Aug 312015

In this interview, Jim Sinclair says that “we are going into unprecedented deflation, and it’s the reaction of central banks around the world to the concept of deflation that brings about hyperinflation” and the resulting increase in the gold price is therefore “a rally that is not meant to be sold. What is coming up in front of us is the Great Reset where currencies wear their gold like ladies wear a necklace, and the most beautiful necklace will be the strongest currency.”

I find this advice dangerous because many people reading it will go away thinking “OK, so in the next gold bull market I shouldn’t sell”. However, how will you know if the initial bull market is just a speculative bubble that will bust or the start of a hyperinflation?

Secondly, the “great reset” and “beautiful necklace” references are to countries going back to (some) version of a gold standard. Some gold standards involve free trade of gold, but the last one involved expropriation and making gold illegal to hold. If Jim is right and countries want the strongest currency, then that would imply they will want all their citizen’s gold, in which case you get expropriated at some pre-reset price.

The retort to my second point is what is the point of selling out for fiat money if that is being hyperinflated. I agree, but my answer is if you believe in the hyperinflation scenario and that gold is money, then logically you should be converting fiat prices into ounces of gold – now. The advantage of doing this is that if gold is just in a bubble, then the prices of other assets in ounces will be really low, indicating that those other hard assets are cheap and giving you a signal to sell your gold for other assets. Below are some charts of what assets priced in gold look like.


This showed that 1980 and 2011 were exceptional gold bubbles.


Stocks also shows the 1980 and 2011 bubbles. These are just two charts to give you the idea, but you should look across all assets in terms of ounces of gold to get a general picture of gold’s relative value. There is even a website dedicated to this, naturally called, which has charts of various things in terms of gold.

In a hyperinflation scenario, these charts will look like the one below of the LME base metals index in ounces of gold. Note how the price is a lot more stable for long periods, even though gold changed a lot during these 20 years.


If you see the price of gold going up but the price of a wide range of other assets priced in gold somewhat stable, then that is an indication that there is general inflationary force in the economy. If that is occurring when dollar prices are going up rapidly, then again, consider selling the “rally” but only for a switch into other assets, not fiat.

Over the past 15 years I have spoken to a number of wealthy Perth Mint Depository clients. They all made their money doing productive things, building businesses. A lot of them felt that gold was a dead asset, producing nothing, but they were buying it because they did not see much business opportunity and economic growth going forward and were sheltering their wealth in gold. However, they all had the strategy of keeping an eye on the value of productive assets and were waiting for when they were cheap and then they would sell their gold and buy those assets. They were not interested in selling out at the dollar price peak, their eye was on productive assets and their relative value and they told me they would rather sell out early and miss the peak to buy these assets cheap before other entrepreneurs bid them up.

If you ignore their advice and follow the “rally that is not meant to be sold” tip, I think you are really just treating gold like a pet rock, watching its nominal fiat price go ever higher and getting that nice psychological payback against the gold haters that “we was right”, while others around you are cashing out their gold insurance and buying real assets at bargain prices.

Aug 262015

Following on from yesterday’s post, below is the chart of the best gold and silver percentage allocations for Australian investors by the year one starts investing.


This is not too much different to the chart for US investors, with a slight skew towards gold in the late 1970s. This is to be expected as we are affecting both USD gold and USD silver by the same AUD/USD exchange rate, which would only magnify the variability in gold and silver by a small amount. The chart comparing the “times increase” of the 100% gold, 100% silver and 50%/50% strategies can be found below.


I have left the scale the same as the one for US investors, so it can be compared directly. Note that Australian investors experience a much lower variability in returns, which is driven by the fact that often US precious metal prices are affected by US dollar strength/weakness, which also affects the value of the Australian dollar, helping to mute changes in AUD gold and silver prices. The advice for Australian investors is the same as that for US – the 50/50 strategy appears to be a good all weather approach to take.

The results above, and for yesterday’s post for US investors, were based on a constant rebalancing. For example, every month the investor would adjust their purchases (and sell one metal if necessary) to bring the portfolio back to 50% gold and 50% silver by value and not just spend their monthly $100 savings as $50 on gold and $50 on silver.

The chart below shows the percentage difference between the two total ending USD values of a rebalance versus a simpler no rebalance/buy in the same proportions each month. It is a busy chart but the key takeaway is that not rebalancing theoretically produces a lower overall return.


However, it is not a big difference considering that we are in most cases talking about increases on the cash invested of 100% to 300%. If we included transaction fees and the tax consequences of rebalancing (having to pay tax on any profits from selling whatever metal is overweight), then I think this negative difference would disappear. The difference could also be reduced by adjusting how much gold or silver one buys so as to move the overall portfolio split as close to 50/50 as possible, although this would only have an effect early on as later in ones savings the $100 a month is minor compared to the value of the portfolio.

While the analysis above and in the previous post is simplistic in that it does not consider one’s rising income, inflation, taxes and transaction fees, it does indicate that there is merit in buying 50% gold and 50% silver as a conservative precious metals investing strategy.

Aug 252015

There are three major types of Perth Mint Depository investor:

  1. Those that only buy gold
  2. Those that only buy silver
  3. Those that buy 50% gold and 50% silver

There are others who include platinum, or have different percentages, but the above three types are a significant majority of our clients. I find it interesting that most investors who weren’t strong goldbugs or silverbugs and couldn’t decide between them went with a simple 50/50 strategy. This begs the question: is this a good strategy and what is the ideal percentage allocation one should make between gold and silver?

To answer this I have assumed an investor saving regularly for retirement, for simplicity $100 a month, including rebalancing each month to bring the value of gold and silver held back to the target percentages. I also assume an investing period of 25 years, on the basis that one does not start saving serious money until 40 (see this post for the investor lifecycle logic behind this) and retires at 65.

I then ran through every combination of gold and silver percentages to come up with a total value at the end of the 25 year investing period (which is 300 months, or $30,000 in total cash invested). As an example, the chart below shows the portfolio value for an investor who started in 1985 and retired in 2010, across various percentage mixes.


If this person only invested in gold then 25 years later their portfolio would be worth just under $89,000. A silver only investor would have just shy of $93,000. However if this 1985 investor had perfect forecasting ability they would know that investing 37% into gold and 63% into silver would maximise their return at $94,932, over three times the total cash they put in.

However, given the varying performance of gold and silver over time, the year a person starts and finishes investing affects their return. To compare different years I divided the total portfolio value by the dollars invested, to give a simple “times” figure (eg 3 means you’ve tripled your money). The chart below shows this calculation for three selected years, each demonstrating that a different strategy maximised the return.


The year 1985 is shown here again, but as a “times invested money” figure. While a gold/silver mix was the best return when starting in 1985, if you started in 1988 you would have been better off just investing in silver as you would have increased your $30,000 by over 5 times, compared to a gold only strategy of quadrupling your money. Starting in 2002 (which only covers 13 years) a gold only would have been the best strategy, increasing your $16,300 investment by 1.67 times to $27,181.

Of course the above is all very handy if you have hindsight, but what if you are starting to invest in precious metals in 2015? In 25 years will starting in 2015 end up like 1985, 1988 or 2002 in terms of what is the best strategy given the relative performances of gold and silver? One way of answering this question is to look at the strategy that gave the best performance for each year and see if there is a strategy that performs best across all different time periods.

The chart below looks at each year starting from 1975 up to today and shows the gold/silver percentages that gave the best return for a person starting to invest in precious metals in that year over the following 25 years. From 1990 onwards it is not for a full 25 year investment period, but I’ve included it for comparison purposes. Note, the chart is not showing the best strategy for that year, but the best strategy for an investor starting in that year).


The chart shows that there isn’t any consistency across time in which gold/silver proportions are best. A skew towards silver seems to be best during the 1980s with 100% gold being best at other times. This is reflecting the relative outperformance of gold or silver over the various 25 year timeframes. I didn’t find this very helpful in terms of identifying an all-weather strategy.

I then noticed that some years, like 1985, don’t have a big difference between the best and worst strategy – in the case of 1985, between $89,000 and $95,000, a gap of less than 7% on an increase of around 200%. To get some sense of the variability of returns, I’ve charted the “times increase” of the 100% gold, 100% silver and 50%/50% strategies below.


This chart is similar to the one above, showing that a silver only strategy performed best in the 1980s and gold better than silver for most of the other investment time periods. The reason for the high performance in the late 1980s is because an investor starting then is averaging in during gold’s bear market, lowering their cost of purchase, and then exiting at gold’s relative highs in 2011-13.

What is interesting is how close the 50/50 strategy is to gold or silver when they are the best strategy and indeed there are times when the 50/50 strategy outperforms a gold or silver only strategy. The key for me is that over time the 50/50 is closer to the best strategy than the worst – for example, if you picked a gold only strategy and the next 25 years turned out like those for an investor starting in 1985 and retiring in 2010, then you would see an increase of 4 times when a 50/50 would have given you a 4.7 times increase, not far off 5 times for a silver only. A silver only approach however, would have underperformed a lot if the future turned out like the 1990s, when a 50/50 was very close to a gold only strategy anyway.

My conclusion is that a 50/50 strategy is a very good all-weather approach to take. You will not give up too much return if gold only or silver only turns out to be the best strategy but a 50/50 will protect you from underperformance if your choice of metal does not turn out to be the best.

Tomorrow I’ll have a look at the situation for Australian investors to see if the advice is any different, and also look at the effect of not rebalancing (just buying on a 50/50 basis each month).

Aug 242015

Richard Watson is a futurist and scenario planner I’ve been following for years. Each year he comes up with unique graphical representations of his thoughts on future trends (see here for an example) with a focus on technology. His latest takes a classic risk based approach (likelihood & consequence) and so is suited to gold which people run to when unexpected things happen. Consider this the intelligent person’s doomer list.

So of all the risks identified, what is Richard’s biggest worry:

“another global financial meltdown (far worse than last time due to increased debt levels, a lack of liquidity and the newly networked nature of fear). This could be triggered by rising US interest rates, although the actual trigger is irrelevant. There is so much stress built up in the system I believe almost anything could trigger a panic sell off. I suspect that QE won’t work again either, although one might argue that QE is itself a risk and should be on the map.”

Aug 212015

Techniques for analysing and trading equities, looking at price and volume, can be applied to precious metal futures markets. Futures, however, introduce another data point – open interest – that has to be considered. With equities, the quantity of shares on issue is generally fixed and rarely changes. Therefore all buying is done from sellers who hold the shares.

With futures, the amount of contracts “on issue” or “open” changes daily, as a future is a contract to trade metal in the future and an exchange will create, or open, as many new contacts as people wish to enter into. If a seller of metal and buyer of metal want to enter into a contract, then a new contract will be opened. If an existing seller of a contact (a “short”) and an existing buyer of a contact (a “long”) want to exit their contract, then the contact will be closed.

Open interest represents the number of contacts created and in existence at a point in time. The table below summarises how open interest will change, depending upon who is buying and who is selling.


In the cases where open interest doesn’t change – that is, an existing long or short is being taken on by a new participant – there may be some information value in knowing who is closing and who is new/adding. This can be done by looking at the changes in the long and shorts held by the various categories on the Commitment of Traders report (material for another post).

It should be noted that a change in open interest indicates very little in and of itself as the opening or closing of a contact requires both a buyer (long) and seller (short). However, looking at changes in open interest in combination with changes in price may give an indication of market strength, as summarised in the table below (see Wikipedia).


Note that increasing open interest can be associated with strong or weak markets. The logic is that if the price is rising and open interest is increasing, then buyers are having to increase their price to induce new sellers into the market. If the price is falling and open interest is decreasing, then longs are having to decrease their selling price to induce shorts to cover and exit the market. The table above can be represented graphically in the stylised chart below showing a rising and falling price with a rising and falling level of open interest.


While this chart demonstrates the highly theoretical nature of the price/open interest trading rule, there is some value in including open interest in your market analysis, as demonstrated in the chart below of the gold price during July 2015.


The light blue lines show the price falling while open interest was increasing, and indeed the market was weak, subsequently breaking through the $1140 support level. The light red lines show open interest decreasing while the price continued to fall and subsequently the market bottomed. Note that the chart also shows violations of the “rules”, so it is not fool proof.

The chart above also includes volume. While volume and open interest are related (they have a simple correlation of 0.81 over 40 years) they do not always move together, so one has to consider changes in both. Keep in mind that, everything else being the same, increases and decreases in open interest will both increase volume.

There are various technical indicators that combine price, volume and open interest, such as the Futures Volume Open Interest (FVOI) Indicator (a variation of On Balance Volume), which Sharelynx calculates and maintains charts for.

For those coming from equity investing, it is important when analysing futures data to remember that the precious metal markets are global and significant volumes are traded in the opaque over-the-counter (OTC) market. While Comex, and increasingly the SGE, have a significant impact on prices, they are not self-contained markets like those for the shares of a company.

Bullion banks and other traders arbitrage between futures markets, ETFs and the OTC market (otherwise prices would not stay in alignment) so action you see in public exchanges could be balanced by offsetting positions in other markets that are not visible to you. The relative wealth of data available on futures markets, and lack of data on OTC markets, can lead analysts to become myopic and forget that there may be other market forces from the OTC market impacting on the “visible” public exchange traded contracts.

Aug 192015

In response to a Craig Hemke comment that “the ability to convert fiat and stack physical metal at these depressed paper prices is a gift, not a disaster”, Chris Powell of GATA noted that “it would be a much more valuable gift for people in their 20s and 30s than for people in their 60s and 70s. Indeed, for the latter group it could look more like another ripoff.”

The response got me thinking about generational differences and the demographic cliff (see this Mauldin Economics article for a summary by Harry Dent about the demographic cliff). Harry’s work on demographics focuses on the generational life cycle in respect of spending patterns, which he says peaks at the age of 46. What I’m more interested in is the peak saving age, because this may give us some clues to gold demand going forward.

Harry says that “people save the most at age fifty‐four and have the highest net worth at age sixty‐four”. This fits in with his peak spending at 46 – after that one would start to save more in expectation of retirement in 20 or so years – and after 54 saving would start to tail off as one approaches mid 60s and the retirement phase of one’s life.

The chart below shows the US population by age as at 2014, with my rough generations based on clear differences in the number of people by age. Can you see the problem?


As the Baby Boomers get further into retirement they will need to sell their gold. The problem is that the 15 years worth of Generation X that is just now coming into their peak savings age are a lot smaller. More sellers and less buyers is not a recipe for higher prices. This is something that affects all asset classes, but I do wonder if gold will be one of the first assets to be sold, rather than dividend paying stocks or rental properties.

It is coincidental that just as the early Boomers started moving into retirement age and the late Boomers reached peak saving age that the gold market was weak? The chart would seem to argue that if you are an early Boomer best to sell now while your later Boomers are still in saving mode rather than wait for when Generation X comes along.

If you are a late Boomer then the news isn’t good because it will be about 20 years before the first of the Millennials are reaching peak saving age, which will be when you are between 70 to 75 years old. However, it is questionable as to whether Millennials will be big goldbugs. Consider this interview with generation expert Neil Howe who says that:

“Millennials are much more collective in their orientation and they are much more optimistic about the future. We do a lot of surveys on political attitudes by age and Boomers are by far the most pessimistic of all generations and the most apocalyptical in their values and orientation. Whereas Millennials are much more practical, collectivist and much more optimistic about how things are going to turn out.”

“Today, we talk about our Millennials, China talks about their Little Emperors, you know, the generation which never tasted bitterness, who are incredibly positive about the future and who trust their parents to educate them and wanting to join something big – the China Dream.”

It sounds like gold is going to be a hard sell to Millennials. Is China the saviour? Consider their demographics from Wikipedia below.


Their “boomers” are a bit younger but by only 5 years or so and they have the same Western Generation X population drop off problem.

Now I’m not asserting that demographics are the major driver in the gold market, and there are a lot of other factors to consider, such as different generational behaviour (eg, Generation X starting families later than Baby Boomers, so maybe their peak saving age differs), effects of migration, and whether gold is something people will spend or pass on to later generations (which probably differs by culture as well). But demographics are certainly something investors should consider and something I’ll be looking to research further (and welcoming your helpful suggestions and thoughts).

Aug 182015

One of the best ways to learn about precious metals is to engage with other investors on a discussion forum. There can be a lot of rubbish on them (as with the internet in general) but generally you’ll get good advice from others who have been there before. The list below has the main active PM forums (or sub forums) where precious metals are discussed from an investing point of view. I have ranked them by total membership numbers, which is not perfect as it doesn’t necessarily represent active users but it is a fair indicator of either popularity or longevity of the forum.

Each forum has its own personality and particular focus – some skew towards one metal or the other, or peer to peer trading, or prepping. I’d suggest checking them all out and reading topics/threads to get a feel and see what suits you. Alternatively, you can subscribe to my Precious Metals Forums bundle on the feed reading service Inoreader, which aggregates threads from Kitco, Silver Stackers, SilverSeek, GoldEagle, Goldtent, Gold is Money, Reddit and Gold Club Asia forums if you want to keep your finger on the pulse of global PM discussion.

My favourite is Silver Stackers, which started out as an Australian PM forum but has broadened since then. I think it has retained an Aussie laid back feel. I’m active on a few other forums and you can check what my legitimate user accounts are here.

If you find other active forums not on this list leave a comment and I’ll add them in.

Forum Total members Total threads Total posts
Kitco 47,262 120,363 2,223,250
Silver Seek 15,329 19,572 174,191
Gold is Money 9,928 78,783 876,332
Silver Stackers 9,538 32,424 529,510
Reddit / Silverbugs 9,129
Silver Doctors 7,651 1,371 17,172
Le Metropole Café 4,103 307,725
Bullion Stacker 3,462 14,611 308,177
Reddit / Gold 2,416
Gold Eagle 2,126 3,419 4,574
Gold Club Asia 1,676 10,647 92,045
Gold Silver Chat 1,222 27,868 221,461 954 60,957 588,309
PM Bug 941 3,321 30,682
The Silver Forum 625 3,027 55,099
Collectors Universe – Precious Metals 11,082
CoinTalk – Bullion Investing 4,895
Coin Community – Precious Metals 3,946
Aussie Stock Forums – Commodites 460 24,307
Hot Copper – Commodites 84,063
Investors Hub – Metals
Goldtent TA Paradise
Kitco Refugees’ Gold and Metals Forum
Yahoo Finance – SLV
Yahoo Finance – GLD
Top Stocks – Gold
Top Stocks – Silver

Statistics as at August 2015.

Aug 172015

Last week I explained why shortages occur and how they are generally caused by production capacity shortages. Often such shortages of retail coin products are spun by commentators into a shortage of raw gold or silver or a physical-paper disconnect and thus a sure sign that metal prices will rise.

Mike Shedlock, in his very direct style, says that “any time you see articles promoting the difference between physical gold and paper gold you are most likely reading a pile of crap”, referring to the fact that “one can get physical gold near spot rather easily” and giving the example of GoldMoney or BitGold.

Mike’s comments were in response to this article that argued that because “demand for physical metal is very high … yet, the prices of bullion in the futures market have consistently fallen during this entire period. The only possible explanation is manipulation.” Market manipulation is certainly a factor but claiming it is the only possible explanation is taking a limited view of the dynamics involved.

The authors start by claiming that “for four years the price of bullion has been falling in the futures market despite rising demand for possession of the physical metal”. As proof, they mention prior periods of coin shortages. While there have been periods of resurgent demand, the fact is that retail bullion dealers have had a tough time since gold prices peaked and many have scaled back the size of their business. One would not see bullion dealer bankruptcies like Tulving or Bullion Direct in a market with rising demand. I’d argue that scaling back of inventories as demand waned was probably a contributing factor in the recent shortages.

The authors also ignore the rest of the gold market. Certainly Chinese demand has provided a base but Indian demand was affected during the last four years with their Government’s raising of duty levels. We have also lost the demand that came from ETFs, which has swung from a net 1,407 tonnes in the 15 quarters from Q1 2008 to Q3 2011 to minus 712 tonnes in the subsequent 15 quarters, a change of over 2,100 tonnes in the supply/demand balance.

After going over Supply & Demand Curves 101 they then argue that it is “nonsensical” to argue that “the drop in precious metals prices unleashed a surge in global demand for coins” because “price is not a determinant of demand but of quantity demanded. A lower price does not shift the demand curve. Moreover, if demand increases, price goes up, not down.”

This view ignores the feedback nature that price has upon demand. Most certainly price shifts the demand curve – people adjust their personal demand curves over time and price is one input into that. The Perth Mint has a lot of clients who bought gold at around $300 an ounce and I’m sure in 1999 if asked they probably would have agreed they’d sell when it got to $1,000. However, many did not and held on because the trend upwards in the price made them revise their perceptions of what was a fair price.

The authors also assume that gold has a normal demand curve, that is, if price goes up then quantity demanded will go down. However, as Paul Mylchreest asks in this article, maybe gold is a Giffen good, where quantity demanded goes up when the price goes up. Ted Butler makes a similar observation in this article, noting that “managed money technical traders … buying on rising prices and selling on declining prices”. Looking at a graph of retail bar & coin demand as reported by the World Gold Council versus price seems to lend weight to the Giffen good argument.


Apart from two surges, quantity demanded seems to increase, and decrease, with price. If I take the data from the chart above and plot it as price versus quantity demanded, then you get the chart below.


The red line is a line of best fit, and it certainly doesn’t look like the demand curve the authors refer to. This is by no means a proof that gold is a Giffen good, but it certainly points to the fact that gold does not neatly fit into an Economics 101 view of the world and the reality of gold investor behaviour is more complex.

The authors then seek to argue that the only other explanation of a lower price, using Supply & Demand Curves 101 theory, is that supply must have increased. They then claim that “there are no reports of any such supply increasing developments. To the contrary, the lower prices of bullion have been causing reductions in mining output as falling prices make existing operations unprofitable.”

Regarding unprofitability, an analysis of the top mining companies’ financials by Adam Hamilton notes that “the gold-mining industry’s cost structure is far lower than that $1200 number often thrown around … on a cash-cost basis, they could weather an $800-gold anomaly for many quarters”. This may be why GFMS figures show no reduction in mine production, with Q2 2015 tonnage of 786.6 up 3.1% on Q2 2014, with the chart below showing that mine production has been rising all during the “four years the price of bullion has been falling”.


The authors then refer to futures market speculators and manipulations. Certainly, gold’s low liquidity allows for manipulative events, which can affect market sentiment in the short term. However this is not enough to supress the price over the long term, or four years, where market fundamentals are the main driver.

Ultimately, the authors’ problem is with speculators, who they see as “selling naked shorts [as] a way to artificially increase the supply of bullion in the futures market where price is determined.” They get so close to the actual nub of the problem but miss it when they say that “if purchasers of these shorts stood for delivery, the Comex would fail.”

The fact is that the longs are as naked as the shorts. Both are using all their available money to fund their margin requirements so as to maximise their leverage, so the shorts don’t have the metal but the long don’t have the money. That is why delivery rates have always been so low on Comex and there is nothing to indicate that this will change. You have gamblers on one side betting the price will go up versus gamblers betting it will go down. If there is any manipulation, one could argue that it is the policy of low interest rates which encourage such excessive speculative behaviour.

The authors conclude that a “rational speculator faced with strong demand for bullion and constrained supply would not short the market” but as I’ve shown above, demand has been weak and supply has been rising. That is not to say that the short speculators are entirely rational continuing with their trade, as many have noted the market is reaching extremes on a number of measures. The nature of markets these days seems to favour trend following rather than fundamentals, which is fine until the trend changes. One thing I can be sure of is that when it does you will not see any article complaining about speculators “buying naked longs”.

Aug 122015

If there is a shortage of coins does that mean there is a shortage of gold/silver and prices will go up?

Shortages of retail forms of gold and silver, which are anything less than 400oz gold bars or 1000oz silver bars, does not necessarily tell us about whether there is a real shortage/price disconnect in the wider precious metals markets. Retail shortages to-date have reflected a shortage in production capacity, rather than a shortage of wholesale gold or silver.

How can I tell if it is a real shortage, or just a production capacity shortage?

A real gold bank run will manifest itself in the wholesale markets for 400oz gold bars or 1000oz silver bars, so to identify a real physical-paper disconnect occurring you need to look at the premium above spot for 400oz or 1000oz bars.

Unless you are in the professional market you won’t see such bars attracting a premium and/or being difficult to source, or bullion banks desperately bidding on the output of refineries like The Perth Mint. However, there are many online pool allocated storage services which back their accounts with wholesale bars. If there is a real shortage of 400oz or 1000oz bars and thus premiums being asked, then you should see the following being reported by these services (in likely order of occurrence):

  1. Reports of difficulties in getting 400oz/1000oz bars
  2. Temporary restrictions on how much gold or silver can be bought
  3. A widening of their normal buying/selling spreads, or increases in trading fees (to cover the additional premium they are being charged)
  4. No longer accepting new clients due to an inability to source wholesale bars

While previous bouts of shortages have been temporary, don’t be complacent. It is possible that a temporary liquidity squeeze in the wholesale markets could turn into a gold bank run which can then turn into a price squeeze. It is important to keep your gold close or stored with non-banks, like The Perth Mint, who don’t engage in fractional reserve banking activities or lending your gold out.

What do you mean by production capacity shortage?

Getting gold/silver from a mine to a coin in your hand involves lots of different people and processes: mining, refining, blanking, minting, distribution and retailing. The amount of coins/bars that chain of processes can produce is limited by the process with the smallest capacity. When the capacity of this bottleneck process is below the quantity demanded by investors, then there is a shortage of capacity to service the demand.

For example, if a baker only has one oven it doesn’t matter how much flour, mixing machines or staff they have, they are only going to be able to produce so many loaves of bread per day. The same constraints exist in the precious metals market.

So what is the bottleneck in precious metals?

Raw Metal – as long as metal prices are above cash mining costs, mines will continue to produce. Even if there was a reduction in mine output, gold has over 60 years of mine production held above ground and this comes back into the market as scrap. Raw metal is therefore unlikely to be the bottleneck.

Refining – the refining industry is highly competitive and by Perth Mint estimates, has had excess capacity for decades, at least double normal mine and scrap volumes. It is also relatively easy for refiners to add additional electrolytic cells and expand capacity, so this process will not be a bottleneck.

Blanking – turning refined gold/silver into blank disc (also called a planchett) with an exact weight and imperfection free surface is a complex process performed by only a handful of manufacturers. This is the key bottleneck in coin production.

Minting – in contrast to blanking, the stamping of a coin is a much simpler process and there are a lot of private and public mints with large capacities, so this is less of a bottleneck.

Distribution/Retailing – while there has been a resurgence in the number of distributors and retailers (bullion dealers) in recent years, given the low profit margins bullion dealers are unable to hold large inventories of gold/silver, as the interest cost of borrowing the money to buy the inventory can significantly reduce their profits. Hence most dealers hold small inventories and/or buy from distributors and mints only when customers place an order. This can mean that dealers will run out of stock on a surge of demand, but should be able to restock quickly.

Why are blanks the problem?

Making coins is a two-step process: make blanks, stamp coin. The stamping part is relatively straightforward from a manufacturing point of view with the most complex part being the making of the dies to stamp the coin. Making a blank disc/planchett is lot more involved:

  • metal has to be melted in a continuous caster and turned into coiled strip
  • heating metal results in evaporation, so you need ventilation scrubbers
  • the strips are then rolled multiple times to an exact thickness
  • the strips are annealed between each rolling
  • the strips are then decoiled and blank discs are punched out
  • metal left over after punching needs to be remelted or re-refined
  • each blank needs to be weighed
  • depending on the quality of coin you want to make, the blanks may undergo various surface treatment processes (eg chemical pickling)

Given the greater complexity of the above process blank manufacture benefits from economies of scale and thus few mints make their own blanks and would rather outsource to simplify their manufacturing facilities. For example, the US Mint buys it blanks from outside suppliers, which was “part of the Reagan outsourcing of non-value added to the private sector. Mint’s value added is stamping” according to Edmund Moy, 38th Director of the US Mint.

But mints make millions of circulating coins, why can’t they do the same for gold and silver?

Mass base metal blank manufacturing deals in metals that are significantly less value that the face value of the coin. As a result, the process is optimised for speed, not quality or security: if a blank is no good, throw it away; weight control tolerances are lax (do you care if your copper coin has slightly more or less copper in it?); metal evaporating when it is melted is not recovered and so on. You cannot allow any of these things with gold or silver, due to their high cost.

Precious metal blank manufacturing requires additional weight control machines, scrubbers to collect evaporated gold, security to lock down the factory, etc. These add additional costs and time to the production of precious metal blanks.

On the minting side, circulating coin production is optimised for high volume/low quality production utilising high speed presses (12 coins a second) to mint coins of a small size, with low relief designs, and on blanks made of metal alloys that are hard enough to withstand such speeds (gold and silver are far too soft relatively speaking).

So why haven’t blank makers expanded their factories?

They have. Sunshine Minting Inc, who supplies the US Mint, was reported as having “almost quadrupled its staff to 270 since 2007”. The Perth Mint, also a blank supplier to the US Mint, has spent tens of millions on new equipment over the past decade.

However, this expansion has been conservative, based on modest projections of coin volume growth. The reason for this is that the cost of a modern blanking production line is high, given all the production steps involved. In addition, you have large working capital requirements cover cash costs and work-in-progress inventory.

Investing capital in production facilities only pays off if current demand for gold coins will continue for a number of years, otherwise one will not recover their investment. The question that executives in mints ask themselves is whether the increase in retail demand is permanent or temporary. If temporary, they don’t want to waste money on capacity that will be left idle. Additionally, since gold coin demand changes with the gold price it is hard to forecast future demand with reliability, making business cases difficult to justify to bankers.

For government owned mints, like The Perth Mint, getting agreement from bureaucratic government advisors to make an entrepreneurial decision to invest to meet future demand is hard, particularly since it will reduce the immediate cash flow that the government gets from the business.

Finally, once a decision is made to expand production capacity, it is not like turning on a tap – there is a big lag in getting additional the machines delivered and operational.

Why don’t mints stockpile blanks?

This would help but often the cost of funding the high dollar value of the blanks is not justified given the low margins earned on coins. Inventory funding costs are an issue throughout the whole industry and the resulting tight inventories (based on normal demand patterns) can be exhausted if there is a demand surge.

When mints run out of capacity, why do they ration production rather than increasing prices?

Most mints rely on a network of distributors to sell their coins. These distributors are often long-term customers of the mint who buy in volume. Rather than picking favourites, or those with the biggest cheque book, mints ration to maintain fairness of supply across all of their distributors (if one dealer cannot get any product they may go out of business).

For those mints who also retail their bullion coins directly to the public, yes they could make their long-term distributors compete at auction for their production with retail buyers. However, mints are at risk that when retail demand declines (which has often occurred in the past) their long-term distributors will remember how the mint took advantage of them and they will either take their business elsewhere or aggressively negotiate terms in retaliation. So based on past experience of the fickleness of retail demand, mints often decide to continue to supply their long-term distributors on a rationing basis rather than move to a “who pays the most wins”.

So what should I do if I see shortages and coin premiums increasing?

If it is not a real shortage of wholesale gold and silver, then don’t panic. Keep in mind that higher premiums mean you are getting less ounces for your dollar. Some strategies to maximise the amount of ounces you are buying include:

Wait – demand surges can occur when prices are high (bubble like herding) or low (bargain hunting). Check the price chart – if the price is high or spiking consider holding off as you may be able to pick up your coins at a lower spot price later, and at a lower premium, when the herd has stopped panicking. If the price is low or bottoming, then it may be cheaper to pay the higher premium rather than wait and pay a higher spot price.

Buy something different – premiums often surge in the most popular coin first (people usually favour their domestic government mint). Consider coins from other mints, government or private. Cast bars from recognised refiners are often cheaper as the casting process is simpler. However, check with your bullion dealer that they will buy back those other coins/bars at a fair price – you don’t want to pay less but receive less back when you sell, it is the spread between buy and sell that matters.

Buy pool accounts – because these are backed by wholesale bars, you can avoid high premiums but still buy at a low spot price. Many facilities will allow you to convert to allocated coins or bars and take delivery later, which you can do when premiums are back to normal. Even for those services which just offer online buying and selling, the total buy/sell fees may be lower than the excess premium you may pay, so it can make sense to sell your pool metal later and buy your coins/bars when premiums are back to normal.

Keep calm and carry on stacking.

Temporary coin shortages first started in 2008 after the global financial crisis and they have occurred repeatedly since then. Don’t get caught up in the marketing hype the next time a shortage occurs – if you follow the advice above on how to tell if it is a real shortage, or just a production capacity shortage, then you will be able to keep calm and carry on stacking (economically).

Aug 072015

Last month I covered Comex warehouse stocks in response to “a lot of chatter about the potential or certainty of failed settlement and Comex default”, making a number of points:

  • inventory can be converted from eligible to registered relatively quickly
  • including eligible inventory give a very different picture of warehouse stocks and owners per ounce
  • the actual percentage that stand for delivery is only 2-4%
  • current registered stocks vs open interest is well within current delivery rates

For those who focused on the registered stocks only, recent Comex deliveries have caused some disbelief. The best example of this is this piece by Zero Hedge. They way they word some statements could be misconstrued by investors new to precious metal, so as an education service below are some quotes from the article and some clarifications.

“the most recent drop in Comex registered gold”

When you see articles referring to “Comex” this or that, the writer is just using that as a shorthand for “client owned metal stored in independently run vaults licensed/recognised by CME Group”. Comex/CME Group does not own or operate any vaults or own any metal itself.

This sort of shorthand you will also see used in respect of “LBMA” or the London Bullion Market Association. The LBMA is just a trade association and does not operate vaults or own metal.

“the Comex once again succeeded in sweeping default fears under the rug by boosting its eligible gold by a whopping 78% overnight”

As per the above point about shorthand use of “Comex”, please do not read this as Zero Hedge saying that the CME Group owned eligible gold and transferred it to registered. What they are referring to is the fact that clients who were holding short contracts would have instructed the warehouse where their metal was stored to move it to registered (or warrant it). This is an electronic process and as the metal is eligible (ie meets delivery requirements), no further verification etc of the physical bars is required, it is just a computer entry.

The reference to whopping I do think is overstated. That 281,000 ounces is not a lot when you look back historically. The chart below goes back 5 years and I’ve circled Zero Hedge’s “whopping” in red.


As you can see with my purple circles, there have been many times that registered stock has increased dramatically and by much more than 281,000 ounces, and in a number of cases, these have occurred not from transfers from eligible stocks but from shipments directly into the warehouses. Hence why I made the point last month that one is bound to get disappointed if one just focuses on registered stocks.

“thanks to JPM reclassifying 276K ounces of gold from the Eligible into the Registered category”

Again, please note that Zero Hedge is not saying that JP Morgan themselves just decided to reclassify gold, as it is the client who owns the metal that has control over that decision. Note that some warehouse operators also trade on Comex for their own account. In this case it could be that JP Morgan may have done the reclassification (or more correctly, the trading desk of JP Morgan instructing the warehouse division of JP Morgan) but we cannot deduce this solely from that Comex report.

“even as actual eligible gold continues quietly hemmorhaging out of the Comex”

I’m a bit puzzled by this “hemmorhaging” as you can see from this chart of total eligible gold held with Comex licensed warehouses below.


While the 1 million or so that has moved out of eligible over the past few weeks is about 10% of the total, it is not a big drop when you look at the big picture: apart from a bump post financial crisis and drop off after gold fell from its peak, it looks to me that Comex warehouse operators have been growing their storage business quite successfully.

“will JPM be as eager to continue “adjusting” eligible gold into registered if the recent trend in gold redemptions not just in its vault, but across all Comex gold warehouses continues”

Again, Zero Hedge here are in shorthand referring to JP Morgan’s customers doing the “adjusting”. What is meant by “all warehouses” is that a client of a futures broker who is short is not limited to tendering metal in a specific warehouse, or a warehouse associated with that broker if the broker also operates a vault. Customers may have metal in any or multiple warehouses and can choose any such warranted metal to make delivery with.

If you are new to precious metal markets, hopefully the above has been of use, otherwise you may have come to the conclusion from reading that article that the CME and/or warehouse operators somehow had some responsibility to make delivery of metal to rescue Comex from default, which to anyone with a basic understanding of how futures markets operates, would be a very silly thing to think.