Monday, March 31, 2014

Monetary Metals Supply and Demand Report: 30 Mar, 2014

by Keith Weiner

Monetary Metals Supply and Demand Report: 30 Mar, 2014

The gold price fell about forty bucks, and the silver price fell about fifty cents. There are many ongoing rumors about what could be happening in supply and demand for the metals. Mostly, these are about how the world is gobbling up physical metal and the prices will soon skyrocket. A well-known commentator this week declared that manipulation is so “obvious” now that it ought to embarrass the manipulators. We’re not big on trying to embarrass anyone, but we would suggest that anyone who wants to know the truth about the persistent manipulation conspiracy theory should read on below, in the discussion on gold.

Here is the graph of the metals’ prices.

chart-1- prices

The Prices of Gold and Silver - click to enlarge.

We are interested in the changing equilibrium created when some market participants are accumulating hoards and others are dishoarding. Of course, what makes it exciting is that speculators can (temporarily) exaggerate or fight against the trend. The speculators are often acting on rumors, technical analysis, or partial data about flows into or out of one corner of the market. That kind of information can’t tell them whether the globe, on net, hoarding or dishoarding.

One could point out that gold does not, on net, go into or out of anything. Yes, that is true. But it can come out of hoards and into carry trades. That is what we study. The gold basis tells us about this dynamic.

Conventional techniques for analyzing supply and demand are inapplicable to gold and silver, because the monetary metals have such high inventories. In normal commodities, inventories divided by annual production can be measured in months. The world just does not keep much inventory in wheat or oil.

With gold and silver, stocks to flows is measured in decades. Every ounce of those massive stockpiles is potential supply. Everyone on the planet is potential demand. At the right price. Looking at incremental changes in mine output or electronic manufacturing is not helpful to predict the future prices of the metals. For an introduction and guide to our concepts and theory, click here.

Here is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio.

chart-2 ratio

The Ratio of the Gold Price to the Silver Price - click to enlarge.

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 terse commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph. We have switched over from the April to June contract, as April is now past First Notice Day, and is therefore illiquid.

chart-3 gold basis and cobasis

The Gold Basis and Cobasis and the Dollar Price - click to enlarge.

The green line represents the price of the dollar, measured in gold. Unorthodox, we know. But it paints a far clearer picture of what’s happening than one can get from plotting the price of gold measured in terms of the (failing) dollar. It shows the dollar has been rising these past two weeks, which is what everyone knows—the price of gold has dropped almost a hundred dollars in two weeks.

Anyways, the very basis of this report (no pun intended) is to look at the fundamentals of the monetary metals markets. “Fundamentals” here doesn’t mean mine production and jewelry consumption. It means tracking the difference between speculators bidding up futures vs. hoarders taking real metal out of the market, presumably never to return.

By plotting the dollar on top of the cobasis, we can see speculative vs. fundamental moves. In a speculative move, the two lines move together. That is, as gold is sold (i.e. the dollar gets stronger) the cobasis rises (i.e. gold becomes more scarce). As gold gets bought (weaker dollar) the cobasis falls (less scarce gold).

If the lines move in opposite directions, it’s not a speculative move but fundamental. Dear reader, if you’re using leverage to bet on a rising gold price, the graph shows bad news. For two weeks in a row we see sharply rising dollar (i.e. falling gold price) and falling cobasis (more plentiful gold).

This isn’t the gold shortage you’re looking for.

Now, as to manipulation… what is supposed to be happening? The manipulators are selling futures like mad, right? What would that do? It would push the price on the futures down, well, presumably by $100, as that is how much the gold price has dropped in two weeks. Forgetting even the persistent rumors that China is buying up physical metal, and there should be a wicked backwardation! If the June future price were $100 below spot, that would give us a cobasis of +31%. Instead, the reality is -0.24%.

The data does not fit the allegation.

Now let’s look at silver.

chart-4 silver basis and cobasis

The Silver Basis and Cobasis and the Dollar Price – click to enlarge.

The dollar got stronger when measured in silver as well. The cobasis has risen again, though it’s still at a far lower level than that in gold. And The May silver contract is now within the period of selling called the contract roll. Not too long ago, we saw backwardation even farther ahead of First Notice Day than we are now in this contract.

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