Gold and Silver - where next after the crash?
At any one time, there can be more futures positions (in fact this is the case in any commodity) in existence relative to the underlying instruments deliverability. This doesn’t act as too much of a disproportionate influence on the price, though, as the very vast majority of futures contracts are in fact liquidated before settlement with very few going to delivery aside from the commercial hedgers. These futures contracts require very small amounts of margin — as little as 5% of the value of the commodity — to gain potentially large swings in the outcome of a profit or loss. Thus, futures markets appear to be a speculator’s paradise, but the statistics show just the opposite: over 90% of traders lose their shirts. You will see the clue here as to how the futures price of gold and silver was cut so dramatically and yet the physical demand remained largely the same. We postured here at SBM that the gold price had gotten ahead of itself last year in our Gold Bear Call guide.
One of the primary pillars of our argument then was the overshoot of the gold price relative to the US monetary base. However, with the gold price declining to $1320/oz at the lows, we can see from the chart below that it has in fact now moderately overshot to the downside. In fact, to get back in sync we would likely be looking at a value towards $1600/oz. I have circled in green below the period when the gold price actually undershot the monetary base and we can see that it remained undervalued for quite a time, in fact from 1999 – 2005, and it was only the onset of the GFC and the subsequent QE programs that really lit the fire under the price. Now, just because there is a disconnect between the monetary base measure and the gold price that has worked so well from a correlation perspective this last eight years does not mean that it will immediately correct — other dynamics at play in the market like large positions requiring liquidating etc. can affect the price. But it does rebuild the fundamental pillar for the gold price back in your favour.
CHART - US MONETARY BASE V GOLD PRICE
May 2013
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