ATLANTA (ResourceInvestor.com) -- All over North America coin and bullion dealers face a frustrating and difficult challenge. They have customers who want to buy gold and silver bullion items, lots of customers right now, but they are finding it very difficult to obtain the popular bullion items their customers really want. Consequently, the real physical metal bullion market is responding the only way it can in the condition of too much demand for available supply. The physical market is responding with much higher, near record premiums.
Premiums are the amount charged and paid by dealers over the prevailing spot or cash price of bullion.
Why the divergence in prices between the COMEX and physical markets?
Many analysts and market watchers have concluded that the absurd circumstance of plunging, artificially low spot bullion prices contemporaneous with extremely high demand seeking a very limited physical supply is a consequence of direct government intervention into the free markets. The most egregious example of that intervention occurred in July, the period BMO's Donald Coxe called the "July Massacre," covered in an October 27 .
Just about anyone could well ask the question, how can spot prices be plunging when there isn't any metal to be had at these prices? Aren't the free markets supposed to answer to the physical markets?
Fact is, that physical metal is available at the spot prices, but only directly from the exchanges themselves as covered in a special Got Gold Report on . That's for investors who wish to put away at least 100 ounces of gold or 5,000 ounces of silver. However inconvenient, investors are able to actually buy futures contracts (at spot) and then demand delivery of them, but not until December. So, in a very real sense, the shortages of physical metal on the street today are for the smaller, more popular forms of gold and silver bullion. Just below we'll take a look at just how those shortages have resulted in extremely high premiums for some of the most popular bullion products in some startling graphs, but first let's look at one reason why.
Who said it was supposed to be fair?
At the moment the main issue is that the futures markets, which trade paper contracts for the future delivery of large amounts of gold and silver, have seen an exodus of speculative buying pressure giving a very small number of very large hedgers and short sellers superhuman strength to drive spot prices lower despite the extraordinary popular demand for the metal on the street.
For example, as reported by the Commodities Futures Trading Commission (CFTC) Bank Participation in Futures Markets Report on November 4, just 3 U.S. banks held a gigantic portion of all the commercial net short positioning on the COMEX, division of NYMEX.
According to that CFTC report, the three U.S. banks held a net short position of 38,949 contracts in gold futures. All traders classed as commercial held 76,406 contracts net short on November 4 with gold then at $763.39, so the three U.S. banks collectively held a staggering 50.98% of all commercial net short positions on the COMEX.
One could rightly suppose that if any one entity had such a large short position they might well be tempted to defend it. (Others might say they have no choice but to defend it.) The way to defend a large short position is to keep downward pressure on the commodity. There are very few entities that have the horsepower to achieve such trading dominance, but the three U.S. banks in question apparently do have that power.
As shocking and infuriating as that potentially illegal positioning in gold futures appears, it pales in comparison to the banks' positioning in silver on the COMEX.
Again, as of November 4, just two U.S. banks held 22,684 contracts net short in silver. All traders classed as commercial by the CFTC held a collective net short position of 27,908 contracts with silver then at $10.20 the ounce. So, just two big U.S. banks held a gargantuan 81.28% of all the collective commercial net short positioning on the COMEX, division of NYMEX.
It is not even fair to call the two U.S. banks position a "net short" position. The banks were so certain that they could drive the futures price of silver lower on November 4, that they did not hold a single long contract for silver then. No wonder silver has since tested as low as the $8.40s on the cash market.
No, that's not fair at all, but it apparently is fine with today's regulators at the Commodities Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC).
When there is a government-allowed imbalance in the futures markets in the strength of the opposing forces of speculators versus hedgers and short sellers, (between buy and sell), such as now, it can cause the normal price discovery purposes of the exchange to become dysfunctional for a time.
Hedgers take positions in futures markets to offset corresponding opposite positions in other markets in order to protect against adverse price movement. Short sellers profit if the price falls.
Pressure building for change
Chris Powell, of the Gold Anti-Trust Action Committee (GATA) kicked off the very important New Orleans Investment Conference this week with a broadside against the continued dominance of the futures market by a few, very powerful and sinister forces. In his comments, published on the GATA website, Powell summed up the current status thusly:
"With infinite legal tender and derivatives you can push the futures price of a commodity below its production costs and below its free-market price for a while, but you risk causing shortages. And of course that's what we have in gold and silver right now -- falling prices for the paper promises of metal even as little real metal is to be had and the spread between the futures price and the real price grows."
This report believes that the lack of speculative long buying pressure from shell shocked futures traders may have temporarily given the two or three big U.S. banks holding enormously large short positions the edge to drive down bullion prices with impunity since July, but that situation will eventually reverse itself. Either speculative buying interest will return to the futures markets with enough force to overwhelm the dominant, but increasingly isolated short sellers, or else the exchanges will lose so much of the underlying physical metal from their warehouses to the physical market to convince them that prices have gone awry.
Goodness, look at the gold and silver premiums
In the last we promised a new service which tracks the premiums being charged and paid by dealers on a few very popular bullion items. We decided to concentrate on four of the most popular bullion items, 1-ounce U.S. gold eagles, 1-ounce South African krugerrands, 1-ounce U.S. silver eagles and $1,000 face value bags of 90% silver old U.S. coins.
We looked for a consistently reliable source for tracking purposes and considered several options. In the end we settled on information published in the Coin Dealer Newsletter (CDN), a very respected and widely used source by the coin and bullion industry. Published weekly in paper form and on the web, just about every coin and bullion dealer subscribes to the "Grey Sheet" as it is known in the trade.
Using the weekly quotes for dealer to dealer transactions, below is what has been happening in the real physical bullion markets according to the most respected pricing voice of the industry, the CDN. The charts below all cover a 3-year period using the last week of each month.
First up is the chart for 1-ounce U.S. gold eagles.
For most of 2007 the premiums charged by dealers over spot for gold eagles stayed under $15. By the end of October CDN reported that gold eagles were fetching $46.50 over spot gold of $741.70.
Next let's look at 1-ounce gold South African krugerrands.
According to CDN, by the last week of October, K-rands commanded a $35 dealer to dealer premium, up hugely from its near-constant minimum premium of around $3 for most of 2007.
Next up is 1-ounce U.S. silver eagles, possibly the most popular U.S. bullion coin.
Remember, these are dealer to dealer premiums being quoted. According to CDN, On October 31 the premium between dealers for U.S. silver eagles popped up from $1.25 over spot in July to $4.15 over. That was with silver at $9.20.
Finally, probably the most versatile and useful of all the bullion products, 90% silver U.S. coins in $1,000 bags. Often called "junk silver coins" by dealers, these old silver U.S. dimes, quarters and half dollars are anything but junk. They are 90% silver and 10% cooper and each bag is priced as though it contains 715 ounces of pure silver. The investor gets the copper for free. (They usually contain a fraction of an ounce more silver.)
Bags of 90% offer more versatility than most other bullion products. They are easily divisible into smaller dollar amounts, they are actual coins that can never go below their face value amount no matter what happens to the price of silver and they are very difficult and inconvenient to counterfeit. This item remains this report's favorite silver bullion item.
Bags of 90% silver were in such high demand as silver fell so far down in price, that between July and October the dealer to dealer premium skied from a discount of $0.67 the ounce of silver all the way up to a $3.81 premium the ounce with silver at $9.20.
That's a 41% premium over spot.
In some respects these charts will understate the actual premiums being charged to consumers, because they are dealer to dealer pricing as reported by CDN. Dealers typically have to charge more than the premiums shown in order to earn a profit.
Lest anyone thinks these high premiums are purely academic or somehow unreal, consider this comment from Bill Haynes, a 35-year coin and bullion veteran who runs CMI Gold and Silver based in Arizona. Bill checked in via email, and among other things he remarked: "Tomorrow, I will inform my clients that we have 15 bags of junk 90% silver coins for sale at $4.00/oz over spot. They will be the first bags we've have in months, and they will be gone before the end of the day."
We can conclude that the premiums are quite real.
High premiums are temporary
Sonny Toupard, another long time coin and bullion veteran who runs Royal Coin in Houston, said in emailed comments Saturday that he has seen premiums easing since last week, "but not by much." Importantly premiums were higher last week than they were the last week of October in the above bullion premium charts. "The last 1 oz American Gold Eagles I ordered I had to pay $66 over spot on a three week delivery! Supply is really low," added Toupard. (In October the CDN reported the premium at $46.50 over spot dealer to dealer.)
The harsh drop in the paper futures silver market since July (spot silver fell from $19 to under $9) has affected the pricing of physical silver on the street, but over the last couple months, as the spot prices reflected a lack of speculative demand in the futures markets and superior fire power by short sellers, the physical market has quit listening or reacting to it. Most think the physical market, not the futures market, is pricing more along the lines of real supply and demand.
As mentioned in the last , this divergence between the real physical markets and the paper futures markets is causing physical metal to flow away from the futures markets warehouses and into the physical market and is strongly increasing demand for silver and gold ETFs.
Eventually, however, a combination of forces will bring the very high premiums back in to more normal levels once the markets stabilize. One of those forces will be increased scrutiny which is coming to the futures industry. Whether they like it or not, they have asked for it.
The abusive actions taken by a small number of very large and well funded banks have now destroyed a good many companies, shuttered a large number of mines and guaranteed that there will be widespread shortages of physical metal as we go forward. Hopefully, that will put the spotlight on the very unfair and one-sided rules the futures markets currently employ and allow for more equal footing for all investors in the months and years to come. We'll undoubtedly have more about that in future reports.
Very high, black market style premiums are unsustainable for long periods of time. Sooner or later speculative demand will return to the futures markets, and probably will sooner rather than later. Right now people are still very worried and uncertain about the very near term future, but we already know that shortages are coming. They are here already in the physical markets. If we know, so do those who trade metals futures. They'll be back, but in the mean time there are other indications that the futures and OTC markets need to consider right now.
Some companies get it right
For example, some companies have begun bypassing the futures markets by directly producing and selling bullion items to the public. In a November 14 press release, First Majestic Silver Corp. [FR.TO] said:
"The Company is continuing to analyze various options to reduce its operating costs and to squeeze out the most optimum margins possible. One example which is proving to add substantial value is management decided to mint 99.9% pure silver into coins, ingots and bars which are actively marketed on the Company's web site. Interest levels for these products are extremely high and are beginning to represent substantial revenues for the Company. These products tend to sell at substantial premiums to COMEX spot prices. It is anticipated that these sales of refined silver products will represent approximately 10% of the Company's silver production by February 2009. The Company is also exploring other ways of selling its silver outside of the normal avenues of commercial sales."
Bully for First Majstic. It's about time we see a company take the bull by the horns to step outside the corrupt, and manipulated established market that has so mispriced a vital commodity. With such a huge disparity between the futures-dominated spot price and the real physical silver markets, it is no wonder that physical silver is flying out the COMEX doors and into the physical market.
That's something we need to see more of. Companies refusing to accept overly low pricing by paper traders. We need to see more of the Big Dogs in the metals biz holding back production, buying metal off the miscreant futures markets to deliver into December commitments in large quantities and removing metal from those who don't respect it in favor of the popular physical markets where people do respect it.
One more time, if the hedger and short seller dominated futures markets are so intent on driving prices for metals to absurdly low levels then they shouldn't mind seeing the metal in their warehouses heading out the door to the physical markets that actually want it.
Got gold report charts
- 1-year daily gold
- 2-year weekly gold
- 1-year daily silver
- 2-year weekly silver
- 3-year weekly HUI
- 2-year weekly Gold:HUI ratio
- 2-year weekly U.S. dollar index
That's it for this special Got Gold Report. Until next time, as always MIND YOUR STOPS.
The above contains opinion and commentary of the author. Each person should study the issues carefully and, as always, make their own informed decisions. Disclosure: The author currently holds a long position in iShares Silver Trust, net long SPDR Gold Shares and holds various long positions in mining and exploration companies.
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