A Fabrication Bottleneck or Something More
A Fabrication Bottleneck or Something More
James Turk
August 17, 2008
Mr. Turk makes some very good points here. He confirms my recent observation about the huge disconnect between retail and wholesale bullion. He points out that leverage in the paper market is primarily responsible for the bloodbath. He shows us log price charts that indicate gold and silver are very close to long-term trend support. He wonders if the lack of supply at the retail level, not only in the U.S., Canada and Europe but in India as well, portends a sharp V recovery in PM prices, especially after the U.S. elections in early November.
His best idea, however, is that the rise in premiums on retail bullion can be viewed as a form of backwardation, as can the lack of availability. I hadn’t really thought about it this way before but he is absolutely right. If there was a price chart for silver Eagles or 100 oz. bars, it would show a growing gap between the price of futures and the price of retail bullion products.
Bear with me here. Actually calculating this type of basis is a bit different from the one we can directly derive from the spot and futures markets. Spot silver or gold does not have a manufacturing or dealer premium (unless bought from a dealer of course). Retail gold and silver does. Typically that premium is expressed as spot + X cents or dollars. Another way to look at fabrication and dealer premiums would be as a percentage of the spot price. Both have their advantages and disadvantages when making historical comparisons. It might be possible, however, to somehow combine the two and establish what the average gap between futures and retail bullion prices has been over time. Or perhaps more simply, we can look at just the gap between retail bullion prices and spot prices.
If wholesale backwardation can be defined as spot (wholesale) bullion prices rising over futures prices, then perhaps retail backwardation can be defined as retail bullion premiums rising over their highest historical average (throwing out the extremes like 1979-80 and 1999). I haven’t completed even a back of the envelope calculation using either cent/dollar or percentage premiums, so I can’t say for sure that, according to such a definition, we are now in retail backwardation. But let’s remember that a key feature of backwardation is a tightness, even lack, of available physical supply at a given price. Isn’t that effectively what’s happening here with retail bullion?
I’ve decided to go back and look very carefully at my spot-futures basis data over the past few days to see if there are any signs of abnormality. There has indeed been a decrease in the contango (the basis has fallen toward backwardation but is still in contango) but frankly not as much as I would expect if there was robust physical demand in the spot market while COMEX and other paper markets were being aggressively sold. It is not at all unusual for the basis to contract and expand right before and during major price moves. We are certainly seeing that now. But there is no official backwardation (yet) in gold or silver. We could see some interesting developments in the days ahead, though. I will try to keep my eyes on this (and a bunch of other things).
Has this not been the whole debate from day one? What happens to paper is not “REAL” yet affects the physical. Shouldn’t we not expect shortages to happen in just this very manner? And thereby confirm to us all what we have been thinking? When there is not enough supply of the smaller bars, I will buy the bigger bars it’s just that simple - at least in my mind :O) And at this current price, 1000 oz’ers are really not so out of my reach.
Again, the pebble has been tossed into the pond
Is there any data to suggest a legitimate explanation for the currently alleged shortage of coin and small bars, other than the obvious supply/demand argument? (retail wants and has bought all available product)
Have manufacturers of this product altered their normal production levels for some reason? Do we know how much coin has been minted recently vs. historically?
It does disturb me that there is both a paper and a hard product market that need to be price reconciled…..more disturbing perhaps that the paper market seems to wag the tail of the bullion market.
In a way this is not very surprising. In recent months Europe has experienced a German preference for Euro notes that have been printed in Germany (the serial numbers begin with an X). So much so that many German citizens have refused to accept all other notes issued in the “Club Med” countries. Another example is where northern notes were favored and more valued than southern notes following the US civil war. Perhaps siver coins and small bars simply are more valued than larger denomination bars because they would be easier to use as currency for small transactions in a fiat currency crisis. This could be a taste of what we can expect if there is a widespread failure in the present monetary system. Perhaps a 1 oz silver coin would trade at a greater % premium to wholesale silver bullion than a 1 oz gold coin would trade to wholesale gold bullion prices simply because a smaller value coin would have a greater utility for day to day transactions.
For Newbies, “the froggydude” is talking about the devolution of money as written by Antal Fekete in “Can we have inflation and deflation all at the same time”. That article is a real mind bender and right now worth a re-read to all that need comforting.
The action within the Euro block is a real world example of horizontal devolution within the same asset class. Its fascinating to watch.
Thanks Lone Ranger. I had forgotten the name of the article. The link is here for anyone interested.
http://tinyurl.com/4qsbz5 [PDF]
You will have to cut & paste the URL into your browser.
The low in both gold and silver prices is at hand or may already be in. The lease rates for both gold and silver have been rising since Aug 5. Should this continue we should see short covering by the commercials.
Dear Tom,
I wish you good luck in tracking the silver basis using actual market values from a worldwide market. I think this is tough enough.
Tracking retail silver purchases seems a daunting task indeed! Questionable or non existent data sources. There is probably a retail silver shortage (at least finished bars and coins). However, Jason Hommel’s stuff seems anecdotal to me. Also, Turk is smart guy and is probably sincere in his writings. However, he does have a big ax to grind as a purveyor of ‘paper / electronic’ silver.
In most markets at most times it rarely pays to ‘follow’ the little guy or the small speculator. They are almost always wrong. Who is to say that the retail investor is correct at this juncture? If there is a real silver shortage: is it this week? next month? next year? 3 years hence? Timing is important in a market this volatile.
Finally, Ted Butler likes to close with comments — like it is better to be three years early than one day late — with silver. True for the hold forever physical silver investor. For the leverage speculator, one day too early can be deadly.
Lone Ranger! Can you expand on your explanation as contained in your statement: “….The action within the Euro block is a real world example of horizontal devolution within the same asset class. Its fascinating to watch…?”
Thanks.
Eddy Sharpe! Also, would you invest the time for us to expand on your explanation as contained in your statement: “….Turk is smart guy and is probably sincere in his writings. However, he does have a big ax to grind as a purveyor of ?paper / electronic? silver…..?
I’m a heavy user of GoldMoney for many reasons. It’s my understanding that Gold/Silver Bullion is on deposit and any investor receives an allocation [with others] in the existing bullion on hand. It is self evident that I use GoldMoney as my bullion bank so that when, as and/or if I need currency “at the store” I don’t have to haul in my PM Coins to settle.
Additionally, it helps prevent the conspiracy theory of confiscation in the future, especially in Zurich besides being a co-owner with others as allocated to each big bar.
Please correct me if I am in error here.
Thanks,
Mr. T: It would indeed be nice to know how much retail bullion is fabricated each year and also in real time, but I don’t have a source for that. At best we have to look at it piecemeal. For example, we know the Canadian Mint is expecting to produce approx. 8 million Maple Leafs this year, which is up from 3.5 million last year and 1 million in years past (http://news.silverseek.com/SilverSeek/1212786741.php). The U.S. Mint might be on pace to produce over 20 million Eagles in 2008, which would be double the previous record (http://news.silverseek.com/SilverSeek/1216387369.php). What we don’t know is how much generic or refiner branded retail silver bullion is fabricated annually. I’m not saying it cannot be determined, as I’m sure the CPM Group and GFMS surveys have access to some of the data. It would certainly be nice to have at least a few details. I doubt it’s in the 100 million ounce range, which I feel would be the starting point for challenging the dominance of the wholesale bullion market, much less the paper silver market.
No problemo Ron,
I was refering to Frogydude’s comments comparing the action in the Euro to silver more recently. First I must recomend a read of the Professor’s articles, “Can we have inflation and deflation all at the same time” and “The Shadow Pyramid”, and for that matter all his other work!
In both of these articles Antal Fekete talks about Exter’s Pyramid. The inverted pyramid consists of layers of assets graded according to risk. Gold, having the least risk is at the bottom. During a monetary crisis money scrambles down the pyramid through the various layers. This is called vertical devolution.
In one of these articles, the professor wrote about horizontal devolution. This is where certain forms of the same asset may be preferred and actually trade at a premium. This is what Froggydude was talking about with silver. After learning this theory, I was fascinated when the Euro story broke. Germans are rejecting Euro’s printed in the southern or “Club Med” countries due to a perceived notion of increased risk. It is a real world example of horizontal devolution in action.
Thanks Lone Ranger,
Will implement all of your suggestions and get my arms around the concepts.
Appreciated,
You are right Tom, Butler is wrong. Covering means buying back a short position, not entering into a new long.
Well, to me, a bird in the hand is worth two in the bush.
If there are 125,000,000 ounces in the “warehouse” and
contracts for 500,000,000 “out there” that means only
1/4 of those contracts can be covered. The contract
is, in effect, a sort of fractional reserve “currency”.
That system will work as long as there is no run on the
bank, so to speak. Bank runs are becoming a
common news item. If there should be a run on the
bullion “bank”, my guess is that they are good for maybe
25 cents on the dollar. Could we call that “fair value”
in a way? Discount the futures and spot prices to th
underlying real value of their inflated contracts?
If we used the Comex etc./spot prices as a guage
of real value the, could we assume that if the price
of paper silver is, say $13/ounce, the value of the “real thing” is
4X that, or $52/ounce?