The Startling Reason Why Gold Will Run Higher

Wait till you hear this breakthrough analysis of the REAL reason gold and silver's surge will run, and why we can look for this new bull market to be powerfully sustained. 

Alasdair Macleod, Head of Research at GoldMoney.com reveals his latest findings that a new and massive market phenomenon that defies technical analysis and dwarfs investor demand is the real and historic driver of what may become the most epic bull market that precious metals have ever seen!

- Source, Reluctant Preppers

Silver Prices with Explosive Upside

Silver prices have lagged gold prices since 2017 which has pushed the gold-to-silver ratio close to the all-time high. Silver prices are also significantly below what is predicted by our pricing model. We think that the reasons for this subdued performance are transitory and that silver will outperform gold again as the next precious metals cycle continues to rapidly unfold.

In spring 2017, we introduced a framework for understanding the formation of silver prices (Silver price framework: Both money and a commodity, March 9, 2017). In this report we are going to use this framework to analyze the recent performance of silver and give an outlook for where we think silver is heading over the coming months. In our framework piece, we concluded that silver is both money (store of value) and an input commodity and thus the impact of both industrial and monetary demand needs to be taken into consideration:

On the one hand, silver is a counterparty-risk-free form of money where replacement costs set the lower boundary for prices – the same energy proof of value that underlies gold prices. Thus, silver should be impacted by the same drivers as gold prices: Real-interest rate expectations, central bank policy, and longer-dated energy prices.

On the other hand, silver is a commodity with extensive industrial applications. Hence, changes in industrial activity should impact the price of silver as well.

In our framework note, we also discussed the two main reasons why we think that silver tends to outperform gold in bull markets and underperform in bear markets:

Because the value of global silver stocks is much smaller than that of global gold stocks – which is the result of silver being used in industrial applications – a rise in monetary demand for silver has a disproportionally large effect. In other words, when demand for metals increases as an alternative to fiat currency, there is simply less silver around to change hands.
A large part of global silver production is a by-product of other mining activities such as copper production. This base production is usually enough to meet industrial demand and “normal” monetary demand for silver. Because much silver is mined as a by-product, the silver cost curve has a discontinuous shape, meaning that base production is relatively cheap -- but to meaningfully ramp up supply, much more costly “pure” silver projects need to become economically viable. Hence, when a sharp increase in monetary demand leads to a shift on the cost curve, prices tend to increase sharply. This is illustrated in Exhibit 1. On a smooth continuous supply curve, an increase in expected future demand leads to a shift on the supply cost curve from A to B. However, for silver, the cost curve is different – it has a “kink” (an abrupt, discontinuous change in the first derivative) as a lot of silver is produced as a by-product, meaning it is produced almost regardless of the silver price. As such, small shifts in expected future demand lead only to very small changes in marginal costs. However, a sharp increase in monetary demand for silver leads to a sharp increase in the marginal cost of future supply (C to D), as an increase in future supply can only be achieved by sanctioning high-cost pure silver projects.

Silver prices have peaked in early 2011 at close to US$50.00/ozt and subsequently gradually declined to a low of US$13.70/ozt in late 2015, around the same time when gold prices hit their low. This silver price decline was in line with the findings of our model: Monetary demand for silver slowed down significantly as USD real interest rate expectations (10-year TIPS yields) rose from close to -1% to almost +1% (see Exhibit 2) which tends to be strongly negatively correlated with precious metals prices, silver more so than gold. As we have highlighted before, the decline in gold prices over that time-period was exacerbated due to a repricing in longer-dated energy prices, which has most likely negatively impacted silver prices as well. However, unlike gold – which since then has been on an upward trend and is up 40% from the lows – silver prices have been largely stagnating (see Exhibit 3).

Moreover, silver prices have not just detached from gold, they have detached from the predicted levels in our pricing model as well (see Exhibit 4). Our model predicts that prices should currently be roughly at US$25/ozt – US$8/ozt higher than they are. Importantly, when silver prices bottomed in late 2015, prices were exactly in line with the predicted levels from our model. Subsequently, our model would have predicted prices to rise on the back of slowly declining real-interest rate expectations and a modest growth in industrial output. The decline in real-interest rate expectations did lead to rising gold prices, but silver prices did not follow...

- Source, James Turk's Goldmoney, Read More Here

Why is China Now Buying Futures?

If I am correct in thinking the whale in the market is the Peoples Bank of China, then instead of suppressing the silver price, she is now hedging approximately one year’s silver imports against future price rises. Having pinpointed the switch from price suppression to futures accumulation to approximately March 2017, we can now say that courtesy of JPMorgan’s dealing skills, no one was aware of the Peoples Bank’s change in price strategy.

This was shortly after President Trump was elected and assumed office, which could have had a bearing. From China’s point of view, the geopolitical outlook had become very unstable, with its Washington sources reporting the Deep State’s conflict with Trump and its attempts to destabilise his administration. At the same time, the global economic outlook was improving, which would have led to greater global demand for silver, making it difficult for China to continue to suppress the price. These are good enough reasons to change price strategy and lock in silver prices by buying futures to cover future shipments.

More recently, China has begun to declare monthly additions of monetary gold reserves, a trend led by Russia and copied by other Eurasian central banks. Gold has suddenly caught a bid and having risen sharply become dangerously overbought. This is in sharp contrast to silver, which on the surface appears to have been side-lined.

The traders at the Peoples Bank now appear to have protected themselves against an increase in the silver price, which normally rises nearly twice as much as gold. Since the Peoples Bank also controls the nation’s gold, the silver desk could have known about the plans to announce monthly increases in China’s monetary gold reserves in advance. It would have been an added incentive for the desk to buy silver futures from the beginning of this year.

It will be interesting to see if this move, combined with China’s increasing gold reserves, results in a significant jump in the silver price. If the silver whale is China, then it’s a reasonable supposition that China is signalling by its actions that it expects dollar prices for gold, and therefore silver, to continue higher over time. An advantage of taking up a silver position is if things cut up rough in the gold market, China will not be implicated so far as Comex futures are concerned. Unlike large-scale dealings in Comex gold futures (which China appears to have studiously avoided), protecting prices on her silver imports is what the futures market is for and is unlikely to be politically contentious.

The message for silver investors is seven of the eight largest traders appear to have become complacent. If China is the whale in the market, then discovery could be a very painful process for them. Its unfolding could be dramatic, likely to coincide with the next move upwards in the gold price.

- Source, James Turk's Goldmoney

A Whale is Accumulating Silver Futures

Silver’s recent price performance has been disappointing. Normally, it is almost twice as volatile as gold, so when the gold price rises 11%, as it has since last December, you would expect silver to rise about 20%. Instead it has fallen marginally.

When we dig into the weekly Commitment of Traders’ Reports covering Comex futures, we see something very odd indeed. The largest four traders, normally bullion banks or major producers hedging future output, almost always run short positions against speculators’ longs. The more bullish speculators are, the more shorts are carried by the big four to accommodate them. Equally, they only go net long when the speculators are extremely bearish and are collectively marginally long or exceptionally net short. Not now, as the following chart of the Largest Four Traders net positions shows.

The number of contracts either net long or net short are derived from the concentration ratios in the weekly COT releases. The net long position is standing at a record high, a move that started in March 2017, marked by the arrow.

With respect to the concentration ratios, the CFTC’s explanatory notes state the following:

“The report shows the per cents of open interest held by the largest four and eight reportable traders, without regard to whether they are classified as commercial or non-commercial. The concentration ratios are shown with trader positions computed on a gross long and gross short basis and on a net long or net short basis. The "Net Position" ratios are computed after offsetting each trader’s equal long and short positions. A reportable trader with relatively large, balanced long and short positions in a single market, therefore, may be among the four and eight largest traders in both the gross long and gross short categories, but will probably not be included among the four and eight largest traders on a net basis.”[i]

So, anyone can be a large reportable trader. Gross positions include straddles and swaps between different silver futures, and do not concern us. It is the net position ratios that are relevant. Chart 1 above is of the four largest traders net positions in the markets calculated on this basis.

The next largest 4 traders can also be calculated by taking the concentration ratios of the eight largest and subtracting the four largest. It turns out, as one would expect when gold is very overbought, the silver positions of the next largest four at net short 20,131 contracts are close to a record short. The second four see prices have hardly moved, and the speculators in the Managed Money category are only moderately long. Despite their individual short positions, they don’t realise they are in acute danger of being victims of a major bear squeeze.

They appear to be blissfully unaware that they are as a group short to a very larger buyer in their own ranks. It is certainly possible no one has done the analysis covered in this article, because analysts and traders rarely look at the concentration figures. Furthermore, the correlation of the positions between the four largest and next four have not closely followed each other for some time as Chart 2 shows, which perhaps also encourages complacency.

We will return to that point later. However, it is only recently that the second largest four’s net shorts have exceeded those of the first largest four, and now we see the largest four traders are record long while the second largest four are record short.

This is the first time this has happened. It seems unlikely that in normal circumstances any of the largest eight would be running a diametrically opposed trading position to the other seven. Comex doesn’t work like that, con­­­­sisting of distinct groupings: producers and merchants hedging their future deliveries, bullion banks acting as market-makers, and speculators, who take on the price risk by going long. They all tend to stick within their group motivations.

Given these normally clear distinctions we can probably rule out a collaboration between more than one large trader. If two or more large traders were involved, it would be known by insiders and the other large traders would not risk being short.

Therefore, it is likely to be only one long position, far larger than the charts above indicate, given the largest four traders will include three other large shorts. We can only guesstimate its size. However, if we assume that the other three largest trades are short in tune with the others, our long trader, our whale, is very long indeed. The long position probably began in March 2017, when collectively the large four were net short 39,215 contracts. This is marked by the up arrow in Chart 1, where the trend reversed. If we take that as our starting point, we can see that as of 2 July (the most recent COT figures) the swing is nearly 50,000 contracts. That is an indication of the long position of our large trader, accounting for over 20% of silver’s open interest. Since each contract is for 5,000 ounces, it represents as much as 7,775 tonnes, which is 28% of 2018’s global mine production of 27,550 tonnes.

In the context of the silver futures market it is huge. But it seems unlikely to be an attempt to corner the silver market, because Comex-registered vaults have about 9,500 tonnes of silver bullion and LBMA vaults at the end of March had 36,195 tonnes. In other words, there is 1.66 times annual mine supply in these two vaulting systems alone. Given healthy vaulting supply, someone attempting a repeat of the Bunker-Hunts’ attempt to corner the market in 1979 has a massive hill to climb, particularly when such an attempt might be thwarted by the regulators changing the rules.

Putting cornering the market aside, we can also rule out a large speculator taking a punt on silver. A look at the Managed Money category net position tells us our whale is not there. Nor does a whale this size show up in the Non-Reportable category either.

By a process of elimination, it looks like a commercial entity, which uses silver for manufacturing purposes and is a continuing buyer of the metal. It would make sense that such a buyer would wish to hedge against future price rises by going long of futures. This being the case, it is a behemoth, larger than any individual processor. And that leads to one conclusion: it is probably the Peoples’ Bank of China, the state institution charged with managing all China’s silver distribution. But with a purely circumstantial case, we need more evidence.

- Source, Goldmoney

Myths About Gold as an Investment Medium

On Monday, Tom Stevenson, an investment director at Fidelity International, in his regular column in The Daily Telegraph wrote an article headed “Gold’s lustre may help hedge your bets if markets head south.” For a senior portfolio manager to recommend some portfolio exposure to gold supports this article’s contention that investment managers have noted the trend, but it appeared to present Stevenson with some difficulties arising from some common fallacies.

As a starting point, his article provides us with material to work with. His bias is clearly anti-gold. But his concern the gold price is telling him something important is evident from his headline, and he then enters into a mea culpa as to why gold should not be considered a normal investment. Stevenson trots out the usual anti-gold-bug stuff, claiming gold being only of interest to the kind of people who stockpile tinned goods and Kalashnikovs. But he also lists some of the alleged disadvantages of gold, commonly believed in the investment management industry.

Stevenson states it pays no income, is expensive to store and insure, it has no intrinsic value, no real use beyond looking pretty, it’s extremely volatile, it’s a greater-fool investment requiring another buyer to believe it’s going higher, and it’s value was higher forty years ago in real inflation-adjusted terms. We shall address all his points.

Before doing so, we must set one thing straight. What he didn’t mention is the common belief in investment management circles that gold is no longer money. We shall start with this issue, given its overriding importance, before addressing Stevenson’s other presumptions.

Myth 1. Gold is no longer money

The first step towards understanding the role of gold is to recognise it is money. It still competes with today’s fiat currencies as money and predates them by many millennia. Over the millennia there have been many other forms of money tried, and apart from silver, they have always failed. The gradual emergence of unbacked fiat currencies, particularly from the 1920s onwards, is the only monetary challenge to gold’s long history as money that has yet to fail.

With today’s state-issued currencies unbacked by anything other than public credibility in their issuers’ standing, the US dollar has loosely replaced gold as the principal currency against which all the other currencies are measured. This was by design: since 1971 the US Treasury has embarked on a campaign to deny gold’s role as money, promoting the dollar as the reserve currency instead.

In the past, when a state-issued currency was freely convertible into gold, its currency circulated as a gold substitute. Today, no currency is convertible into gold, so gold does not circulate as money even indirectly. By insisting its state-issued currency is used for tax payments, and therefore is the basis for everyone’s accounting, a government ensures it is the circulating medium. But another important function of money is as a store of value, preserving it for the lapse of time between it being earned and finally spent, and in this function state-issued currency fails.

The continual loss of purchasing power in fiat currencies since gold backing was removed has rendered them unsuitable as a savings medium. Only gold retains sound-money attributes and is still valued as such in a number of populous nations. In fact, the naysayers who claim gold is no longer money are only a very small proportion of the world’s population, given the general public as a whole in the advanced nations have no definite view on the matter. It is a common error to assume neo-Keynesian economists speak for entire populations.

For ordinary people, gold will become an increasingly important refuge, given the prospect of an acceleration in monetary inflation as the world tips into recession. With government spending already out of control, governments are relaxing budget discipline even further while promising greater spending. Consequently, the monetary quality which will become more valued is the ability to preserve value and it is upon this quality that gold markets are beginning to place a premium.

That is why gold is being valued as a more stable form of money, despite the fact it is not commonly found in general circulation. However, in the growing certainty that fiat currencies will die, gold can and will rapidly return to circulate as money.

We can now address Stevenson’s unfounded presumptions.

Myth 2. Gold doesn’t pay interest

Only hoarded gold, like physical currency cash, does not pay interest. Gold is loaned and borrowed for interest, just like fiat currencies. When markets are acting freely without state interventions and distortions, gold should have a lower originary interest rate than a fiat currency for the same loan term, because it is no one’s liability, unlike a fiat currency. The originary rate is shorn of all loan risks other than a pure time-preference value.

Today’s bullion market sets gold’s interest rate in the context of dollar interest rates. In London’s forward market, gold’s interest rate is termed its lease rate, which is derived from the gold forward rate (GOFO) and the London dollar interbank offered rate. GOFO is the rate at which a bullion bank is prepared to lend gold to another bullion bank on a swap basis against US dollars. The notional formula is the gold lease rate equals LIBOR minus GOFO.

In the days of the gold standard, when currencies were accepted as gold substitutes, the originary interest rate was that of gold. While it was impossible to quantify, because actual loan rates depended on borrower risk, the originary rate, as described above, was set by time preference. Expressed as an annualised interest rate, gold’s originary rate was normally in the order of two or three per cent.

Compared with today’s unbacked currencies, gold’s interest rate was very stable, but it was not immune to changes in its purchasing power. There were some fluctuations in supply, such as those caused by the Californian and South African mining booms. The rate of technological progress, to the extent productivity was advanced, lowering the general level of prices over time was also an important factor, which meant that a saver would experience the purchasing power of savings increase. For this reason, savers were prepared over time to accept a lower rate of interest on gold than would otherwise be the case.

The modern mantra that gold does not pay interest is simply untrue.

Myth 3. Gold is expensive to store and insure

This is untrue. At Goldmoney, fully insured annual storage fees for gold in LBMA approved vaults range between 0.01% and 0.018%.[iii] ETFs and mutual funds charge far higher rates for management, administration and custody. There is ample margin for Fidelity to pay Goldmoney’s vaulting and insurance fees, and for Fidelity to enjoy a substantial mark-up within its existing fee structure. We won’t hold our breath.

Myth 4. Gold has no intrinsic value

From Wikipedia, the definition of intrinsic value is as follows:

“In finance, intrinsic value refers to the value of a company, stock, currency or product determined through fundamental analysis without reference to its market value. It is also frequently called fundamental value.”

It is clear from this definition that the financial concept of intrinsic value depends on the income stream generated by an asset. In the case of a currency, this can only relate to the interest it earns for a lender. Like a currency, gold pays interest on being loaned out, so it must have an intrinsic value.

The concept of intrinsic value applied to money is little more than a red herring. But if we are to pursue it, we should observe that the suppression of interest rates reduces the intrinsic value of a currency, that zero interest rates remove it altogether, and negative rates give rise to negative intrinsic values.

On this basis, gold will always have an intrinsic value, while unbacked currencies in the current financial climate often do not. Gold clearly wins over today’s currencies on this basis.

Myth 5. Gold has no real use beyond looking pretty

We can all agree gold looks pretty. But it is also incredibly durable. Gold’s physical qualities and its rarity have made it the money of choice for diverse people and their cultures throughout the long history of mankind’s economic cooperation.

For Stevenson to imply that gold is only ornamental infers that the marginal price of gold is set by its supply and demand for that function. This is not the case. Gold is demanded in Asia for its property as a readily realisable store of value. It is a mistake to think diverse Asian communities, including the poorest in society, waste significant sums of their governments’ currencies on the frivolous function of making their women look pretty.

To have one’s accumulated wealth held beyond the control of government has proved to be a wise decision for the middle and lower classes in populous countries such as India, as well as all the other nations between Turkey and Indonesia inclusively. An Indian has seen the price of gold increase from under 200 rupees when Bretton Woods failed to nearly 100,000 rupees today. It is not so much a rise in the price of gold; rather it is a measure of the loss of purchasing power of the rupee. In Asia, where half the world’s savers reside, gold is the basis of a wise man’s family pension fund. Lack of gold ownership could be his western equivalent’s folly.

Clearly, gold is much more than a bauble upon which rupees and rupiah are continually wasted by ignorant natives. And if it is only pretty, why is it that central banks are adding to their gold reserves at a record pace?

Myth 6. Gold is volatile

This observation is in the same category as that which states the sun rises in the morning and sets in the evening. It appears to be true, but it is the result of the earth’s own rotation, not the sun rotating round the earth. Those that say gold is volatile subscribe to a flat-earth fallacy that ignores the volatility that arises from currencies.

Measured in dollars, in 1971 the price of a barrel of oil was $3.60. At that time, the official gold price, before gold backing for the dollar was suspended in August that year, was $42.22, which meant oil was priced at 0.085 ounces of gold. Today, the oil price is $57, an increase in the dollar price of nearly fifteen times. Measured in gold, the price is 0.04 ounces, roughly half the price in 1971.

Energy, typically measured by the price of oil, is the most important of all commodities to human life. The price in gold-ounces is demonstrably more stable than the price in dollars. Clearly, the volatility is in the currency and all the other currencies that defer to it, not gold.

Myth 7. It’s a greater-fool investment

That gold is a greater-fool investment, requiring another buyer to believe it is going higher, is surely the most preposterous statement for any investment manager to make. The whole basis of equity investment and dealing in derivative markets is just that. With this statement, Stevenson has defined his own company’s stock in trade. Every investment, putting aside bonds held to maturity, requires an exit strategy. If Stevenson and his colleagues apportion equities into their clients’ portfolios without one, they would have good cause to remove their funds and seek a manager who at least looks before he leaps.

With respect to gold, nothing is further from the truth, which is why it is so important to understand that at its most fundamental level gold is money and not an investment to be traded. You can trade it of course, but the ultimate purpose of owning gold is to spend it.

Myth 8. Gold’s value was higher 40 years ago in real terms

Besides being highly selective with his timing to make his point, Stevenson’s statement that gold has failed to keep pace with inflation over the last forty years is presumably made to emphasise gold is a disappointing investment. As an investment, it therefore must be under-priced, given gold is widely recognised to be a hedge against paper currencies losing purchasing power.

Stevenson’s approach is to only wrongly view gold as an investment, when in fact it is money. It is in the same category as uninvested cash, though with its own special sound-money characteristics. It is intended to be spent, not to be compared with financial assets. But as cash, it has retained purchasing power, which is more than can be said for the dollar. Since the Bretton Woods Agreement was terminated in August 1971 by President Nixon, the dollar has lost 97% of its purchasing power measured against gold.

If gold has produced a bad return for a dollar portfolio, one wonders what Stevenson thinks is a good one. To be fair, the performance of the S&P 500 Index gets close.

At the end of the same month the Bretton Woods Agreement was suspended, the S&P 500 Index stood at 97.24. Today it stands at 3,000. Therefore, the S&P500 has risen 30 times, while over the same period gold has risen nearly 33 times. Ignoring dividends, dealing costs to constantly rebalance the S&P index and the interest earned on gold, the performance is remarkably similar. But that is before considering the increased risk factors facing equities today, factors which are enormously positive for gold.

There is growing evidence of a developing global recession and a US slowdown. On the eve of these enhanced investment risks, the upside for the S&P500 seems limited at best, while there is a growing likelihood of an equity bear market developing. At the same time, the loosening of the Fed’s monetary policy clearly boosts prospects for the gold price.

- Source, James Turk's Goldmoney