Bullion drop sparks shortages

October 12, 2016
Pat Heller

Last week, the price of gold dropped almost five percent, silver was down almost 10 percent, platinum fell nearly seven percent, and palladium was off close to eight percent. Are precious metals crashing?

Yet, at last Friday’s closes, gold’s price was up almost 18 percent year-to-date, while silver had climbed more than 25 percent. Platinum had risen almost eight percent thus far this year and palladium was up over 18 percent. If any other financial results had been that strong during the course of 2016, they would probably have been front page headline news. So, are precious metals soaring?

In my judgment, none of what happened in the precious metals markets last week made one bit of difference in the long-term outlook for prices. While I think platinum and palladium may do well in the coming few years, I am far more optimistic that gold and silver will outperform them and will also do better than the average stock, bond, or paper currency through the end of this decade.

Ultimately, it is physical supply and demand, tempered by changes in 1) above ground inventories, 2) economically recoverable underground reserves, and 3) technology developments that will determine equilibrium prices. These factors don’t change from day to day. Instead, it takes months or years for falling or rising prices to significantly impact the production of new supplies or alter investor and customer demand.

When you think about it, prices of precious metals are always defined in relation to something else. An ounce of gold or silver now will still be worth an ounce of gold or silver next week, next year, or next century. In a sense, the value of each of these metals doesn’t change. What does change is the value of competing monies, such as paper currencies.

The above year-to-date statistics compare the precious metals against the U.S. dollar. People in the United Kingdom have a different perspective. Through last Friday, the British pound had fallen close to 16 percent versus the U.S. dollar, so the price of gold as measured in that currency was up around 40 percent thus far in 2016!

There were no particular news developments Tuesday, Oct. 4, to explain why the price of gold fell by the greatest one-day dollar amount since June 20, 2013, and silver saw its worst performance since Jan. 20, 2015. The one-day percentage losses from the prior day COMEX closes were 3.3 percent for gold and 5.8 percent for silver.

Sometimes, markets can be randomly quirky like this, though rarely to this extent. If you dig beneath what was going on in precious metals markets that day, you will note some “interesting” developments.

• There was a significant quantity of short sales of gold contracts right before the British vote in late June to leave the European Union. When prices jumped upon learning the vote results, these short sellers were in a significant loss position. Prices would almost certainly have gone much higher but for the multiple-year high short positions in the gold futures markets. The same applied for silver, where open positions reached an all-time record level of more than one billion ounces. The decline in prices last Tuesday enabled many short-sellers to bail out without having to realize a loss.

• Within the first 30 minutes of trading on the COMEX about 3.2 million ounces of paper gold contracts were sold, putting downward pressure on the prices.

• As prices started to slide, some long positions were sold off when prices reached their stop-loss points. This pushed down prices further. Note that the companies selling the paper contracts to start the decline are pretty much the same firms that execute trade for the investors with long positions. What that means is that the short sellers know what price levels need to be reached to trigger stop-loss selling.

• After prices fell, the short sellers covered by buying back their short positions, thus locking in profits.

• The day of the sale was during China’s Golden Week, when almost no financial trading occurs in that country, the world’s largest gold consuming nation. This coordination was not an accident.

• The other precious metals declined in sympathy with the drop in gold, not because of any specific news for those particular elements.

When you put these factors together, it appears almost certain that the Oct. 4 price drop was a coordinated, well-planned manipulation of precious metals markets, not just random movements.

As of Tuesday this week, the Shanghai Gold Exchange was trading silver contracts at prices 60 to 90 cents per ounce higher than in the London or New York markets. How could that be? In Shanghai, almost all trading is for contracts where physical delivery is made immediately. In fact, sellers cannot even offer metal for sale on the SGE until the actual metal is received in the SGE vaults. London and New York markets, in contrast, are almost purely markets for trading paper contracts. Buyers and sellers invariably close out their positions before delivery is due.

Precious metals prices will never move in a straight line, even in overall boom or bust markets. This time will be no different.

Premiums on bullion-priced silver products are rising. Some spot shortages of products are developing. This is all part of the standard pattern after a significant price decline. If these shortages persist or get worse, expect the price of silver to recover sooner rather than later. This may turn out to be your last bargain buying opportunity.