If you think the recent moves in gold and silver are wild, buckle up. There is a realistic scenario where the gold price goes full-on parabolic, and it could happen at any time.
If this scenario takes hold, we could see the gold price blast through the $2,500 level, or even the $3,000 level, within a timeframe of weeks or even days.
If this happens — again, the scenario is not at all guaranteed, but plausible — silver would likely follow suit, both due to its role as a monetary metal (silver is half monetary, half industrial) and because the same dynamics are at play in the silver market to a less-extreme degree.
Bitcoin — which is already in bull-run mode, and above $11,000 as of this writing — would likely also take off, with a direct relationship to the scenario we’re describing, and could easily return to its old $20,000 highs.
So, what is the scenario we’re talking about? Think of it like a “reverse bank run.”
A bank run, also known as “a run on the bank,” takes place when the depositors of a bank lose faith in the institution. Due to that loss of faith, everyone tries to pull their money out at once, and the line of customers waiting to make a withdrawal snakes down the street.
Banks runs are an old-fashioned concept, more associated with the 19th century or the early 20th century, than anything we’re familiar with today.
The Federal Reserve was created specifically to stop bank runs, along with other forms of financial panic. To further increase confidence in the banking system, the Federal Deposit Insurance Corporation (FDIC) was created via the Banking Act of 1933.
Most people came to believe that, thanks to the modern financial system, bank runs were a thing of the past. And yet, in 2007, a British bank called Northern Rock experienced one of the first old-fashioned bank runs in living memory for a rich Western country, complete with lines of customers out on the street. In February of 2008, Northern Rock was taken over by the British government.
But getting back to gold, you can think of a “reverse bank run” as the opposite of a traditional bank run. In a reverse bank run, there is a stampede to get in, rather than out.
Evidence suggests that physical gold is experiencing a slow-motion reverse bank run even as you read this, and it has been gaining speed for a while now. Hedge funds, family offices, private institutions, and wealthy individual investors are all trying to get their hands on physical gold bars.
In June, the Wall Street Journal reported that a record-busting 29.7 million troy ounces of gold had piled up in Comex-approved bullion vaults. More than three-quarters of that total — “weighing as much as nine fully loaded Boeing 737-700 airplanes” — had arrived in the past twelve weeks.
The gold showing up in Comex vaults is a result of gold futures contracts being assigned to physical delivery. This means that, when the futures contract expires, the person or entity who is “long” the contract does not sell to close it out. Instead, they agree to take the actual metal.
The vast majority of futures contracts are cash-settled, even in the futures markets that have physical delivery terms written into the contract.
That is because, most of the time, it is simply easier to use the futures contracts as a price hedge, settling up in dollars and doing the actual physical commodity transaction, if required, in some other venue.
Now, though, it is becoming incredibly hard to locate, and transport, the actual, physical gold bars that so many investors crave.
If a pool of investment capital is large enough, and a desire exists to hold physical gold, dealing with warehouse costs and insurance can make sense. Then, too, the purchase of physical gold bars is the only way to remove counterparty risk (in the event the financial system goes haywire).
The trouble, though, is that gold is now even harder to transport than it used to be. In the past, gold would frequently be transported on commercial planes, for example — but that doesn’t really work in a pandemic. Even charter flights are harder to book, and far more expensive, due to high demand for the movement of medical equipment and supplies.
So, what we are seeing is a historic spike in the number of gold futures contracts being assigned to physical delivery. What’s more, this hunger for physical delivery is not coming from commercial players in the gold market, but rather the private entities just mentioned — family offices, hedge funds, high-net-worth investors, and so on.
This could turn into a nightmare for the swap dealers on the other side of these gold futures contracts.
Swap dealers are large-scale financial institutions — like JPMorgan, Goldman Sachs, Citibank, and others — with the capital backing to serve as the middleman in complicated “swap” transactions, a type of derivatives play involving commodities, interest rates, and other exotic instruments.
For more than twenty years, precious metals investors have expressed skepticism at the activity of the swap dealers in precious metals markets, and the bloated size of the “paper” gold market relative to available quantities of actual, physical gold.
There has long been a theory, never actually proven, that dealers and other entities on the “paper” side of the gold market have been shorting gold in greater quantity than actually exists in physical reality — the equivalent of shorting more shares of a stock than are actually issued, depressing the market price.
That theory could be tested in real time now, as a wave of private-market investors seek delivery on their gold futures contracts. According to data from Longview Economics, a research firm, the gold futures market has never seen a spike in delivery assignment requests, the likes of which is happening today.
Delivery requests could create a “short squeeze” for the ages because, if the swap dealers are overwhelmed by demand for physical gold bars they don’t have, they will have to pay unimaginable prices, either in a “melt-up” gold futures market or in physical markets elsewhere, to get out of the jam created by a lack of physical supply.
This phenomenon also has the potential to become a self-fulfilling prophecy.
Based on the merits of what the Federal Reserve is doing, and where the world is going, holding physical gold in a private vault — if one has the scale to absorb the costs — makes sense for large-scale investors anyway, regardless of whether there is a squeeze.
But if a squeeze could push the price of gold higher, why not press harder by taking delivery on a greater number of futures contracts? Indeed, private investors may start doing this anyway, as the futures market becomes more and more the delivery mechanism of last resort.
In addition to this, as the gold price rises and the U.S. dollar declines, the desire to hold physical gold could take on a new urgency among private investors and central banks alike.
The whole world is watching the gold price right now, as a kind of “canary in the coal mine” indicator for the health of the global financial system; the more the gold price rises, the more nervous everyone gets.
And what is the antidote for a worsening case of central bank jitters? Buying more gold.
All of this creates the potential, or even the likelihood, of a positive-demand feedback loop: The more the gold price rises, the more that private demand for physical gold intensifies.
And the more that demand for physical gold intensifies, the more trouble the swap dealers could be in, as they scramble to locate physical bullion that doesn’t exist, or is far from readily available compared to the waves of new demand flooding in.
This is also a bullish dynamic for silver, where a spike in futures delivery assignment is also noted (though not to as extreme a degree as gold’s). As the gold price gains ground, and media attention, silver is likely to gain ground and attention, too.
Last but not least, Bitcoin, as “digital gold,” gets a tailwind from this as well. To the extent that private investors fail to get their hands on all the gold bars they would like, Bitcoin serves as an alternative store of value hedge to fill the gap.
And Bitcoin, like gold, is available in “physical” form in the sense that large investors can own Bitcoin, if they so choose, without any counterparty risk (by setting up their own cold storage).