the stock market, bank failures, inflation related to the economic impact of the pandemic… a number of factors will drive investors to purchase physical metals. Supply simply can’t withstand demand in these scenarios.

When you look at the long-range picture, it is clear the best way to protect your wealth against inflation and other economic factors is to hold physical pre-1933 gold and silver. Don’t be concerned if the price of metals does not match the spot price. Spot price and physical metal are two different things. You get what you pay for and the pre-1933 coins are no exception to that rule.