Monetary Metals Supply and Demand Report: 18 Jan, 2015

The dollar is absolutely on a tear! It fell over a milligram, from 25.43 to 24.29mg. In silver terms, it fell even more dramatically, from 1.89 to 1.75g. ‘Course, most people still prefer to see this as a rising gold price—from $1,223 to $1,280 or $57—and a rising silver price—from $16.47 to $17.77 or $1.30.

The big news came from Switzerland. The Swiss National Bank, who had been pegging the franc to the euro at a ratio of 1.2 since 2011, announced they were letting it go. Naturally, the franc smashed higher. Some bankruptcies have already occurred, and more are surely on the way. By the time you read this, my article on this disaster will be on my Forbes site.

Big gold news came from Switzerland also. Gold fell (as franc bettors reckon it) big time. It closed the prior week at CHF1240.82, and hit a low of CHF941.70. Holy moly, if anyone had been long gold futures in francs, just over 3:1 leverage would have wiped him out. Gold ended at CHF1100.10. Still, gold delivered an incredible loss of wealth for the Swiss who hold it, in the same week when it delivered a gain in wealth for Americans who hold it.

Wait… There has to be a contradiction there, somewhere.

Gold can’t have delivered both gains and losses. Perhaps it is the paper currencies that move, the dollar down and the franc big-time up? Perhaps gold is not going anywhere…

We see, once again, analysts coming out with calls of “breakout”. Is this it? Read on, for a picture of the supply and fundamentals…

First, here is the graph of the metals’ prices.

The Prices of Gold and Silver

We are interested in the changing equilibrium created when some market participants are accumulating hoards and others are dishoarding. Of course, what makes it exciting is that speculators can (temporarily) exaggerate or fight against the trend. The speculators are often acting on rumors, technical analysis, or partial data about flows into or out of one corner of the market. That kind of information can’t tell them whether the globe, on net, is hoarding or dishoarding.

One could point out that gold does not, on net, go into or out of anything. Yes, that is true. But it can come out of hoards and into carry trades. That is what we study. The gold basis tells us about this dynamic.

Conventional techniques for analyzing supply and demand are inapplicable to gold and silver, because the monetary metals have such high inventories. In normal commodities, inventories divided by annual production (stocks to flows) can be measured in months. The world just does not keep much inventory in wheat or oil.

With gold and silver, stocks to flows is measured in decades. Every ounce of those massive stockpiles is potential supply. Everyone on the planet is potential demand. At the right price, and under the right conditions. Looking at incremental changes in mine output or electronic manufacturing is not helpful to predict the future prices of the metals. For an introduction and guide to our concepts and theory, click here.

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It moved down quite a bit. We are not technical analysts, but it looks like there is a pretty clear line to be drawn through several lows. The chart has clearly broken down.

It would not be surprising that many traders see this, and pile on with a trade to short the ratio (i.e. long silver / short gold). They could push it further, perhaps significantly.

However, there’s a reason we are not technical analysts. Read on…

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 terse 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

Look at that. Contango—abundance, a positive basis—appeared on Thursday. A few weeks ago, we had backwardation—a positive cobasis—which means scarcity. And $92 in price gains was enough to squelch that. Even against the grain of the contract expiry (by now, people are selling February, and if they wish to remain long gold are buying April or June) and yet the basis could rise so much.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

The cobasis (scarcity) is falling proportional to the fall of the dollar (rise of the silver price). This move has been driven largely by speculators.

We’ve used Obi Wan Kenobe recently. So let’s paraphrase Gandalf from The Lord of the Rings (with all due respect to J.R.R. Tolkien).

“A bull market is never late, Frodo Baggins. Nor is he early. He arrives precisely when he means to.”

We don’t believe he means to arrive just yet. Oh, there’s no question that the technicals are perking up. We would almost be surprised not to see a bit more gain in the price of silver, and a larger gain is easily possible. Just don’t mistake this speculative wave for a driver of sustainably higher prices.

© 2015 Monetary Metals