NEW YORK ( TheStreet) -- As a financial adviser, I recommend gold as part of a diversified investment plan. For Baby Boomers I tend to prescribe an extra dose of gold, about 10% and sometimes up to 20%.
Usually, it is not a problem getting investors to accept this prescription -- until the recent gold collapse that gave investors a "stock market crash" feeling.
As a result, I think it's time for investors to change their thinking.
Should gold be skyrocketing?
One very good reason it isn't is because of the bifurcation in the gold market. Specifically, now there are two markets and they are behaving in different ways. Moreover, speculation in one market is negatively impacting upon the other. The two markets I am referring to are the physical market -- gold bars and coins -- and the derivative market consisting of gold ETFs, gold funds, gold options and gold futures.
I interviewed Jim Rickards, lawyer, former investment banker, and the author of "Currency Wars: The Making of the Next Global Crisis," for my radio show, and he was unequivocal about the impacts of speculation through derivative products.
"Leverage gets into the system when people buy gold ETFs on margin, and suddenly there are margin calls because the market takes a hit," he said. "When that happens, like it did recently, the buy and sell decisions are no longer rational."
There are several challenges that come with this bifurcation that were not readily apparent until recently.
First, the number of derivative products betting on gold is now far larger than the gold supply itself. My speculation, and my worry, is that if all of the derivative products that have a claim on physical gold were put to central banks and other depositories, that physical delivery could not be made.
It would be the equivalent of having a cash redemption feature on all U.S. debt, where all the buyers suddenly wanted their money back at 100 cents on the dollar.
Second, the prices in the gold market are rather easy to manipulate in the futures market (See
"Not Your Grandfather's Bank Holiday"
), and once these prices are manipulated it creates an opportunity to arbitrage between the physical market for bars and coins and the derivative markets such as ETF, futures and options.