This was excerpted from the Weekly Review of June 29, 2013 -
The cornerstone of the free market system is the law of supply and demand. This is the premise that governs how the prices of resources are determined in any free market economy as opposed to prices being set by government edict or monopoly control. It is the mechanism by which resources are produced and consumed in the freest and most efficient manner. Here’s a great definition of this law from the Free Dictionary – “the theory that prices are determined by the interaction of supply and demand: an increase in supply will lower prices if not accompanied by increased demand, and an increase in demand will raise prices unless accompanied by increased supply.”
http://www.thefreedictionary.com/law+of+supply+and+demand
There are three components to the law – supply, demand and price. Price serves as the fulcrum between supply and demand, balancing the two. But the important point is that the interplay between supply and demand is what determines the price. That’s elementary and spelled out in the above definition; a free market price means the price is determined by supply and demand. This is the definition we expect our children learn in school. Unfortunately, this definition is old-fashioned and no longer operative in gold and silver and other commodities. Instead a new definition of the law of supply and demand has supplanted the version still in the dictionary.
Simply put, the new law of supply and demand has the price determining supply and demand and not vice-versa as it should be. This may sound like a game of words at first blush, but it goes to the heart of the matter. When price determines how much is produced and consumed, instead of supply and demand being the determinant of price, that’s just another way of describing price manipulation. All our laws against manipulation and the restraint of free trade are aimed at preventing an artificial price from coming into existence. That’s because it is well-known that an artificial price will adversely impact production and consumption and cause overall harm to society. An artificial high price must lead to over-production and under-consumption and an eventual price crash, while an artificial low price must result in an eventual shortage and price explosion.
There is undeniable proof that the recent price action on the COMEX in gold and silver is the new and manipulative version of the law and supply and demand. There was no big increase in production or weakening of demand for gold or silver leading to sharply lower prices; instead the price decline, due to speculative selling of futures contracts, is determining what will be produced and consumed in the future. Speculative selling on the COMEX has resulted in prices low enough to threaten mine production and encourage increased demand (especially investment demand).
Think of how crazy that is – speculators on the COMEX are dictating what amounts real producers and consumers will make or use. Far from being a matter of semantics, this goes to the spirit of the law of supply and demand. It’s just that we’ve come to accept it. Worse, since our regulated futures markets were created for the purpose of allowing legitimate hedging and there is little to no actual hedging occurring (who hedges production below the cost of production?), this is a double-whammy for legitimate producers; not only do they have no input in the price determination process as they should, but they are also are damaged by it. Futures markets are supposed to “discover” prices following the worldwide interplay between real producers and consumers, not dictate prices to those same real world market participants.
Let me give you two real world examples of the impact of the price being set on the COMEX. If the prices of gold and silver stay at the level where they closed yesterday, the largest gold miner in the world, Barrick Gold, won’t be producing at a profit and Pan American Silver, an important primary silver producer, will start reporting losses. Let me be careful to point out that I am not predicting future earnings or losses (as I don’t do that). What I am doing is taking each company’s first quarter earnings report and adjusting revenue by the price of metals today versus the prices actually received in the first quarter. Barrick reported profits of close to $850 million in the first quarter on production of 1.8 million oz of gold sold at $1630. Pan American reported net profits of $20 million on production of 6.3 million oz of silver sold at $30.11 and 32,000 oz of gold sold at $1630. If you do the math, Barrick’s first quarter profit will all but disappear at with gold near $1200 and Pan American will be deeply in the red should silver and gold prices remain as low as they have been. The great irony here is that these two mining companies have been vocal in the past about there not being a price manipulation in gold and silver.
Please don’t misinterpret what I am saying. I am not saying gold and silver prices will remain here or go lower; I have been stating the opposite (and have been wrong to date). What I am saying is that it is crazy (and illegal) for speculators on the COMEX to be establishing prices that will cause great harm to legitimate producers. The COMEX has bastardized and turned upside down the law of supply and demand and all the owner of the COMEX, the CME Group, does about it is announce trading volume records. All the CFTC does is waste valuable and limited resources on pointless lawsuits with a political agenda (against Jon Corzine).
The reason I bring up this new and distorted version of the law of supply and demand is that it confirms and verifies everything I have alleged about silver being manipulated for the past 30 years. Again, with a straight face, I’d like to see someone explain how the mining industry is in trouble due to any overproduction on its part of gold and silver. I’d like to see someone deny how the price of the resource is not the most important factor for any producer and how the crooks at the COMEX are not setting the price.
I have no expectation that anything will change, but that doesn’t mean we shouldn’t at least understand what’s really going on with gold and silver prices. I can’t see how it would be better to remain unaware of what’s responsible for the low prices and why the miners are suffering. Who wants to live in the dark? Actually, as upside down as the price setting process has become, because of it the prospects for sharply higher prices now looms large.
Yes, it has been excessive speculative selling on the COMEX that is responsible for the lower prices, with all its effects (ETF liquidation and miner suffering), but it is also obvious that those selling have been tricked into selling by the crooks at JPMorgan and others, so that the crooks could buy. And buy they did as I and many others have detailed each week when the COT reports are published. And this has led to the extraordinary bullish set up in place.
It seems foolish to keep talking about a pending price explosion as prices sink further, but I have no choice based upon the facts. I can’t guarantee what will happen, but I can point out the possibilities. The big speculative selling on the COMEX and elsewhere has been a self-reinforcing process to the downside, namely, low prices beget lower prices in a vicious cycle. The selling that has been short selling, in particular, represents open transactions; meaning the sales must be closed out at some point, either by delivery or a buy back. Forget delivery as that is not remotely possible by speculators in the normal course of business. Effectively, that means all the speculative short sales must be bought back at some point.
If you accept my contention that gold and silver prices have been smashed lower due to speculative selling (and not overproduction by real world producers), including a large amount of short sales that must be bought back, then it is reasonable to assume what caused prices to fall will also cause prices to rally. The same selling force responsible for falling prices must be responsible for rising prices when the force is reversed from selling to buying. In fact, the actual measurement of that force will be determined by how quickly the short sales are bought back versus how much time it took to sell them originally. By my observation it has taken about five months (so far) to accomplish all the speculative selling. (If I had to pick one date, it would be Feb 5). Over that time gold prices have fallen by more than $400 and silver by more than $13.
All things being equal (and I know they never are), if an equal amount of buying came in over the next 5 months (assuming we’ve seen the bottom), gold and silver prices could be expected to climb by the amount they have fallen. If the buying occurred over a longer period of time, it would take longer for prices to recover. However (and this is my point), if the buying were condensed into a much shorter time frame, the price would recover much quicker. That’s the likely outcome, as I see it.
Speculative short sales are special in that they tend to be bought back quicker on price rises than any other type of buying transaction. That’s because there is no limit to how high prices can rise, whereas prices can’t go below zero. Shorts get real nervous when prices start to rise. If we rise enough in gold and silver (and we will rise enough in time), the tempo of buying back short sales will increase, which in turn will cause prices to rise even further. Considering who the sellers will be at that point (think JPMorgan and other commercials) it’s highly possible the speculative shorts buying back will be forced to pay enormously higher prices.
Of course, I can’t guarantee this is what will occur, but I’d be negligent not to outline what I feel could occur. If prices stay or go lower, we’ve only begun to see the damage to real world producers due to the perversion of the law of supply and demand. If prices go higher, the possibility of an explosion exists like never before.
Ted Butler
July 5, 2013
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