Derivative Overhaul is Powerful for Physical Metals

By: Dr_Jeff_Lewis

As Congress looks to pass a financial overhaul bill to prevent a second coming of the Troubled Asset Relief Program and another financial crisis, one of the biggest winners are holders of physical precious metals.  Language in the bill meant to reduce the volume of the derivatives market could send the price of physical metals soaring.

A Case of Supply and Demand

Physical precious metals investors around the world know that the gold and silver markets are at best over inflated and at worst manipulated.  A reduction in the amount of derivatives bought, sold and issued would reduce the amount of “paper” gold and silver trading in the system.  The result?  There would be less paper metals and just as much physical metals.  Couple the decreased supply with the same amount of demand, and this leads to higher prices for physical metals.

A Diluted Market

As it stands today, there are literally hundreds of ways that investors from investment banks to individuals can “track” the price of gold and silver, but there is only one way that investors can actually own the metal itself.  The derivatives market allows for investors to make bets on a metal without any metals actually trading hands.  Instead, two investors reach an agreement to pay each other the change in price up or down from today to some point in the future. 

For example, you are bullish on silver, while your friend Jim is bearish.  You make a bet, agreeing to pay Jim the difference from today's price if silver tumbles.  Jim agrees to pay you the difference if the price rises.  Both of you can claim to be tracking the price of silver, and you are, but neither of you actually own any silver.  In actuality, all you own is a claim from someone else to make up the difference. 

This is exactly how derivatives work, and how they dilute demand with extra “supply.”  Demand is displaced with paper bets.

Derivative Crackdown is Just the Beginning

A crackdown on derivatives investing is only the beginning of the end of the manipulation that has taken place in the gold and silver markets.  However, with the derivatives market valued anywhere from $30-600 trillion (after all, no one really knows definitively), it is sure that several hundred billion dollars have been waged, both bull and bear, on the price of metals.  This money, once removed from the derivatives market, will have to find a place somewhere, and that place is in physical metals. 

Should this bill pass, and derivatives become discouraged by greater liquidity requirements, gold and silver in their physical forms will begin the next stage of their bull market. 

Of course, the only way to take advantage in a change in price is to own the commodity itself, not a paper position.  Once the house of cards begins to crumble, it may be only a matter of days before every paper asset under the sun is regulated or outlawed.  At that point, the paper dust will settle, and only physicals will remain.

By Dr. Jeff Lewis

Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of Silver-Coin-Investor.com and Hard-Money-Newsletter-Review.com

Copyright © 2010 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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