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“FUD. Fear, uncertainty, doubt. Salesmen, politicians, markets
thrive on it and create it whenever possible” - TinyTim,
28 Aug 02:12 PM, comment on Sorry, There Is No Silver
Conspiracy
A fine little dispute has recently been stewing on the net around what is
happening in the gold and silver market, prompted by the heavy correction in
their prices. I’ve been following it here:
The Disconnect Between Supply and
Demand in Gold & Silver Markets – James Conrad, 18 Aug
Gold Refining Squeezes Silver Bar Production? –
Jason Hommel, 21 Aug
The Strange Case of Dr. GLD &
Mr. Bullion – Graham
Summers, 22 Aug
Ignoring the Free Market Causes Shortages – Jason Hommel, 23 Aug
The Disconnect Between Supply and
Demand in Gold and Silver Markets, Part II – James Conrad, 25 Aug
Sorry, There Is No Silver
Conspiracy – Otto
Rock, 27 Aug
Independence Day: Decoupling Gold
and Silver from the Dollar – James Conrad, 27 Aug
The Great Gold, Silver Conspiracy
Explained – Mike Shedlock, 27 Aug
How to Explain Fiat Currency to Silverbugs – Otto Rock, 28 Aug
Conspiracy Theory Psychology – Mike Shedlock, 28
Aug
Gold Sale Spurs Manipulation Talk – Mike Shedlock, 30
Aug
Where are the insider admissions about gold? Right here
– Chris Powell, 30 Aug
People seem to sit on either end of a number of propositions (doesn’t
seem that shades of grey or agnostic positions are accepted), some agreeing
with all, some disagreeing with all, some picking and choosing:
- There is a shortage of retail forms of gold and
silver.
- Prices for retail forms of gold and silver are
high.
- COMEX price is different from retail prices,
therefore COMEX price is “fake”.
- Conspiracy to manipulate the gold and silver
markets (by bullion banks for profit, by bullion banks on behalf of
central banks).
A lot of the hype stems from the interpretation that because it is difficult to
get hold of retail forms of gold or silver (e.g. 1oz coins, 100oz silver
bars) that there is a “shortage” of gold and silver. I think it
has now been accepted that there is no shortage of gold and silver in the
wholesale markets (that is, for 400oz gold and 1000oz silver bars). This
should be obvious if you consider the fact that miners churn out 2000+ tonnes a year. What we have is a shortage of retail
forms. It is also worth noting that demand and supply is also localised in the gold and silver markets. So you really
need to be specific instead of just saying “shortage” – you
need to indicate of what form and in what location.
Anyway, this is understandably frustrating for the retail buyer and naturally
leads to questions, and attempted answers, as to why this has occurred and
why manufacturers are not responding, say by auctioning off the limited
quantities they have, or increasing production. I mean, they are profit
seeking entities, are they not? Why would they be missing out on extra profit
from all this demand?
Now one thing I can agree on is “profit seeking”, these
businesses are not going to pass up profit. So how to explain their behaviour? For those who are puzzled, they only
explanations can seem 1) they are idiots or 2) they are part of some conspiracy.
Let me suggest an alternative explanation (and I use gold here to also
include silver).
The gold industry's production capacity, distribution networks, and client
base is set up to service a certain ratio of retail versus wholesale volumes.
This is to be expected - if you are making big dollar decisions on equipment
you will do so based on past demand patterns. There are long-term
relationships in place with major distributors and clients. Production
processes are set up to service this demand and with a bit of flexibility to
service the shifts in this demand in response to price movements.
Now I don’t doubt for a moment that the demand has increased for retail
forms of gold – there is plenty of proof of this in the above articles
and discussion forums. With a sort of fixed production plan at the source
manufacturers and some lead time/delay from source to end buyer, it is not
surprising that retail coins and bars can run out from time to time. Now
don’t get offended if you are a retail buyer, but in the big scheme of
things all of your purchases added up are not that important volume wise. So
the initial response by the industry is, short-term blip, it has happened
before, production will catch up with demand, backlog orders will be cleared
and thing will be back to normal before too soon. From my side of the fence,
I’ve seen these surges in demand occur (plenty of times without running
out of stock) and then subside. This is the nature of the market, it responds
to prices, or drives them. It is difficult to compare this market to other
goods (eg milk), because their prices don’t
fluctuate like precious metals. When demand is stable, so are prices and so
is supply.
OK, so based on past experience, people in the industry don’t get all
excited when they run out of small coins and bars. This explains their lack
of response to the initial demand. Then the demand continues, and the
backorders increase, delivery times increase. Why does the industry not
respond now? Well they are still not sure if this increase in demand will be
sustained. Also consider that they don’t spend their time reading all
these commentaries or watching ebay, so they
don’t see the initial increase in premiums. The price signals are not
getting through. But even if they are aware of the increasing interest in
retail forms of gold (and increasing prices), they still don’t
response. Why?
Manufacturers of gold and silver have long-term customers who buy in volume.
Maybe the price they are receiving from these customers is lower than what
they can sell their retail products at, but they have a difficult decision.
Sure they could sell to retail buyers, or make their long-term customers
compete at auction for their production with the retail buyers, but they
worry that when the demand declines (as they have seen occur in the past) you
retail buyers won’t be there anymore but their long-term customers
will, and they will remember how the manufacturer “screwed” them
and they will either take their business elsewhere or screw them back in turn.
So the manufacturer, based on past experience of the fickleness of retail
demand, decides to continue to supply their long-term customers. You also
have to consider that some may have supply agreements, either for volume or
at a price, that they cannot break.
Some manufacturers may have relatively flexible production processes and can
switch production capacity to retail forms, but there is still a cost
involved. Again, the delay in responding may be a result of the executives of
these firms not being sure about the longevity of the demand and switching
capacity also means that they have to cut back on some other products,
products that they supply to their long-term customers.
What about putting on extra capacity? As you can imagine, capital expenditure
decisions and bringing on new capacity is not like turning on a tap, there is
a big lag in getting additional the machines delivered and operational.
Again, the question that executives in the refineries and other manufacturers
would be asking themselves is whether the increase in retail demand is
permanent or temporary. If temporary, they don't want to waste money on
capacity that will be left idle.
Given the above, the question then becomes: how long before the industry
responds? This is hard to say. I see us at a crossroad - the future will take
one of two paths:
Scenario 1
Given the natural conservatism described above and the continuing retail
demand we see continuing shortages of retail forms of gold and silver,
probably occurring in a stop/start fashion as one supplier catches up and
then another runs out. This erratic supply increases premiums for retail bars
and coins. This fans further hysteria about "shortages", driving
more retail demand. Industry executives see the demand and premiums and finally
see profit and decide to ramp up production. During the delay in getting
capacity online (some quicker than others depending on how their production
process are set up) the hysteria continues, increasing retail physical
demand.
The retail shortage “story" is picked up by more commentators and
increasingly by mainstream media, who in their ignorance create the
perception of a shortage of wholesale physical. Fanned on by retail dealers
who are making a killing from marking up bars and coins, conspiracists
who think this will be the straw that will break the (short) camel’s
back, and those who recommended investors into gold and silver, this drives
average investor and speculators into the ETFs (because they are comfortable
with this investment form and don’t have any idea how to buy physical
even if they wanted to) which drives the gold price even higher. Eventually
capacity will come online and retail bars and coins are supplied and stories
of shortages dry up. Now there are two possible end games:
a) The hysteria process reverses as product is easily available. Perceptions
change, there is now "oversupply" of gold, talk of similarities
with the 1980s bubble, demand contracts and price drops, savagely. Lots of
egg on certain faces.
b) Product is easily available but that has no effect. Retail demand is at a
new level and remains there, the “shorts” have been broken, gold
has moved to a new “level”, reclaimed its inflation adjusted
price. The public are aware of the gold and silver again, distrustful of fiat
currencies. A new Golden Age has dawned. Lots of egg on certain faces.
Scenario 2
Retail demand for gold and silver, while significantly higher than in the
past, is not significant compared to the wholesale physical market to really
move the physical spot price. Combined with the possibility that suppliers
may be more flexible in production capacity than we suspect, product is
brought onto the market in a few months. "Shortage" stories dry up,
retail demand drops. Lots of egg on certain faces.
Either way, someone is going to be wrong. Unfortunately, only time will tell
so we will have to wait to find out who. The second half of 2008 will
certainly be interesting.
Bron Suchecki
Goldchat.blogspot.com
Bron Suchecki has worked in the precious metals markets
since 1994, when he joined the Perth Mint as an Administration Officer in
their Sydney retail outlet. In 1998 he moved to Perth to work in the then
fledgling Depository division. He has held a number of roles since then in
the treasury, risk and governance areas of the Mint.
All posts are Bron's personal opinion and not
endorsed by the Perth Mint in any way.
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