This is a long, convoluted and controversial topic.  But essential to any discussion on the global financial system.

Gold has a fascinating role as money and as a store of wealth.  There is enough evidence that the price of gold is being manipulated and surpressed, that I wanted to understand why, what the real role of gold is in the economy, and what the end game is.

My blog entry will be an ongoing essay, which will be updated as the market evolves and I clarify my thoughts.

At this point, my basic thesis is that the global financial system is highly stressed and is being debased by a flood of fiat currency.  The US$ is presently the global reserve currency.  An alternative gold-backed currency is rumored to be under negotiation as a replacement reserve currency.  Should this occur, it will fundamentally undermine the US$ and the ability of the US to underwrite its global adventurism and export its economic problems to the rest of the world by printing dollars. If the US$ loses its status as the global reserve currency, the American Empire would no longer be funded by the rest of the world.  This would bring instant clarity to the US as a debtor nation.  Avoiding such a US$ fall from grace has to be a primary objective of US foreign policy.  But it is impossible to constrain the entropy of the global financial system.  Its natural tendency is towards chaos — something always breaks loose.  I think we are on the verge of something big breaking loose.  And gold is the bellwether.

The current disconnection between the paper value of gold (i.e. futures) and the actual value of physical gold is indicative of massive manipulation of the gold market, on a scale so large it must involve the US Fed and other central banks.  The disconnection is fact.  “Why” is conjecture.

Despite anti-goldbug rants, gold continues to act as a proxy reserve measure of value in the prevailing and highly manipulated monetary system.  This is because gold is a finite, non-consumable commodity of recognized, established value, and has traditionally acted as an intermediary in transactions (i.e. a currency).

One of the major advantages of gold as a currency is that there is no counterparty risk, ie the risk to each party of a contract that the counterparty will not live up to its contractual obligations. Once a transaction is settled in gold, its inherent store of value is fully conferred to the new owner/holder.

Gold is not considered a performing asset, such as bonds, equity or real estate.  But its price does vary wildly.  In 2000, gold was $273 / ounce.  In 2013, it is about $1,400.  It reached an all-time high of $1,900 in London on August 2011.   Is this price increase a reflection of the enhanced desirability of gold the commodity (e.g. a hedge in troubled economic times), or is it a reflection of the diminished value of fiat currency?  Probably a blend of both.  As fiat currencies flood financial markets, the gold price has been adjusting (through market forces) to establish a relative value against these currencies, which have been declining in value due to oversupply, hence pushing the price of gold up.

This is what irritates the US in particular, who want to assure financial markets that the US$ continues to be perceived as a safe haven.  But the pressure is on, and gold is the boogeyman.  As a result, powerful global forces seek to preserve the status quo and undermine gold as a reserve store of value, hence the ongoing attacks on gold by (western) Central Banks (e.g. Friday April 12,  2013).  This is against a backdrop of declining (depleting is more like it) reserves in bullion banks as real “physical” gold is demanded by owners and to satisfy contractual obligations (i.e. futures contracts that are not rolled over).

To underscore the anticipated ascendency of gold, against its denigration by western financial media, a number of major market players, while talking down gold continue to accumulate significant gold positions. This suggests that market players themselves believe gold will ascend in status and value as a hedge against the diminishing real value of fiat currencies.

But the real attack on US$ hegemony is likely to come from the growing power and influence of the BRICS and other emerging market nations.  There is a concerted effort amongst the extended BRICS to free themselves from western financial subjugation and US$ currency tyranny.  Their effort is multi-pronged: 1) negotiate bi-lateral trade agreements for direct currency exchange; 2) establish a rival to the western-controlled World Bank and 3) establish a gold-backed regional reserve currency system.  The BRICS want to have currency convertibility without needing the US$ as an intermediary, making it easier to use the real, ruble, rupee, renminbi and rand amongst themselves. The bi-product is the erosion of the US$ cache as global reserve currency.  This concept has been floating around since at least 2008, but now, with the heavy flow of gold from the west to the east, appears to be on the verge of becoming viable.

There is considerable evidence that BRIC (and associated) countries are aggressively accumulating large stores of physical gold.  Rumors suggest that gold inventories of China and Russia, in particular, greatly exceed official accounts, and even some speculation that China may be behind the latest market manipulation of gold to keep its price down while the country increases its reserves.  This could be in anticipation of a global devaluation of fiat currencies against gold, or even the creation of a gold-backed currency by the BRICS.  A gold reserve price of $7k / ounce for such a gold-backed currency is a topic of lively discussion.  This would represent a nearly 5-fold increase from current values.

Against this backdrop, the precious metals market is not acting rationally. Gold prices appear to have softened, but in the face of increasing demand.  Basic economic theory suggests that increasing demand for a good in limited supply would result in an increase in the price of that good. But that is not what is happening.  The COMEX spot price for an ounce of gold is in the $1,400 range.  And yet, there is an increasing demand for real, “physical” gold, ie “I wanna see and touch it”, as opposed to the paper, once or twice removed ownership of the good at a future point in time.  Actual delivery of gold bullion (i.e. I want the gold, not a promise for future delivery) commands a premium over the COMEX spot price.  In some markets, this is as high as a 25% premium.  On average across all markets, physical gold prices are 10% higher.  Hardly the profile of a spurned commodity.

Remember this: The gold price and the price of gold are mutually exclusive.

The gold price = the last traded price of the front month futures contract at various exchanges around the world.

The price of gold = what you must pay to take ownership of physical gold.