Fools Gold? (A Cautionary Note): 17th February 2025

Beware ‘Paper Gold’ is ‘Fools Gold’

Introduction:

Paper gold refers to financial instruments that represent gold ownership without physical possession of the metal itself. While these instruments have their uses, they can be seen as fool’s gold for several reasons:

Lack of physical backing… Unlike physical gold, paper gold doesn’t guarantee actual gold delivery, potentially leaving investors exposed to counterparty risk.

It’s important to note that paper gold instruments can serve legitimate purposes in financial markets. However, for DIY-Investors seeking the full benefits of gold as a store of value and hedge against economic uncertainty, physical gold ownership may be preferable to avoid the potential “fool’s gold” aspects of paper gold.

Three main areas of concern:

Manipulation concerns: The paper gold market is much larger than the physical gold market, leading to potential price manipulation and distortion of true gold value. Effectively, physical gold owned by institutions (BofE etc) can be highly leveraged!

Systemic risk: In times of financial crisis, paper gold may not provide the same security as physical gold, as its value depends on the stability of financial institutions.

Artificial supply: Paper gold can create an artificial supply of gold, potentially suppressing the price of physical gold. Of course, the same is also true of silver and other precious metals. Where the metals have dual use, such as silver and platinum, the situation becmes even more complex.

Is there any evidence of systemic problems?

While there are no specific recent examples of paper gold investments gone wrong mentioned in the search results, there are several concerning developments and potential risks in the paper gold market as of February 2025:

1. The paper gold market is currently trading under stress, with US gold trading at a massive premium over the London Bullion Market Association (LBMA) price. This price discrepancy has created arbitrage opportunities for big banks, leading to stockpiling of gold in the US and draining liquidity from the London market, as recently widely reported.

2. The Exchange for Physical (EFP) swap lines are deteriorating, which could potentially catalyse structural changes in the global gold market. This situation is putting pressure on the paper gold market’s stability.

3. There is a significant disparity between paper gold and physical gold. Estimates suggest that trading volumes of paper gold are well over 100 times the trading volumes of physical gold. This leverage creates systemic risks, especially in the event of a financial crisis or banking collapse.

4. Transparency issues persist with major gold banks. For example, HSBC has been perceived as being ‘secretive’ about its gold holdings, and there’s a lack of clear information about the sources and types of gold used as collateral for ETFs.

5. Recent convictions of major banks for manipulating the precious metals market have raised concerns about the trustworthiness of key players in the paper gold system. JPMorgan, for instance, was fined nearly a billion dollars in autumn 2020 for such manipulation.

6. It’s a matter of record that JPMorgan was fined nearly a billion dollars in autumn 2020 for manipulating precious metals and U.S. Treasury markets. Specifically, on 29th September 2020, JPMorgan Chase & Co. agreed to pay $920 million to settle federal U.S. market manipulation probes. The settlement included admitting to wrongdoing in connection with schemes to defraud precious metals and U.S. Treasury markets.

The $920 million penalty was composed of:

1. A civil monetary penalty of approximately $436 million

2. Additional fines and disgorgement to cover the remaining amount

This settlement resolved investigations by multiple agencies, including; the Department of Justice, Commodity Futures Trading Commission, and the Securities and Exchange Commission. The charges were related to unlawful trading practices in the precious metals (including gold) and U.S. Treasury markets, spanning nearly a decade

It’s Still Happening!

Since 2020, several financial firms have faced record-keeping issues and regulatory fines:

1. In September 2022, the SEC charged 15 broker-dealers and one affiliated investment adviser for widespread recordkeeping failures, resulting in combined penalties of more than $1.1 billion.

2. In February 2024, the SEC imposed additional penalties totaling over $81 million on various financial institutions, including broker-dealers and investment advisers, for record-keeping lapses.

3. A global financial services firm was fined $5.5 million by the CFTC for failing to record mobile device calls and preserve records as required by regulations.

4. In the UK, Ofgem fined a firm £5.41 million for failing to record and retain electronic communications related to energy trades.

5. Wells Fargo agreed to a $3 billion settlement with the Department of Justice in 2020 for opening unauthorized accounts and engaging in illegal practices affecting millions of consumer accounts.

These cases demonstrate that record-keeping issues are widespread across the financial industry, affecting various types of institutions and resulting in significant penalties. Regulators worldwide are increasingly focused on trying to ensure compliance with recordkeeping requirements, to maintain market integrity and protect investors.

Summary

These factors collectively seem to point to increasing instability in the paper gold market, which could potentially lead to significant problems for DIY-investors (and all investors), if market conditions deteriorate further or if there’s a sudden loss of confidence in the system.

Caveat Emptor (Buyer Beware)!

Mick (17th February 2025)