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Creating Illiquidity in Gold



August 19, 2011 – Comments (18) | RELATED TICKERS: GLD

This morning there was a story in the Milwaukee Journal Sentinel about a police sting on illegal gold trading at one of Milwaukee's pawn shops.  Illegal gold trading.  Imagine that.  Interestingly, this shop really did not have a big interest in gold a few years ago.  Today it is big business.  Around town, and around the country I saw this summer as I traveled west by road, there are as many signs popping up saying "buy/sell gold here" as there are "for lease" signs. 

Back when the mortgage bubble was inflating one thing I noticed, and mentioned to a friend in mortgage finance, was the amount of strip malls with new mortgage brokers.  He said, "yeah, they're cracking people left and right."  Cracking was a reference to the high fees that generated broker commissions.  The FBI had identified a rash of "cracking" all the way back in 2002, but was ignored.  I wonder what they have to say about gold trading now.  I'm going to look that up.

Today, the "buy/sell gold here" guys are cracking people left and right.  The spread on what they are buying and selling is huge.  It doesn't matter if they buy it or sell it, they are making a ton of money.  This time, unlike the mortgage market, which was bred on greed and desperation to own a home, this gold market is being bred on fear of the end of the world and desperation to pay bills.

I also have a friend who bought $50,000 of the mini-gold bars recently at $1700/oz.  This friend is willing to pass the gold onto his kids someday, so it's not a short term investment, which I guess makes it ok since he doesn't need the money probably.  Still, at this point I'd rather have dark chocolate bars myself because if the proverbial shizot hits the fan I can trade those.  But, I do understand his approach and I'm probably overstating a bit, though dark chocolate is good. 

Another guy I know bought a little earlier, buying $100,000 of coins at $1350/oz.  He was explaining it to me over a beer one day.  His economic analysis didn't make much sense to me, but I'm not that smart so it could have been me.  His premise was he'd sell it all around $4000 then retire.  I'm not sure who he'd sell it to at that point.  It's not like he can press a button to sell gold coins.  Even if I had a better explanation at the time, in the condition I was in it wouldn't have mattered as there would have been no explaining it between the beer and the deep, deep emotions.

To note, both paid hefty shipping and handling to get their gold, which is sort of getting cracked.

So what I see is that now we have late investors and people hocking gold involved in the gold market way after the bull market started.  Gold is up what?  600% the past decade?  Something like that. 

I remember a client asking about gold in 2001 or 2002.  I didn't know much about it, and since I understood oil we bought that instead.  I haven't bothered to look at which has done better, but I suspect it is similar and I am not afraid of oil.  

Why am I not afraid of oil?  Simply because it has a use.  Gold is an emotional investment.  Even when it is used for jewelry it is emotional.  Guys, you know what I mean.

Back to gold, I was talking to a relative last night who had a seat in Chicago awhile back.  He made a comment that the market does the same thing over and over.  Blow the market out, scaring out the little guy, buy it a bit at a time causing it to drift up, then sell the pop up when the little guy gets back in.  Rinse.  Repeat.  I can't help think that gold is being soaped up real nice right now.

Back when the mortgage bubble was getting to the point of stretching the rubber too far, credit default swaps were being sold by Gregg Lippman at Duesche Bank, interestingly a bank that had been funding the mortgage credit bubble.  I wonder who is today's "gold" Gregg Lippman.  Gold is inflating a bubble.  I don't know how much the rubber can stretch, but I suspect we are closer to the popping point than many expect.  $2000/oz gold?  Probably.  $3000/oz gold?  Maybe.  $4000/oz gold?  I sure hope so because that would be an easy short even for a nube like me.

Now, back to my buddies.  Both are up on their trades.  Will they be able to sell a pop if it comes?  I doubt it.  Who will buy?  If gold goes to $3000 but stalls, who will be there.  The "buy/sell gold here" guys?  No way, they are going to pack up shop the minute they can't crack people.  Just like the mortgage brokers who used to be in their strip mall spots. Will Glenn Beck buy it all.  No way, he is way too smart of a huckster to buy it after it goes up another 100%.  Goldline?  Nope. 

Now, I admit, I am on board with the "after trying everything else, the United States will do the right thing" thought process.  Could equities head lower another 20%.  Sure.  Could the world end as we know it.  Yep.  But if it does, who cares.  We have a demographic shift going on complicated by a debt rebalancing.  It will pass.  It might take a few years if Congress can not see we need to jump start things by shifting tax loophole money to infrastructure spending quite yet, but it will happen, the infrastructure needs to be rebuilt and upgraded soon if not now.

If the world does end I'll swap some of my dark chocolate for whatever else I need.

18 Comments – Post Your Own

#1) On August 19, 2011 at 11:25 AM, leohaas (30.08) wrote:

"If the world does end I'll swap some of my dark chocolate for whatever else I need."

That's proven to work. When the Nazis invaded Holland in May 1940, my grandfather bought a tremendous amount of dark chocolate. My grandmother chastised him for doing so. But during the winter of 1944/5, when tens of thousands in Holland died of hunger, his family survived eating and trading chocolate bars!

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#2) On August 19, 2011 at 11:43 AM, miteycasey (29.01) wrote:

The thing about investing is the unknown future.

These guys are betting, gambling actually, on the situation getting worse before it gets better. Do they know this for a fact? No, but they've made the decision that there gamble has a positive expected value, just like we do when we buy stocks.

The down side to their wager is what if things dont' get worse and improve. I think they are stuck losing money. If they had bought oil I think they could make money if the market goes up or down. The swing just isn't going to be as big with oil. 


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#3) On August 19, 2011 at 11:43 AM, whereaminow (< 20) wrote:

Still, at this point I'd rather have dark chocolate bars myself because if the proverbial shizot hits the fan I can trade those.

Highly doubtful, and should you research the economic term "exchange value" you will whistle a new tune :)

David in Qatar

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#4) On August 19, 2011 at 11:46 AM, whereaminow (< 20) wrote:

To be more specific, you need double coincidence of wants, so you would have to find someone with something you need that also wants dark chocolate bars.  Very unlikely.

David in Qatar

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#5) On August 19, 2011 at 12:26 PM, kirkydu (90.45) wrote:

Come on David, everybody wants dark chocolate.

Will you buy my friend's physical gold without cracking them if it has a spike (as opposed to the decade long drift upward which is behaving rationally so far, though showing signs of irrationality setting in) and they want to sell?.

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#6) On August 19, 2011 at 12:34 PM, penguin74 (< 20) wrote:

Actually, couple minor corrections. I bought at $1650. Also, one of the reasons I deal with is because they throw in free shipping+insurance on purchases over $25,000. So every single penny of my $50K went into metals (I also bought some silver). Granted I did pay hefty premium ($70 over spot), it still beat the hell out of local dealer who wanted $50 over spot but then state wanted its share of 5.6% sales tax.

You are accurate I could care less if I sell or not, having kids it's something neat to pass on. However, I do have my sell point identified. Rather than fixed $ amount like your other friend and most other speculators, I simply believe that market will correct itself like it did before in the history, and DOW and AU will meet 1:1. Not only that, I believe that an ounce of gold will surpass a share of DOW. Stock market is still way over valued. We don't produce anything. All went offshore. DOW is truly worth no more than an ounce of gold, and when and if that happens, I will attempt a sale. How much will that be? I have no idea, but I can venture to guess it will be somewhere between 6-9 K.

You make a  good point about potential buyer. I believe that at 1:1 there still be demand because I also believe that  hyperinflation is in store for us. Anyway, to keep it short, if we hit 1:1 it means my house gets paid off for free, so great. Otherwise, my kids will have a neat wedding gift or whatever.

As far as oil is concerned, you're missing one crutial point. We're past global peak production, and from here on, production and consumption can only go down. Combine that with expanding global population and you see that solar energy is the future (we're on the same page here). However, oil investment has actually much bleaker future than gold or any PM for that matter.


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#7) On August 19, 2011 at 1:22 PM, kirkydu (90.45) wrote:

Adam, I knew you were a flightless bird. 

Oil consumption will go down someday, but not for decades, in the intermediate term we will see cost push due to demand outstripping supply. Oil at $200 this decade is a no-brainer, maybe $300 or $400 on an event spike.  Futures traders are going to make a fortune on oil in the next several years as the economy recovers.

I would love for solar to be ready to go big time right now, but that is probably a decade or two away as efficiency makes its next couple jumps.  I am selling puts on TAN though pretty aggressively at these prices and have a small position in it.  Also like WFR and AMAT right now due to being near bottom of semiconductor cycle.  I want to invest in some Chinese companies but they are so scary.

On a side note, URA is a no-brainer right now as well.  I hope it doesn't become more of no-brainer.

With regard to the economy recovering, after over a decade of bearishness I am coming out of hibernation.  The sun will come up tomorrow.  I am not sure if that is in the next year or a few down the road, but we are closer to an upturn than many people expect.  Only Congress can decide if andwhen they will simultaneously cut debt and stimulate, so that is the wild card.  Even if they screw up again, they'll get it right eventually and well before we fall off of a cliff. How do I know, because this time will be like the last time and the last time and the last time.  As has been said, after trying everything else, America does it right.

So, while I do agree that long term flattening of the debt is important, I am not on board with the United States needing to go into a Greece style austerity. The United States is in fact a special case.  While we can not take on debt forever, the fact is that our capacity for debt far exceeds any other nation due to our accumulated wealth and resources.  While we are light on production right now, that is easier fixed than believed popularly right now given the resources, physical, financial and labor, in this country.

I agree with many Austrian principles, David in Qatar would like that, but they too have a fundamental problem.  They, and by they, I mean those who do the interpretations lately, miss that the tendency towards absolutism of balanced budgets right now does not account for human psychology anymore than the Marxists missed on human psychology. 

1:3 is a better ratio btw on gold:dow.  When the gold ride ends, it will end faster than the mortgage collapse which took a year and a half (Bear to Lehman).

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#8) On August 19, 2011 at 4:08 PM, XMFSinchiruna (26.59) wrote:

"1:3 is a better ratio btw on gold:dow.  When the gold ride ends, it will end faster than the mortgage collapse which took a year and a half (Bear to Lehman)."

You are welcome to your opinion. I don't think time will be very kind to this perspective. Unless, of course, you meant to say dow:gold instead of gold:dow.  :)

I don't follow the logic of the initial post one bit. If gold is trading for $4,000, that means buyers are willing to pay $4,000. Contrary to your assumption, I believe your friend would have no trouble whatsoever selling his physical gold at or near $4,000. If there were no buyer at $4,000, then the price would not BE at $4,000. Forgive me if I missed ssome other nuance of the argument ... it's ben a long day and I only gave it a quick scan.

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#9) On August 19, 2011 at 4:25 PM, smartmuffin (< 20) wrote:

Yeah, what Sinch said.  The very nature of the spread is true regardless of what you are buying or selling.  Whether it's rice in a grocery store, a new car, 100 shares of Apple, or gold coins.  You are going to pay a small markup when you buy it, and will probably be charged a small markup when you attempt to sell it.

If, at some point, gold is spot-priced at 4,000 an ounce, you're correct that your friend might not be able to, on that very day, find someone in his own town willing to buy 100% of his gold at that exact price.  But, I'd bet you that he'd be able to sell most of it over a relatively short period of time for, say, 3,850 an ounce, which would still leave him sitting slightly prettier than your dark chocolate investment. 

I'm curious though, why do you think Goldine WOULDN'T buy it?  They're a gold broker.  They make money buying gold for slightly below spot, and selling it for slightly above.  That's an effective business model regardless of what the spot price is.  Do you also believe that NYSE would stop buying or selling your stock simply because the stock gets too high in price?

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#10) On August 19, 2011 at 4:48 PM, kirkydu (90.45) wrote:

@Sin and muffin

Go to a "buy/sell gold here" guy.  It's not a small spread.  They will be the first guys to dry up.  Then, gold services/houses like the two mentioned in this thread will stop buying gold back in as soon as there is a scary crack in the spot price.  It will happen very quickly when it happens. 

Look at the mortgage market.  Home prices came down over years.  I'm saying gold when it peaks, will crash quickly thereafter.  Some folks might find dealer buyers, which is what you will need for physical gold, but most won't.  Just like many, many people can not find a buyer for their home they thought was worth $500,000 at $300,000.

I did mean 1 gold:3 Dow, i.e. $3000 gold: 9000 Dow.  Gold will not hit a 1:1 matching point with the Dow.  Might get to 1:2, but trying to sell there will be very tough with physical gold (with GLD it could be done if that security is indeed funded- I believe it is, though many physical gold holders don't).  Remember, when GLD starts to fall, it will fall hard and it will sell gold quickly adding to gold supply further driving down price.  It will be a very quick and harsh thing.  It won't take years.  It will take months, maybe weeks.

Sell on the way up if you have physical gold, do not try to hit a peak or a pre-determined point beause you will most likely miss. Be ahead of that market.

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#11) On August 19, 2011 at 4:53 PM, kirkydu (90.45) wrote:


specifically to Goldline.  They are a broker, not an exchange.  Big difference v NYSE.  If the market starts to fall, they will delay, then stop taking gold in.  Just like the mortgage brokers did after the CDS guys stopped selling CDS.  Why?  Because it will move too fast making the risk too big.  They are the last guys you should expect to be left holding the bag when gold finally crashes, and it will, because it has no real use.

Now, I tell ya what, how about some diamonds? Now that's a store of value:-}

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#12) On August 19, 2011 at 5:17 PM, penguin74 (< 20) wrote:

Gold will fall after it's repriced in Amero or whatever new currency we have after the USD busts. As long as USD is in circulation there will be demand for gold.

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#13) On August 19, 2011 at 5:26 PM, smartmuffin (< 20) wrote:

Well, I suppose you have a point in that if the market becomes exceptionally volatile they may suspend buying for a period of time, although I'd still doubt it.  They'd probably just increase the spread.  I mean, even during the height of the mortgage crisis, there was never a point where you literally could not sell your house.  You just couldn't sell it for what it was supposedly "worth."

 This is where Sinch's point comes in.  If you can't sell your gold for 4,000, then it's market value isn't really 4,000 now is it?

The thing about living in a (mostly) free market economy is that you can always buy or sell your goods or services, just not necessarily at the price you might prefer.

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#14) On August 19, 2011 at 5:30 PM, leohaas (30.08) wrote:

If gold is in (the uprun to) a bubble, kirkydu's prediction that one day the "buy/sell gold here" guys are gone will become true. There can be no doubt about that. and in that case, there will not be too many willing to buy your gold. Maybe the Chinese using all those dollars they have? However, it all depends on the If clause with which I started off my comment!

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#15) On August 19, 2011 at 5:54 PM, kirkydu (90.45) wrote:

remember, I said a bubble is forming.  I don't think a bubble is necessarily here yet, although it did bust some technical levels this week that imply the bubble phase has begun.  How high does it go?  I don't know.  But when it ends, it will end fast- that's the main point.

@muffin, you are trapped in a push button world aren't you?  You can't push button with a hard asset.  There must be a liquid market to sell it.  So, if the spread on a $500,000 house according to the bank and CDO or CDS or whoever can't be sold for any higher than $300,000 it's more than a spread.  That's a market collapse. The difference is because there is no push button house market (we'll avoid a CDS talk here), that collapse took a long time.

The biggest mistake that people made with their houses was not lowering prices to get ahead of the perceived spot price.  They thought their house was worth $500,000 and priced at $489,999.  Couldn't sell.  Repriced to $459,999.  Couldn't sell.  Now they are at $299,999 if they are even trying anymore to sell or they are upside down and getting foreclosed.  

The biggest mistake people holding physical gold will make is not selling fast enough.  The push button guys will click click click their gold away and take their profits and the next day the physical gold market will be crushed and disappearing for the average guy.  

Like I said, I have a relative who used to own a seat in Chicago, and he made the point that the market sucks people in in order to spit them out.  That is happening now with people buying physical gold.  Glenn Beck.  Goldline.  "buy/sell gold here" guys...  don't you hear the sucking sound.  It ain't Ross Perot's sucking this time, it's the futures traders sucking.

I don't know where the bubble busts, but I know for a fact that the people who followed some good newsletters and advisers who bought under $1000 are some of the sellers right now.  Only a little at at time because momentum is strong right now, but they are slowly taking profits.  

Guys like penguin and others have been getting beaten over the head with pessimism and bastardized versions of economic theory to think the United States is going to collapse.  They are today's buyers. 

Folks, the U.S. ain't going nowhere. We have more resources than any other country.  This is lucky due to geography, but it is the truth.  We can't piss it all away, no matter how much we try (and we do try).  At some point, probably soon, people realize there are a handful of things to be done to save the oily goose.  Ok fine, golden goose.  The rich will get richer sure, but the middle class is about to get a huge bag of bones and things are going to get better.  When the echo boom and alternative energy hit about simultaneously we will see a multi-decade boom. Play gold for what it is, a trade.

Of note, I've been economically and equity bearish for over a decade.  I've been more right than most, although I traded like shizot last week.  What I know is that things don't change that much, especially in the strongest nation in almost every way on earth by far.

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#16) On August 19, 2011 at 6:11 PM, smartmuffin (< 20) wrote:

The collapse you're talking about would have to be pretty damn huge though.  I mean, if your friend is buying gold at $1800, and then it rises to $4000, let's say then things get REALLY bad and the mots he can possibly sell for is $1800, he's still even.

Now, people who buy gold at say, $2500 might be setting themselves up for an eventual fall, but man, if you think $4000 gold is in the future and gold is $1800 now, how can you recommend against buying?

Remember, for every person who bought a house at 500k and had to sell at 300k, there's (roughly) one person who bought at 300k and sold for 500k.

In any case, you really shouldn't lump Glenn Beck in with the rest.  He makes it very clear that he's not recommending gold as an investment for the purposes of making money, but rather as "all hell breaks loose insurance."  You may disagree with that assessment, but it's not quite the same as a lot of the "advisors" out there.

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#17) On August 19, 2011 at 7:25 PM, kirkydu (90.45) wrote:

I didn't say $4000 is the future.  I said $4000 is a no-brainer easy short. 

What if the futures price moves up to $2400, which is an important technical level and the gov'ment does some things right- it could happen you know, really, it has before- just after a bunch of retails get sucked in, then what for them?  Well if that is the peak, they are no way making money.  All I'm saying is that we are getting into bubble territory and hard assets, whether gold or real estate or whatever are relatively illiquid markets to begin with.  I don't know how far the rubber stretches but when it stops stretching, it'll pop fast.  This is a liquidity argument, NOT a price argument. 

I do believe we are closer to the end of the gold run than the beginning, at least with regard to the calendar and percentage gains.

I think GLD is a better vehicle for most if folks want to be in gold.  Even there a person had better be nimble and unemotional.

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#18) On August 20, 2011 at 10:15 AM, XMFSinchiruna (26.59) wrote:


I hear your thesis, and understand the rationale. Some of what you say may be true, particularly with respect to the number of "buy gold" boutiques in mall kiosks, etc., but much of the remainder is in my opinion an unfounded concern regarding what liquidity will look like in the gold market on the way down. Also, while there will undoubtedly be some very violent moves near whatever level becomes an eventual top, the trajectory on the other side will likely surprise a lot of people. Remember, nothing about our condition resembles 1980 when the economy was strong enough to withstand interest rate hikes to 20% in order to reign in inflation and gold.

But one part of your statement is very true and deserves repetition. If you're buying gold purely as price speculation and not as a protection of capital / long-term safe haven asset; then yes, absolutely, the best approach is to not get too greedy with respect to a selling point, and sell on the way up rather than the way down. That's not because I foresee problems with liquidity, but merely because that approach is likely to yield more orderly decision-making.

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