Thursday, August 7, 2014

Simple Explanation - Complicated Times

So back in May I opined that gold price expectations were being managed to around $1300 / oz. Many goldbugs have predicted that "the price" would rise and fall dramatically from that starting point, and here we are in August still traveling that narrow band of $1285 to $1315. Perhaps by writing again about price, it will jerk away spasmodically in one direction or the other, if only to discredit the clairvoyance of the disenchanted Roacheforque and his surly annals ;0)

But what in fact are we pricing anyway when we speak of "the price of gold"?

Yes, many have covered the view that we are speaking of contract gold, or paper gold, or gold derivatives. But what in fact is the underlying asset, regardless of it's percentage basis through hypothecation? Is it a commodity like soybeans or copper, or ... titanium?

Oh, I think not. In fact, I believe this underlying asset is as ethereal as it's derivative function. Yes, physical gold has always been used as jewelry, and it does have limited industrial uses (though non-optimal). We know that it was once used as "money" in the sense that it was well accepted as a store of value and a means of exchange, even though it never really functioned well as a unit of account.

But today, both derivative gold and physical gold serve more as an "insurance asset" against fiat (debt) repudiation to some degree from local to regional to global. And when we understand gold as functioning in this regard, we can more easily justify how both paper gold and physical gold are equally valued, or priced.

In today's status quo, pre-collapse environment, contract gold (futures, forwards, swaps, etc) functions as "asset insurance" just as well as physical gold. We do not have to justify the disparity between paper and metal - because like any insurance, what it provides is a guarantee. And as long as you accept that the guarantee is valid, your "coverage" affords peace of mind, or "a hedge", or whatever other emotional state an asset insurance policy provides for the particular holder.

We might argue that gold functions as another form of insurance, perhaps "fiat paper collapse insurance" or "political restrictions" insurance, or "FX volatility" insurance (etc. ad finitum - let us just call the variable "EVENT X"). But your "policy" nonetheless affords "coverage" and the coverage affords you a state of mind not unlike the states of mind that predict, bet upon or buy/sell "the price of the coverage" which in turn impacts price both of the contract and the underlying asset equally today.

So with this understanding of the gold pricing mechanism, we can abandon all the writhing in agony over the dichotomy of the paper price and the metal price being so flagrantly incompatible. They are perfectly compatible because both prices are the product of a state of mind.

And so we better understand how the collective global "state of mind" moves price a bit here and there within this recently banded dollar tunnel, based on fear, apprehension and related propaganda induced mood swings of the collective, along with whatever manipulation helps to manage these expectations along.

HOWEVER ...

If and when (and much more likely the latter) the actual "claim" upon EVENT X is made, the function of paper gold and metal gold will become hugely disparate, and then (and only then) will the heralded divergence between the two take place.

At that time my friends, paper gold will become a worthless payment of the claim, while the metal will actually replace the denominator of the award, functioning again as "money" from a standpoint of settlement.

There is a thin line between this definition of demonetization and remonetization. When your paradigms change, so shall your definitions. And time, of course, proves all.

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