Precious Metals Supply and Demand

Fundamental Developments

The prices of the metals shot up last week, by $28 and $0.57.

“One way to think of these moves is as the addition of energy into the market. Like tossing a pebble into a still pond (not quantity of water, but energy that perturbs it). Once the speculators get the idea that gold and especially silver should go up, well it becomes self-fulfilling. Statements by the Fed, the ECB, or even the fatboy who rules North Korea can all have an effect.”

That described this week perfectly, especially Friday morning. The Consumer Price Index came in below the Fed’s target. It was up 1.7%, below the 1.8% expected and 2% Fed policy target. This news ignited a 20-cent increase in the price of silver within minutes.

We have to take a moment to savor the irony. Suppose the economy is underperforming Fed targets. And therefore the Fed will do more of what it had been doing, during which time the prices of gold and silver had been falling. But this time — so the theory goes — the increase in the quantity of dollars will cause the prices of the metals to go up.

Eurozone Consumer Price Index

Actually, headline CPI is already above the Fed’s target, as its rate of change amounted to 2.2% y/y. However, so-called “core” CPI (excludes food and energy prices on account of their volatility) came in at slightly less than 1.7% y/y, which the markets evidently considered a “miss” in terms of achieving the Fed’s stated target rate (an utterly bizarre and quite frankly outright dangerous aim to pursue). - Click to enlarge

A brief comment on Keith’s remarks below: it is true that these month-to-month data releases are essentially meaningless. However, the increase in the money supply over time does lead to a rise in prices across the economy roughly to the extent to which it exceeds the growth in the production of goods and services. But it does so in an uneven manner – not all prices increase at the same time or to the same extent –  some of them will even fall (the so-called “general price level” is a mirage – in fact, it cannot be calculated, as there exists no fixed yardstick with which to “measure it”, even if one is prepared to ignore the logical fallacy of adding up the prices of disparate goods and averaging the result). Moreover, in the short to medium term an increase in the demand for money (cash balances) can overcome the effects of a surging money supply. In a well-developed economy, the demand for money usually only rises significantly during times of crisis (modern payment systems have generally lowered the need to hold large cash balances or large amounts of standard money). Over the long term, prices will tend to “catch up” with the increase in the quantity of money. As a reminder, when gold first began to trade freely, it could be bought for a little over $35 per ounce. In the 46 years since then, the broad true money supply has grown from approx. $500 billion to $12.7 trillion and prices in the economy have increased accordingly; whether one looks at the gold price or a McDonalds menu, the difference is palpable, and the money supply is the culprit. It should be obvious that if the money supply had e.g. remained unchanged, prices could not possibly be where they in fact are today – the purchasing power of money would have increased rather than decreased over time, due to growth in economic productivity.

In our view, these data releases are not important, just noise. We will look at an updated picture of the fundamentals of supply and demand of both metals. But first, here are the charts of the prices of gold and silver, and the gold-silver ratio.

Gold and Silver prices

Gold and silver priced in USD - Click to enlarge

In this graph, we show both bid and offer prices for the gold-silver ratio. If you were to sell gold on the bid and buy silver at the ask, that is the lower bid price. Conversely, if you sold silver on the bid and bought gold at the offer, that is the higher offer price.

Gold:Silver Ratio

Gold-silver ratio, bid and offer - Click to enlarge

For each metal, we will look at a graph of the basis and co-basis 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 co-basis in red.

Here is the graph showing the gold basis and co-basis overlaid with the price of the dollar (inverse to the price of gold, measured in dollars).

Gold Basis and Co-basis and the Dollar Price

Gold basis and co-basis and the USD priced in milligrams of gold - Click to enlarge

Our calculated Monetary Metals gold fundamental price was up, but not as much as the market price. Six bucks.

Now let’s look at silver.

Silver Basis and Co-basis and the Dollar Price

Silver basis and co-basis and the USD priced in grams of silver. - Click to enlarge