Since December the yellow metal has sharply increased and is now trading between 1200 and 1250 dollars per ounce. For many people, physical gold is useless as it does not provide dividends and has storage costs that can be very high. However, in the last four years, gold has lost more than 30% of its value and a lower gold price indicates confidence in central bank actions. Ironically despite massive and never-ending intervention by policymakers around the world (QEs and low rates) and a risk-off sentiment that dominates, gold has been in constant decline. With regards to the US rate hike, the price of gold in US dollar should have gone down but instead the opposite has happened. Gold has sharply increased since the beginning of the year and the global economic slowdown sustain this trend. In particular, the American economy is under pressure, domestic data are released mixed while a decade of low interest rates should have been sufficient to trigger a sustainable recovery.
The price of gold is low because it does not only represent the state of the physical market. The paper market is a great component of the gold price and while the underlying asset is physical gold itself, the paper market is far larger compared to the physical market. The ratio is an astonishing 200 vs 1.
Most banks issue mainly paper ounces driving down the price of gold, resulting in a major counterparty risk. In the result of difficulties in the banking sector due for example as the era of low interest rates, the price of paper gold is set to decrease. However, as physical gold is also included in the overall price, this legitimises the purchase of physical gold which is undervalued. Banks are also experiencing massive exposure to derivatives. When we look at the balance sheet of Deutsche Bank for instance, one can guess how it is possible to be exposed as much as up to 25 times the German GDP. Another important issue is the premium paid for gold on the physical market and this has never been so high due to scarcity.