There was some big price news this week. We gold thinkers say that the dollar jumped over ½ mg gold, and 100mg silver on Thursday. Harry Potter’s muggles would say gold fell to $1257 and silver to $16.94 before gold bounced back to nearly unchanged and silver bounced much less. All can agree that the gold to silver ratio rose sharply, up almost 4 points or 5.2%.
Pay attention to the currencies market. The Russian ruble fell more than 8% in dollar terms, the Brazilian real fell almost 4%, and the Swiss franc fell more than 4%. If you’re picturing an iceberg, that’s about it—more under the surface than what’s visible.
For an updated look at what’s going on beneath the surface of the gold and silver markets, read on…
First, here is the graph of the metals’ prices.
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 up sharply.
It had broken down from technical standpoint. It’s almost back to re-crossing the line. We’ll leave the analysis of this to technicians. We have our own view of the likely direction (up) of this ratio, based on the fundamentals.
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 price is down $10 (i.e. the dollar price is up), and what do we see? The cobasis (scarcity) is rising sharply (currently above -0.2%). A sign of firming up for now, or perhaps a bigger move is developing.
Our fundamental price for gold is $50 over the market price. This does not mean that the market price necessarily has to rise (much less rise tomorrow morning). It’s just a way of putting supply and demand into context, and estimating a likely path for the gold price to take.
Now let’s look at silver.
In silver terms, the dollar had a big move up this week, +6.5% (in dollar terms, silver fell).
The silver cobasis (scarcity) rose quite a bit. This is not surprising as we approach First Notice Day and speculators have to sell their March silver positions. The selling pressure becomes intense, and the new normal post-2008 is temporary backwardation for expiring contracts about this far out. Not happening yet (and farther contracts had much smaller gains in their cobases). Cobasis = spot – future (to oversimplify slightly), so heavily selling of a future pushes the cobasis up.
Silver is in a very different market dynamic than gold right now. Everyone knows that when the gold price goes up, then the silver price has to go up 2X or more. However, there is some tightness in the gold market (hence our fundamental price $50 above the current market) and none in silver.
Last week, we honored Gandalf and Frodo, in order to make our point about a possible drop in the price of silver. This week, at the top of the Report, we foreshadowed that we will look to the Harry Potter series this time.
“The silver.” Dumbledore sighed. “It is a beautiful and terrible thing, and should therefore be treated with great caution.”
Our calculated fundamental price is about $2.35 under the market price.
What could cause this disparity? In a word: credit. Take a look at this graph.
The correlation isn’t perfect, but it’s pretty clear. The credit spread is TLT-JNK, a measure of how much more expensive junk credit is than Treasury. As this rises, we would expect weaker fundamentals for silver including industrial demand and speculation.
Another way of looking at it is when people seek safety, they tend to turn to gold more than silver. At least that’s how it is currently.
© 2015 Monetary Metals