The Once And Future Unit Of Finance - Precious Metals Supply And Demand

by: Keith Weiner

Sally Forth and Speculate on my Behalf!

Last week, the price of gold was down ten bucks and silver four cents. Someone on Twitter demanded if we didn't find it odd that the biggest sovereign debt bubble has managed to inflate a bubble in virtually every asset price except for gold.

Snapshot from a recent Goldbugs Anonymous meeting. Why, oh why have you failed to bubble my asset, dear fellow speculators? [PT]

Given that he went on to assert there is a bubble in paper gold claims, he is trying to say that gold has to be suppressed. Otherwise its price would be much higher. We won't reiterate here the proof that this conspiracy theory is false.

Instead, we want to address two points. One, the term bubble is used quite flexibly. Does it mean the price of something is too high? For example, the S&P Index at nearly 3000. Or does it mean there is too much quantity of something, e.g. debt.

Or that something is being done to an unhealthy degree, e.g. sending non-students off to university to get degrees that will not increase their employability? One should use each word with care and precision. Otherwise ambiguity permits one to migrate freely between different concepts.

Clearly, this guy is jealous that the prices of other assets have gone up, making other speculators rich. But the price of gold has not, thus not making him rich. Instead of admitting he was wrong to believe the gold-to-$10,000 story, he blames the world. Also, he is wrong about something else. The price of oil has not exactly gone up, or real estate in many non-trendy locations.

Let us just note here that the question of what has performed best always hinges on the starting point one chooses. Here we see what has happened since gold made a generational low at the turn of the century after a 20-year long bear market. Despite showing weakness since its 2011 peak, it still outperforms stocks and bonds by light years since 2000/2001. [PT]

But that is not quite our point. We think it is important to understand that prices of things do not go up in an automatic way, as many take the quantity theory of money to imply. Prices go up when buyers are aggressive and sellers are reluctant.

Whether or not an increase in the quantity of the counterfeit paper that is yet called money causes this, we leave to another day. But even if so, this would obviously be a two-step process. Step one is increase quantity. Step two is when many people take their surplus free cash and trade it for assets such as gold bars.

And even that is not quite right. There is no such thing as a helicopter drop of free cash. There is lending, perhaps at near-zero interest (in the US-in some countries, below zero). Would you borrow money to buy gold? You can, you know. It's called margin. You can buy GLD with 2:1 leverage, or a gold futures contract with 10:1 margin.

But people don't do this casually, as leverage increases risk. They do this only for assets that are going up. We have already established that gold is used by people like our Twitter interlocutor for one thing. For betting on its price. We don't know his portfolio, but we would bet that even he is not betting with leverage right now. It is much easier - and less risky - to complain that others aren't betting with leverage, i.e., driving the price up so he can sell and make profits in dollars.

He does not conclude that every asset is like the planchette of an Ouija board, moving around as speculators shift their preference. And instead of concluding that the price of gold is really just the mirror of the price of the dollar, which is strong right now for readily visible reasons, he feels hurt.

And he does not think through that if gold were useful only when it went up, then it would be useless for any other purpose (one of our main criticisms of bitcoin), and hence its price would move all over the place. Including downwards and sideways. And only begin moving up again, when all the frustrated speculators like him finally capitulated and sold off their gold.

Then, unloved and neglected - not breathlessly anticipated by a whole sector full of self-declared contrarians - it would finally begin a stealth bull market once again. Of course, the whole point of our extended bout of snark today is that this is not so! Gold does have uses other than betting for dollars.

Gold is the once and future unit of finance.

Fundamental Developments

There is a way to analyze the likely price direction of gold. It is not to buy into stories, even true ones, much less manipulation conspiracies. It is to look at the basis, the spread between spot and futures prices.

So let's look at the only true picture of the supply and demand fundamentals of gold and silver. But, first, here is the chart of the prices of gold and silver.

Gold and silver priced in USD

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio (see here for an explanation of bid and offer prices for the ratio). It fell this week.

Gold-silver ratio

Here is the gold graph showing gold basis, co-basis and the price of the dollar in terms of gold price.

Gold basis, co-basis and the USD priced in milligrams of gold

As the price of the dollar rises (inverse of the price of gold, which fell), we see a rise in the scarcity of metal (i.e., the co-basis).

The Monetary Metals Gold Fundamental Price fell another $5 this week to $1,288.

Now let's look at silver.

Silver basis, co-basis and the USD priced in grams of silver

In silver, we see the same pattern. And unlike in gold, the Monetary Metals Silver Fundamental Price rose 8 cents, to $15.14.

Charts by: StockCharts, Monetary Metals

Chart and image captions by PT