May 132015

Bob Moriarty posted an article yesterday saying that he doesn’t “believe in either fundamentals or technical analysis … they give you some information but I’m not convinced either really works if your goal is to make money investing. I am always looking for measures of pure psychology”. Now I wouldn’t go as far as saying that fundamentals or technical analysis only have “some” value, but certainly I think gold and silver are driven a lot more by psychology than many analysts acknowledge.

I think the main reason for this is that there is so much “stock” of gold held relative to new supply. Fundamental analysis can pay off in commodities as new supply is significant compared to inventories, so changes in it, and marginal demand, drive prices. But in the case of gold, as I argued in this post from 2012, the massive amount of gold above ground means that it is the withholding of supply by existing investors that matters more.

The gold market is unique in that it has “a stock overhang so large relative to new supply that in any other market would push the price to zero, but for some reason for gold it doesn’t”. This some other reason is otherwise know as monetary demand. Investor demand for monetary safety is more about human perceptions, which are influenced by narratives, and is thus more psychological in nature.

So how do we measure market psychology for gold? Bob’s says that “I find the Sprott Physical Silver Trust to be an excellent measure of psychology” with PSLV “signaled a high in 2011 and negative discounts have been excellent as precursors to the XAU moving higher”. The chart below comes from Bob’s article and shows the key signal points (see his article for more of an explanation).


I think there is merit in using NAV discount/premiums, but my only concern with using the Sprott funds is that as they have a redemption mechanism, arbitrage means that the discount can never get too large. It is interesting that Bob uses PSLV (the silver fund) rather than PHYS (Sprott’s gold fund) as an indicator for gold. This may have something to do with the fact that PHYS has had an active arbitrageur redeeming physical, which caps discounts (see this post if you are interested in more detail on this activity and redemption arbitrage).

The result of redemption arbitrage is that you aren’t getting a full read on sentiment. For that you need a fund with no, or very costly, redemption ability. For that we can use the Central funds CEF and GTU. Below is a chart of GTU’s (the gold trust) premium/discount to NAV from CEF Connect.


You can see that the premium/discount for GTU has a lot more variability than PSLV and has much bigger discounts. The chart for CEF shows a similar pattern. At the moment they are both not showing the same extreme discount as PSLV, and they may not be of much use as a sentiment indicator going forward, if the Sprott offer to exchange GTU for its funds goes ahead. The potential for this action to succeed has affected GTU’s pricing as investors weigh up the possibility that a successful Sprott offer will eliminate the discount.

The Central Fund/Trust – Polar Securities – Sprott story is itself an interesting study in investor psychology and I will cover this story when the details of Sprott’s offer is released. In the meantime, Kid Dynamite’s article gives a good summary of the drama.