On Friday there was a big move in precious metals, with gold up $25 to around $1135 and silver up $0.70 to around $15.20. In percentage terms the silver move was much more dramatic, approximately 4.8% compared to gold’s 2.3%. The move was in reaction to US non-farm payroll numbers, but in this recent post, Keith Weiner at Monetary Metals goes behind the headline grabbing move and looks a little deeper into what it tells us about scarcity in the silver market.
Keith focuses on the difference between spot and futures prices to get an insight into the hoarding or dishoarding of gold and silver, which he sees as more useful than conventional supply/demand analysis given the large stocks of gold and silver relative to their flow.
Metal is hoarded, or carried, if there is a profit to be had buying metal and selling it later in the future. This occurs when future prices are higher than spot (today) prices and is called contango – the measure of this is the basis.
If metal is scarce then people will bid up the spot price above future prices and this will create an incentive for gold owners to dishoard or decarry, as there is a profit to be had selling metal now and agreeing to buy it back later in the future. This situation is called backwardation and Keith’s measure of it is the cobasis.
The interesting thing about the increase in the silver price on Friday was, Keith notes, that “the cobasis (i.e. scarcity) fell. A lot. In fact, it is the biggest drop in the silver cobasis in years” falling from a profit of 2.9 cents to 1 cent. “Speculators bid up the price of futures so fiercely and so aggressively, that the spread between December and spot was compressed to about 1/3 its previous size.”
To put this move in pictures, I’ve stylised the market situation on Thursday according to Keith below (I don’t have his exact figures, but this chart has the relativities about right and I’ve assumed a bid/offer spread of 5 cents for simplicity).
Note that if you are looking to hoard/carry then you have to buy at the spot offer price and sell at the future’s bid price. If you want to dishoard/decarry then you are selling at spot bid and buying at future offer. Keith says there was a 3 cent profit to be had on Thursday for decarrying, which is represented on the chart up the upward sloping red arrow.
Now consider the situation on Friday.
The way I’ve charted this, by not putting Thursday and Friday on the same chart and using the same 15 cent y-axis scale, emphasises the change in the cobasis rather than the change in price. You can see that the red line is now nearly flat, indicating the compression in profit to be had from dishoarding.
The most interesting aspect of Keith’s post, however, is his discussion about the high silver coin premiums. Keith says that the premiums are not just an indicator of demand for silver coins but also reflects the fact that “the capacity to produce silver coins is inelastic. Manufacturers can only stamp them out so fast” and compares it to “like pulling liquid from a large pool through a thin straw. Yes, it’s drawing liquid out of the pool. But the straw can only flow so much.”
Keith then goes on to compare his cobasis indicator of wholesale market shortage with the coin shortage indicator (ie coin premiums):
His conclusion is that “the same market forces that are driving silver into scarcity can also drive coin stackers, but it does not work so well the other way. Stackers can’t pull enough silver through that thin straw, to cause any serious scarcity in the bullion market. Though they can exacerbate scarcity if it’s already rising”. Not surprising given silver bar and coin demand is only around 20% of global silver demand, although this chart from The Silver Institute would indicate that investors seem to be the marginal swing factor.