To Frexit or Not to Frexit?

By Keith Weiner of Monetary Metals

This was also a holiday-shortened week.

As we write this, the big news comes from the election in France. The leading candidate is a banker named Emmanuel Macron, with about 24% of the vote in a 4-candidate race. The anti-euro Marine Le Pen came in second with just over 21%. From the sharp rally in the euro, which was up about 2% at one point, we assume that observers believe the odds of France leaving the euro have just gone down.

Of course, France (and the other European countries) faces a false alternative (well they ought to consider Keith’s gold bonds proposal, but that is not on the table). Staying with the euro means ongoing wealth destruction, and a downward slope that leads to nowhere good. However, that raises the question. What would happen if they were to try to leave?

We believe that no matter which theory prevails, and what measures are taken by les dirigistes (central planners), all roads lead to an accelerated default of trillions in bad credit. To understand why, consider the balance sheets of the banks and other financial intermediaries in France.

Suppose the new French franc goes down relative to the euro (we won’t address here whether it is likely to go up or down). This means that any French entity who had borrowed from a bank in Germany or Italy or Spain now sees its liabilities spike up relative to its assets which are now redenominated in francs. It would not take that much leverage or a very large decline in the franc to cause some major bankruptcies. The initial round of bankruptcies could cascade causing yet other bankruptcies in a highly interconnected financial system.

On the other hand, suppose the franc rises. Then the French banks get hit the other way. Their euro-denominated assets outside France are going down, but their domestic liabilities to depositors and bondholders are firm.

A regime of floating currencies sounds good in Milton Friedman’s argument about being an easy way to adjust wages downwards which are otherwise sticky. However, an actual currency revaluation means a wealth transfer from parties A, B, and C to parties X, Y, and Z. That may seem to be good for the latter, until you realize that they are creditors of the former. And the former were already leveraged, and already surviving on thin margins compressed after decades of falling interest rates. There is scant capital to absorb such a shock.

Then there is the question of who will buy French government or corporate bonds? No matter how you slice it, inserting a new currency into a block that currently has one adds friction, which means trade and production will further slow. The market will shrink (and this could in itself push some marginal corporations under).

And there are other serious problems. One is the intra-euro balances. Will these be redenominated? Another is the political response by the European Central Bank and the members of the European Union. What will they do? Will they try to shut off funds flowing to and from France? It would be naïve to assume there will be no response, and France will get away with it consequences-free.

The euro patient may have cancer, and the cancer may be terminal. But that does not mean blowing up the patient with dynamite is going to help.

Of course, traders want to know how this will affect gold and silver. As we write this, we see that silver went down 30 cents before rallying back up to where it closed on Friday. Gold went down about $20, and then half way back up.

At this point, we are not sure if the metals are supposed to go up because more printing. Or go down because the euro constrains France from printing. Or silver at least should go up because the economy is going to be better with France remaining in the Eurozone. Or go down because the ongoing malaise will only progress as it has been. Or some other logic… and the price gyrations this evening show that traders don’t agree either.

Continue reading To Frexit or Not to Frexit?

Gold-Silver Divergence

By Keith Weiner of Monetary Metals

This was a holiday-shorted week, due to Good Friday, and we are posting this Monday evening due to today being a holiday in much of the world.

Gold and silver went up the dollar went down, +$33 and +$0.53 -64mg gold and -.05g silver. The prices of the metals in dollar terms are readily available, and the price of the dollar in terms of honest money can be easily calculated. The point of this Report is to look into the market to understand the fundamentals of supply and demand. This can’t necessarily tell you what the price will do tomorrow. However, it tells you where the price should be, if physical metal were to clear based on supply and demand.

Of course, two factors make this very interesting. One is that the speculators use leverage, and they can move the price around. At least for a while. The other is that the fundamentals change. There is no guarantee that the prices of the metals will reach the fundamental price of a given day. Think of the fundamentals as gravity, not the strongest force in the system but inexorable, tugging every day.

This week, the fundamentals of both metals moved, though not together. We will take a look at that below, but first, the price and ratio charts.

The Prices of Gold and Silver
gold and silver prices

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It didn’t move much this week.

The Ratio of the Gold Price to the Silver Price
gold-silver ratio

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
gold and the us dollar

The scarcity (i.e. the cobasis, the red line) is in a gentle rising trend for about six months. This week, the cobasis was down slightly. Not a surprise given the (relatively) big price move of +$33. Nor does it appear to break the trend.

Our calculated fundamental price of gold is at $1,301, just above the market price.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price
silver and the us dollar

In silver, it’s much harder to say that there is an uptrend in the cobasis. Our indicator of scarcity is at the same level it was in October. Back then, the price of silver was $17.60 and on Thursday it was just about 90 cents higher.

The fundamental price back then was just under $15. Now it’s just under $16.50. This happens to be down about 40 cents this week.

With the fundamental of gold rising, and that of silver falling, it’s not surprising that the fundamental gold-silver ratio is up to a bit over 79.

Mea Culpa

By Keith Weiner of Monetary Metals

Dear Readers,

I owe you an apology. I made a mistake. I am writing this letter in the first person, because I made the mistake.

Let me explain what happened. I wrote software to calculate the gold basis and cobasis (and of course silver too). The app does not just calculate the near contract. It calculates the basis for many contracts out in the distance, so I can see the whole picture. I developed a model for the fundamental price, based on the basis. My software calculates this, too (spoiler alert: the reported fundamental prices were high).

I have long since debugged it. It works reliably. So reliably, that every day I pored over the results, but I no longer checked the inputs and intermediate steps of the calculation. Now, in retrospect, I realize that I should have.

The root cause is simple. For as far back as I have ever seen, the symbol for a future has been a two-letter code for the commodity + a one letter for the month and one digit for the year. For example, gold is GC. December is Z. And 2017 is 7. So the December gold contract is “GC Z7”. Silver is SI, so December silver is “SI Z7”.

I did not expect my realtime quote provider to change year codes for contracts in 2018 and beyond. No longer is it one digit for year—8 in this case. Now it requires two digits. So the December 2018 gold contract is “GC Z18”. Even now that I have looked, I do not find any announcement of this change. I am not even sure it is an official COMEX change, or just a quirk of one quote provider.

This error was compounded because my software was not programmed to notify me of a problem. In software, the only thing worse than a failure in a system that is used in production is a silent failure that goes unnoticed, and hence goes uncorrected. This failure was unnoticed.

Before I get to the impact, I want to discuss how we will make sure this does not happen again.

My team and I have been working hard on a new website, and the centerpiece will be our ongoing data science work in the precious metals markets. We will publish about 45 graphs, with daily updates. Obviously, this is driven by a much more sophisticated software system than my humble application.

The new software is developed by one of the best coders in the world (not me, I’m rusty after not coding full-time in almost 15 years). Rudy Mathieu worked for my last company, a software company called DiamondWare.

Rudy has built a hardened, enterprise-grade software system (now undergoing extensive testing), and when it encounters an error, it does not fail silently. It is constantly checking the status of all key components, and has a dashboard so we can monitor how the software and the server running it are doing. It emails us if anything goes wrong. It will instantly detect problems, such as a change in the year code or even the Spanish Inquisition, which nobody expects (sorry, just a bit of humor).

For years, I have been publishing a unique view into the markets. Our new site takes it a thousand times further. I expect that it will become an essential tool for anyone who uses or trades gold. We need to ensure it is as reliable as clockwork.

I promise to make it so.

Continue reading Mea Culpa

The Balance of Gold and Silver

By Keith Weiner of Monetary Metals

Last week, we discussed the growing stress in the credit markets. We noted this is a reason to buy gold, and likely the reason why gold buying has ticked up since just before Christmas.

Many people live in countries where another paper scrip is declared to be money—to picture the absurdity, just imagine a king declaring that the tide must roll back and not get his feet wet when his throne is placed on the beach—not real money like the US dollar. It should be obvious, but we have seen much disinformation out there promoting the idea that the dollar is collapsing. Most of the time, most of these people buy dollars as the escape hatch from their native currencies.

They buy the dollar first, and gold (for now) is a distant second.

That leads to the question of silver. Do they buy silver in equal measure as gold, or is silver a distant second to gold, as gold is a distant second to the dollar?

Theory tells us that gold is more portable. It is much, much more portable. First, the same weight of gold is about half the volume of silver. A 1oz gold Maple Leaf coin (which is pure gold) is much smaller than a 1oz silver Maple. And right now, the value of an ounce of gold is just about 70 times greater than the value of an ounce of silver. The math works out that the same value of silver is 126X more bulky than gold.

If you are paying for storage, that may be important. It sure is, if you are thinking you may need to carry it on your person. A gold bar worth $120,000 would fit in your trouser pocket (a bit heavy at 3kg, but you could do it). That much silver would be almost 7 of those big bars which are the size of small loaves of bread. Each. All that silver would weigh about as much as two heavyweight boxers.

Gold is also more liquid.

What does the data tell us about demand for silver relative to gold right now?

We will look at that below in the only true picture of supply and demand in the gold and silver markets. But first, the price and ratio charts.

The Prices of Gold and Silver
gold and silver prices

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It moved down this week. Is it approaching a line of support?

Continue reading The Balance of Gold and Silver

Gold and Silver; Putting Pennies in the Fusebox

By Keith Weiner of Monetary Metals

Back in the old days, homes had fuse boxes. Today, of course, any new house is built with a circuit breaker panel and many older homes have been upgraded at one time or another. However, the fuse is a much more interesting analogy for the monetary system.

When a fuse burned out, it was protecting you from the risk of a house fire. Each circuit is designed for only so much current. The problem is that higher current causes more heat, and it can start a fire. So they put fuses in, which burn out before the wire gets hot enough to be dangerous.

The problem is that it’s annoying when a fuse burns out, especially when it’s the last one and the hardware store is far away and/or closed for the weekend. So people all too often put a penny in the place of the fuse. And then, human nature being what it is, they left it there long-term. As an aside, pennies in those days were solid copper, not the copper plated zinc they use today because it’s cheaper.

We would guess that a disproportionate number of house fires were started because an overloaded circuit became overheated, and the protective fuse was replaced with a penny that would keep the juice flowing no matter what.

So, what has that got to do with gold and silver? A penny in the fuse box is a perfect analogy for what President Roosevelt did in 1933. Many believe when he confiscated gold, it was to grab the loot. While we have no doubt that he and his cronies lusted for the gold of the people, he had a more serious purpose.

Until 1933, gold was the core monetary asset in the banking system. When people withdrew their gold coin—redeeming their gold, not buying gold—that forced the bank to sell a bond to raise the gold to redeem depositors. If a bank could not raise enough gold, perhaps because bond prices were going down, then the bank was bankrupt. Another problem is that falling bond prices mean rising interest rates.

Roosevelt was trying to stop the run on the banks, and trying to push interest rates down.

He did stop the run, and interest continued to fall through the end of World War II. However, his act was the monetary equivalent of the penny in the fuse box. In making it illegal to own gold, he made the dollar irredeemable for Americans. Gold is the only financial asset that is not someone else’s liability. Deprived of this outlet, people were forced to be a creditor. The only choice was to lend to the Federal Reserve, the US Treasury, a commercial bank, a corporation, etc.

Continue reading Gold and Silver; Putting Pennies in the Fusebox

‘Real’ Performance Comparison

By Steve Saville

Inserted below is a chart that compares the long-term inflation-adjusted (IA) performances of several markets. This chart makes some interesting points, such as:

1) Market volatility increased dramatically in the early-1970s when the current monetary system was introduced. This shows that the generally higher levels of monetary inflation and the larger variations in the rate of monetary inflation that occurred after the official link to gold was abandoned didn’t only affect nominal prices. Real prices were affected in a big way and boom-bust oscillations were hugely amplified. As an aside, economists of the Keynesian School are oblivious to the swings in relative ‘real’ prices caused by monetary inflation and the depressing effects that these policy-induced price swings have on economic progress.

2) Commodities in general (the green line on the chart) experienced much smaller performance oscillations than the two ‘monetary’ commodities (gold and silver). This is consistent with my view that there aren’t really any long-term broad-based commodity bull markets, just gold bull markets driven by monetary distortions in which most commodities end up participating. The “commodity super-cycle” has always been a fictional story.

3) Apart from the Commodity Index (GNX), the markets and indices included in the chart have taken turns in leading the real performance comparison. The chart shows that gold and the Dow Industrials Index are the current leaders with nearly-identical percentage gains since the chart’s January-1959 starting point. Note, however, that if dividends were included, that is, if total returns were considered, the Dow would currently have a significant lead.

IAcomp_240316

Chart Notes:

a) I use a method of adjusting for the effects of US$ inflation that was first described in a 2010 article. This method isn’t reliable over periods of two years or less, but it should come close to reflecting reality over the long term.

b) To make it easier to compare relative performance, the January-1959 starting value of each of the markets included in the above chart was set to 100. In other words, the chart shows performance assuming that each market started at 100.

c) The monthly performance of the scaled IA silver price peaked at more than 2600 in early-1980, but for the sake of clarity the chart’s maximum Y-axis value was set to 1500. In other words, the chart doesn’t show the full extent of the early-1980 upward spike in the IA silver price.

d) The commodity index (the green line on the chart) uses CRB Index data up to 1992 and Goldman Sachs Spot Commodity Index (GNX) data thereafter.

Why Did Silver Fall?

By Keith Weiner of Monetary Metals

The question on the lips of everyone who plans to exchange his metal for dollars—widely thought to be money—is why did silver go down? The price of silver in dollar terms dropped from about 18 bucks to about 17, or about 5 percent.

The facile answer is manipulation. With no need of evidence—indeed with no evidence—one can assert this and not be questioned in the gold and silver communities. We have recently come across a term normally used to describe Leftists and Social Justice Warriors, virtue signaling. One piously declares that one supports the cause, one speaks truth to power, one sticks it to The Man, well you get the idea. The concept of virtue signaling seems equally appropriate to those who sing the chorus on every price drop, “manipulation.”

Besides, we have peeps in high places in London and New York and Beijing, and they tell us silver is manipulated…

Actually, we rather prefer to look at data than listen to whispers. What would the data show if demand for physical silver metal was robust and rising while someone sold so many futures contracts that the price of the metal was forced down just about a dollar?

The basis and cobasis are spreads between physical silver metal and futures. The scenario we just described would collapse the basis and skyrocket the cobasis.

Is that what happened this week?

Before we get that, we want to note that crude oil fell from $53.33 last week to $48.49, or -9%. Copper fell from $2.70 to $2.60, or -3.7%. Wheat fell from $4.53 to $4.40, or -2.9%. People miscall this deflation.

We don’t know whether this will affect the Fed’s seeming commitment to damn the economy, full rate hikes ahead. However, we do know that sentiment bleeds from one speculative asset to another (and in a near-zero interest rate environment, all assets are used by speculators). “If energy, industrial metal, and food are going down, then surely silver should go down too,” seems to be the logic.

At least this week.

We are much more interested in the supply and demand fundamentals. We acknowledge that speculators can temporarily move prices—sometimes a lot—but we firmly insist that eventually the market price reverts to the level called for by supply and demand.

So what happened to those fundamentals? Below, we will show the only true picture of the gold and silver supply and demand. But first, the price and ratio charts.

The Prices of Gold and Silver
gold and silver prices

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It moved up sharply this week.  If we were chartists, we might note that the ratio seems to be making a series of higher lows since mid-July.

The Ratio of the Gold Price to the Silver Price
gold-silver ratio

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.

Continue reading Why Did Silver Fall?

Worried You Might Buy Bitcoin or Gold

By Keith Weiner of Monetary Metals

The price of gold has been rising, but perhaps not enough to suit the hot money. Meanwhile, the price of bitcoin has shot up even faster. From $412, one year ago, to $1290 on Friday, it has gained over 200% (and, unlike gold, we can say that bitcoin went up—it’s a speculative asset that goes up and down with no particular limit). Compared to the price action in bitcoin, gold seems boring. While this is a virtue for gold to be used as money (and a vice for bitcoin), it does tend to attract those who just want to get into the hottest casino du jure.

Perhaps predictably, we saw an ad from a gold bullion dealer. This well-known dealer is comparing gold to bitcoin, and urging customers to stick with gold because of gold’s potential for price appreciation. We would not recommend this argument. Whatever the merits of gold may be, going up faster than bitcoin is not among them.

We spotted an ad today from a mainstream financial adviser. The ad urged clients not to buy gold. This firm should have little need to worry. Stocks have been in a long, long, endless, forever, never-to-end bull market. Gold is not doing anything exciting now. $1234? “WhatEVAH (roll eyes)!” Stocks, well, the prices just keep on going up. Like we said, nothing whatsoever to worry about. Other than declining dividend yields. There’s more than enough irony to go around.

Speaking of dividend yield, that leads us to an idea. Readers know that we like to compare the yield of one investment to another. This is why we quote the basis as an annualized percentage. You can compare basis to LIBOR easily. And also stocks. Or anything else.

For example, the basis for December—a maturity of well under a year—is 1.2%. The dividend yield of the S&P stocks is just 1.9%. For that extra 70bps, you are taking a number of known risks, and some unknown risks too.

It is worth noting that the yield on the 10-year Treasury is up to 2.5%. Yes, that’s right, you are paid less for the risk of investing in big corporations than you are for holding the risk free asset. Of course, the Treasury bond is not really risk free. But in any case, if the Treasury defaults then it’s safe to assume most corporations will be destroyed, if not our whole civilization.

Continue reading Worried You Might Buy Bitcoin or Gold

Curious Gold-Silver Ratio That Did Not Fall

By Keith Weiner of Monetary Metals

This holiday-shortened week (Monday was President’s Day in the US), the price of the dollar fell. In gold, it fell almost half a milligram to 24.75mg, and prices in silver it dropped 30mg, to 1.7 grams of the white monetary metal. Flipped upside down, gold went up 23 notes from the Federal Reserve, and silver appears to go up by 41 cents.

Below, we will show the only true picture of the gold and silver supply and demand fundamentals. But first, the price and ratio charts.

The Prices of Gold and Silver
gold and silver prices

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It moved sideways again this week, which would normally be odd for a time when the prices of the metals are rising.

The Ratio of the Gold Price to the Silver Price
gold-silver ratio

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
gold and the us dollar

For a very long time, we would post graphs that looked almost the same. Oh, the specifics of month, price, and basis would be different. But they had a certain sameness. The price of the dollar (i.e. inverse of the price of gold, in dollar terms) would move along with the cobasis (i.e. scarcity of gold). So as the dollar would rise (i.e. the price of gold would fall), the scarcity would rise. And vice versa. This means changes in price were due to changes in behavior by speculators.

And now we have a clear picture of … the opposite. The dollar has been falling since mid-December. And for that same time, the cobasis (scarcity of gold) has been rising.

Yes, gold has been getting scarcer as it becomes pricier.

How could this be possible? Doesn’t the law of supply and demand work for gold? You know, the standard “X” graph from Econ. 101?

Gold has several unique properties. One is that it is not purchased for consumption, but for monetary reserves or jewelry (which in most of the world is monetary reserves). Contrast that to copper which is purchased by plumbing manufacturers to make pipe. It’s a competitive market, and if the price of copper plumbing goes up too much then home builders will switch to plastic. Demand drops as price rises. Also, the marginal copper mine will increase production. Supply rises as price rises. It is self-correcting.

Gold, not being bought to consume, does not have a limit to demand as price rises. If anything a rising price (i.e. a falling currency) signals to people that holding gold is a good thing. They were wise to get out of their falling paper currency, and should consider buying more gold.

Also, virtually all of the gold ever mined in human history is still in human hands. All of this gold is potential supply, at the right price and under the right conditions. Even if gold mining worked like copper mining, and miners could just produce more, changes in mine production at the margin are not material to the overall gold supply. By official estimates, the total inventory of gold would take over 70 years to be produced at current mine production rates (and we believe this is a low estimate).

Readers may object that this question is a bit unfair, as any commodity can experience rising tightness and that will accompany its rising price for a while until the market can correct itself. That is true, but what we are looking at in gold is not that at all. When the market corrects itself—which we think is very likely, we do not see Armageddon just yet—it will not be because gold miners have cranked up their outputs, nor because gold users have substituted another metal. There is no substitute for monetary reservation, particularly as paper currencies are in the terminal stages of failure.

Our calculated fundamental price is now up to almost $1,400.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price
silver and the us dollar

The trend of falling dollar (i.e. rising price of silver) and rising cobasis (scarcity) is here in silver, too, but it’s weaker.

Silver does not quite have the same stocks to flows ratio as gold, but it has far and away a higher ratio than copper or any ordinary commodity. That is why silver is the other monetary metal.

The fundamental price of silver is now up to about $18.70. While this is over the market price of the metal, it’s not nearly so much above as gold.

This is why we calculate a fundamental on the gold-silver ratio over 74.

Don’t Short This Dog

By Keith Weiner of Monetary Metals

This week, the prices of the metals mostly moved sideways. There was a rise on Thursday but it corrected back to basically unchanged on Friday.

This will again be a brief Report, as yesterday was a holiday in the US.

Below, we will show the only true picture of the gold and silver supply and demand fundamentals. But first, the price and ratio charts.

The Prices of Gold and Silver
gold and silver prices

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It moved sideways this week.

The Ratio of the Gold Price to the Silver Price
gold-silver ratio

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
gold and the us dollar

The price was unchanged, but the basis is up slightly and cobasis is down (i.e. gold became slightly more abundant). This is not the news dollar shorters (i.e. those betting on the gold price) want to see.

Our calculated fundamental price is all but unchanged around $1,360.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price
silver and the us dollar

In silver, the basis is basically unchanged but the cobasis went up a bit. The silver market got just a bit tighter, and our calculated fundamental price is up more than 30 cents to about a quarter above the market price. Not exactly “bet the farm with leverage territory”, but definitely not “short this dog” either.

Watch this space. We have some exciting data science to reveal soon.