Monetary Metals Supply and Demand Report: June 30, 2013

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 is 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.

The price action this week was incredible. The dollar was rising and hit almost 26 milligrams on Wednesday, before backing off late in the week. It hasn’t been this high in years.

 The Price of the Dollar

Letter June 30 Dollar in Gold

We believe that the dollar is 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.

At the high set on Wednesday, the dollar was already up almost 40%.

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.

You could lock in the price now, and not have to come up with the money for two 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.

The August basis continues to fall, and cobasis is flat to rising. Gold is at its scarcest in a long time.

Gold Basis and Cobasis

Letter June 30 Gold

Here is the basis chart for September silver. On Friday, as the price began to rise the basis began to rise.

For the past two weeks, we have been discussing the September silver cobasis. It was backwardated, but just by a smidge (under 0.1%) two weeks ago. Last week, it hit around 0.4%. That is a big move in a short time. And yet the silver price had kept falling. There was a big rise in silver on Friday, and we can see in the basis data that this rise was driven more by buying in the futures market than in physical metal. Not only did the basis rise sharply, but the cobasis fell. The cobasis is barely higher than it was a week ago.

Silver Basis and Cobasis

Letter June 30 Silver

Here is the graph showing the ratio of gold to silver. On Wednesday, it spiked up to a new high of just about 66, before falling back sharply. 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. We may be close to the point of calling for the ratio to fall. Although we’re cautious; if something precipitous occurs in China or Japan, then the ratio could go much higher.

Gold to Silver Ratio

 Letter June 30Ratio



6 replies
  1. thinkpeace says:

    Keith, are you buying the dips? I like how you added China to the, “If something precipitous occurs” statement. I would love to hear more about the end-game, like when one can’t buy physical gold with FRNs. Enjoy the week!

    • Keith Weiner says:

      thinkpeace: did you read my article When Gold Backwardation Becomes Permanent? And the followup Using Gold Bonds to Avert Financial Arrmageddon?

    • Keith Weiner says:

      pobendorf: the true meaning of “world’s reserve currency” is not simply that commodities are priced in gold or that when Korea sells something to Spain the transaction is conducted in dollars.

      It means that the dollar is on both sides of every major balance sheet in the world.

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