Paper vs. Physical Gold: Basic Supply & Demand (Video)

Michael Lombardi of Profit Confidential calmly explains the difference between the paper price of gold and the physical price of gold. Paper gold contracts traded on the COMEX and other speculative markets can significantly influence the nominal price of gold from day to day, as we saw with the sharp downturn in the dollar price of the metal this summer. Conversely, physical buyers are simultaneously paying some of the highest premiums ever for gold, because the supply of the metal is so limited. In fact, gold production has gone down in 2015, while demand in both the US and Asia has been growing.

Lombardi reminds us that in the end, gold is a physical commodity, and basic supply-demand dynamics will be the ultimate arbiter of its value. This point can’t be emphasized enough, but mainstream investors tend to ignore it and get distracted by the dollar price of gold. This dollar-centric mindset ultimately prevents investors from seeing the reasons to own physical gold for the long-term, which is the most prudent reason to buy.

Follow along with this transcript:

“When we talk about gold, viewers have to understand that there are really two different prices for gold. There’s the price you pay when you go into a gold bullion dealer and you buy a bar of gold. And there’s the price that you see on the COMEX, which is a paper exchange for gold. Today, in mid-2105, if you were to walk into a gold bullion dealer and try to buy a solid bar of gold, you will pay one of the highest premiums ever in respect to that bar of gold. The reason being is there just isn’t that much gold out there. On the other hand, on the COMEX, if in the middle of the night somebody – a speculator, an investor, or an institution – drops $100 million or $200 million worth of paper gold, it’s going to bring the price of gold down.

“Looking at the supply and demand situation of gold – because in the end of the day, in regards to this paper gold [versus] real gold, the regression to the mean, buy the supply/demand equation, is what is going to matter…

“Starting with the supply, we see that in the United States, US gold miners have produced 11% less gold in the first quarter of 2015 than they did in the first quarter of 2014. Canada is a major gold producer. It’s producing less gold. South Africa, another major gold producer, is producing less gold. The reason that’s happening is as gold fell from $1900 an ounce in 2011 to $1100, $1050 today, mines cut back on their exploration programs. As they cut back on their exploration programs, we have less gold today that’s being mined.

“We move now to the demand side of the equation, we see that central banks purchased in the first quarter of 2015 119 tons of gold. That is the seventeenth consecutive quarter that central banks have purchased gold. Russia on its own in the month of the June, bought 25 tons of gold. That makes Russia the world’s sixth largest hoarder of gold.

“If we look at the consumer side, we see that in India, in the first quarter of 2015, they bought 15 percent more gold than they bought in the first quarter of 2014. And even China, which has a slowing economy compared to the way it used to grow, we see that in the first quarter of 2015, Chinese consumers imported about the same amount of gold that they brought in the first quarter of 2014. Over a five year average, they actually imported 15 percent more gold in the first quarter of 2015.

“Moving domestically into the United States, we see that the US Mint during the month of June sold 76,000 ounces of gold in American Eagle coins. That’s a 250% increase from May of 2015.

“So the demand and the supply, where you have such a strong demand happening, and the supply is actually contracting – for those two reasons, I believe the prices that we see in the market for gold will only increase in the months ahead.”

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