Paying a Premium for a Lack of Default Risk

The price action got pretty intense last week! The prices of the metals were up Monday, Tuesday, and Wednesday. But Thursday and Friday, there was a sharp reversal and the silver price ended the week below its close of the previous week.

 

The net speculative position in gold futures has become very large recently – the market was more than ripe for a shake-out. [PT]

 

Silver made a round trip down from $18.35 to $18.16 by way of $19.65. That is it was +$1.35 for a moment on Wednesday, and then ended -$0.19. Gold was a bit more muted, going from $1,520 down to $1,507 by way of $1,557. It was up +$37 to close down -$7.

OK, so how do you explain this? One facile answer is “da boyz in da cartel smashed the metals down.” Aside from the government having no reason to care about the price of gold, as it has little economic impact, this idea holds no water. As we explained to Ted Butler, the evidence is against it. We won’t rehash the same old argument today.

We offer a rather more prosaic answer. Actually, two drivers.

Gold has no default risk but no yield (other than Monetary Metals investments). It is therefore the asset to own when you are more concerned with return of capital than return on capital.

This is why the price of gold has been up when the stock market has been down. Every time President Trump has tweeted a policy that will be bad for business, stocks have responded by nose-diving and the price of gold has moved up. As has the price of Treasury bonds. So Treasuries are near their all-time high, and gold is getting there too. The price of long bonds in Germany is making new highs.

In the latter half of the week, optimism, if not for the economy then at least the stocks of big corporations, has grown. By Friday’s close, US equities in the S&P 500 index were up 2.7% from Wednesday’s open.

So long as people think they can make speculative gains in equities, they don’t prefer to hold a yield-less lump of metal. And they don’t prefer silver in preference to not preferring to hold gold. In other words, silver is more speculative than gold, and therefore they sell it first.

Renewed optimism is one driver. We shall see how long that lasts. “Normally” during the boom phase, wealth-destroying enterprises like WeWork can enjoy skyrocketing valuations. Speculators aggressively demand assets, and the lowest-quality issues can go up the fastest. WeWork’s pending IPO may be in trouble.

 

UBER, daily – not exactly a convincing performance so far. [PT]

 

Fellow wealth-destroyer, Uber, went public in May and its stock has fallen about 25% since the end of July. Can they juice up another move higher in equities? Anything is possible, but the more capital is destroyed — both by speculators and by these wealth-destroying enterprises — the more that the risk of a wave of defaults ratchets up.

The other driver is in the nature of speculative markets. There are many speculators who bought gold, and especially silver, at higher prices. They have been long suffering, not willing to sell at such low prices, and despairing of the chance of higher prices. They have seen any number of price blips, which have not been durable. So the price has gone up, and they begin to think it’s time to sell, and get out.

Perhaps the down tick on Wednesday due to the renewed optimism in equities was the trigger for these speculators with their likely hair-trigger offers to sell. The price dropped and many would certainly have seen their chance to sell going up in smoke.

So they dumped their metals, as they reckoned it, before it would be too late. Too late may turn out to be when the selling wave is over, and the price begins to rise again. We shall look at the supply and demand fundamentals below.

 

Fundamental Developments

But, first, here is the chart of the prices of gold and silver.

 

Gold and silver priced in USD

 

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio (see here for an explanation of bid and offer prices for the ratio). The ratio had fallen very sharply through Wednesday, hitting a new low of 79.25. But then the last two days of the week, it rocketed up to close just above the previous week’s level.

 

Gold-silver ratio, bid and offer

 

Here is the gold graph showing gold basis, co-basis and the price of the dollar in terms of gold price.

 

Gold basis, co-basis and the USD priced in milligrams of gold

 

The October gold basis, now approaching expiry, is falling. But this may be due to tendency towards temporary backwardation as the contract rolls. To find out, we look at the gold basis continuous. There was no change in this measure.

So naturally, the Monetary Metals Gold Fundamental Price dropped a bit, anther $11 to $1,525.

Now let’s look at silver.

 

Silver basis, co-basis and the USD priced in grams of silver

 

The scarcity of silver (i.e., the co-basis) rose a bit last week.

The Monetary Metals Silver Fundamental Price moved up another $0.41, to $18.72.

It seems that the selling of metal on Friday, if not on Thursday, was led by those selling futures contracts, likely bought on margin. This fits with our idea that speculators turned back to the stock market as their preferred go-to casino table.

Let us end with a chart of the gold-silver ratio, showing both the market price and the Monetary Metals Gold Silver Ratio Fundamental.

 

Gold-silver ratio based on the Monetary Metals calculated fundamental prices of gold and silver.

 

The fundamental price ratio fell from 83.9 to 81.4 this week. It is now back to where it was at the beginning of August 2018. Except the difference is that this time it is falling.

A bet on a rising ratio here is a bet that the stock market is back to full bull, and also that the mean reversion in the ratio will be further postponed. One might not want to bet on a falling ratio with leverage, but it’s hard to see the case for betting that the ratio will rise.

The battle is on! [PT]

 

© 2019 Monetary Metals

 

Charts by Sentimentrader, stockcharts, Monetary Metals

 

Chart and image captions by PT

 

Dr. Keith Weiner is the president of the Gold Standard Institute USA, and CEO of Monetary Metals. Keith is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads. Keith is a sought after speaker and regularly writes on economics. He is an Objectivist, and has his PhD from the New Austrian School of Economics. He lives with his wife near Phoenix, Arizona.