Monetary Metals Supply and Demand Report: September 1, 2013

Silver continued to outperform gold until a sharp reversal towards the end of the week. Is this the big breakout? Or is it a headfake? Silver Read about the recent 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. Nor does it measure past price action in an attempt to predict future price action. The basis measures the spread between the spot price and the futures contract price.

Obviously, the recent falling price until last month told us that demand for gold and silver is lower. But the basis was also falling, and this told 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

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 started strong, but did not finish strong.

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 gold contract remains in a small backwardation (December has subsided).

This week, the gold price ended at around the same level as the prior week. And the cobasis is around the same too. This is something to make one go “hmm”.

All eyes should be following this development closely.

Gold Basis and Cobasis

Here is the chart for December silver (we are dropping September as it is now illiquid). As last week, we still see a contango with a positive basis. The drop in the silver price is visible as a drop in the basis, though interestingly there is not such a sharp rise in the cobasis.

For now, there is no serious scarcity in silver. As the price rose, metal was drawn out of all corners of the market—real metal, not alleged naked paper “shorts” (which would show up as a deep backwardation and further sharp increase in the cobasis).

Silver Basis and Cobasis

Here is the graph showing the ratio of gold to silver. It is up from last week.

Gold to Silver 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.