Mountains of Paper Gold: The Difference Between Real and Fake Gold

Gergely Juhász's commentary on the market price of physical gold bars and the difference between paper gold and real gold

A commentary on physical gold market spreads and the difference between paper gold and genuine gold.

A physical gold dealer would likely smile wryly at the announcement that appeared on one of the leading investment portals yesterday morning, reporting that a leading fintech startup is offering gold for purchase at a 0.25% spread.

LET US TAKE A LOOK AT WHAT IS ACTUALLY HAPPENING IN THE REAL GOLD MARKET!

In the 25 years I have spent close to commodity exchanges, currency speculation and physical precious metals trading, never before has there been such a good opportunity to understand what the true difference is between paper gold (or fake gold) and real, tangible, physical gold. My thanks to the market! Here is what has been happening:

Last November and December, demand for physical gold and silver was already rising steadily, and this only intensified in January and February. Precious metals dealers were busier, their turnover was higher, but they held their spreads stable at the usual levels — which, for the narrowest-margin product, the 1,000-gram Swiss or Austrian gold bar, is approximately 4% for a round trip. Once direct costs are deducted (manufacturing cost, transport, insurance, volume-dependent taxes, business tax, etc.), it becomes clear that a traditional gold dealer earns no more than a 1% spread on a kilo bar — which was also the standard commission in the classic brokerage profession.

Then came the virus crisis in early March 2020, when the epidemic reached northern Italy. The already elevated demand began to turn into panic buying; money was pouring in by the barrowload, but everyone raised their spreads only a little, because it was still possible to order stock — until 16 March, when the borders were sealed. At that point it became apparent that new shipments might not be able to get through, which of course immediately translated into a 2-4% price increase across all products. By then gold was already some 4-5% above the usual spread, but demand did not fall — it continued to rise. Gold importers quickly reorganised, found new and typically more expensive solutions to get goods through, but the next shock arrived almost immediately: within days, the largest Swiss refineries would be closing, which account for approximately one third of global gold bar production. Every dealer immediately rushed the remaining available stock, and within a few hours the small-denomination wafers and bars — the most liquid products — were stripped from wholesale inventories. Those with strong capital and good timing managed to buy a great deal; the rest got considerably less. Retail prices were immediately raised further by a few more percentage points, as the wholesale market had dried up and virtually every small-denomination bar product entered "sold out" status. Many retailers, citing the virus situation and stock shortages, simply shut their doors.

The next phase of market disintegration arrived within days: well-known Austrian and German companies operating in both wholesale and retail practically ceased supplying their resellers, which could be seen from the fact that their spreads had risen approximately 5-10% above the levels that had been standard for years. The global European market fragmented into small local markets, with everyone selling their existing stock at ever-wider spreads. By 22 March, even the larger kilo bars had disappeared, or were being offered at 6-10 percentage points above the previous price by wholesalers, depending on their temperament (those who refused to raise prices had their stock cleared immediately; the rest signalled through their high prices that they were now focusing on their own retail customers).

Stock-hungry dealers also "milked" the capacity of the mints, leaving even Münze Österreich unable to cope with demand — the mint had never been sized for a rush of this kind.

By early April, the refineries were still closed, and dealers were scraping up the last of their coins from the depths of their safes, entering a new phase of stock speculation. They began raising their buy-back prices, paying well above the exchange price for quality goods in order to source stock from the retail buy-back market.

Turnover began to fall, simply because there was nothing left to sell. Those who still had stock were charging 12-15 percentage points above the usual spread — and the market was still absorbing it.

And then one of the most prominent London fintech startups announced gold for purchase at 0.25% above spot...

That is the difference between physical gold and paper gold.

This commentary was written by Gergely Juhász, founder of Conclude Zrt. and Goldtresor, on 3 April 2020.