Monetary Metals Supply and Demand Report: July 28, 2013

“Gold and silver went up this week,” is how most people would say it. This would be perceived as good news amongst the gold bugs. Of course, Monetary Metals looks at it differently. We say, “The dollar fell this week.” Expressing it this way makes it clear that there is no cause for celebration.

As we go forward, there is more boilerplate material in this report. This is good for first-time readers or as a refresher. But if you are reading it every week, you may want to skip over it. To make the report more readable by both groups, all repeated boilerplate material that is repeated from the prior week is be marked in italics like this.

The Gold Basis Report is fundamental analysis of gold and silver. The basis is a measure of availability of metal to the market. When the basis is high and rising, then metal is abundant. When the basis falls below zero, and the cobasis rises above zero (gold goes into backwardation) then that means danger (and likely higher dollar prices).

The basis doesn’t measure flows of metal from one corner of the market to the other. We make no assumptions that one side is the “dumb” money and one side is the “smart” money. The basis measures the spread between the spot price and the futures contract price.

Obviously, the recent falling price tells us that demand for gold and silver is lower. But the basis was also falling, and this tells us that those who do buy gold want it now. They are willing to pay a premium to get it now, and don’t want to wait until August for gold or September for silver.

Since gold and silver have huge inventories that are not consumed—they are held for monetary purposes—a sign of scarcity of the monetary metals in the market is a sign that the dollar is moving towards collapse, when gold will no longer bid on it.

One cannot truly understand the gold market in terms of the quantity of dollars, price charts, or by charts of open interest, ETF holdings, COMEX inventories, etc. One must study the basis.

In general, the positive basis (i.e. contango) is disappearing (hence the full name of this report). This is a process of gold withdrawing its bid on the dollar. One cannot understand this if one lives in the dollar bubble, looking at the gold “price” as if it were comparable to the price of Apple shares or crude oil.

The “bull market” in gold and silver is not over. We do not recommend that anyone sell his gold now, unless he is using leverage (and we don’t recommend using leverage). When the gold price rises, we don’t recommend selling then, either. A rising gold price gives only an illusion of profit (and the tax man will take a big piece of that).

We generally prefer to look at the price of the dollar in terms of gold, rather than the price of gold in terms of the dollar. The reason is simple. One can measure a rubber band using a steel tape, but not a steel tape using rubber bands.

As noted above, the dollar prices of gold and silver rose.

The Prices of Gold and Silver

Letter July 28 GoldSilver

We believe that the dollar had been getting stronger for the simple reason that debtors are being squeezed. They are scrambling to get dollars. It is not just Japan with a collapsing bond market but possibly China as well. If this gets going in any significant way, the price of every asset from copper to real estate in LA could crash.

In this report, we have been tracking the temporary backwardation in both metals. It is like a distortion field; as we move closer to each futures contract expiry, that contract is pulled into backwardation. The bid drops, which causes the basis to fall off the bottom of the chart. This could be due to heavy selling, as naked longs must sell before First Notice Day (since they haven’t got the cash to buy the metal). Their selling, of course, presses down the bid.

But the mechanics of the contract roll does not fully explain the phenomenon. For one thing, the distortion field is wider for silver than for gold. The basis for September silver has been falling in earnest since shortly after the April 15 crash. This shows that scarcity is increasing at the lower price.

Think of temporary backwardation as rot in the heart of a tree. It can spread for years, undermining its integrity. The collapse of the tree at the end is “unexpected”. As the financial system rots, people increasingly discount monetary metals for future delivery. Despite the cost to carry gold, it is cheaper to buy gold for delivery in August than it is now. Update 7/28: well, not much any more—perhaps 20 cents. October is not in backwardation at all.

You could lock in the price now, and not have to come up with the money for a few months. And you are offered a discount to do this. Few people appreciate the significance, just as only a tree surgeon would recognize the rot in the heart of a tree.

For gold this week, we depart from our regular format to show the cobases for both August and October, overlaid with the dollar price in gold. As the dollar price (measured in gold milligrams) rises, that means the gold price is falling and vice versa.

In the contract roll, currently ongoing for the August contract, the “naked longs” must sell, and if they wish to remain long gold they can buy October or some other month. This puts pressure on the bid for the August contract, which we should see as a falling basis. It also puts pressure on the offer for October and December, which we should see as a falling cobasis.

We see a flat to falling cobasis in August and October this week. October is not in backwardation.

Gold Cobases and Dollar Price

Letter July 28 goldcobases and dollar

We should immediately notice that the price of the dollar has been falling for the entire month of July, from about 26mg to about 23.5mg on Friday. With a slight lag, so has the gold cobasis fallen (especially August). This is not an encouraging sign for goldbugs who are betting on the dollar to fall further, i.e. the gold price to rise further. October has fallen out of backwardation and if August does as well, that would be a bullish sign for the dollar, i.e. bearish for gold.

Here is the basis chart for September silver. That cobasis does not look like it wants to rise further. This means silver is not increasing in scarcity.

Silver Basis and Cobasis

Letter July 28 Silver

Here is the graph showing the ratio of gold to silver. It rose sharply to a new high.

Our prediction (in a video and articles) was for the ratio to reach at least 60 and maybe 70. At the time, the ratio was 52.

Last week we wrote, “If we had to pick a direction, we would guess [the ratio would move] upwards. But we would not necessarily bet on it. Right as we turned out to be again, it was not a bet we cared to make. We are increasingly leaning towards a rising gold:silver ratio once again (as we wrap up this report Sunday evening, the ratio is up to 67).

Gold to Silver Ratio

Letter July 28 Ratio


4 replies
  1. eidetic says:

    Hi Keith,

    I sure wish that you would refrain from using the terms “naked” long, “naked” short. In doing so, you compromise your excellent work – it becomes co-opted by using nonsensical buzz words that so-called analysts have popularized.

    • Keith Weiner says:

      eidetic: I will think about other terms to use for those who buy futures on margin, without the cash to take delivery. Thanks for your feedback.

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