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).
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