The big news this week is that Donald Trump was elected to
be the next president of the United States. Whether due to his comments about
restructuring the government debt, tariffs on imported goods, or other economic
concerns, many expected news of his election to push up the price of gold.
They were wrong.
Every day since last Friday (November 4) has seen the price
of gold falling. From a peak of over $1308, the price fell to $1227 on Friday.
There was a rally from $1269 to $1337 on the evening of
election day, from 8pm to midnight in New York. This is roughly the time when election
results began to trickle in and show that Trump was going to win. At the same
time, the stock market tanked. S&P futures fell from 2150 to 2028, or
-5.7%. Volume was off-the-charts high for US evening time.
But then what passes for normal took hold once again. The
price of gold resumed its slide. The stock market recovered.
One thing is for sure. The price of gold does not go up for
the reasons supposed by most gold bugs. Any more than it goes down for the
reasons given by the propaganda of the paper bugs.
There is something else going on that could drive the gold
price up. I refer to the new Indian policy of demonetizing larger-denomination
cash (500- and 1000-rupee notes, worth $7.40 and $14.80—i.e. not so large). So
many Indians rushed out to buy gold that credible sources report a temporary
20% spike in the rupee-price of gold.
We doubt that Prime Minister Modi can force many Indian cash
holders to increase their bank balances. However, he could push the marginal
cash holder to increase his holdings of gold. If that proves to be durable,
that could drive the price of gold up substantially. This situation with cash and
gold in India needs to be watched.
The price of silver took a big dive on Friday, ending down a
buck twenty. Yes a buck twenty, as in -6.4% (the low of the day was 15 cents
lower).
The question is: what did the election do to the
fundamentals? Are people now stacking silver bars and gold coins, who had not
been doing it before the election? Or is this price move just more noise that
will be lost in a month, much less over the long term?
We will give a teaser. Something changed in the market this
week.
We will update the pictures of the gold and silver
fundamentals below, and show our first-ever intraday basis charts. But first, here’s
the graph of the metals’ prices.
The Prices of Gold and Silver
Next, this is a graph of the gold price measured in silver,
otherwise known as the gold to silver ratio. It rose this week, how could it
not with the big price move in silver?
The Ratio of the Gold Price to the Silver Price
For each metal, we
will look at a graph of the basis and cobasis overlaid with the price of the
dollar in terms of the respective metal. It will make it easier to provide
brief commentary. The dollar will be represented in green, the basis in blue
and cobasis in red.
Here is the gold graph.
The Gold Basis and Cobasis and the Dollar Price
And now we see or old friend, who has been absent for a
while. Backwardation. The cobasis is over +0.3% (30 bps).
We admit that we have a conundrum. We are not quite sure how
to handle Friday. In the US, Friday was a bank holiday Veteran’s Day. The
Treasury bond market was closed, as were the banks. However, the stock market
was open as was the gold futures market. And there was high volume (the third
highest day of the year, after Thursday and June 27).
We are including Friday.
Friday had a big price move in gold, with the dollar up
almost 2/3 of a milligram gold (muggles will see this as gold going down -$32).
Last week, we said:
“Are we predicting a crash, much
less on Monday morning (as we write this, the price of gold is down in Asian trading
by $11)? No, but we are saying gold is not looking like a good value here. If
you don’t have any, then there is never a bad time to buy. But if you’re
trading a position, we could think of better times to buy than now. Maybe now
(especially at Friday’s price over $1,300) might be a good time to consider
selling a covered call.”
That was then and there (a week and 76 bucks ago).
And something else changed. The fundamentals got stronger.
Unless this turns out to be an anomaly due to the bank holiday and the absence
of some market makers, the fundamentals are stronger now than they have been in
quite some time.
We calculate a fundamental price of over $1310.
We will take a look at intraday basis charts for gold and
silver, below.
Now let’s look at silver.
The Silver Basis and Cobasis and the Dollar Price
The same thing happened in silver. And unlike last week, it
occurred across all contracts. Falling basis (abundance) and rising cobasis
(scarcity). ‘Course, in silver, the price drop was epic, much bigger than in
gold.
We calculate a fundamental price of just over $17. So, like
with gold, we had buying of physical metal and selling of futures.
Many times over the years, we have seen reports of a big
paper flush amidst strong physical demand. We have debunked several of them,
and dismissed the rest.
What happened on Friday was different than those other events.
Here are intraday graphs showing basis and price (the cobasis moved pretty much
inverse to basis so not included to keep the graph as readable as possible).
Intraday Gold Basis and Price
From just before 13:30 (London time, or 90 minutes before
the PM gold fix), the basis begins falling. The basis is the spread of futures
– spot. So futures begin selling off before even the price begins to decline.
Shortly after 2pm, the price of gold is still holding at $1259, but the basis
is already dropping. And boy does it drop, to a trough of -64bps. From there
on, the basis recovers somewhat.
We have annotated the graph to highlight three distinct
phases. In the first phase, it is simply selling, driven by selling of futures.
How do we know? First, the basis begins to fall before the price. Of course,
the fact that the price begins to fall while the basis continues to fall proves
it. It is simple enough, lots of traders
sold gold futures and the price fell around $30 initially.
The second phase is more interesting from a market theory
point of view. Here we see the basis rising, and it’s a pretty big move up from
a low of -64bps to -38bps—just about a 2/3 retracement of the original drop.
However, the price is sideways to positive. The basis is changing but the price
is not. In other words, the spread between futures and spot is compressing
(basis is
negative here, so rising
value means
tighter).
What this means is simple. For an hour and a half, the
panicky herd of speculators stampeded at will. After that, the market makers
were able to reassert some control. No, not over price but of spread! The
market makers did not manipulate the price of gold up or keep it from falling.
They began to
decarry gold, that is
sell spot and buy futures. This pushes down the bid price on spot, and pushes
up the offer price on the futures contract.
Why would they decarry? To take profits, of course! In
recent months, the profit on offer to
carry
gold has been very high. This has tempted many arbitrageurs to exploit the
opportunity: by buying a bar of metal and simultaneously selling a futures
contract. They are long metal and short a future.
When the basis drops, that provides an opportunity to close
the position and make more than one would have made by holding to maturity. For
example, suppose you put on this trade on June 27. You locked in a profit of
1.45% on your investment (in dollars, of course). Ever since then, the basis
has been declining. Now the basis hit a low of -0.64b%. At that moment, the
cobasis was +0.44%. So you could close your trade a month and a half early, and
add 44 bps to your profit.
And after this, in the third phase, the basis goes sideways
while the price falls another $13. In this phase, the arbitrageurs are still
decarrying. What’s our evidence for this? The price is moving down, which means
lots of selling again. But in this phase, the arbitrageurs are keeping up. They
are decarrying as fast as speculators are selling.
As we have described in many past Reports, while basis is
rising the marginal demand for metal is to go into the warehouse. It feeds the
gold carry trade. We emphasize that when this builds up, it’s dangerous because
the marginal demand can abruptly turn off and a new marginal supply come
online. A high basis cannot predict the timing, but it can tell you that the
market is ripe for a drop the way a
supersaturated solution is
ripe for a precipitation
. They have seen their opportunity to profit, and
are reluctant to keep holding their positions and risk the basis continuing to
rise.
Intraday Silver Basis and Price
We did not mark up the silver chart. It is interesting that
the basis correlates more highly with the price. Or, in other words, while the
selling pressure in gold largely abated, it continued in silver. The total drop
in the Dec silver basis was nearly 100bps.
If you had carried silver on August 10, you could have
locked in a profit of 156bps. If you decarried it on Friday, you could have
added another 95bps.
If gold was in a supersaturated solution, then silver was in
a superdupersaturated solution.
It will be interesting to see this week, if the arbitrageurs
can catch up in silver and we see a rising basis. And if the elevated silver
fundamental price of $17.08 holds.
It is also possible that some market makers were off on
holiday on this Veteran’s Day.
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Keith Weiner is CEO of Monetary Metals, a
precious metals fund company in Scottsdale, Arizona. He 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. He is founder of DiamondWare, a software
company sold to Nortel in 2008, and he currently serves as president of
the Gold Standard Institute USA.
Weiner attended university at Rensselaer
Polytechnic Institute, and earned his PhD at the New Austrian School of
Economics. He blogs about gold and the dollar, and his articles appear
on Zero Hedge, Kitco, and other leading sites. As a leading authority
and advocate for rational monetary policy, he has appeared on financial
television, The Peter Schiff Show and as a speaker at FreedomFest. He
lives with his wife near Phoenix, Arizona.
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