Monetary Metals Supply and Demand Report: 20 Oct, 2013
On Thursday, the prices of gold and silver took off 50 dollars and 54 cents, respectively, on a statement by Dallas Fed President Dick Fisher. He declared that, “fiscal shenanigans have swamped QE taper prospects”. That was enough to light the fuse. As always, the question is: speculators or hoarders? Read on.
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, 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 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. 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.
Here is the graph of the metals’ prices.
The Prices of Gold and Silver
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
We have labeled the drop in the dollar (i.e. rise in the gold price) when Fisher made his statement. Right next to it, we can see that the cobasis fell. This means gold became less scarce, at the higher price. The price moved by the actions of speculators.
Like Pavlov’s dogs, traders buy gold and silver when the Fed says anything about increasing the money supply (or not slowing down the rate of increase). They are trying to front-run what they believe will be the endless buying of gold by hoarders, who take it off the market. Unfortunately, in this case, they front-ran themselves. There is no guarantee that the price will drop right back to $1280, but in the past each of these Fed-announcement moves has been undone fairly quickly.
For several weeks, we have been documenting a pattern. The fundamentals of gold aren’t really changing at the moment. So with each price increase, we see the cobasis drop and with each price decrease, we see the cobasis rise. Gold is scarcer when it’s cheaper, and more abundant when it’s more expensive.
Now let’s look at silver.
The Silver Basis and Cobasis and the Dollar Price
Silver is in a similar trend, though the cobasis is at a much lower level. In case you missed it above, December gold is slightly backwardated. By contrast, the silver cobasis is quite far below the zero line.
The Ratio of the Gold Price to the Silver Price
The ratio of the prices of the monetary metals rose slightly this week.
Hi Keith,
Nice work. Quick question – why is the Cobasis-Basis spread for silver so much smaller than the Cobasis-Basis spread for gold? Is it because the Silver price spread is larger than the gold price spread? Thank you, Jeff.
jtibbs: Thanks for your question. Ordinarily, what one would expect is that the basis and cobasis curves would be a mirror image of one another. The higher the basis, the lower the cobasis and vice versa. It is not possible for both to be above zero at the same time, for example.
In silver, we have this tendency for the basis to drop like a rock. At times in the past, this was accompanies by a rising cobasis, but this is not really occurring at the moment. By the definition of basis = Future(bid) – Spot(ask) and cobasis = Spot(bid) – Future(ask), how can we get a dropping basis and at the same time dropping cobasis? It happens if we get a wider bid-ask spread.
How important is trading volume in determining the breadth of a wider (or smaller) bid-ask spread? Does lower volume mean wider spreads? Or not necessarily? Thanks in advance for your response.
Typically, lower volume will cause wider spreads. But there can be other reasons too.
Thanks yet again for this valuable summary, Keith. Would it be fair to sum it up as saying that gold remains under moderately strong hoarding pressure, but that the this pressure seems to be pacing itself so as not to drive gold into permanent backwardation? Your observation that the supply is responding to mild price changes says to me that the market can move smoothly in and out of backwardation over a few of the shortest contract months. Doing this for a while is likely to take all the “alarm” out of the condition itself, and should help the largest hoarders to achieve their objectives if they remain patient.
I’ve been re-reading Fekete’s “Kondratiev’s Long-Wave” essay (Jan 2005). In addition to several prescient paragraphs on the (then unimaginable) credit crunch, it suggests that the onset of hoarding pressure of this magnitude begins a turning point in that cycle (from deflationary to inflationary). Where do you see us on that (very) large trend? Would you expect hoarders to be followed eventually by commodity speculators and severe price inflation to set-in?
This week’s data suggest that gold speculators are still at work on the margins, but that the trend is driven by gold hoarders, right? What will the data look like in the next inflationary phase of the K-60y cycle? It cannot have been the case that gold went into “permanent” backwardation during every Kondratiev inflationary phase, although in a sense it did in 1971 when the Fort Knox gold went off the market.
These are not urgent questions, they are more of the existential variety: why are we where we are? Where is this all taking us?
Thank you for your report. :))