The price of gold moved up moderately, and the price of silver moved down
a few cents this week. However, there were some interesting fireworks in the
middle of the week. Tuesday, the prices dropped and Thursday the prices of
the metals popped $23 and $0.34 respectively.
Everyone can judge the sentiment prevailing in gold and silver articles
for themselves, but we think there is a growing feeling of optimism (that is
a renewed fall in the dollar, which most think is a rise in gold). This goes
along with a sense that the long bull run in the stock market is rolling
over.
We are inclined to agree that the stock market may be overdue for its
appointment with gravity. This is not a good business climate, and we sure
don’t see where earnings growth could come from. At the same time, we see
lots of forces that could cause margin compression, not to mention rising
default risk in many disparate places (e.g. shale oil bonds). We are not
stock market prognosticators, so treat this is nothing more than a feeling.
Gold market participants may be expecting the price of gold to move up if
the stock market moves down. This would be a continuation of the pattern of
the last several years, with the prices moving opposite to each other. We are
inclined to agree with this. That said, to shamelessly borrow a phrase from
the London Underground (we’re currently visiting London), please mind the gap
between the theory and the data.
For an updated picture of the only true supply and demand data read on…
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 up a little 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
We switched to the December contract, as the October contract is nearing
the end of its life.
Look at that incredible correlation between the price of the dollar
(inverse of the commonly accepted price of gold) and the gold cobasis (i.e.
scarcity indicator)! Since mid to late august, they have been tracking almost
perfectly.
What does this mean? It means as the dollar drops (i.e. the gold price
rises) gold becomes less scarce. As the dollar rises, gold becomes scarcer.
For now—we emphasize this is not a permanent feature of the gold market!—the
gold market is moving like any commodity market. A lower price encourages
buying and discourages selling. A higher price is the opposite.
During this period, our calculated fundamental price has inched its way up
an additional $45. It’s now more than $130 above the market price. The market
price increased only about $10.
This does fit the narrative expecting stocks to move down, and the price
of gold up. However, let’s look at silver.
The Silver Basis and Cobasis and the Dollar Price
Silver also shows the same basic pattern. The price of the dollar
(measured in silver this time) moves with the scarcity of silver, thought the
correlation isn’t quite as neat. The cobasis had moved way up and now has
reverted.
In the same period since August, both the market and fundamental prices of
silver have moved sideways. The market price is down about twenty cents, and
the fundamental is up about a dime.
The market price and the fundamental price are now basically the same.
Unlike gold, which is offered on sale at a big discount, silver is fairly
valued.
This does not mean that the demand for silver metal couldn’t rise and its
fundamentals couldn’t get stronger. Of course, we will keep monitoring for
any such change.
However, it does contradict part of the stocks down and metals up theme.
When the price of gold moves up, traders expect the price of silver to move
up even more. As we continue to warn, that may not be the case this time. The
ratio of gold to silver is currently about 76. We calculate a fundamental
ratio of about 84.5.
Monetary Metals is sponsoring a seminar in central London this Friday
(October 2), to discuss economics and markets, with a focus on how to
approach saving, investing, and speculating. Please register here.
© 2015 Monetary
Metals
