Heading into Wednesday, the prices of the metals were sagging. Then, the announcement from the Federal Reserve took everyone by surprise. They said they would not “taper” their purchases of bonds. And BAM! All prices rose sharply: stocks, currencies, and our favorite metals. In a minute, the gold price went up $25. Clearly, traders are still betting that if the Fed increases the quantity of money, then the prices of the metals should rise. They aggressively met their own expectation on Wednesday.
We had one question on our minds, watching this. Who dunnit?
Was it speculators, using leverage in the futures market? Or was it “stackers”, waiting in their cars outside the coin shops, watching CNBC on their mobile phones, and running in to buy up coins by the double handful? With a few graphs, below, we will show the clear answer to the question.
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.
First, here is a graph of the prices. We have labeled the big “Bernanke move” with an arrow.
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 did not label the “Bernanke move”, but it’s the obvious drop in the price of the dollar by about 1.5mg, near the right edge. On Friday, the dollar rose again. But this is not the main focus for us to look at.
The moves in the basis and cobasis are absolutely amazing! Look at that basis skyrocket, and the cobasis drop! Last week, the October gold contract was backwardated. The cobasis was about 0.15%. Now it has fallen to -0.3%. This fall was “against the grain” of the mechanics of the contract roll.
Buyers of futures must make a decision by First Notice Day (which is this coming Friday). They can either put up the cash and demand delivery of one gold bar per contract. Or they must sell the October contract, and buy a farther month if they want to keep their gold position. This past week, open interest in the October contract fell from 20,177 to 17,514 contracts, a drop of 13%.
These contracts must be dumped on the bid, which presses it down. Let’s look at our definition of the basis again:
basis = Future(bid) – Spot(ask)
The basis rose dramatically, in the face of what we know is a lot of downward pressure on the bid on the future. The cobasis moves in the opposite direction.
This is the answer to our question. Speculators dunnit.
They sat at their desks, watching CNBC with their fingers hovering over trading orders. As soon as they heard “no taper” they hit the BUY button. And they drove the price higher, and with it the basis.
We have written several times in the past that these knee-jerk moves after Fed announcements are usually reversed quickly. The move on Wednesday was so big and so popular that reversal did not begin on Thursday. We had to wait until Friday.
Did I mention that gold, which had been backwardated, isn’t any more? That is pretty important, because it means that the extraordinary scarcity seen for most of 2013 is gone. And now the price is $1,325.
Does this mean that the price has to fall further? Not necessarily. But against this big change in the basis, we would certainly not bet on a rising gold price. The balance of risks does not seem prudent for that.
Now let’s look at silver.
The Silver Basis and Cobasis and the Dollar Price
We see the same price move as in the gold chart, with the dollar getting sharply weaker, losing about a tenth of a gram of value on Wednesday and Thursday, and gaining it back on Friday.
The cobasis in silver did not show the same dramatic moves as in gold, but it began from a much lower point. And we must emphasize that the silver cobasis also fell in the “Bernanke move”. Like in gold, Wednesday’s silver mania was driven by speculators, buying on margin.
The Ratio of the Gold Price to the Silver Price
Falling prices tend to correlate to a rising ratio.