Vade Retro, Pet Rock!

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.

 

lingote-sujeta-puertas-01It’s not a pet rock, Mr. Zweig – it’s a door stop! We thought everybody knows this… (PT)

Photo via tiendasmayoristas.com

 

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.

 

The Buried Good Point

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.

 

chart-1-prices

The prices of gold and silver – click to enlarge.

 

Hoarding and Dishoarding

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.

 

chart-2-ratioThe ratio of the gold price to the silver price – click to enlarge.

 

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.

 

chart-3-gold basis and cobasisGold basis and co-basis and the dollar price – click to enlarge.

 

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.

 

chart-4-silver basis and cobasis

Silver basis and co-basis and the dollar price – click to enlarge.

 

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.

 

Charts by Monetary Metals

 

Dr. Keith Weiner is the president of the Gold Standard Institute USA, and CEO of Monetary Metals. Keith is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads. Keith is a sought after speaker and regularly writes on economics. He is an Objectivist, and has his PhD from the New Austrian School of Economics. He lives with his wife near Phoenix, Arizona.

 

 

 

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4 Responses to “Monetary Metals Supply and Demand Report 26 July, 2015”

  • therooster:

    VB … You’re defining a gold-as-currency- marketing challenge. That’s all. You’re actually exciting me now. LOL The point that I wanted to make is that to use gold as a form of debt-free currency is not an issue of it being banned from the marketplace. That’s all. Thanks

    • VB:

      I don’t think that you understood me at all. Nobody cares if the money they use is debt-free or not. But they do care if it is taxed – i.e., if the government takes part of it. The mere fact that capital gains (in dollars) of gold are taxed creates disinitiative to use it as a medium of exchange when people trade goods. It’s much easier to use dollars instead and not give some of them to the government. And when something is not used as a medium of exchange, people stop recognizing it as “money” (currency, actually). And since money is what people agree is money, something that is not widely recognized as money won’t be money. That is how governments have demonetized gold – not by “banning” it but by taxing it.

  • therooster:

    The article states , “Just because governments have banned it from the monetary system, does not make it either useless or a fraud.”

    This above statement is simply not true. Gold may not be a currency in a legal tender sense , but that does not mean it is banned from the marketplace as a currency used in a sense of agreement between two parties. It is , in fact, lawful money. It simply cannot be shoved down someone’s throat in the same manner that debt currency (by fiat) has been shoved down our throats.

    Imagine that, a market currency that gives you a choice …. and one that’s debt-free !

    • VB:

      It might not be “banned” from the marketplace, but two parties can transact in barter, too, using any commodities – and that doesn’t make these commodities money. And while not “banned”, gold capital gains are TAXED, which severely discourages its use as a currency. (And also severely hampers its ability to hedge against inflation.)

      But I think that both you and Keith are wrong. Just like value, money is subjective. Money is what people who are exchanging goods agree is money. Nothing more, nothing less. If people agree that paper dollars are money, then paper dollars are money. If people agree that cigarettes are money, then cigarettes are money.

      I am all for using a form of money freely chosen by the free market, instead of being imposed by a government. However, I am not aware of even a single case when this is how what is money has been chosen on a wide scale (like a country). All official currencies, even when the world was on a gold standard, were endorsed by a government.

      This is pertinent to my previous point – that money is what people agree is money. An ounce of gold is an ounce of gold everywhere, but if an one-ounce gold “dollar” is the officially established currency of the country, then people would be wary of accepting an one-ounce gold “franc” coin, simply because they don’t recognize it as widely accepted form of money – it doesn’t carry the kind of official stamp of approval they are familiar with and they have no easy way of determining that it indeed has the same value.

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