Gold and Silver Markets Start to Normalize, Report 4 May

Blowout in Spreads

Below is a graph of the spot price bid-offer spread in both gold and silver. Notice that, since April 3, the spread in gold is down significantly from its high (with one spike), though not back to its pre-2020 normal. Silver appears to have rolled over, but at $0.04 its bid-ask spread is still quite elevated.

Below is a graph of the gold basis continuous (the June contract shows the same thing).

Gold Basis and Co-basis and the Dollar Price

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Like gold, the basis had become quite elevated. Like gold, the basis has come down. Unlike gold, the silver basis is still elevated, though not extraordinarily so anymore.

So, what does all this mean?

Silver Basis and Co-basis and the Dollar Price

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Dollar Supply and Demand

We think it means that the Fed’s massive asset-buying program has had its intended effect (it will have a number of other effects, as well). The Fed has bought about $2.5 trillion worth of bonds, which has grown its balance sheet by 60%. This is the stuff of madness. See the graph of the Fed’s assets below.

The change is greater than the Fed’s then-crazy buying frenzy in the wake of the last crisis, though smaller as a percentage of growth.

The intended effect is to take the pressure off the banks. Reduced contractionary pressures on bank balance sheets frees up the banks for profit-making and risk-free activities such as carrying gold.

The Fed will be able to get away with this for so long as gold bids on the dollar. And the high basis is proof that this bid is very strong for now.

We can think of two primary gold bidders on the dollar. One, likely short-lived, is the leveraged player who buys dollars in order to meet margin calls. Each drop in asset prices, whether in stocks, real estate, or elsewhere, forces some of them to liquidate whatever they can to raise dollar cash—which is often gold.

The other, is a much larger group of people worldwide who are forced by economic circumstances to sell gold to buy food.

Those who would claim that the dollar can go poof in an instant—the moment that everyone loses faith in it—would do well to understand the desperate need for dollars of both the farmers and the eaters. Neither party is acting on faith, or for that matter, driven based on belief in the credit of the United States government. They are responding to the incentives with which they are presented: they want to keep their farms and fill their bellies, respectively.

So long as these dynamics continue, there will be a robust gold bid on the dollar.

NB: This is not to say that the price of gold need go down, the dynamics we described could occur with a dramatically rising gold price reaching new record highs over many years.

Gold as an Investment

Of course, there is the other side of the trade. A group of people is buying gold. Ignoring the speculators and momentum-chasers, as these groups have little effect on the long-term price trend, there is a logical reason for people to turn to gold as an investment.

As an aside, gold is not an investment. People may say they are “investing in gold”, but if they are just buying gold to hold or wait for its price to rise, they are not investing at all. They are either speculating on the gold price, or they are opting out of investment. That’s what it means to hold money: to not invest (those who invest in Monetary Metals gold leases or gold bonds are earning gold interest and can be properly said to be gold investing, like dollar investing but with principal and interest repaid in gold).

There are two reasons why people are turning to gold now, more than ever.

Assets: Total Assets: Wednesday level 2009-2020

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Why gold, why now?

One, by our count, the baseline deficit before the virus was $1.7 trillion. Then, the CARES Act pus its follow-on added $2.3 + $0.5 trillion. Finally, tax revenues have dropped substantially—let’s assume by $1 trillion. The U.S. government is now sinking deeper into debt at a rate of at least $5.5 trillion a year (we say “at least” because it seems likely there will be another stimulus/bailout bill).

Do you want to be a creditor to Uncle Sam?

Everyone who holds a dollar balance is a creditor. Investing in gold or gold investing are the ways to opt out.

The other reason is that the interest rate has collapsed. In Fall of 2018, the interest rate on the 10-year Treasury bond was 3.2%. As recently as January, that interest rate was 1.9%. But, by March 9, it had fallen to 0.5%, and since then has been bouncing along the floor. See the graph of Treasury yields below.

10-Year Tresury Constant Maturity Rate

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