More than almost ever before, gold is being used for collateral for loans, hedge funds are borrowing to buy it, and Indians are using it for shadow banking loan reserves. There is a loan against a significant proportion of the world’s gold.
These are not 30-year fixed mortgages, these are not loans that as long as you pay the interest you get to keep the loans. These are collateralized loans. If you miss a payment, the gold will be sold, if the price of gold drops enough, the gold will be sold, if the rest of your portfolio has an issue, the gold can be sold.
Gold is dead, it does not generate more wealth; all it does is store wealth. As long as things go well and people want more gold versus less gold the price will go up, but weird things start to happen when you leverage gold.
So let’s start with a hedge fund that has 30% of its assets in gold. Sounds great for the gold market, but let’s talk about what the fund is going to do. They are going to collateralize the gold, and do something active with the cash. If there is a general market crash they will be forced to meet margin calls, and yes, that gold will be sold. Even if they did not borrow against the gold, I can tell you that if we end up with reduced liquidity like 2008 (yes, it will happen again), the investors of the hedge fund will be calling up for cash. When they call for the cash, the first thing that can be sold is the gold.
If you have a middle class Indian family, and they need to pay for a wedding, or pay for a car, you can bet that they will use gold for backing of a loan. If the price of gold drops, I can assure you that the gold will be sold ASAP.
I could continue, but the point I want to make is when you look at the gold market you must figure out how many of the investors can afford–or are even structured–to hold their positions through a second market collapse.
My prediction: there is going to be significant short term drop in gold prices and an increase in gold volatility in price if there is another liquidity crisis. It could in the long term drive the gold price up, but if you are buying gold make sure that you hold it, that you are not in a leverage position in the ownership of it, and that you are not planning to use it as a basis for a loan.