Monetary Metals Supply and Demand Report: August 25, 2013

Silver outperformed gold this week. Is this the big breakout? Or is it a headfake? Read on to see the emerging contango in silver!

As we go forward, there is more boilerplate material in this report. This is good for first-time readers or as a refresher. But if you are reading it every week, you may want to skip over it. To make the report more readable by both groups, all repeated boilerplate material that is repeated from the prior week is be marked in italics like this.

The Gold Basis Report is fundamental analysis of gold and silver. The basis is a measure of availability of metal to the market. When the basis is high and rising, then metal is abundant. When the basis falls below zero, and the cobasis rises above zero (gold goes into backwardation) then that means danger (and likely higher dollar prices).

The basis doesn’t measure flows of metal from one corner of the market to the other. We make no assumptions that one side is the “dumb” money and one side is the “smart” money. The basis measures the spread between the spot price and the futures contract price.

Obviously, the recent falling price until last month, tells us that demand for gold and silver is lower. But the basis was also falling, and this tells us that those who do buy gold want it now. They were willing to pay a premium to get it immediately, and didn’t want to wait for delivery. As the prices have risen, the scarcity (especially in silver) has been disappearing.

Since gold and silver have huge inventories that are not consumed—they are held for monetary purposes—a sign of scarcity of the monetary metals in the market is a sign that the dollar is moving towards collapse, when gold will no longer bid on it.

One cannot truly understand the gold market in terms of the quantity of dollars, price charts, or by charts of open interest, ETF holdings, COMEX inventories, etc. One must study the basis.

In general, the positive basis (i.e. contango) is disappearing (hence the full name of this report). This is a process of gold withdrawing its bid on the dollar. One cannot understand this if one lives in the dollar bubble, looking at the gold “price” as if it were comparable to the price of Apple shares or crude oil.

The “bull market” in gold and silver is not over. We do not recommend that anyone sell his gold now, unless he is using leverage (and we don’t recommend using leverage). When the gold price rises, we don’t recommend selling then, either. A rising gold price gives only an illusion of profit (and the tax man will take a big piece of that).

We generally prefer to look at the price of the dollar in terms of gold, rather than the price of gold in terms of the dollar. The reason is simple. One can measure a rubber band using a steel tape, but not a steel tape using rubber bands.

Nevertheless, here is a chart of their prices. The dollar prices of gold and especially silver rose significantly.

The Prices of Gold and Silver

 Letter Aug 25 price

We believe that the dollar had been getting stronger for the simple reason that debtors were being squeezed. They were scrambling to get dollars. It is not just Japan with a collapsing bond market but possibly China as well. If this gets going in any significant way, the price of every asset from copper to real estate in LA could crash. Now India and its collapsing rupee has made everyone’s radar screen. These past few weeks have seen a respite. For example, the euro near a multiyear high.

This week, again, the speculators were out in force.

In this report, we have been tracking the temporary backwardation in both metals. It is like a distortion field; as we move closer to each futures contract expiry, that contract is pulled into backwardation. The bid drops, which causes the basis to fall off the bottom of the chart. This could be due to heavy selling, as leveraged longs must sell before First Notice Day (since they haven’t got the cash to buy the metal). Their selling, of course, presses down the bid.

But the mechanics of the contract roll does not fully explain the phenomenon.

Think of temporary backwardation as rot in the heart of a tree. It can spread for years, undermining its integrity. The collapse of the tree at the end is “unexpected”. As the financial system rots, people increasingly discount monetary metals for future delivery. Despite the cost to carry gold, it is cheaper to buy gold for delivery in October than it is now.

You could lock in the price now, and not have to come up with the money for a few months. And you are offered a discount to do this. Few people appreciate the significance, just as only a tree surgeon would recognize the rot in the heart of a tree.

The October and December gold contracts remain in a small backwardation.

Last week we noted the rising gold price and the fact that the cobasis was reluctant to fall. We said, “This may herald higher prices of gold to cone.” That was at $1365. Friday, gold closed at $1395. We see that the cobasis this week has fallen, but only a little.

All eyes should be following this development closely.

Gold Basis and Cobasis

Letter Aug 25 gold

Here is the chart for September and December silver. For the first time in a long time, we see a contango with a positive basis. Even against the mechanics of the contract “roll”, where longs in the futures market must liquidate their September contracts and buy December, we see a rising Sep basis and falling Sep cobasis.

Scarcity in silver has disappeared, for now. As has been the pattern, the cure for backwardation has been a rising price.

Silver Basis and Cobasis

Letter Aug 25 silver

Here is the graph showing the ratio of gold to silver. It dropped sharply from the high set a few weeks ago.


Letter Aug 25 ratio

As we develop our business, Monetary Metals is working on changing the format of this report. The public (free) Gold Basis Report will continue to provide a weekly picture of the data in a variety of graphs to show the prices and supply and demand fundamentals in gold and silver. It is also intended to help sound the early warning as we head into permanent gold backwardation. It may help give traders in the metals an edge, but that is not the focus in this report. We will be announcing some other products soon.


5 replies
  1. bvigorda says:

    I keep reading the boilerplate and the article together and I still don’t understand the answer to the question “Silver outperformed gold this week. Is this the big breakout? Or is it a headfake? Read on to see the emerging contango in silver!”

    Could someone please answer this question for me? I own no gold or silver presently and would like to buy some when there is a true breakout or whatever is needed to confirm the bottom.

    Thank you

    • Keith Weiner says:

      A rising basis / falling cobasis is bearish. It means that the price jump is being fueled by leveraged speculators in the futures market rather than fundamental demand for silver metal. The December contract is in backwardation, which means the marginal demand for the metal is to be carried in the warehouse.

  2. drdavis2 says:

    Keith, your reply above says “The December contract is in backwardation.” Is this a mistake? It is extremely confusing to me, a new reader, studying this past report! Your chart on this page shows the December basis crossing above zero. This positive basis is labeled, “Dec silver is in contango.” Your intro says, “Read on to see the emerging contango in silver!” In general I am struggling with your terminology, writing, and conclusions that are not always clear to me.

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