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THE
ROCKET SCHOOL OF ECONOMICS


Early Warning Signs
by Professor von Braun

December 3rd, 1999

The rapid rise in the gold price to $340 was exactly that, a rapid rise, followed by a decline and another decline. The pricing of gold stocks has mirrored both the rapid rise and the decline as well. No surprise there. What is surprising is that people are still bullish on the outlook for gold and gold stocks. Which is fine. But until the participants in the paper gold market get a serious kick in the seat of their respective pants, the pricing of gold will not reflect fundamentals.

This is unfortunate. But we live in the age of derivatives and derivatives are nothing other than paper contracts that are derived from the existence of something else, in this case the trading of physical metal.

This paper market will implode at some time and in a sense, already is out of control. The main players have not yet realized that. But eventually they will. Until that happens most bullish gold supporters will continue to get squeezed. Regardless of whether the price goes up or down that pricing is dictated by writers of paper, not supply and demand.

Mining company's income used to be derived from the sale of gold. Nowadays a large portion is derived from the sale of derivatives, of paper contracts written on gold produced, gold reserves and in some cases, on contracts already written up.

This too will end at some stage in the not too distant future. But it has not ended yet. Which is why we stated some time ago that not all gold stocks are created equal. In another article (written as gold started to retreat from $340) we said that it was way too early to get bullish on gold, that the rally would be short lived (which it was) and that the market was still under the control of the writers of paper contracts (which it is).

The Y2K build up, touted as the answer to gold's "problem" may have caused a shortage in gold coins, (wait till January and lets see how many come back on the market), but it did not impact the price. One newsletter writer that I spoke to still insists that gold will be at $400 by the end of this month. Wouldn't that be nice? Just don't bank on it.

There is no doubt that a long-term strategy of purchasing physical metal at $280 or under is a sensible thing to do. It is widely (within a narrow field) believed that a squeeze will happen (a long lasting one) and we have no argument with this. The question is when.

The answer is not until somebody collects the pens that are being used to write the contracts. When the bottom line is seriously impacted, as opposed to impaired, somebody will come looking for the writers of these paper contracts and will remove their ability to write contracts.

This will be caused by the realization that the contracts cannot be honored, which will most likely be preceded by a delivery problem or perhaps margin calls. Or both.

We have seen some evidence of this recently, but so far the band-aids appear to be working and it is entirely possible that they will last through to early January. It is unlikely that the powers that be would allow upsets in the gold market to occur during the run up to January 1, 2000.

When an upset does occur it will affect most, if not all of the players, including mining companies that are participants in the paper gold game. Shareholders need to be aware of this and stay alert to the potential impact on their investments. Perhaps the question should be "is this an acceptable risk?" Certainly there are some shareholders that are more than happy to sell in to any rally.

The often referenced connection between the gold price and gold stocks also needs to be reevaluated as the paper gold market participants include many of the mining company's as well. The term muddied-waters comes to mind.


The Prof can be contacted by email at profvonb2@aol.com

Copyright by Professor von Braun. All Rights Reserved. Reprinted at USAGOLD by permission.

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The Rocket School of Economics -- The Lecture Series Index

  • 22 May 2009 -- An Often Overlooked Issue!
  • 28 Mar 2009 -- Problematic Banking Systems!
  • 14 Nov 2008 -- What Exactly is an Asset?
  • 23 Aug 2008 -- Through the Looking Glass?
  • 02 Aug 2008 -- Compounding to the Downside!
  • 26 May 2008 -- Back to Basics Again!
  • 31 Mar 2008 -- The Broken Watch -- Part 2.
  • 27 Mar 2008 -- The Broken Watch -- Part 1.
  • 06 Feb 2008 -- The Financial Equivalent of Faulty Towers.
  • 10 Dec 2007 -- Monetary Systems & Productive Assets.
  • 14 Feb 2007 -- Divorced from Reality
  • 06 Sep 2006 -- Gold, Bankers, the Trade Deficit and Unsettled Transactions
  • 19 Jun 2006 -- When is a Reserve Not a Reserve?
  • 31 May 2006 -- The significance of August 15, 1971.
  • 08 Apr 2006 -- Keep Your Eye on the Ball!
  • 30 Mar 2006 -- What came first?
  • 11 Mar 2006 -- An Unanswered Question.
  • 08 Jan 2006 -- Where have all the projects gone!
  • 11 Dec 2005 -- Gorillas, Rising Gold Prices and Depreciating Paper Currencies!
  • 23 Oct 2005 -- Custodial Risk.
  • 16 Sep 2005 -- An Inherent Flaw.
  • 08 Aug 2005 -- Central Banks and 'Reserves'.
  • 31 Jul 2005 -- Central Bankers, Actors and 'We'.
  • 17 Jul 2005 -- Unintended Consequences! -- Part 3.
  • 07 Jul 2005 -- Unintended Consequences! -- Part 2.
  • 25 Jun 2005 -- Unintended Consequences! -- Part 1.
  • 14 Jun 2005 -- The Two Greater Fools Theory.
  • 03 Jun 2005 -- Real Money, Funny Money and YOU -- Part 4.
  • 30 May 2005 -- Real Money, Funny Money and YOU -- Part 3.
  • 26 May 2005 -- Real Money, Funny Money and YOU -- Part 2.
  • 21 May 2005 -- Real Money, Funny Money and YOU -- Part 1.
  • 09 Nov 2002 -- Carrying a Big Stick.
  • 17 Sep 2002 -- Wishful Thinking!
  • 27 Jul 2002 -- Gold Bugs Beware -- part 2.
  • 10 Jun 2002 -- Gold Bugs Beware!
  • 06 Apr 2002 -- Currencies versus Gold.
  • 26 Jan 2002 -- Bear Market Strategies.
  • 01 Jan 2002 -- 2002 -- A Perspective.
  • 20 Oct 2001 -- The Storm Clouds are Gathering.
  • 30 Sep 2001 -- What to Say?
  • 01 Jul 2001 -- ...Said the Fly to the Spider.
  • 14 Jun 2001 -- Upward and Downward!
  • 28 May 2001 -- Volatility Time, Again!
  • 14 May 2001 -- The Coming Bull Market in Gold Stocks?
  • 24 Feb 2001 -- High Hopes, Wishful Thinking & The Absurd
  • 20 Feb 2001 -- Who Put the Holes in the Swiss Cheese?
  • 22 Jan 2001 -- US Dollar Admits Identity Crisis!
  • 16 Jan 2001 -- Dear George W.
  • 24 Nov 2000 -- The Bubble Has Burst
  • 11 Nov 2000 -- The Media, Bull Markets & the Gold Price
  • 02 Nov 2000 -- Gold Stocks
  • 29 Oct 2000 -- Oh The Tangled Web We Weave ...When We Set Out to Deceive
  • 24 Oct 2000 -- A Mystery!
  • 16 Oct 2000 -- A Peso Here ...and a Few Thousand Pesos There
  • 10 Oct 2000 -- The Unfolding
  • 30 Sep 2000 -- What's Wrong with THIS Picture?
  • 25 Sep 2000 -- Buy Gold Now!!
  • 23 Sep 2000 -- The Times, They Are a' Changing
  • 15 Sep 2000 -- Time WILL Tell!
  • 27 Aug 2000 -- SS "Paper Assets" Begins to Take on Water
  • 06 Aug 2000 -- The Indian Summer
  • 26 Jun 2000 -- A Yellow Brick Wall
  • 22 May 2000 -- The King IS Naked
  • 30 Apr 2000 -- Goodbye Yellow Brick Road
  • 18 Apr 2000 -- Beware the Ides of March, April and May
  • 08 Apr 2000 -- Really, Sir Aldot!
  • 25 Mar 2000 -- Where To From Here?
  • 18 Mar 2000 -- The Gnomes of Zurich
  • 12 Mar 2000 -- The "New" Economy??
  • 06 Mar 2000 -- Two Questions
  • 04 Mar 2000 -- Iceberg Dead Ahead!
  • 28 Feb 2000 -- The Wizard of Oz
  • 06 Feb 2000 -- Here We Go Again!!
  • 15 Jan 2000 -- Comments on the Gold Market
  • 29 Dec 1999 -- No Raw Ingredients Required
  • 28 Dec 1999 -- No Way Out
  • 14 Dec 1999 -- Ho, Ho, Ho!
  • 07 Dec 1999 -- Greenspan's Bubble
  • 03 Dec 1999 -- Early Warning Signs


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