It was a pretty quiet week until, BAM, the European Central Bank dropped a bomb. They lowered three of their benchmark rates, and made the deposit rate negative. I wrote an article on Forbes, contrasting what they say it will accomplish with what I think will actually happen.
The prices of the monetary metals had been flat to sagging. In a pattern that’s become very familiar, they jumped abruptly on the news, with the price of silver sharply outperforming the price of gold. Starting around 5am Pacific Time (1pm in London) on Thursday, the silver price shot up 25 cents.
Read on to find out if this move was driven by fundamentals, or speculation…
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, 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.
Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. The ratio moved down a bit this week.
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 price of the dollar has been rising since March, and was flat on the week. The cobasis is down a hair.
Now let’s look at silver.
The silver cobasis had been rising above zero—backwardation—but broke down on Thursday’s reaction to the ECB news. On Friday, although the price ended up the same, the cobasis fell further. It’s now below -0.1%.
It will be interesting to see what happens to the volatility in the silver basis, when the silver fix is ended, if no other party steps up to provide the same service in the meantime.
© 2014 Monetary Metals