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Last year's
disastrous collapse of MF Global has impacted financial markets around the world in many ways. Given
that it was one of the largest brokers
of leveraged products, it is no surprise that this area has felt the full force of MF Global’s
collapse.
For example,
futures trading volume on US exchanges has dropped noticeably, mainly for two reasons. First, MF Global customers
who are still waiting for their money to be returned are not trading. Second, customers of other brokers have understandably
become worried about the safety of their money and withdrawn funds from those firms,
which has reduced their capacity to trade.
Gold has not been spared from the MF Global fallout. One of the biggest
impacts has been to bring about a better understanding of the risks of owning paper gold. Customers who stored their
gold at MF Global received
a nasty surprise. As reported
by Reuters recently “customers
whose accounts were frozen when
the futures broker collapsed…[and]...who hold physical
property such as gold
bars…[have]…seen no recovery
as of yet.” MF Global clearly
illustrates that owning metal through a brokerage house is a paper-gold
product, not physical
gold.
It is
important to recognise the fundamental
difference between paper gold and physical gold, aside from the fact that paper
gold enables one to take
a leveraged position. With
paper gold you own exposure to the gold price; you do not own real gold. Paper gold is a financial asset that comes
with counterparty risk, as MF Global’s customers learned. The value of
their paper gold was dependent upon a financial institution’s promise. In contrast,
physical gold is a
tangible asset, with no counterparty risk.
To highlight
a key point, there is a
lot more paper gold outstanding
than physical gold available for delivery. The
Comex clearinghouse in New York City and the clearinghouse of other
exchanges where leveraged
gold products are traded
are just one visible part of the paper gold position that exists worldwide. No one really knows how much paper gold has been sold in its entirety,
but it is huge.
So as the scramble
for physical metal by individuals, central banks and other institutions intensifies, as has been happening during the ongoing banking and sovereign debt crisis of recent years, defaults are
possible. They occur when those needing
to deliver metal to fulfil their promises do not own any physical
metal. In the final analysis,
the Comex is no different
than the London Metal
Exchange, which defaulted
on its nickel contract a
few years ago. Worryingly, it seems reasonable to conclude that our immediate future unfortunately holds the
prospect of seeing the collapse of more financial companies and banks.
For several
years, the global economy
has been working its way through a financial bust, and throughout history these are always filled with the breaking of promises. For example,
Lehman Brothers could not meet its promises, and more recently,
the Greek government has
been unable to repay its commitments. Therefore, the rule-of-thumb is to avoid
financial assets during a financial bust, and by extension, avoid leveraged gold as well.
Given that today’s global monetary
and financial problems remain largely unsolved, own physical gold and not any paper-gold substitute. Also, make sure that your gold is not kept with a broker or bank because they are not safe, as Lehman Brothers, MF Global and
the failure of other firms have made clear. Instead, always store your metal in the vault of companies who are in the business or storing,
not the business of lending or trading
leveraged products.
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