For those who are speculating on the dollar—i.e. most people—there was
good news this week. The dollar rose almost a milligram, to 28.3mg gold.
That’s a big gain, and welcome news for those who keep all of their eggs in
the one dollar basket, perhaps because they don’t want to risk any of it on pet
rocks.
Yes, Jason Zweig at the Wall Street Journal actually said
that. He couldn’t be more wrong—and yet he had a point. Wrong? Let me
count the ways.
One, per his title, he compares gold to a pet rock. A pet rock is either a
useless knickknack, or else a fraud that preys on the irrational psychology
of people in crowds. Gold is honest money, and the extinguisher of debt. Just
because governments have banned it from the monetary system, does not make it
either useless or a fraud.
Two, he quotes a Barclays researcher saying that investors have become
disillusioned with gold. Well, gold is not an investment. Even if one accepts
the mainstream premise that gold is a commodity that you buy so you will make
money—i.e. dollars—when it goes up, this is speculation. It is not investing.
Our whole financial world is now stoned on the drug of zero interest rates.
With no yield to be had, capital gain is all.
Three, he says to own gold is an act of faith. Boy is this backwards! To
go all-in on the debt of bankrupt governments is the real act of faith. And
that is what one does, if one holds dollars or euros or pounds, etc.
Fourth, he refers to inflation (by which he means rising prices)
a few times. Gold purportedly has magical powers to fight inflation, but gold
isn’t a “panacea” for it (straw man, much?) He later says gold is viewed as a
hedge against inflation, but it does not go up as much as the alternatives
(whatever those may be).
I could go on, but I will stop here. Despite the cornucopia of errors,
there is an excellent point buried in Zweig’s blog post.
Suppose, as Zweig says, that everyone—or at least the current marginal
gold trader—views gold as a speculative vehicle. In this view, it’s only
useful to make bucks. Then, of course its price action is about as rational
as the path of the planchette on a Ouija board. Everyone has the
same price charts, and the same technical tools. Everyone can see the same
trends. So when it is going up, it goes up. And when it is going
down, it goes down.
Of course, this may temporarily describe market conditions. But it in no
way objectively describes gold.
The price of gold dropped further this week, especially last Sunday night.
We would guess that margin calls in China forced some liquidation. The price
of silver did not drop as much, which is interesting in itself. Whomever was
forced to liquidate either did not have a silver position, or else they have
greater faith in that the price of the white metal will rise.
The question is: did these hapless Chinese folks sell futures or metal?
And we do not have to guess the answer to this question. We have the data to
show it. Read on for the only accurate picture of the supply and demand
conditions in the gold and silver markets, based on the basis and cobasis.
First, here is the graph of the metals’ prices.
The Prices of Gold and Silver
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, is 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
(stocks to flows) 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, and under the right conditions.
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.
Next, this is a graph of the gold price measured in silver, otherwise
known as the gold to silver ratio. The ratio moved down this week.
The Ratio of the Gold Price to the Silver Price
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 brief commentary. The dollar will be
represented in green, the basis in blue and cobasis in red.
Here is the gold graph.
The Gold Basis and Cobasis and the Dollar Price
Note that we transitioned to the October contract, as First Notice Day for
the August future approaches.
Look at the price of the dollar rising (i.e. the price of gold falling)
and along with it the scarcity of gold rising. This answers the question we
posed up top. The price action this week was driven by selling of futures.
Our comment last week now seems well-timed:
“Is this a good time to bet on gold? While other events could continue to
dominate the fundamentals (temporarily), we can think of worse times for this
trade.”
Other events—we suspect credit conditions in China—did dominate. And the
attractiveness of a gold position increased this week. The fundamental price
is now more than $100 over the market price. This is no guarantee that the
market couldn’t go lower. The basis is not a timing indicator. It is helping
us measure value.
The December contract, by the way, also entered backwardation this week.
Now let’s look at silver.
The Silver Basis and Cobasis and the Dollar Price
The silver price dropped about 20 cents (i.e. the price of the dollar,
measured in silver rose to about 2.12g silver). However, the cobasis actually
fell. The December cobasis is nowhere near backwardation.
The bottom line is that the fundamental price of silver fell even more. It
is now dead even with the market price.
We think it’s best to continue approaching silver with extreme caution.
While the time is long past for shorting it (we never recommend naked
shorting a monetary metal!) it is not the time for betting on silver either.
We want to see either one more price drop, or else a steady increase in the
scarcity of this metal to the market.
© 2015 Monetary
Metals
