Is gold about to get crazy?

The gold market may be in for some serious volatility soon as an important process is going on between Germany and the USA. Germany, fuelled by a recent audit, angry voices from the Bundestag and a healthy dose of fear are asking for their gold back (repatriation) that is held on deposit in the NY fed reserve.

Countries around the world have accounts with each other just like individuals only a lot larger. Gold deposits have often been used as a source of collateral in times of emergency loans etc and also as a way of diversifying the country’s reserves. 

It’s been no secret that emerging economies and Eastern countries like China have been building large holdings in gold. The demand for gold in India and China is huge not only from their central banks but also from individuals where gold is a preserver of wealth and status symbol. 

Most central banks have large gold balances (except UK as G. Brown sold it all back at what now looks like very depressed prices) and Germany is no exception. This article estimates £115bln in gold holdings and they say 45% or so is on hold at the Fed.

This blog has been bearish on gold for a while but these developments would make you want to step out and become a neutral and watch this space. I think the impact on the price of gold will be extremely volatile as I would love to know if the Fed actually has the required amount of gold available for delivery to Germany should they stick their heels in and demand it. Should they do so then I’m sure like dominoes there will be other central bankers following suit.

What is worrisome is the extent of open interest in paper gold or futures, options, ETF’s i.e investable instruments derived from the price of gold. The entire open interest in paper based gold contracts is difficult to estimate but its fair to say its large. Probably much larger than what is actually available to physically deliver.

We saw what can happen when a situation like this occurs a few years ago when the car company Volkswagen share price went up over 1000% in a day or two  as too many call options had been sold to investors, traders and companies (namely Porsche ) than there were shares available to cover these option contracts. While this caused a dramatic squeeze for a few days the price eventually came back down but only after people had made and lost millions. One German billionaire lost everything and took his own life over the incident. 

You can see how then if there is a rush to own physical gold or a call from central bankers around the world to repatriate their gold held abroad it may cause carnage in the gold market. There would be a massive squeeze in prices but then may be ultimately a massive dump in prices also as those long realise they are not going to get what they have paid for. Owning the physical outright will be a wild ride but ultimately the better idea owning the paper is just that ….paper. 

http://www.telegraph.co.uk/finance/personalfinance/investing/gold/9804444/Bundesbank-to-pull-gold-from-New-York-and-Paris-in-watershed-moment.html

 

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