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Paper Gold Question


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Paper Gold Question

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  #1 (permalink)
 mathius777 
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I had a quick question about paper gold. Hypothetically if the US experienced hyper inflation and gold skyrocketed, what would gold futures do? Would they keep up with the actual physical price of gold? I have heard many people say owning physical metals is better than paper gold, but I am not sure. Thanks for any information.

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 Fat Tails 
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It is very likely that paper gold (= gold futures) keeps up with the physical price of gold.

The explanation is simple. Let us assume that you have a long position in gold futures and that the futures contract trades at a significant discount to physical gold. In that case you may simply hold your long position until the expiry of the futures contract. As a result you will be able to purchase the contractual amount of gold covered by your futures position at a lower price than the price for physical gold.

Now those holding a short position will only get the settlement price for the gold that they have to deliver. This does not make sense to them, because they would get a higher price for the physical gold when selling it directly. Therefore prior to settlement they will bid higher and higher, until the price for paper gold approaches the price for physical gold. You will be able to close out your postion prior to final settlement and without owning physical gold.

The only scenario that I can imagine where the futures price at expiry does not match the price of physical gold, is a significant counterparty risk related to settement. This would mean that the exchange - which guarantees all transactions - is going bust. As far as I know this has never happened before.

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 hobart 
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the answer is complected, but is basically 'yes, it will track it'. There is no such thing as a central market for the 'price of physical gold'. You will sometimes hear people talk about 'spot'. There is a distributed market that gold 'wholesalers' utilize, but its more like a set of rules( LBMA - Home), than a true market, and also not open to retail traders that right now is running 10$ above the front month contract. So the premise of the question is invalid.

People who say owning physical is better believe that for whatever SHTF event will make their paper ACE (an ace is the 'delivery coupon' you take to a vault) invalid. This is pretty unlikely. anytime you convert an ace to physical, there is a fee. to store the gold for you, there is a fee, to withdraw the gold from the vault, there is a fee. this is why ACE is better than physical for most people. 15$/mo storage fees to store gold adds up over 2% (3600$) over 20 years.

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 mathius777 
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Great. Thank you for the info and replies. It was my thinking that futures would still track physical as well, but I always hear gold bugs saying how worthless "paper" gold is, so I just thought I would ask. Thanks!

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 SMCJB 
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The advocates of owning physical gold as opposed to paper gold are such large naysayers that they not only believe that things like 'hyperinflation' may be around the corner but they also believe that the entire financial and banking system would collapse and as such things like futures would become worthless. These people also tend to have fully stocked bunkers in their back yards, their own petroleum tank and of course guns, lots of guns.

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