Silver’s on Fire, Report 24 Apr, 2016
Another interesting week, in that the price of silver separated from the price of gold. The former went no nowhere, while the latter gained over 4.5%.
We get the trading thesis, that if the precious metals are in a bull market, then silver should go up more than gold. Silver is the high-beta gold. It’s a smaller market, less liquid, and at the same time it’s the preferred vehicle for betting on a rising price.
We don’t quite get the thesis that gold is going nowhere or even down, and bet on silver which is going to $50. Yet that is now our market reality. Excited silver bulls have watched as pushed silver up from $14 in late January to $17. Meanwhile the price of gold went from $1,100 to $1,260 and then back down to $1,230. The gold silver ratio initially rose from 78.5 to over 83, and down so far to 72.7.
The growing consensus is bullish. As always, we’re more interested in the fundamentals than in opinions. Let’s look at the only true picture of supply and demand fundamentals. But first, here’s the graph of the metals’ prices.
The Prices of Gold and Silver
Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. The ratio was down sharply again 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 brief 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
Look at that. Carrying gold for June delivery is now even more profitable, over 55 basis points. This is up from last week at 51bps. The increase tells us something. However much gold was carried last week, it became incrementally more attractive to carry this week.
A positive basis is a measure of abundance. This is because it tells us about the profitability of buying metal to warehouse in carry trades. If profitability is rising, then that means the marginal demand for metal is to put into the warehouse.
Not a bullish sign, with a flat to falling price. Indeed our fundamental price for gold is still sagging, down another six Federal Reserve Notes this week.
Now let’s turn to silver.
The Silver Basis and Cobasis and the Dollar Price
How much higher can the price of silver go? One talk show host appealed to the “silver faithful” with a promise of a price to skyrocket to levels even they will find “stunning”.
Our response is to point to the basis (blue line). Note that we switched from May to July.
If gold is showing some signs of abundance, silver is practically lying about in the marketscape. To carry silver for July delivery yields an annualized profit of over 1.1%. The flow of metal into the carry trade must be a torrent. If anything occurs that will stun the silver faithful, it will be the epic drop in the silver price. This will be decried as a smashdown.
Our calculated fundamental price did rise a dime this week, but it’s more than two fiat units below the market price.
There are times when the basis analysis does not predict a price move. We certainly did not call for the price of silver to jump. It’s speculation, or “animal spirits” if you will. However, then the basis can predict the reversal of the speculative move.
To be conservative—though this risks missing a quick collapse—one should wait to see the momentum peter out. As we often say at times of bearishness, we NEVER RECOMMEND NAKED SHORTING a monetary metal. The way to play this move would be to go long gold and short silver. If the gold silver ratio is 70, short 70 ounces of silver for every ounce of gold you buy.
70 would be an attractive entry point (assuming momentum dies by then). If the ratio rises to 83, then you have a gain of over 18.5%. For example, if you buy 100oz gold and short 7,000 oz silver, you will pick up over 15.6 ounces of gold.
© 2016 Monetary Metals
Recommendation noted: go long the GSR at 72.7 on April 24 2016.
More stats on common features of previous GSR moves in the past 20 years.
Mean move in the final 12 months is around 32 GSR points, regardless of initial GSR.
There is a rough 6+ year cycle with peaks in 1997, 2003, 2009 and 2015 and troughs of the stable trading GSR in 2000, 2006, 2012.
Lows do not correspond to these troughs perfectly and in fact often precede them,
The sustainable range excluding high and low spikes appears stable at 50 to 80 points.
Low spikes tend to occur in spring
Rapid phase of travel from high to low extreme occurs over 3 to 8 months.
So contrary to the long GSR recommendation above (which could pay in the very short term), it is more rational to expect:
– a GSR low ahead, not a high.
– a cyclical date for this of around early 2018
– a spike down to around 50 between early 2017 and early 2019
– a spike low in springtime
– a rapid terminal phase of only 3 to 8 months.
The current move is anomalous; if it is the terminal spike it should end in July to November, which would be odd. If it is not the terminal spike Keith’s long recommendation, counter-cyclical though it is, could come good.
In 1980 when it spiked down to 15 area, GSR was actually in an uptrend which continued thereafter. The magnitude of mania spikes can dwarf the slow fundamental waves. So the observation that the ratio has moved 10 in a single month should be taken very seriously.
Follow-up
It seems probable to me that the “fundamental” price based on forwards that Keith refers to is in effect a composite of mining and industrial supply/demand and investor supply/demand.
These two drivers have conflicting behaviour. Mining industrial supply/demand displays negative feedback over a few years for fundamental reasons and accounting for the cycle mentioned above. Investor supply/demand (which is also physical, see “stackers”, China and SLV) displays positive feedback over several months, driven by narratives (see 2008-2010) but powerfully fed by actual physical shortages when these occur at cyclical GSR highs (as recently) and also in the midst of investor manias (as in early 2011).
So if what we have regularly reported on these pages is a genuine short term fundamental indicator, it fails to predict in the medium term primarily because it is a confusing composite of two tenuously related and occasionally conflicting price drivers. Both can, however, be predicted independently based on their own factors – such as fluctuations in reported supply and demand and (shock, horror) price or ratio chart patterns. A medium term composite can be constructed from the two. Unlike Keith’s indicator this has little to do with anything visible in the futures or forwards markets – these merely indicate tightness or looseness which can occur at any point and fluctuates very rapidly as we saw in the recent lurch in gold’s “fundamental” price.
Fundamental analysis of the true drivers could, however, suggest medium term price trends more reliably, particularly for those trading in the physical market who cannot pick up pennies because they have to contend with bulky spreads between physical buy and sell prices.
In short, stackers have to get the medium term trend right and today’s forwards market can be safely ignored.
Keith, I must ask; do you still hold to the premise that gold and silver are not manipulated? With the recent admission, that indeed in fact, they are, would this make your “fundamental price” irrelevant, or is there still some validity in it?
Overnight repo rates may be beginning to spike in Saudi Arabia, per ZeroHedge. This would result in a dump in gold prices as banks lose trust in financial asset collateral and in each other and only take gold as collateral for overnight loans. The bank receiving the collateral then sells the gold at the first opportunity (in the wee hours of the morning). Of course, all the banks receiving gold are doing this, and doing the sale thru JPMorgan, which is why it looks like only one seller doing something stupid to purposely crash the gold price. It’s merely a concrete example of the Wall Street adage, “he who sells first, sells best.” Of course, people who don’t understand anything will yell “manipulation”. Reference my comments on this forum in May of last year.
Hi Keith,
one question: Was the basis in gold / silver negative (cobasis positive) when gold and silver ‘rallied’ from 2002 – 2008? I would think not since I read somewhere, either on monetary-metals.com or somewhere else, that gold first went into backwardation 2008.
Isn’t it correct to say that the basis/cobasis is the most sensitive indicator to measure ‘price’ direction – but it is not a safe bet – it might go the other way. Do you agree with this?
How do we get information on the fund run by Monetary Metals?
Under, “About Us”
“We developed and manage a fund that provides a yield on gold, paid in gold. This is the first true gold investment since the 1930’s. Investors in this fund are high net worth individuals, family offices, funds, and institutions.”
I’d suggest using the “contact us” tab.
Thanks for the comments.
Ratio: the actual recommendation was to watch the momentum peter out. I suggested a ratio target of 70, with the risk of missing the opportunity.
In our annual Outlook (https://monetary-metals.com/outlook-2016/), we talk about the players in the market. It is not simply mining, industry, and investors.
Sage: We shall have to wait to see (or at least I have not seen it yet) precisely what DB admitted to. A few years ago, a trader for Barclays was convicted of gaming the fix to avoid paying on an option he had sold to a client. He sold a few hundred bars into the fix, locked the price below the options strike, and then bought those bars back. He took a loss on the bars of metal, but saved a much larger amount on the option. What he did was unethical and illegal. But it has nothing to do with the belief that the price of gold would be far higher than it is. If the price of gold should be $2000 or $5000, but a massive short-selling of paper pushed it to $1200 then we would see a massive backwardation.
amused: why would a bank accept only gold and then immediately sell such gold? When they sell the gold, what are they buying with the proceeds? Why wouldn’t they accept that asset as collateral? If the banks owed the borrower safe return of the gold, then they cannot sell it without at least buying a future or forward. If that was happening, we would see a rising basis. Which is happening, so that part is plausible. But where do the borrowers get the gold? Are they buying it in order to have the collateral? In which case it’s hard to see that this is causing the price to drop.
petter: we plan on publishing historical basis and other material, so I want to hold off commenting until that project is ready.
The basis is indeed very sensitive. And obviously speculators can stampede against the fundamentals. This is why we said this:
“There are times when the basis analysis does not predict a price move. We certainly did not call for the price of silver to jump. It’s speculation, or “animal spirits” if you will. However, then the basis can predict the reversal of the speculative move.”
For the past few years I was perplexed at these periodic wee-hour dumps of gold, initially accepting at face value the claims of manipulation but I had to assume the people who control such sums of metal weren’t exactly stupid. So what was really going on? I figured that panics in the overnight repo market were analogous to natural disasters in the insurance industry, that is, stretches of calm punctuated with random disasters.
During normal times, insurance companies are taking in premiums and making investments. When a disaster strikes, their stock goes down because there is uncertainty as to its actual cost, plus the market goes down because investors/traders know the insurance company needs to sell investments to raise cash to pay claims. Afterwards, the insurance company raises premium rates and makes new investments.
The overnight repo market is a trading marketplace run, in my understanding, mostly by JPMorgan. A bank’s account has assets in it that it is willing to post as collateral (in custodial care of JPM) and also lists asset types that it is willing to accept as collateral. During normal times collateral is mostly your standard types like T-bills and other very low risk paper. But during a panic when interest rates are extremely volatile and rising (values dropping) who knows what your interest-bearing paper is worth, or if it will even be redeemed? But the market value of gold is available 24 hours a day, so there is no question as to its correct price. So now I can begin answering your questions.
Why would a bank accept gold and immediately sell it? Because a bank makes money by lending money at as high a margin as it can, not gold.
What are they buying with the proceeds? Cash most likely in the currency which is their unit of account.
Why wouldn’t they accept that asset as collateral? Because if the bank that needed the loan had cash, it wouldn’t need the loan.
If the banks owed the borrower return of the gold, they cannot sell it without buying a future or forward. That is correct.
Where do the borrowers get the gold? During the normal times.
Are they buying it to have collateral? Yes, or in other words, to have as insurance for when they need money and nothing else is accepted.
A final note here is that the repo market changed in the 1990’s. Before then, the owner of the asset kept title when posting it as collateral; after, they passed title with the asset so the receiver could sell it and eliminate holding risk. Remember, the borrowing bank is in the overnight repo market because it needs cash right now; it can’t wait for settlement delay.
Can you rule out the scenario below with 100% certainty?
A widespread physical delivery failure occurs on the LBMA and CME exchanges. Unallocated gold accounts and gold futures contracts are settled in cash at a previous closing price. This event was not preceded by a rising cobasis in gold.
Keith: momentum plays on more than one time frame. Looking at the 1997, 2003 and 2009 GSR peaks the initial thrust – which normally does not breach the uptrend – does generally peter out but it is followed, within a year or two, by the rapid downward segment to the blowoff low in each short term mini-mania. This is sentiment driven, as are all movements in monetary metals. First it is perceived that silver is no longer lagging, then suddenly it dawns that it can lead.
If short term momentum does die around 70, your revisit of higher ratios, although probably not 83, has historical precedent. In 2009, for example, ratio first declined for a year, then hesitated for a year around 65 with price at highs up to that point, then succumbed to the mania and plunged 35 points to 32. In 2004 it dropped 35 points to 45 without the hesitation.
My main contentions are:
– the uptrend has been breached early in the process, creating powerful sentiment
– the interest rate and gold geopolitical environment are unusually conducive since a gold upturn is generally expected to hurt the ratio based on consistent historical experience
– the decline in both metals has been prolonged and extreme, again 2003 is a good analogy
– contrary to your more recent comments, production has in fact topped and is in fact relevant to s/d dynamics, as per Econ 101
So … you may get your hesitation, which you can label a failure, but a) you may not and b) it will probably turn out to be just that, a temporary hesitation. To optimise your longer term credibility, moderate the pro-GSR rhetoric. Nitpicking on the terms used will not suffice. If you have been strongly bullish the ratio all the way down, people will remember.
I have no doubt that any advice offered is from genuine concern. But I would like to say, for my part, that I read Monetary Metals because I value Keith’s unhedged analysis and views. I use it together with other material to get my view of the market. If he ends up being wrong, then he’s wrong. But I still want his honest view.
Amusedobserver,
My reason for reading it is similar to yours. Keith’s unhedged analysis and views are interesting in part because they are generated by his model, which is to say the least unusual and I have worked on something similar of my own. Unfortunately the raw output of the model is overlaid with a narrative – a pungently tendentious one in Keith’s case at least when it comes to silver – and it is here that I generally feel the need to comment. The model says what it says, but Keith chooses how to present the output and he is one of only a small number of well informed commentators. The result is that you have a short term measure of scarcity of limited value, generating data which is then used as material for a longer term, strongly one-sided and mostly unhelpful narrative.
The site is still very valuable because we get to learn about the data that the model is disgorging – if we are capable of disaggregating it from the narrative. I want Keith’s readers to attempt this since it will enable them to sift the diamonds from the chaff, so yes my criticisms are offered from genuine concern. I would also like the site itself to thrive and continue, which it is unlikely to do if it suffers the humiliating experience of shrilly railing against silver for three years while the GSR drops to 40, 30 or worse.
Caveat lector
PS Amusedobserver,
Personally I found your own comments on overnight repo extremely valuable. Please continue to post your insights into these markets. There is a flood of nonsense in this domain, mostly pushing more extreme views such as the FOFOA fantasy and militant silverbug rhetoric, even once one has laid aside the drivel emanating from the mass media. It has got to be the most obfuscated market in the history of mankind and it is uniquely important so people deserve better.
Ratio, I look forward to visiting your website where you use your similar model presented without a pungently tendentious narrative, that guides everyone who will believe to reward and riches. This is not what I really wanted to say but Keith’s manner has been such a bad influence on me.
Glad to see you think it is worth defending. If you think it is worth following too, good luck and see you at 90.