Trading Paper Gold and Silver Versus Owning Physical Gold and Silver

A couple days ago I went out on a limb and called a top in gold and silver for traders. Today we are possibly getting that short squeeze I mentioned in that article with gold and silver pushing higher, but now settling back down. This short squeeze could last more than a day, but it’s not out of the realm of possibility that we could see gold higher for a bit. Calling a top is the time to start taking profits if one is sitting on them.

The hardest thing for a trader to do is take profit. This is where greed comes into play. In the push for that extra buck, one gets emotional rather than thinking logically and being satisfied with the profit already obtained.

My father, a retired commodities broker, said the number one reason his clients lost money was “greed.” My thoughts are simply; an investor can’t go broke by taking profit. But physical gold and silver are a different animal and I’ll explain how so later in this article.

Dennis Gartman Also Called a Top In Gold

It turns out that Dennis Gartman, writer of The Gartman Letter, also called a top in gold. Gartman is a trader. He sees gold only as a trade. He doesn’t see gold as money. I have seen him on CNBC in the past making fun of gold with Melissa Lee, agreeing with her that “you can’t eat gold.” In other words, what is it good for but a trade?

For physical holders of gold and silver, the only kind of gold and silver I recommend people own, I said in the “gold is topping off” article that it makes no difference what gold and silver do from a short term perspective. Long term, we all know where gold and silver are headed. There are multiple reasons as to why gold and silver are headed higher long term, that Gartman doesn’t understand. Although, he does say to have a 5% “insurance” exposure. But can paper gold assets be considered “insurance.” This is where Gartman and I part ways.

I want to expand on this a little bit more in this article in explaining trading/owning paper gold and silver versus owning/possessing physical gold and silver. The two philosophies of owning the precious metals are not the same, although some would have you believe this to be the case. You may not be aware of this today, but in the future, this will become an issue.

Trading Paper Gold and Siver

Many investors who are trying to capitalize on the gold and silver bull market, do so with the false understanding that they actually own gold and silver. They do this through stocks, mutual funds or the various ETFs that are proxies for physical gold and silver.

Paper Gold and Silver Investments Are Not the Same as Owning Physical Gold and Silver

The problem is, these paper substitutes for gold and silver can’t be converted to the real wealth that physical gold and silver represent.

Take the ETF; GLD for example. The following table outlines the major differences between the paper gold asset GLD and physical gold and silver.

*Some homeowner policies will insure certain types of gold and silver but not others. State Farm for example won’t insure gold bars. These policies need to be updated annually to keep pace with the rising price of gold and silver. Check with your insurance agent for specifics.

Trader vs. Owner

Some may ask why this is even an issue. If I can buy gold and silver through an ETF, pay lower costs to get in and sell at a moments notice, why do I need physical gold and silver?

What I have described here is a “trader” of gold and silver. The fact that they may want to sell at a moments notice shows they don’t understand where gold and silver fit into a properly diversified portfolio. It also shows they don’t view gold and silver as money. I would put this person in the Dennis Gartman category.

The Future of Paper Assets

In Chapter 4 of my book, “Buy Gold and Silver Safely,” I lay out the case for a deflationary credit contraction where paper assets flow down the liquidity pyramid chasing the real wealth of gold and silver.

What will be occurring as things deteriorate in the U.S. economy and even on a global basis, is first derivatives of assets need to be liquidated or defaulted upon. At the same time, loans are either paid back or defaulted upon. As the quality of these assets are diminished, the proceeds trickle down towards more secure assets. We are seeing that already occur as U.S. Treasuries, gold and silver have been the beneficiary.

The graphic of this liquidation can be seen in Trace Mayer’s take on Exter’s reverse pyramid in the following graphic.

I don’t expect most people to understand what the above graphic represents. I have 100 footnotes for that chapter alone where I describe the process of writing it as “taking a 1,000-piece puzzle of a portrait of the Pacific Ocean, and trying to figure out which wave each piece of the puzzle belongs to… when all the waves look the same.”

While this may not be an issue in 2010, as the liquidity for GLD and other ETFs is quite high, at some point, this may become an issue. It has to do more with the psychology of the individual and their understanding of what real wealth represents, as opposed to the quasi-wealth represented by all of the other paper assets listed in the graphic above.

When this psychology shifts, good luck converting your paper assets to physical gold and silver. The “when” is the only question. The liquidity of the various paper assets is what I would keep an eye on.

Physical Gold and Silver as Insurance

So when Gartman calls the 5% he recommends for investors to hold as “insurance,” the only real insurance is represented by ownership of physical gold and silver in your possession, and not a paper proxy of it.

And when I make a call for a top on gold and silver, it is only speculation for “traders” to take profit based on the data that I analyze. Traders simply need to take profit. But it is what they do with that profit that matters.

Inevitable reversals in the price of gold and silver will occur and the greed in the trader will push them towards getting back in the trade at the bottom of the cycle and riding the paper profits higher as they have in the past. But at some point, those paper profits have to be converted back to paper Federal Reserve Notes, which in turn will at some point be chasing the ever dwindling availability of the real wealth that physical gold and silver represent.

The coming fall in the price of gold and silver, when it occurs, will be the perfect time to acquire the physical bullion as insurance for your portfolio. Dollar cost averaging into a position, hoping the price falls even further so you can get a better overall price makes sense.

The peace of mind of knowing you are insured comes from owning home owner policies, car insurance policies, life and health insurance policies. Your portfolio needs this insurance too. And unlike those other insurance policies you pay dearly for, the payments for gold and silver insurance aren’t wasted.

What you have to decide is whether your portfolio is worth this insurance. Price is secondary.

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About Doug Eberhardt

Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534


Commodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don’t trade with capital you can’t afford to lose. This is neither a solicitation nor an offer to Purchase/Sell futures or options. No representation is being made that any account will or is likely to achieve gains or losses similar to those discussed in this outlook. The past track record of any trading system or methodology is not necessarily indicative of future results.

All trades, patterns, charts, systems, etc. discussed in this outlook and the product materials are for illustrative purposes only and not to be construed as specific advisory recommendations. All ideas and material presented are entirely those of the author.

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