Derivatives, ETFs, and Other Confusing Investments

You may have heard of the SPX, XAU, EFTs and a bunch of other derivative/paper types of investments that seems very confusing. Would like to know more about it?

Well.....you've come to the wrong place. (Again, they actually PAY me to do this!)

I don't know much about that kind of stuff, as it is mostly used by traders and speculators to make a quick buck. Since I'm not that smart, I stay away from anything with initials. (Especially the IRS.)

But, I am about to tell you all that you need to know about these things.

Investor A thinks the price of gold is going down. He writes a contract and offers to sell gold to Investor B at $900/ounce. Investor B thinks the price of gold is going up to $1000/ounce, so he buys the contract.

Now A doesn't actually have the gold he is selling, and B doesn't really want to buy the gold. They just each want to make the difference on the price movement.

This is known as a "naked" contract. (no clothes) You are selling something you don't have.(no gold)

So even though A doesn't have any gold, the contract is still enforceable by B to demand delivery of the gold. But this never happens as no one wants the hassle of exchanging physical gold.

Back to our story.

Now if gold goes up from $900 to $1000, Investor B gains $100. Why? Because he theoretically buys the gold from A at $900 and sells it at the current market price of $1000.

Investor A obviously loses $100. He now has to "theoretically" buy gold at $1000 and sell it to B at $900.

It is a paper transaction only. That is the key thing to remember, and billions of dollars of these contracs are outstanding.

So Why Do I Care?

Regarding gold, there are thousands upons thousands more of these little paper "claims" to gold out there in cyberspace than there is "physical" gold. And that is no big deal as long as no one wants to enforce their contract and take delivery of the "physical" gold.

But, what if our "paper" economic system were disrupted? What if foreigners all decided that they no longer wanted to be paid in dollars, but in gold? (This is already happening with our Asian and Arab trading partners and they have hinted that it will escalate.)

Overnight, the dollar coud become worthless, or at least deeply devalued. Gold would skyrocket in price. And everyone who has one of these legal contracts that says they can buy gold at $900/ounce will demand their gold.

Problem is....there's not enough of it to go around........at any price, which fuels the cycle and forces gold prices higher and higher.

And if you think that can't happen here, don't forget, that is exactly what happened in pre-WWII Germany.

Europe quit taking Germany's "inflated" paper money and demanded gold in exchange for goods and services. This sparked a massive decline in the value of their currency, and in the end, it took a whole wheel-barrel load of Deutchmarks to buy a loaf of bread.

Germany needed gold and/or other tangible assets, and Hitler rode in on the white horse and saved the day by stealing it from....guess who?.....the Jews.

"And now," as Paul Harvey used to say, "you know the rest of the story."


Conclusion

If you don't own physical gold, you are at risk. At HUGE risk.

I have been in the financial business since 1983 and I can tell you with certainty that this house of cards will fall sooner or later. Hopefully it will be later, but it could be tomorrow.

And when it does, your investments in tangible assets will save you.

So stay away from anything with initials, and people named Adolph.


If you care to read more articles about gold as an investment, go to our Gold Commentary site. If you wish to purchase gold, go to our Bullion Services site.