The price of gold was up about thirty bucks this week. The price of silver was up almost seventy cents.
Last week, a reader reminded us that in the long run the dollar is going to zero. He said:
“At some point in time, unknown to me, the futures market for gold/silver will collapse… and the price will undoubtedly be multiples higher…”
Yes, but a lot can happen between now and then. This idea is not tradeable. It was just as true when the price of gold hit $1,920 as it is today at $1,350.
So if this doesn’t work, how do you trade gold? One way is to look at charts of price, or the integral (sorry for the calculus) of price—momentum. While these charts can give you probabilities of the next move, they can’t tell you anything about the fundamentals. And if there’s a truism, it’s that the market may be a voting machine in the short term but in the long term it’s a weighing machine. The fundamentals will matter.
Of course, trading gold is really trading the dollar—but in a mirror that reverses how everything looks. Gold futures traders say gold is going up, but we say it’s the dollar that is going down. Who is right?
It’s entirely uncontroversial that the dollar is not a stable store or measure of value. Heck, its manager the Federal Reserve, has set a policy of 2% annual declines in their paper. Unfortunately (for them), they are not getting the rising trend of consumer prices that they want.
So why would anyone insist on measuring the value of gold—which has been precious for thousands of years—by reference to a dollar that’s designed to go down? Would you measure the height of the lighthouse by reference to deck of your sinking ship?
We think there’s but one answer. Traders want to believe they’re getting richer. It’s rather boring to think that one’s 100oz of gold is still worth … 100oz. Not to mention, it leads to the uncomfortable question of whether one wants to spend one’s gold down.
At any rate, let’s look at the only the only true picture of the supply and demand fundamentals for gold and silver. But first, here’s the graph of the metals’ prices.
Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. The ratio fell 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 brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.
Here is the gold graph.
Now there’s a move! Gold became a bit less abundant (blue line, i.e. the basis) in the latter part of the week. At the same time, its price was rising (i.e. the dollar was falling).
Unsurprisingly, the fundamental price spiked up $90. Unfortunately, while it’s closer to the market price, it’s still about $110 below. Gold is less overpriced but still no bargain here. This is the mirror of saying the dollar is less underpriced, but still not a sell today.
Now let’s turn to silver.
The big moves we see in gold are reflected as pale shadows in silver.
The fundamental price did move up, but only 44 cents. It is now a whopping $3.63 below the market.
We find ourselves in almost exactly the same position today as in April 2014. The market price of silver then was just over $20. The fundamental price was in the 16’s too. We said that the price could snap back down, and of course if it did that it could overshoot and we could see a 12 handle.
The same setup exists today. Market price just over $20. Check. Fundamentals in the 16’s. Check. We recall the permabull silver commentators back then, and they are certainly out in force today, check.
By the way, after that point was a long slow slog down to $13.98 in August a year later. There were ups and downs, but the fundamentals—like gravity—won in the end.
That episode—indeed the whole business of the falling price after it peaked in 2011—should have put to bed the quantity theory of money. You know, the Fed and other central banks are printing money (it’s not printing, it’s borrowing anyways) and this causes prices to shoot up. Especially the prices of the monetary metals. Here we are in 2016, with the quantity of dollars continuing to increase, and the prices of the metals may be up recently but they are down considerably from 2011.
Here is a graph of the premium of the silver market price over silver fundamental as a percentage – the premium price that silver market demands to sell you the metal. It has been steadily rising (with some zigs and zags) since last August, and particularly aggressively since late November.
We do not attempt to predict when sentiment will turn. All we can say is that unless the fundamentals turn first, the price of silver is likely to crash. Again.
© 2016 Monetary Metals