Bob Moriarty posted an article yesterday saying that he doesn’t “believe in
either fundamentals or technical analysis … they give you some information
but I’m not convinced either really works if your goal is to make money
investing. I am always looking for measures of pure psychology”. Now I
wouldn’t go as far as saying that fundamentals or technical analysis only
have “some” value, but certainly I think gold and silver are driven a lot
more by psychology than many analysts acknowledge.
I think the main reason for this is that there is so much “stock” of gold
held relative to new supply. Fundamental analysis can pay off in commodities
as new supply is significant compared to inventories, so changes in it, and
marginal demand, drive prices. But in the case of gold, as I argued in this post from 2012, the massive amount of gold above
ground means that it is the withholding of supply by existing
investors that matters more.
The gold market is unique in that it has “a stock overhang so large
relative to new supply that in any other market would push the price to zero,
but for some reason for gold it doesn’t”. This some other reason is
otherwise know as monetary demand. Investor demand for monetary safety is
more about human perceptions, which are influenced by narratives, and is thus more psychological in nature.
So how do we measure market psychology for gold? Bob’s says that “I
find the Sprott Physical Silver Trust to be an excellent measure of
psychology” with PSLV “signaled a high in 2011 and negative
discounts have been excellent as precursors to the XAU moving higher”.
The chart below comes from Bob’s article and shows the key signal points (see
his article for more of an explanation).
PSLV NAV
I think there is merit in using NAV discount/premiums, but my only concern
with using the Sprott funds is that as they have a redemption mechanism,
arbitrage means that the discount can never get too large. It is interesting
that Bob uses PSLV (the silver fund) rather than PHYS (Sprott’s gold fund) as
an indicator for gold. This may have something to do with the fact that PHYS
has had an active arbitrageur redeeming physical, which caps discounts (see this post if you are interested in more detail on this
activity and redemption arbitrage).
The result of redemption arbitrage is that you aren’t getting a full read
on sentiment. For that you need a fund with no, or very costly, redemption
ability. For that we can use the Central funds CEF and GTU. Below is a chart
of GTU’s (the gold trust) premium/discount to NAV from CEF Connect.
You can see that the premium/discount for GTU has a lot more variability
than PSLV and has much bigger discounts. The chart for CEF shows a similar pattern. At the
moment they are both not showing the same extreme discount as PSLV,
and they may not be of much use as a sentiment indicator going forward, if
the Sprott offer to exchange GTU for its funds goes ahead. The
potential for this action to succeed has affected GTU’s pricing as investors
weigh up the possibility that a successful Sprott offer will eliminate the discount.
The Central Fund/Trust – Polar Securities – Sprott story is itself an
interesting study in investor psychology and I will cover this story when the
details of Sprott’s offer is released. In the meantime, Kid Dynamite’s article gives a good summary of the drama.
