The Curious Case of Falling Gold and Silver Prices. Part II

In Part I , we presented the data for gold and silver price, open interest, and basis. They form a curious combination, which we discuss in this Part II.

If open interest is rising, then it means one of two things. Contracts are being created by fresh buyers taking the ask, in which case we should see prices rising. Or it could be that new sellers are selling on the bid, in which case we should see prices falling. Prices have been falling, so there are fresh new sellers. That would seem to be simple enough.

Selling of futures will depress the basis. In gold, this is straightforward. We see the basis for every contract month falling, which means the price in the futures market is falling relative to the price of gold in the physical, or spot, market.

In silver, it’s a little less clear. Other than the last two days, February 14 and 15, is not doing much falling. Could selling of physical been present to nearly match the selling of futures until the last two days? Since January we have been downright bearish on silver in gold terms  and cautious on silver in dollar terms .

What’s curious about the falling gold price is that, unlike in silver, we saw little reason for physical gold to sell off and on Friday sounded the alarm bell about gold backwardation.

So we have physical silver and paper silver selling. And we have paper gold selling. Is this really naked shorting of gold? There could be some of that going on, of course.

But here is the question—and it is a question for discussion, not a certain conclusion by any means—could arbitrage be the larger force here? For a long time, the Internet has been awash with rumors of silver shortage, mints are out of coins, products aren’t shipping due to inability to obtain silver used in them, etc.

Might traders have put on a long silver futures / short gold futures position?

This is an extremely important question, because if so those traders are taking on water as the gold:silver ratio rises. As they hit their stops, they must unwind which will result in selling of silver futures and buying of gold futures.

We don’t typically see the silver price fall significantly on a day when the gold price rises significantly. If traders really did put on this trade (they obviously weren’t readers of Monetary Metals!), then the unwind could cause this to occur.

We encourage comments below. Maybe we can crowdsource an answer!

40 replies
    • GoBroncos says:

      I don’t know where the author saw backwardation. I checked the Comex settlement prices for Friday and there was perfect contango. I have not oberved true backwardation for quite some time.

  1. wmbates says:

    A factor — real but I don’t think too major — in the OI increase is the reduction in margin requirements by the CME last week. Assume all the longs are fully margined; this reduces the amount of dollars required to add contracts. The best numeric is probably “dollars flowing in (out) of market each day.”

  2. JerseyJoe says:

    Could it be that due to the Backwardation (ie few willing to sell at the current price) that the supply shortage in gold spooked the manipulators to flush out the call options expiring Feb 25th?

    With less calls left “in the money”, less phyzzz will stand for delivery thus keeping more phyzzz in the vaults for further manipulation.

    Side note: What is with the huge open futures in April? Is this part of the run down equation?

    I am new to this and just trying to get some insights.

  3. bnick says:

    I think this is a simple case of the long specs getting flushed. It is quite possible that the OI has been increasing while price is declining because the producer/merchants and swap dealers (the smart money) are not providing the fresh shorts; rather, it is more than likely the trend followers (managed money) shorting into what are in all likelihood tradeable lows. This would explain why both the gold and silver basis charts are reflecting backwardation or an approach to backwardation. In other words, it’s my opinion that the new shorts providing the open interest in here are going to be punished and will be forced to cover at much higher prices.

    • Mike says:

      I hope your right. Higher prices ( honest reflection of true supply and demand ) are comming. I hope sooner rather than later. Time the redistribution tool ( fiat currency ) come to an end.

    • asabi says:

      consistent with fresh shorts starting today NOT being “smart” money, do you think there is any value in watching the volume on slv or agq as this dive progresses? slv volume today (2-20 wed) was highest of any day in last sell off sessions, and is highest since 12-18-12 which was about the end / bottom of last nosedive.

  4. Keith Weiner says:

    Dingie and GoBroncos: I have showed the data for backwardation. You can’t look at last cleared price for futures and compared that to last cleared price for spot. Backwardation is when the bid on spot is greater than the ask on the future. One arbitrages backwardation by simultaneously selling spot (on the bid) and buying future (at the ask). This is called “decarrying” the commodity.

    Jersey: April is the active contract at the moment; most people who are obliged to get out of February choose April, though of course they could choose June, August, October, December, or something in another year.

    David: for silver, yes. For gold I am bullish period.

    Jersey: I am not a fan of the manipulation theories and have written several articles debunking them. Gold is not very liquid in the March contract so I doubt there are many options expiring at the end of February.

  5. JimT46 says:

    This will be a bit lengthy as the subject is complex. As stated, a rise in open interest is bearish when combined with falling prices. It signals not long liquidation but new short selling coming into the market. It is important to know where all the selling is coming from.

    Gold commercials had a huge short position on in early October of last year and have been slowly unwinding it. Commercials, as of last Tuesday, had the lowest net short position since then. It isn’t financial institutions or producers that are selling. The selling is mostly coming from funds and small specs. The funds tend to make the trend. Funds engaged in selling to the tune of 10,630 contracts last week. Small Specs increased their short positions by 3324 contracts. Commercials increased their long positions by 13,954 contracts. All the selling was coming from funds and specs.

    Silver is a bit different. Commercial selling peaked in December and they have done less covering over the last couple of months. The breakdown over the last week has been Funds had net shorts of 3789 contracts. Small specs sold a net 1360 short. Commercials had a net long addition of 5149 contracts. Again, the selling is coming from funds and specs.

    Funds and specs determine the trend. At the bottom they will be relatively very short while commercials are relatively very long. Commercials are always right at the turns while funds are right on the trend. It is the nature of the beast.

    Looking at basis, the cash and nearby futures will always tend to converge until the last trading day when they will be close to merger. Volume dries up so you might only get a few trades in the morning and everyone else will stand for delivery. That may cause a slight differential in price. It is meaningless. It is a little more informative to use the most active contract to get a feel for the futures market. On that basis, both gold and silver have been in backwardation on and off all of the last week. I also check the difference between the most active and the contract one year out from the most active and look at the basis there.

    Over the year you should ideally see that spread accurately reflecting full carry. If you don’t, there is some nervousness about distant delivery vs just paying cash now. The market is not willing to fully compensate for storage. In this case we see gold dropping from a spread of .69% to .64% over the last week. In silver we have seen it increase from .84% to .88%. While neither market is fully covering carry, the silver market is getting less nervous and the gold market more so. This is also reflected in the gold/silver ratio, which is increasing. While that is true in almost every down move, it seems to be more telling here.

    In summary, it appears that silver is actually looking at a bear market here while gold is a reluctant companion as the entire complex is sold by the funds. The test will come at $1524-$1527 in gold and $26.10 -$26.15 in silver. Then we’ll see if the commercials can overcome the funds and specs. In the meantime, physical gold supplies seem to be tightening while silver supplies are not, at least not to the same extent, as silver heads back towards carry. Long gold and short silver seems the smart play.

  6. Keith Weiner says:

    bnick: I think you are likely right, especially in gold. Silver could have some more downside (certain in terms of gold, if not the dollar).

    JimT: thanks for spending the time to write your thoughtful comment. I hope everyone reading it benefits from it, as I did. And if you’ve seen my videos, you know I emphatically agree with long gold / short silver. :)

    Carpenter: Yes, the central banks sold gold. But not silver. If they were suppressing gold but not silver, then wouldn’t we expect to see the gold:silver ratio much more strongly in favor of silver? Today it’s over 55 ounces of silver to 1 ounce of gold. Historically, the ratio was 16.

  7. besing says:

    Two explanations exist either there is a war in the silver pit like Ted Butler says or JPM is going onto the long side. JPM uses the high impact long liquidation to ram the market down and then buys back as the waterfall occurs. There are no other major players out as the traders have been washed out and they are covering their shorts.

  8. JR says:

    What would be most interesting Keith is whether this fall in the $ gold price under 1600 has affected the basis further.

    For the record, I remain skeptical about the whole thing. I just don’t see any rational, thus measurable, ‘basis’ for a bid in gold for $, but admit I could be wrong.

    I’m now going to lay some more s**t on Max Keiser for being an ignorant moron. If you didn’t see it, he called you a f**ktard, then used your call on backwardation to justify his argument.

    • happel says:

      Keiser is an entertainer playing to a particular audience. Anyone who invests their disposable wealth on his words is sorely looking for pain. I would be curious to know what his educational background is. Theater, drama, stage production… or economics and finance? Keith has showed some compelling clues to why manipulation is unlikely. If there are forces that are trying to manipulate gold and/or silver, they are likely preying upon exactly those theories to affect their entires and exits to their trading. My $.02 (in USD terms a slowly devaluing amount.) Trade wisely, all.

  9. Keith Weiner says:

    besing: you may want to read some of my previous pieces on the conspiracy theories of naked shorting in the futures market, and also see the video of my appearance on Lauren Lyster’s last show of Capital Account. The markets just do not behave the way the conspiracy theory would predict.

    JR: Yes, with every drop in price, the gold basis has been falling and cobasis has been rising. I think the reason why there is still a gold bid on the dollar is that many people who own gold still think in terms of dollars, still believe the dollar is money, and want to sell to take “profits” or need to sell before “losses” become too large. It is a long slow process for people to think in ounces or grams. Monetary-Metals now has currencies priced in grams on the right margin of this site and plan to discuss from time to time. I don’t really understand why someone would reduce himself to cursing at someone. In a disagreement, anyone should be able to explain why they disagree.

  10. Carpenter says:

    @ Yes, the central banks sold gold. But not silver.
    If they were depressing gold but not silver…


    GSR was 30-1 before the March ’11 takedown.

    Commissioner Chilton knows.

    • Keith Weiner says:

      Carpenter: I have debunked the theory of take downs via the futures market. Since they don’t have any silver, how else could they force the gold:silver ratio up to 55?

  11. samiam says:

    As I understand it, to be bullish for gold you predict inflation. makes a convincing argument for deflation, and drastically falling gold. Any chance that is kicking in?

  12. mossmoon says:

    This analysis presumes spot=physical. Spot is not physical. Repeat: Spot is not physical. If you assume this, you will never see manipulation, which just requires a little common sense.

  13. Keith Weiner says:

    samiam: I define inflation as an expansion of counterfeit credit, and deflation as a forcible contraction of credit. What is the value of a defaulted bond? Would you want to hold a bond knowing it is about to default? That is the case for gold. I agree, deflation (by my definition) is the prescription. Professor Antal Fekete uses the word “deflation” to mean falling interest rates. By his definition, there is no question that we are in and will continue to have deflation.

    mossmoon: have you read my pieces debunking the conspiracies? Have you read my pieces looking at the bases? I am curious why you assert that spot is not physical. Do you mean that a retail buyer who wants a one ounce Eagle will pay a big premium?

    • samiam says:

      Keith: I guess people have different definitions…anyway, the type of deflation that talks about results in a very strong dollar, the DOW falling to 3300, and $750 (yes, $750 not $7500) gold, and depression. I think they also predict collapse of the eurozone, thus strengthening the dollar. Can you envision any possibility for such a scenario? Was the dollar strong during the depression of the 1930’s?

  14. mossmoon says:

    I’ve read all your stuff and learned a great deal.

    I am saying that Comex is not a price discovery mechanism for physical metal. It IS the price. It is paper settling paper.

  15. Keith Weiner says:

    samiam: I think one has to be careful about linear assumptions. Most people today think that the money supply is linearly connected to prices. In this view, if the money supply shrinks then prices fall including gold. But it’s not linear. The price of gold (we should really start thinking of the price of the dollar measured in gold ounces) is a measure not of the quantity of dollars but of their quality. The quality of the dollar has been falling for many many decades, and I do not foresee it reversing.

    danho: we publish basis charts here periodically. Stay tuned!

    • JR says:

      “The price of gold (we should really start thinking of the price of the dollar measured in gold ounces) is a measure not of the quantity of dollars but of their quality.”

      You’ll go far with that attitude Keith. Kudos to you.

      I would suggest though, that rather than the quality of the dollar falling for decades, & continuing to fall, the $ – all government credit actually – has been junk for decades. It is lead trading as gold, oregano as weed. It is an irrational credit bubble of inconceivable magnitude.

      Hence my skepticism that it can be measured, rationalised, if you will.

      • Keith Weiner says:

        “Oregano trading as weed” — I shall have to remember that!

        Sometimes I think that the whole point of the journey of business is to collect cool expressions! :)

        In all seriousness, the quality is lower now than it was 5 years ago. It has been falling. One could argue it was junky 41 years ago when Nixon made it irredeemable but the debtor was still able to pay.

  16. David_Leclerc says:

    Keith, in an earlier article, you mention that Gold had fallen into backwardation.

    Perhaps people are taking the bait and selling their physical now, in exchange for delivery later on.

  17. Worthmonkey says:

    Hey Gang I am a newbie here…made some money and bought physical gold and silver plus some income producing real estate. Bought the metals within the past 90 days…I like being able to touch and feel it and whenever the prices drop I get the urge to buy more to bridge…and I have..and unlike investing in companies or the market I can touch and feel the stuff whenever I want so kinda cool…but my question is independent of all the conspiracy theory etc floating around…should I buy more silver, gold, or both..physically to hold? Any input would be great…Thanks!

  18. ex nihilo says:

    i could see a number of factors playing out at the same time rather than just one event being the cause of the decline: (a) due to changes in irs reporting for tax reasons, a lot of individuals could be selling their paper claims on gold, via funds, for cash. i dont underestimate the herd mentality when gov’t changes rules; (b) large players are staking claims on physical (by bar #) and selling paper gold. same for silver. by precedent, it is my believe that once the large players (i.e. cb’s) allocate among themselves all the physical metal they can get their hands on, they will default on the paper gold iou’s, i.e. stiff the dummies who didnt take possession of phyzz. inherently, the establishment already demonstrated that the market is nothing but fraud. just like “they” will default on the $fiat, they will default on the fiat paper gold.. on balance of probabilities, default across the board is baked in. i see prices of paper gold going down and premiums for bullion going up in the near future. the unknown, wrt time, is how many wars the west can get into to rob foreign holders of phyzz gold in mena to satisfy marginal deliveries of bullion to refiners and retailers. for as long as armies can invade other countries to find phyzz gold for deliveries to privileged parties, and also pacify the loud and hysterical “eagle hoarder/buyer” at the same time when blanks are not immediately available, this paper market will go on. until it doesnt. charts and theories be damned.

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