Gnome Underpants Gold Model, Report 21 May, 2017

There is a often-promoted plan to grow your wealth. Here’s the background. The dollar is going to be worthless. Soon! The reason is because [their peeps in high places tell them / the Chinese / end of the petrodollar / historical fiat currencies / Rothschild Jekyll Island Master Plan Private Fed / Fed printing] will cause the dollar to collapse and gold will rocket to $50,000. In fact, it’s a miracle that the price is a mere $1,253 and it hasn’t already. It will, once people discover this One Weird Secret that They Don’t Want You to Know that we have been reiterating every day for decades.

(By the way, Monetary Metals is about to publish the data to finally shine the full sunlight of disinfectant on this—stay tuned)

The plan has three phases.

Phase 1: You gotta buy gold. Now. In fact, call 1-800-BUY-GOLD now! That number, again, is one eight hundred bee yoo wye gee oh ell dee.

Phase 2: Price goes up

Phase 3: Profit!

This is a bit reminiscent of the underpants business model on South Park. South Park of course showed phase 2 as “???” but the analogy holds.

Pay particular attention to the context switch. The story switches midway from the-dollar-will-collapse to gold-will-go-up.

In fact, these are the same thing. It is important to realize because a higher price of gold does not make you richer. Sure, you have more dollars but each of them is worth proportionally less. And why would you want to exchange your gold for collapsing Rothschild private bank petrodollar printing press Monopoly money? On top of this, the tax man will take a big chunk of any price appreciation. So, if you sell you have less wealth.

Aside from being wrong as a matter of fact, it is an example of dollar thinking. It comes from the belief that gold is to be sold. That is not historically how people thought about it. Gold is money and those who have it should seek to earn a return on it, not sell it.

This week, the prices of the metals went up. Perhaps that rubber stopper under the silver elevator is durable.

However, as always we are interested in the supply and demand fundamental of the metals. We will show graphs, but first, the price and ratio charts.

The Prices of Gold and Silver

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It moved lower this week.

The Ratio of the Gold Price to the Silver Price

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph.

The Gold Basis and Cobasis and the Dollar Price

We changed to the August contract.

August is far from expiration, and we see no sign of temporary backwardation (another phenomenon that disproves the naked short manipulation theory). And we see something clear and revealing. There is a steadily rising scarcity (i.e. the cobasis, the red line) and falling abundance (the basis, the blue line). The trend has been ongoing for many months, with not a lot of jitter. The scarcity of gold, as indicated by the August gold spreads, has been on the rise.

For somewhat less time, the price of gold has been rising.

Our calculated fundamental closed the week up another $21, to $1,275. That’s hardly “call 1-800-BUY-GOLD now before it hits $10,000” territory, but noteworthy nonetheless.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

Last week, we said that “silver does not yet show any backwardation, though it’s close at -0.03%.” This week, it’s +0.1%. However, this is definitely temporary backwardation. The near contract in silver tends to fall earlier than the near contract in gold.

Obviously, past a certain date, speculators looking to bet on silver would not buy the July contract but instead the September. Everyone may have his own boundary, in part depending on how long they want to hold the position. But clearly, for the marginal silver speculator, we are past that point in the July contract.

So there is an imbalance, less and less buying. The selling (to roll July) may not be urgent yet, but silver is less liquid than gold. So a small imbalance will show up as a change in basis.

Our calculated fundamental price of silver was down a few pennies.

We will end on an amusing note. The previous week, we said:

“We saw a technical analysis trader write a note this weekend. He said he plans to short silver on Monday. When the technicals and then fundamentals align, that can make for an interesting week.”

Assuming he shorted it early on Monday morning, he might have top-ticked it at $16.40. On Tuesday, he could have closed at $16.05, for a gain of 2.1%. There has to be an easier way to earn a few bucks (and we never recommend naked-shorting gold or silver).

Well, as of Friday silver is $16.84. Depending on how much leverage he used, that could be a big owwie.

 

Keith will be speaking at the Mining Investment Europe event in Frankfurt in mid-June. He will be in London the week of June 19, and in New York the week of June 26. If you’re interested in attending a Monetary Metals seminar on GOFO and transparency in the gold market in either city, or to meet with Keith to discuss gold investment, please click here.

 

© 2017 Monetary Metals

A Bumper Under that Silver Elevator, Report 14 May, 2017

If you can believe the screaming headline, one of the gurus behind one of the gold newsletters is going all-in to gold, buying a million dollars of mining shares. If (1) gold is set to explode to the upside, and (2) mining shares are geared to the gold price, then he stands to get seriously rich(er).

We are not mining experts, but we will address (2) by saying that mining shares only go up if the input costs don’t go up as much as the price of gold. And if the company keeps efficiency up, and costs down. And if local tax authorities don’t get greedy. And if mine labor unions don’t get violent, environmental regulators don’t make expensive demands, etc. And if the company finds new ore bodies at the same rate it depletes them.

Here is a graph showing the price of the VanEck Vectors Gold Miners ETF (GDX) against the price of gold. We have plotted both price as a percentage of the start price to put them both on the same scale.

GDX vs Gold

You can see the problem. The price of gold from late May 2006 through present. In five years, the price of gold rose to 288% of its starting level. GDX was more than 100% behind, at only 170%. Note that the GDX is more than 40% down from its level in 2006. For comparison, the price of gold is just under double over the same period.

If this is gearing, then it looks like the gear box was bolted on backwards.

To bet big on gold mining shares now, your bet includes another conditional: (3) if the gearing has since been fixed…

Anyways, this is not really our wheelhouse. We focus our commentary on (1). Did something change in the market, that will drive the price much higher? Before that can happen, we would have to see something happen to put a bumper under that falling silver elevator.

Below is the only true look at the supply and demand fundamental of the metals, but first, the price and ratio charts.

The Prices of Gold and Silver

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It began the week moving up, but then reversed and ended lower.

Last week, we said:

“If it breaks above 76, then the next resistance looks to be 80.”

It did not break 76. It closed Monday at 75.7, but ended the week below 75.

The Ratio of the Gold Price to the Silver Price

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph.

The Gold Basis and Cobasis and the Dollar Price

Note that the June contract has just a touch of backwardation, with the cobasis now at + 0.01%. Back in early 2013, we dubbed this new normal behavior, when each contract would go into backwardation before it expired, temporary backwardation. That is all this is, and not a very impressive specimen either.

Yes, it is true that the scarcity of gold has been rising for about a month (look at the red line, the cobasis). However, that corresponds to the rise in the price of the dollar (which is the inverse of what most people measure, the price of gold in dollars). On April 12, the dollar was 24.18 milligrams gold, corresponding to a price of gold at $1286. The cobasis—our measure of scarcity—was at -0.81%. Since then, it has been a run up on the price of the dollar (which most people perceive as a run down in the price of gold), to 25.52mg gold (which people generally think of as a price of gold of $1,219).

When we see such a clear correlation between the price of the dollar and the cobasis, we know that the move is just speculators repositioning (in this case, obviously selling). The more the price of gold is down, the more speculators liquidate their futures, the scarcer the metal becomes.

Our calculated fundamental closed the week up $3, to $1,254. While this may be welcome news for gold speculators after a few weeks when it fell, it’s hardly the stuff of making million-dollar bets.

Far be it from us to get in the way, when there’s serious money to be made. It’s a (more or less) free market. Where there’s an opportunity, people will take it. We refer, of course, to the newsletter hawkers and their explosive upside call. We assume this is a lucrative business.

However, unlike the opportunity to sell newsletters to gold speculators who don’t know what most newsletters have been promising over the last 6 years, the opportunity to bet on a gold price increase looks rather less likely, at the moment.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

Silver does not yet show any backwardation, though it’s close at -0.03%.

However, the sharp and sustained rise of the cobasis is notable—along with the sharp and sustained rise in the dollar. Measured in silver, the dollar has risen from 1.68 grams of silver to 1.92 grams earlier this week. That’s a big run up (i.e. run down in the price of silver as popularly perceived).

We have been talking about an ongoing flush in the silver speculators. The price fell through Wednesday, then rallied sharply on Thursday and Friday. Perhaps that elevator has found a rubber bumper?

Significantly, our calculated fundamental price rose a buck this week. From around $15 last week, it’s now $16.

We will end on an amusing note. Last week, we said:

“We saw a technical analysis trader write a note this weekend. He said he plans to short silver on Monday. When the technicals and then fundamentals align, that can make for an interesting week.”

Assuming he shorted it early on Monday morning, he might have top-ticked it at $16.40. On Tuesday, he could have closed at $16.05, for a gain of 2.1%. There has to be an easier way to earn a few bucks (and we never recommend naked-shorting gold or silver).

 

Keith will be speaking at the Metal Writers Conference in Vancouver, at the end of the month. And at the Mining Investment Europe event in Frankfurt in mid-June.

 

© 2017 Monetary Metals

Silver Elevator Keeps Falling, Report 7 May, 2017

The dollar moved strongly, now over 25mg gold and 1.9g silver. This was a holiday-shortened week, due to the Early May bank holiday in the UK.

The big news as we write this, Macron beat Le Pen in the French election. We suppose this means markets can continue to do what they wanted to do before the threat of Frexit, shutting off trade between France and the rest of Europe, and who knows what else Le Pen was plotting to do to the French people.

This will be a short Report this week, as Keith has been working hard on a paper to address the question of which metal will have the higher interest rate. Look for that tomorrow.

Below as the only true look at the supply and demand fundamental of the metals, but first, the price and ratio charts.

The Prices of Gold and Silver

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It had another major move up this week, after a major move up last week and one the week before.

It now sits at the same level it was a year ago. If it breaks above 76, then the next resistance looks to be 80.

The Ratio of the Gold Price to the Silver Price

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph.

The Gold Basis and Cobasis and the Dollar Price

If we didn’t know better, we would say that as fast as the cobasis (i.e. scarcity, the red line) ran up, the price of the dollar (which is the inverse of the conventional view of the price of gold) ran up faster.

Actually, that is accurate. And consequently, our calculated fundamental price of gold fell over twenty bucks (though it’s still more than twenty bucks over the market price).

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

In silver, the same phenomenon occurred though with exaggerated degree.

Last week and the week before, we asked:

Some speculators definitely got flushed. However, the question is how many and how much?

Then we said:

Clearly it happened to more of them this week. And, unless the fundamentals get stronger, it is likely to flush even more leveraged futures positions. Our calculated fundamental price fell three cents this week, now a buck thirty under the market.

It happened to more of them this week. That’s what a rising cobasis with falling price of silver means. A selloff of futures. A flush of the leveraged speculators.

Unfortunately for them, owners of metal were also selling. Our calculated fundamental price of silver fell almost penny for penny with the market price. It remains about a buck twenty under the market.

We saw a technical analysis trader write a note this weekend. He said he plans to short silver on Monday. When the technicals and then fundamentals align, that can make for an interesting week.

 

Keith will be speaking at the Metal Writers Conference in Vancouver, at the end of the month.

 

© 2017 Monetary Metals

Silver Takes the Elevator Down, Report 30 April, 2017

Last week, we talked about the effect of the French election on the gold and silver markets, and noted:

Of course, traders want to know how this will affect gold and silver. As we write this, we see that silver went down 30 cents before rallying back up to where it closed on Friday. Gold went down about $20, and then half way back up.

At this point, we are not sure if the metals are supposed to go up because more printing. Or go down because the euro constrains France from printing. Or silver at least should go up because the economy is going to be better with France remaining in the Eurozone. Or go down because the ongoing malaise will only progress as it has been. Or some other logic… and the price gyrations this evening show that traders don’t agree either.

It didn’t take too long. Here is what happened to silver this week. The graph below shows the price of silver in real money (i.e. gold).

The Price of Silver in Real Money

Silver has been falling for going on one year, but clearly since March 1. After one last hurrah at the end of March, it has been taking the elevator down. And by its fundamentals it should be quite a bit lower—0.0125.

In any case, we are interested in watching what the fundamentals of the metals are doing. We will take a look at the graphs below, but first, the price and ratio charts.

The Prices of Gold and Silver

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It had another major move up this week, after a major move up last week.

Last week, we said:

If prior peaks are an indication, there may be a spot of resistance at 72.5 (+0.8 above Friday’s close) and another at 73.25. If the ratio should go over these levels, then it may go all the way to its fundamental level (discussed below).

Well, it broke those levels and ended the week just under 74.

The Ratio of the Gold Price to the Silver Price

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph.

The Gold Basis and Cobasis and the Dollar Price

The scarcity (i.e. the cobasis, the red line) was on the rise this week. It makes sense, that as the price of gold drops (which is the mirror of what this graph shows, the price of the dollar in gold milligrams) the metal becomes scarcer. This means speculators are selling their paper. If owners of metal were selling, then the metal would not become scarcer and might even become more abundant.

However, it only became a little scarcer while the price dropped almost twenty bucks. So our calculated fundamental price fell $15 to $1,274, a few bucks above the market price.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

In silver, the price fell a lot. 72 cents. The cobasis rose (i.e. abundance dropped and scarcity increased).

Last week, we asked:

Some speculators definitely got flushed. However, the question is how many and how much?

Clearly it happened to more of them this week. And, unless the fundamentals get stronger, it is likely to flush even more leveraged futures positions. Our calculated fundamental price fell three cents this week, now a buck thirty under the market.

 

© 2017 Monetary Metals

To Frexit or Not to Frexit, Report 23 April, 2017

This was also a holiday-shorted week.

As we write this, the big news comes from the election in France. The leading candidate is a banker named Emmanuel Macron, with about 24% of the vote in a 4-candidate race. The anti-euro Marine Le Pen came in second with just over 21%. From the sharp rally in the euro, which was up about 2% at one point, we assume that observers believe the odds of France leaving the euro have just gone down.

Of course, France (and the other European countries) faces a false alternative (well they ought to consider Keith’s gold bonds proposal, but that is not on the table). Staying with the euro means ongoing wealth destruction, and a downward slope that leads to nowhere good. However, that raises the question. What would happen if they were to try to leave?

We believe that no matter which theory prevails, and what measures are taken by les dirigistes (central planners), all roads lead to an accelerated default of trillions in bad credit. To understand why, consider the balance sheets of the banks and other financial intermediaries in France.

Suppose the new French franc goes down relative to the euro (we won’t address here whether it is likely to go up or down). This means that any French entity who had borrowed from a bank in Germany or Italy or Spain now sees its liabilities spike up relative to its assets which are now redenominated in francs. It would not take that much leverage or a very large decline in the franc to cause some major bankruptcies. The initial round of bankruptcies could cascade causing yet other bankruptcies in a highly interconnected financial system.

On the other hand, suppose the franc rises. Then the French banks get hit the other way. Their euro-denominated assets outside France are going down, but their domestic liabilities to depositors and bondholders are firm.

A regime of floating currencies sounds good in Milton Friedman’s argument about being an easy way to adjust wages downwards which are otherwise sticky. However, an actual currency revaluation means a wealth transfer from parties A, B, and C to parties X, Y, and Z. That may seem to be good for the latter, until you realize that they are creditors of the former. And the former were already leveraged, and already surviving on thin margins compressed after decades of falling interest rates. There is scant capital to absorb such a shock.

Then there is the question of who will buy French government or corporate bonds? No matter how you slice it, inserting a new currency into a block that currently has one adds friction, which means trade and production will further slow. The market will shrink (and this could in itself push some marginal corporations under).

And there are other serious problems. One is the intra-euro balances. Will these be redenominated? Another is the political response by the European Central Bank and the members of the European Union. What will they do? Will they try to shut off funds flowing to and from France? It would be naïve to assume there will be no response, and France will get away with it consequences-free.

The euro patient may have cancer, and the cancer may be terminal. But that does not mean blowing up the patient with dynamite is going to help.

Of course, traders want to know how this will affect gold and silver. As we write this, we see that silver went down 30 cents before rallying back up to where it closed on Friday. Gold went down about $20, and then half way back up.

At this point, we are not sure if the metals are supposed to go up because more printing. Or go down because the euro constrains France from printing. Or silver at least should go up because the economy is going to be better with France remaining in the Eurozone. Or go down because the ongoing malaise will only progress as it has been. Or some other logic… and the price gyrations this evening show that traders don’t agree either.

Of course in an actual credit default (i.e. deflation) one may choose to hold paper, as there is a shrinking quantity of it. But the problem is that one may find that the shrink comes out of your balance! We think it may be better to sell the paper and hold money (gold or silver) as money cannot default, unlike credit.

In any case, we are interested in watching what the fundamentals of the metals are doing. We will take a look at the graphs below, but first, the price and ratio charts.

The Prices of Gold and Silver

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It had a major move up this week. That is, the price of gold didn’t change much, but that of silver fell from $18.49 to $17.91.

The ratio made a fresh high (you would have to go back before the new year to see this level). So we drew in a line showing this level going back many months. We are not too focused on charts, preferring to understand the fundamentals, but in a case like this we think it’s worth looking.

The fundamentals are well above the current market level. If prior peaks are an indication, there may be a spot of resistance at 72.5 (+0.8 above Friday’s close) and another at 73.25. If the ratio should go over these levels, then it may go all the way to its fundamental level (discussed below).

The Ratio of the Gold Price to the Silver Price

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph.

The Gold Basis and Cobasis and the Dollar Price

The scarcity (i.e. the cobasis, the red line) fell slightly this week. This occurred as the price of gold fell a few dollars (i.e. the price of the dollar, which is the mirror image, rose).

Therefore, it should be no surprise that our calculated fundamental price fell a few bucks, to just under $1,290.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

In silver, the price fell a lot. So we are not surprised to see that the basis fell and cobasis rose (i.e. abundance dropped and scarcity increased). Some speculators definitely got flushed. However, the question is how many and how much?

Our calculated fundamental price of silver fell over 50 cents, down to $15.92. This is quite a lot in two weeks (recall that it had been over $16.80 on April 7).

Our calculated fundamental gold-silver ratio is now up to about 81. Frexit or no Frexit, is not the question. The question is ratio to hit or not to hit 80.

 

© 2017 Monetary Metals

Gold-Silver Divergence, Report 17 April, 2017

This was a holiday-shorted week, due to Good Friday, and we are posting this Monday evening due to today being a holiday in much of the world.

Gold and silver went up the dollar went down, +$33 and +$0.53 -64mg gold and -.05g silver. The prices of the metals in dollar terms are readily available, and the price of the dollar in terms of honest money can be easily calculated. The point of this Report is to look into the market to understand the fundamentals of supply and demand. This can’t necessarily tell you what the price will do tomorrow. However, it tells you where the price should be, if physical metal were to clear based on supply and demand.

Of course, two factors make this very interesting. One is that the speculators use leverage, and they can move the price around. At least for a while. The other is that the fundamentals change. There is no guarantee that the prices of the metals will reach the fundamental price of a given day. Think of the fundamentals as gravity, not the strongest force in the system but inexorable, tugging every day.

This week, the fundamentals of both metals moved, though not together. We will take a look at that below, but first, the price and ratio charts.

The Prices of Gold and Silver

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It didn’t move much this week.

The Ratio of the Gold Price to the Silver Price

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph.

The Gold Basis and Cobasis and the Dollar Price

The scarcity (i.e. the cobasis, the red line) is in a gentle rising trend for about six months. This week, the cobasis was down slightly. Not a surprise given the (relatively) big price move of +$33. Nor does it appear to break the trend.

Our calculated fundamental price of gold is at $1,301, just above the market price.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

In silver, it’s much harder to say that there is an uptrend in the cobasis. Our indicator of scarcity is at the same level it was in October. Back then, the price of silver was $17.60 and on Thursday it was just about 90 cents higher.

The fundamental price back then was just under $15. Now it’s just under $16.50. This happens to be down about 40 cents this week.

With the fundamental of gold rising, and that of silver falling, it’s not surprising that the fundamental gold-silver ratio is up to a bit over 79.

 

© 2017 Monetary Metals

Mea Culpa, Report 9 April, 2017

Dear Readers,

I owe you an apology. I made a mistake. I am writing this letter in the first person, because I made the mistake.

Let me explain what happened. I wrote software to calculate the gold basis and cobasis (and of course silver too). The app does not just calculate the near contract. It calculates the basis for many contracts out in the distance, so I can see the whole picture. I developed a model for the fundamental price, based on the basis. My software calculates this, too (spoiler alert: the reported fundamental prices were high).

I have long since debugged it. It works reliably. So reliably, that every day I pored over the results, but I no longer checked the inputs and intermediate steps of the calculation. Now, in retrospect, I realize that I should have.

The root cause is simple. For as far back as I have ever seen, the symbol for a future has been a two-letter code for the commodity + a one letter for the month and one digit for the year. For example, gold is GC. December is Z. And 2017 is 7. So the December gold contract is “GC Z7”. Silver is SI, so December silver is “SI Z7”.

I did not expect my realtime quote provider to change year codes for contracts in 2018 and beyond. No longer is it one digit for year—8 in this case. Now it requires two digits. So the December 2018 gold contract is “GC Z18”. Even now that I have looked, I do not find any announcement of this change. I am not even sure it is an official COMEX change, or just a quirk of one quote provider.

This error was compounded because my software was not programmed to notify me of a problem. In software, the only thing worse than a failure in a system that is used in production is a silent failure that goes unnoticed, and hence goes uncorrected. This failure was unnoticed.

Before I get to the impact, I want to discuss how we will make sure this does not happen again.

My team and I have been working hard on a new website, and the centerpiece will be our ongoing data science work in the precious metals markets. We will publish about 45 graphs, with daily updates. Obviously, this is driven by a much more sophisticated software system than my humble application.

The new software is developed by one of the best coders in the world (not me, I’m rusty after not coding full-time in almost 15 years). Rudy Mathieu worked for my last company, a software company called DiamondWare.

Rudy has built a hardened, enterprise-grade software system (now undergoing extensive testing), and when it encounters an error, it does not fail silently. It is constantly checking the status of all key components, and has a dashboard so we can monitor how the software and the server running it are doing. It emails us if anything goes wrong. It will instantly detect problems, such as a change in the year code or even the Spanish Inquisition, which nobody expects (sorry, just a bit of humor).

For years, I have been publishing a unique view into the markets. Our new site takes it a thousand times further. I expect that it will become an essential tool for anyone who uses or trades gold. We need to ensure it is as reliable as clockwork.

I promise to make it so.

Back to the question: what was the net effect? My software was not able to calculate a basis for gold or silver contracts maturing in 2018 or beyond. However, my fundamental price model relies on them. Its accuracy began to suffer starting around last August. This error continued to grow in magnitude. As of last week’s Report, the fundamental price of gold was overstated by about $175, and silver’s fundamental by $2.30.

The correct fundamental prices as of Friday March 31 were about $1,260 and $16.70.

Interestingly—and this is important—the gold-silver ratio fundamental was robust to this error. The value stated in last week’s report, 75.75, was almost perfect. It was off from the revised estimated fundamentals by 0.2. I say revised and estimated, because I went back over the time period where I have incomplete data and derived what I need. The result is good enough for horeshoes and hand grenades, as we say in America (but it has higher uncertainty).

There is a bigger lesson here. Monetary Metals focuses on the ratio (which we trade in our fund), because it is less error-prone, more accurate, and less risky than trading either metal against the dollar.

OK… The bottom line is that on March 31, the corrected gold fundamental was above the market price, though not nearly so far above as I had reported it. It was about 1.4% over the market price (I reported 15.6% last week).

As an aside, my friend Pater Tenebrarum at Acting Man blog wrote about the disparity between the fundamental drivers that he monitors, and the fundamentals I reported. He is right in thinking that demand for physical is not going ballistic yet.

Though as you will see in the graphs below, the fundamental price has indeed been rising since mid to late December (as I have been correctly reporting), from a low of around $1,115 to $1261 at the end of March.

The correct silver fundamental price is below the market price. My commentary actually stands up pretty well, in light of the correct data. Even while I erroneously reported a silver fundamental running up to about $19, I have not been enthusiastic about silver. I haven’t “trusted” it enough to encourage a big silver trade, nor called for a major price move. I think there were two reasons.

One, obviously, the nearer-term contracts which I monitor are accurate. They did not show the kind of moves I would expect to see if the market for physical metal was getting so tight. The error only occurred for contracts in 2018. Two, the fundamental gold-silver ratio was correctly calling for a higher market ratio.

Below, I include graphs of the fundamental prices for both metals. The correct values will be overlaid with the ones I have been calculating. So you can see where it went off the rails, and by how far it deviated.

There is one last thing, which I am reluctant to discuss now, before we are ready to launch. Yet it is germane.

Monetary Metals has licensed market data from Thomson Reuters. When the new charts go live, they will be based solely on this data. This data is of better quality than the data from the realtime quote provider I have been using. And we have developed some very sophisticated algorithms that allows us to extract the maximum signal with the least noise, far superior to what my little app does with the data from my current provider.

The new basis and fundamental prices will not line up perfectly with the old data series. One reason is that the bid-ask spread is tighter. By the nature of the math to calculate the basis, tighter spread means a higher basis and higher cobasis.

That said, I am confident of two things. One, the new data is more accurate. And two, the old data set has served well in showing the big picture (notwithstanding the error I corrected this week).

We will look at the only true picture of supply and demand in the gold and silver markets. But first, the price and ratio charts.

The Prices of Gold and Silver

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. Last week, we asked if the downward-moving gold-silver ratio had hit a line of support. It seems it did, as it moved up sharply on Friday.

The Ratio of the Gold Price to the Silver Price

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph.

The Gold Basis and Cobasis and the Dollar Price

Not much change in the scarcity of gold (i.e. the red line, the cobasis) while the price moved up slightly. Our calculated fundamental price is up $30, to about $1,290.

Let’s take a look at two graphs. Both show enough time to see where the error began to creep in, and where it ends. They are May 3, 2016 through March 31, 2017.

The first is the continuous gold basis, with the erroneous line overlaid with the corrected. As you can see, the erroneous basis was lower (indicating, falsely, lower abundance) and the erroneous cobasis was higher (indicated higher scarcity).

The Reported and Corrected Gold Basis and Cobasis

The second is the market price of gold, overlaid with the erroneous and corrected fundamental prices.

The Reported and Corrected Gold Fundamental Prices

The erroneous one takes off for the stars. The corrected value is much closer to the market price, though a bit above.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

We switched from the May to the July contract, as the May contract is in the process of being rolled (where traders must close positions in May and if they want to keep their positions, open a July or farther-out contract).

There is a small decrease in the basis and increase in cobasis, along with a falling price this week. And our fundamental price is up 14 cents, to just under $16.85. Yes, alas, that is more than a buck under the market.

Here are the same extra two graphs for silver.

The Reported and Corrected Silver Basis and Cobasis

The Reported and Corrected Silver Fundamental Prices

You can see here that there are two salient features. One, the fundamental has been rising for about a month longer than gold, though from a much more volatile bottom ($12.39). Two, the fundamental is way below the market price.

 

© 2017 Monetary Metals

The Balance of Gold and Silver, Report 2 April, 2017

Last week, we discussed the growing stress in the credit markets. We noted this is a reason to buy gold, and likely the reason why gold buying has ticked up since just before Christmas.

Many people live in countries where another paper scrip is declared to be money—to picture the absurdity, just imagine a king declaring that the tide must roll back and not get his feet wet when his throne is placed on the beach—not real money like the US dollar. It should be obvious, but we have seen much disinformation out there promoting the idea that the dollar is collapsing. Most of the time, most of these people buy dollars as the escape hatch from their native currencies.

They buy the dollar first, and gold (for now) is a distant second.

That leads to the question of silver. Do they buy silver in equal measure as gold, or is silver a distant second to gold, as gold is a distant second to the dollar?

Theory tells us that gold is more portable. It is much, much more portable. First, the same weight of gold is about half the volume of silver. A 1oz gold Maple Leaf coin (which is pure gold) is much smaller than a 1oz silver Maple. And right now, the value of an ounce of gold is just about 70 times greater than the value of an ounce of silver. The math works out that the same value of silver is 126X more bulky than gold.

If you are paying for storage, that may be important. It sure is, if you are thinking you may need to carry it on your person. A gold bar worth $120,000 would fit in your trouser pocket (a bit heavy at 3kg, but you could do it). That much silver would be almost 7 of those big bars which are the size of small loaves of bread. Each. All that silver would weigh about as much as two heavyweight boxers.

Gold is also more liquid.

What does the data tell us about demand for silver relative to gold right now?

We will look at that below in the only true picture of supply and demand in the gold and silver markets. But first, the price and ratio charts.

The Prices of Gold and Silver

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It moved down this week. Is it approaching a line of support?

The Ratio of the Gold Price to the Silver Price

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph.

The Gold Basis and Cobasis and the Dollar Price

The price of the dollar fell a bit more (this is the inverse of the rising price of gold, measured in dollars, +$14). But look at that move in the cobasis (i.e. the red line, our measure of scarcity). What does it mean when the price of gold rises, but the metal becomes more scarce?

We have been saying for a few weeks that fundamental buying—when people take real metal home, presumably not to bring it back to the market for the foreseeable future—is “sputtering”.  Last week, gold buying this week was biased towards speculation on futures. This week, the bias is back to physical metal.

Our calculated fundamental price of gold is up over $30. It’s just a hair under $200 over the market price. Gold is being offered at a quite a discount.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

Uh oh. We can see immediately, that the cobasis has fallen in silver about 2/3 as much as it rose in gold. Granted, the price of silver rose 2.9% whereas that of gold went up only 0.5%. The speculators were much more aggressive in the silver market, as they often are.

Our calculated silver fundamental price is up about 40 cents, whereas the market price was up 51 cents. The silver fundamental price is now about $0.80 over the market.

Getting back to our question at the top, we can see in the data that people buy first gold when they fear credit stress and default. Speculators can temporarily move the price quite a lot, as they attempt to front-run the market. So, naturally, they are focusing on the silver market as the general rule when gold goes up, silver goes up more. That may be true when central banks’ stimulus efforts are successful in causing an increase in production of goods, including goods that contain silver.

Less so, when metal buyers are not buying to consume but to opt out of the banking system.

There are people who buy silver metal in preference to gold, for example those who cannot afford to buy gold. But at this stage, the balance favors gold.

We calculate a fundamental gold-silver ratio of about 75.8.

 

© 2017 Monetary Metals

Putting Pennies in the Fusebox, Report 26 Mar, 2017

Back in the old days, homes had fuse boxes. Today, of course, any new house is built with a circuit breaker panel and many older homes have been upgraded at one time or another. However, the fuse is a much more interesting analogy for the monetary system.

When a fuse burned out, it was protecting you from the risk of a house fire. Each circuit is designed for only so much current. The problem is that higher current causes more heat, and it can start a fire. So they put fuses in, which burn out before the wire gets hot enough to be dangerous.

The problem is that it’s annoying when a fuse burns out, especially when it’s the last one and the hardware store is far away and/or closed for the weekend. So people all too often put a penny in the place of the fuse. And then, human nature being what it is, they left it there long-term. As an aside, pennies in those days were solid copper, not the copper plated zinc they use today because it’s cheaper.

We would guess that a disproportionate number of house fires were started because an overloaded circuit became overheated, and the protective fuse was replaced with a penny that would keep the juice flowing no matter what.

So, what has that got to do with gold and silver? A penny in the fuse box is a perfect analogy for what President Roosevelt did in 1933. Many believe when he confiscated gold, it was to grab the loot. While we have no doubt that he and his cronies lusted for the gold of the people, he had a more serious purpose.

Until 1933, gold was the core monetary asset in the banking system. When people withdrew their gold coin—redeeming their gold, not buying gold—that forced the bank to sell a bond to raise the gold to redeem depositors. If a bank could not raise enough gold, perhaps because bond prices were going down, then the bank was bankrupt. Another problem is that falling bond prices mean rising interest rates.

Roosevelt was trying to stop the run on the banks, and trying to push interest rates down.

He did stop the run, and interest continued to fall through the end of World War II. However, his act was the monetary equivalent of the penny in the fuse box. In making it illegal to own gold, he made the dollar irredeemable for Americans. Gold is the only financial asset that is not someone else’s liability. Deprived of this outlet, people were forced to be a creditor. The only choice was to lend to the Federal Reserve, the US Treasury, a commercial bank, a corporation, etc.

When people are running to the bank to withdraw their gold coin, it’s like a fuse burning out. You really should find out the root cause when a fuse keeps burning out, and not just jam a solid copper conductor into the circuit. You really should find out why people keep pulling money (i.e. gold) out of the banks, and not just outlaw it.

The reasons were simple. The rate of interest was below the marginal time preference of the savers. This is, of course, the purpose for which any central bank is established: to enable the government and its cronies to borrow more cheaply. And the banks had become unsound (due in no small part to the actions of the Fed taken prior to 1933).

By corralling everyone in the banking system, FDR put a penny in the monetary fusebox. In 1971, President Nixon realized there was one last fuse that could still burn out and thereby signal that all was not well. Americans could not withdraw gold, but foreign governments could. And, led by France, they were doing. So Nixon “closed the gold window”, thereby inserting a second penny.

Now the system was perfect—perfectly irredeemable. Money is credit and credit is money and there is no longer a way for the market to express concerns about either interest rates or soundness. An individual can escape being a creditor if he buys gold (legalized in 1975, after gold was entirely demonetized), but his dollars simply trade hands. The seller of the gold gets the credit-dollars, and the buyer gives them up for the gold. There is zero effect on the banking system (other than causing the price of the dollar to go down).

Unlike the simple and elegant mechanism of the bank run in the gold standard, buying gold is awkward, clunky, and risky for the participants. With dollar-credit no longer being tied to gold, there is a price risk. And of course, price is the motivator for many participants.

Two people, call them Joe and Mary, could both be right that the dollar-credit system is headed towards a crisis. Joe bought at $1,060 in the last week of 2015. Unfortunately, Mary bought at $1,375 in July of 2016. Both bought because of the same reason. But Joe has a big fat gain of $183 and Mary has a loss of $132. This volatility makes people alternatively greedy and fearful, which is not really providing a good signal that the monetary system has problems urgently in need of addressing.

And so the system goes, careening around, from crisis to crisis and nothing gets fixed and there is no signal that is clear to everyone the way a run on the banks is clear.

With this backdrop, we note that the price of gold is on the rise again. Since its low around $1,120 late last year, it has been rising to its current price about $120 above that. What’s more, the fundamentals have been getting stronger at the same time. What could be causing this, and now?

Rising interest rates (which we believe is just a correction in the long falling rates trend) are putting more and more stress on banks and corporations alike. If you have borrowed short to lend long (as all banks do nowadays, this is called “maturity transformation”) then rising rates cause immediate pain. Your cost of funding goes up instantly. However, the interest you earn on long-term bonds does not go up. Instead, the market price of those bonds drops. Equity is disappearing from your balance sheet.

Now consider major corporations, who too often borrowed in the short term bond markets. Their cost of funding is rising. Nearly every carmaker now offers 0% financing to qualified buyers. Their cost to offer this is now obviously much higher than it was a year or two ago. And that does not even count if they had used short-term borrowing to finance those loans, in which case their existing book is bleeding cash too.

This same pressure is occurring anywhere a vendor is financing its customers. The vendor can always try to pass through the increased cost. However, if buying volume was anemic previously with lower interest cost, it will only get worse when this cost goes up.

In the housing market, most people are monthly payment buyers. A higher interest rate means a lower price to get the same payment.

And what happens to lower credit corporations who issue junk bonds? Like most corporations they have to roll over their bonds when mature. So far, rising rates has passed over this market and junk bonds have held up. However, should this tide turn, many of these companies will be forced to default under a deluge of rising interest expense, if not softer demand for their products. They are junk credits for a reason, and higher rates can be the final straw.

Or let’s look at the pension funds. They are already badly underfunded. That is, they are already destined to arrive at terra firma. Many have bought equities and real estate in an attempt to juice up their returns. What happens if the prices of those assets comes down significantly?

Finally, let’s look at municipalities. They derive revenue from home building and turnover of not only homes but home furnishings, remodeling, etc. If these markets slow down significantly, their ability to service their debts is going to be taxed to the limits and beyond.

No wonder people are buying gold. Fundamental demand, as opposed to speculative, is when people buy gold coins and bars, presumably not to bring back to the market soon.

Below, we will show the only true picture of the gold and silver supply and demand. But first, the price and ratio charts.

The Prices of Gold and Silver

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It moved down this week.

The Ratio of the Gold Price to the Silver Price

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph.

The Gold Basis and Cobasis and the Dollar Price

The price of the dollar fell another 0.3 milligrams gold (this is the inverse of the rising price of gold, measured in dollars, +$14). However, this week, the cobasis (our measure of scarcity) decreased a bit. Gold buying this week was biased towards speculation. Last week, we said fundamental buying was a trend but it’s “sputtering”. This is an example.

Our calculated fundamental price of gold is up $3, or still about $160 over the market price.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

The story is the same in silver. The price rose, a bit more than the price of gold did. With the rising price, we see decreasing scarcity this week.

Our calculated silver fundamental price rose 4 cents, now about $0.85 over the market price.

We leave on a question today. When interest returns to gold and silver, which metal will have the higher rate? We plan to publish something about this soon.

 

© 2017 Monetary Metals

Technical vs. Fundamental, Report 19 Mar, 2017

Every week we talk about the supply and demand fundamentals. We were surprised to see an article about us this week. The writer thought that our technical analysis cannot see what’s going on in the market. We don’t want to fight with people, we prefer to focus on ideas. So let’s compare and contrast ordinary technical analysis with what Monetary Metals does.

Technical analysis, in all of its forms, uses the past price movements to predict the future price movements. In some cases (e.g. momentum analysis) it calculates an intermediate signal from the price signal (momentum is the first derivative of price). But no matter the style, one analyzes price history to guess the next price move.

This is necessarily probabilistic. There is no way to know that a particular price move will follow the chart pattern you see on the screen. There is no certainty. And when it does work, it is often because of self-fulfilling expectations. Since all traders have access to the same charts, and the same chart-reading theories, they can buy or sell en masse when the chart signals them to do so.

We are not here to argue for or against technical analysis. We simply want to say that it’s not what we are doing. Not at all.

Our analysis is based on different ideas. The key idea is that there is a connection between the spot and futures market. That connection is arbitrage. Think of each market as a platform that moves up and down on its own vertical track. The two tracks are close together. And the platforms are connected to each other by a spring. Suppose platform A is a bit above platform B. If you push up on A, then the spring stretches a bit more and will pull B up, though perhaps not as much. The same happens if you push down on B.

Conversely, if you push down on A, then it will compress the spring and platform B will tend to go down, though not as much.

A and B are the futures and spot markets for gold (the same analogy applies to silver). Arbitrage works just like a spring. If the price in the futures market is greater than the price in the spot market, then there is a profit to carry gold—to buy metal in the spot market and sell a futures contract. If the price of spot is higher, then the profit is to be made by decarrying—to sell metal and buy a future.

There are two keys to understanding this. One, when leveraged speculators push up the price of gold futures contracts, then that increases the basis spread. A greater basis is a greater incentive to the arbitrageur to take the trade. Two, when the arbitrageur buys spot and sells a future, the very act of putting on this trade compresses the spread.

If someone were to come along and sell enough futures contracts to push down the price of gold by $50 or $150 or whatever amount is alleged, then this selling would be on futures only. It would push the price of futures below the price of spot, a condition called backwardation.

Backwardation just has not happened at the times when the stories of the big “smash downs” have claimed. Monetary Metals has published intraday basis charts during these events many times.

The above does not describe technical analysis. It describes physics—how the market functions at a mechanical level.

There are other ways to check this. If there was a large naked short position in a contract that was headed into expiry, how would the basis behave? The arbitrage theory predicts the opposite basis move. We will leave the answer out as an exercise for the interested reader, as thinking this through is really good work to understand the dynamics of the gold and silver markets (and you can Google our past articles, where we discuss it).

This check can be observed every month, as either gold or silver has a contract expiring (right now it’s gold, as the April contract is close to First Notice Day).

This week, the prices of the metals both rose. The price of gold is almost back to where it was the prior week, but that of silver is not.

Below, we will show the only true picture of the gold and silver supply and demand. But first, the price and ratio charts.

The Prices of Gold and Silver

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It moved sideways this week.

The Ratio of the Gold Price to the Silver Price

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph.

The Gold Basis and Cobasis and the Dollar Price

NB: we switched from the April to the June gold contract.

As the price of the dollar fell (inverse of the rising price of gold, measured in dollars) we see the cobasis (our measure of scarcity) increased a bit. This means the buying in gold, which pushed up the price, was buying more of physical than of futures. This seems to be the new pattern of late, though it is sputtering a bit like an engine trying to start up and run at a steady RPM.

Our calculated fundamental price of gold is up nearly $50. It is now over $1,400.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

The story is the same in silver. Rising price accompanied by rising scarcity.

The silver fundamental price rose 50 cents. It is now aboit $1.30 over market.

 

© 2017 Monetary Metals