Consider the sport of betting on the sport of horse racing. It’s actually
similar to the analysis of the gold and silver markets. How’s that?
First, there is the manic-depressive crowd. Sometimes (as we are told—we
don’t hang out at race tracks) the bettors sometimes get overly excited about
a horse with slim chances to win, or get totally unexcited about a strong
horse. The track responds by lowering or raising the payout for winning,
respectively. The more betting on a horse, the lower the payout.
The track does not care which horse is likely to win or not win. What it
wants to do is take its rake from the total bets placed. It does this by making
a spread between what it takes in on all the horses, and what it will have to
pay out if any given horse wins. We don’t know the precise formula, but if
horse X gets ¼ of the total bets then the payout if X wins had better be less
than 4:1.
In keeping with our theme of emphasizing spread rather than price, there
is a spread that smart bettors should be paying attention to. A smart horse
bettor should have a way of assessing the probability of X winning (and for
every other horse in the race). He should bet when the payout is higher than
the probability of winning. Suppose in the frenzy of betting on X, almost no
one bets on Y. So Y pays 10:1. If a bettor assesses Y’s odds as 5:1, it’s a
good bet. Yes, the horse is not probable to win. However, the payout is
greater than the odds. Given enough bets with 5:1 odds and 10;1 payouts, a
bettor will win in the long run.
We admit to not knowing much about betting at racetracks. There may be
lots of reasons why this scheme is not practical (not least of which is being
accurate in assessing odds for each horse). That’s not the point, and we
certainly don’t recommend anyone to start betting on horse racing.
The point is that the “house” focuses on spread. Sophisticated operators
focus on spread. You should focus on spread too.
Mainstream analysis often dismiss gold as having no value, on grounds that
they know not how to assess it. Gold bugs often like to divide some measure
of the quantity of dollars by some measure of the quantity of gold to get an
intrinsic value. This exercise in arithmetic usually shows that gold is
massively underpriced.
Both approaches are equally wrong.
The fact is that virtually all of the gold mined over the millennia is
still in human hands. The proportion for silver is lower, but still orders
and orders of magnitude greater than that of any other commodity. This means
that the people on this planet do value gold and silver, without much regard
to quantity already held. The value they place on the metals can be measured
at the margin. How?
By studying spreads.
We can theorize that people will value gold and silver more highly (i.e.
value the dollar at a much lower level). But that is not a measurement of the
current market reality. It is speculation. Perhaps smart speculation. It may
even be based on sound economics. But it’s nothing to do with the current
market and supply and demand conditions within it.
…
Monday was a holiday in the US (Labor Day), so it was a short week.
The prices of the metals went down, with the gold move slightly larger
than the silver. Yes, but what happened to the spreads of the metals this
week? Read on…
First, here is the graph of the metals’ prices.
The Prices of Gold and Silver
We are interested in the changing equilibrium created when some market
participants are accumulating hoards and others are dishoarding. Of course,
what makes it exciting is that speculators can (temporarily) exaggerate or
fight against the trend. The speculators are often acting on rumors,
technical analysis, or partial data about flows into or out of one corner of
the market. That kind of information can’t tell them whether the globe, on
net, is hoarding or dishoarding.
One could point out that gold does not, on net, go into or out of
anything. Yes, that is true. But it can come out of hoards and into carry
trades. That is what we study. The gold basis tells us about this dynamic.
Conventional techniques for analyzing supply and demand are
inapplicable to gold and silver, because the monetary metals have such high
inventories. In normal commodities, inventories divided by annual production
(stocks to flows) can be measured in months. The world just does not keep
much inventory in wheat or oil.
With gold and silver, stocks to flows is measured in decades. Every
ounce of those massive stockpiles is potential supply. Everyone on the planet
is potential demand. At the right price, and under the right conditions.
Looking at incremental changes in mine output or electronic manufacturing is
not helpful to predict the future prices of the metals. For an introduction
and guide to our concepts and theory, click here.
Next, this is a graph of the gold price measured in silver, otherwise
known as the gold to silver ratio. The ratio moved down again this week. Is
it bouncing off support, or just correcting before it goes higher? Read on…
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
The price of the dollar rose slightly, but the scarcity (i.e. cobasis) of
gold backed off slightly. At least for the October contract.
The fundamental price did not move much. It’s still over $1,270.
Now let’s look at silver.
The Silver Basis and Cobasis and the Dollar Price
While the price of the dollar went up (i.e. the price of silver, measured
in dollars went down) the scarcity rose.
The silver fundamental price rose, and is now about a dollar over the
market price.
The fundamental ratio moved down slightly, but is still over 80.
Monetary Metals may sponsor an event in London in early October, and
another in Sydney in late October, to discuss economics and markets, with a
focus on how to approach saving, investing, and speculating. Please let us
know if you may be interested in attending either one here.
© 2015 Monetary
Metals
