An extraordinary thing is happening in silver. Not to its price, which went sideways, but its supply and demand. Read on.
Most people would say that “gold went up” $24. Of course, gold does not go anywhere. It is the dollar, which is jittering around like a seismograph needle during an earthquake. Measured in gold, the dollar fell half a milligram.
The ratio of gold to silver rose substantially, about 1.6%.
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, 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 a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. The ratio fell a bit more this week.
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 dollar fell though the cobasis did not. We shall have to wait and see if this is a change in trend. Since October, we’ve been watching speculators move the gold price up and down. When they move it up, gold becomes a bit more abundant; when they move it down, gold becomes a bit scarcer. A trend change means that the hoarders are changing their behavior. Let’s not read too much into too little data, just yet.
The Gold Basis and Cobasis and the Dollar Price
Now let’s look at silver.
The Silver Basis and Cobasis and the Dollar Price
The dollar barely changed, and the cobasis fell for another week. It’s notable that the basis rose as well (it should normally be a mirror image of the cobasis, though that relationship breaks as we near each contract’s expiration and the inexorable tug of temporary backwardation). Silver is now nowhere near backwardation.
We continue to see articles talking about the bullish case for silver, including one this weekend about the coming “silver short squeeze”. For the 1001st time, there is no such giant naked short position. We have no doubts that traders short the monetary metals (which we NEVER recommend), or for that matter short one and long the other (which we do sometimes recommend). But the vast naked short of the conspiracy theories?
There is an arbitrage position. So long as there is a positive basis, and especially if it’s above LIBOR, traders will put on a simple trade: buy spot / sell future. There is a positive basis in farther-out silver contracts, and as of Friday in the May contract.
Speaking of farther-out contracts, here is a graph showing the cobases of May and July, overlaid with the silver price. These contracts are far enough out that they are not yet sliding into the gravity well of expiry that pulls cobases towards zero and then backwardation.
Silver Cobases and the Silver Price
There are three trends visible. From July 1, the cobases are falling gently. Falling cobasis means falling scarcity, or rising abundance. This goes along with the rising price through the end of August. It makes sense that a higher price brings out more sellers and discourages some buyers. But the cobases continue to fall through the end of October.
Next, a rising trend begins and becomes especially sharp at the beginning of December.
Finally, beginning around Christmas, the fall has been very sharp. There has not been an increase in price to correspond to this. Silver is now as abundant—by the measure of the July cobasis—as it was when the price was a dollar higher.
There is absolutely no basis (pun intended) to call for higher prices here. Could the price rise? Yeah, sure, maybe. Silver is a monetary metal and central banks are doing crazy things (and speculators are excited). But the fundamentals of supply and demand have deteriorated even in the face of a falling price.