Gold market report: producers going long silver

2013-JUN-28

Gold was hammered overnight in Asia on Wednesday, and on Thursday slid further to test the $1,200 level. If you adjust the gold price by the increase in aboveground stock and the expansion of US dollar money supply, gold in real terms is the same price as it was in 2006 – about $600/oz. During that time currency and systemic risk has also escalated from minimal to extremely dangerous. The combination of a gold price that has effectively halved and an increase in the reasons to buy it tell us that it is undervalued to a truly extraordinary degree.

No substantive reason for the most recent price slide has emerged, but presumably the bullion banks, which pass their dealing books around the world as it follows its diurnal course, took the view that restrictions on credit in China would dampen demand, and that the collapse in the rupee would make gold too expensive for Indians.

This is nonsense, because the Chinese do not usually buy gold on credit and the Indians buy to protect themselves from currency depreciation. While demand for physical metal has not maintained the blistering pace of mid-April, so far demand in China has remained strong and anecdotal reports are that it has picked up again this week. Early reports from India are that price premiums for gold are increasing and demand for silver has accelerated in response to government efforts to clamp down on gold sales.

At these prices, increasing numbers of gold mines are unprofitable, as evidenced by the appalling performance of their shares. While no mining company will readily admit to hedging given their embarrassing hedge losses two and three years ago, a look at the make-up of commercials on Comex, where the banks have managed to close their gold shorts, showed genuine producers and refiners increased their net shorts in May to about 66,000 contracts (6.6 million ounces). And who can blame them when a mine manager’s priority is to pay the bills?

This contrasts sharply with silver, where the non-bank commercials are net long by the equivalent of 113,400,000 ounces and stubbornly so, as shown in the chart above. The explanation is that manufacturers who depend on silver for industrial use are making sure they have stock at low prices, and there is nothing the bullion banks can do about it. At the same time mine supplies are often contracted forward to the bullion banks in off-market agreements, so are not reflected in Comex statistics. Attempts by the bullion banks to close their shorts by manipulating prices downwards will only increase genuine industrial demand.

The message here is very important. The large banks on Comex are long gold and short silver. Any further falls in the silver price will work to their disadvantage, because lower prices are stimulating real demand. However, the bullion banks appear to have had some limited success forcing speculators to close their long silver positions, as open interest fell by a large 7,892 contracts on Tuesday, reflecting 5,000 July contracts eliminated and not rolled forward, together with a sale of 1,339 December 2013 and 1,432 December 2014 contracts. To shake more longs out of the trees they will probably need the assistance of a margin hike.

Next week

A data-heavy Monday is followed by a relatively quiet week.

Monday: Eurozone Manufacturing PMI, Unemployment, HICP. Bank of England Mortgage Approvals, Net Consumer Credit, M4 Money Supply. US Construction Spending, ISM Manufacturing Index.

Tuesday: Eurozone PPI. US Factory Orders, Vehicle Sales.
Wednesday: Eurozone Composite PPI, Retail Trade. US Initial Claims, Trade Balance.
Thursday: Bank of England MPC Base Rate. Eurozone ECB Interest Rate.
Friday: Non-farm payrolls, Unemployment.

Author: Alasdair Macleod

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