Paper Gold and Silver - A Shady Endeavor?

by David EngstromSeptember 15, 2016

In the right light, everything casts a shadow and from that dark dimensionless image, one can generally discern the nature of the object from which the shadow is cast.  Whether a tree, a building or some creepy person entering a poorly lit alley, the shadow seen provides us a clue.  

Shadows however, can be deceiving.  Late in the day a short tree can cast a long shadow.  At mid-day the shadow of a tall skinny man makes him look short and fat and late at night, two hands can come together to send an eagle flying across your bedroom ceiling.  Because we can see shadows we think we know what it is we are looking at.  But, as soon as we try to touch one, we suddenly realize how little we actually know about the object behind the shadow.      

So it is with certain of today’s investments – what you see may not always be what you get.  This is especially true in the case of paper gold and silver investments.  We may see a paper contract that represents the purchase or sale of 1000 ounces of physical silver.  Or, another that represents 100 ounces of gold.  But, the question being asked more and more of late is, does that amount of physical gold and silver being traded actually exist, or, is the investment a little shady?


It is widely reported that in today’s gold and silver futures markets, many times more gold and silver ounces are traded than actually exist.  Let’s say an ounce of silver is $20.  Because I am so sure that ounce of silver is going to be $30 in 3 months, I am willing to bet on that belief.  So, I go to the owner, and say, I will give you $1 today for the right to buy your $20 dollar ounce of silver for $25 dollars in 3 months.  The owner thinks about it and figures if silver never makes it to $25 an ounce the option to buy for $25 expires and the owner makes a buck and keeps his ounce of silver.  If silver goes to $30, as was my bet, the owner has to deliver me that ounce of silver in exchange for $25 of my dollars. 

When all is said and done and assuming the price of silver indeed rose to $30 an ounce, I have paid $26 for a $30 ounce of silver and the owner has earned $6 on his ounce that was worth $20 at the time we entered into our futures contract.  All in all both sides took advantage of rising silver prices. 

Where it gets a little shady is when 100 investors vie for the same $20 ounce of silver and in the end they all want to take delivery.  OOOOPS!

Reportedly this is a regular occurrence in the gold and silver futures markets.  To the average investor this sounds like fraud.  Charges of such may be arguable but so far have been avoidable.  When the situation described occurs, sellers simply offer to settle the trade with $4 of cash for each ounce sold.  No physical delivery required. 

Theoretically, this charade can play out indefinitely even if no physical silver ever exists.  As long as investors are willing to settle in cash at the end of a contract, who needs silver?  It’s not until investors stop accepting cash settlements and demand physical delivery that things can get a little dicey.   When that day comes and delivery is refused, investors will suddenly realize they have been investing in the tall shadow cast by a very short stack of coins.


The futures market provides one option to trade paper gold and silver.  Mining stocks would be another.  When you invest in a mining stock you feel like you are investing or making a bet on rising gold and silver prices.  And, for the most part you are.  In the case of mining stocks however, there is no guarantee your shares of stock will rise in correlation with rising metal prices.  You see, you don’t actually own the metal.  You own a piece of paper that may entitle you to some of the profit earned by the mine who digs it up and then sells it in physical form to someone else.

There are many variables that come into play when running any company.  Operating costs, labor costs, research and development, management salaries . . . you get the idea.  If, for example, operating costs rise as fast as gold and silver prices may rise, your mine may produce no profit and share prices can fall despite rising metal prices.  Many mines have been shut down by labor disputes, energy shortages, tragic accidents even earthquakes.  Acts of God usually occur un-announced and are difficult to plan for.  Some of the other pitfalls of investing in mining stocks can be avoided with proper due diligence. 

Of course investors can make money buying mining stocks but to be sure, a stock certificate is just a piece of paper.  As such, there are risks to owning paper that do not exist when you own the physical metal itself.  Stocks can lose all their value while physical gold and silver have never been worth zero.


In the early ‘90s another kind of paper gold and silver investment came to America.  It was called the Exchange Traded Fund or ETF as we know it today.  The ETF is a hybrid investment.  It holds assets like stocks, bonds or commodities and gives investors a low cost option to own a fractional amount of the assets held within the fund.  Gold would be a good example.

Today, gold sells for more than $1300 an ounce.  For someone who sets aside a certain amount of money each month for retirement, a $1300 gold coin may not fit the budget whereas a $100 share of a Gold ETF does.  Because a share of a gold ETF is said to be backed by an amount of physical gold, it gives the appearance of being as safe as holding onto the gold itself.

It already sounds a little shady doesn’t it?  If you want to own physical gold, buy this piece of paper that says you own physical gold.  Hmmm!  Obviously, the sales pitch for owning this type of paper gold and silver is sophisticated and attractive enough to entice investors into holding paper instead of the physical metal.  Still it begs the question, why does this product exist if the paper is backed by physical?  Sounds like a lot of paperwork to me.  That has to cost something. 

The fact of the matter is that it does.  Think about it.  Why would you set up this gigantic investment mechanism just to sell people fractional amounts of gold or silver - purportedly at some kind of savings - if every bit of what I sold you was backed dollar for dollar by the metal?  The only logical conclusion anyone can come to is that it isn’t backed dollar for dollar by the physical metal.  Then what is it backed by?  It could be backed by some physical, some futures contracts (otherwise known as options or the right to own) or maybe nothing at all.  That’s how they can sell you paper gold or silver instead of the actual metal and in the process, make a profit.

In my humble opinion, the ETF today is to gold and silver what Mortgage Backed Securities were to real estate in 2008!

 This criticism may seem harsh and unjustified until this.  According to a recent report, Deutsche Bank was the sponsoring bank of a gold bond issued by Xetra-Gold.  Xetra-Gold is a service that offers investors a cost-efficient means to trade precious metals.  A unique feature of the gold bond they sell is the ability to convert that bond to physical gold upon demand.

Per this report, a client of Xetra-Gold did attempt to convert but was refused delivery by the sponsoring bank – Deutsche Bank.  The client was then told they could effectively convert to physical themselves by selling the bond and then buying individual coins through other sources.  This, of course, defeats the entire purpose of buying a redeemable bond to begin with.  Xetra-Gold was supposed to track the gold price dollar for dollar which suggests you can own physical gold without paying retail mint premiums.  If you have to sell the bond in order to buy the physical metal, why pay the fees for dealing in paper gold to begin with?

Today, it is believed by many that the actual physical supply of investible gold and silver is very low.  There is not enough of either to cover all the paper gold and silver investments on the books.  Billionaire Eric Sprott of Sprott Asset Management has said, when the paper markets fail to deliver on demand, the price of gold and silver will rise dramatically.  Sprott is on record saying silver will rise to $100 an ounce and gold should be $5000 an ounce or more.

Buyer Beware! Next time you consider an investment into paper gold or silver take a good look at what’s behind the shadow and know this!  There is nothing shady about owning and holding a piece of gold in one hand and a piece of silver in the other.  Physical gold and silver is easy to buy, easy to sell and neither has ever, in 5000 years, been worth zero!



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