These are astonishing times for precious metals. Not just because of price volatility. Underlying developments in the supply-and-demand fundamentals for physical gold and silver are currently extraordinary. On one hand, the paper market (futures contracts, etc.) continues to be heavily pressured in a bearish direction by institutional short-selling. On the other, the physical market has heated up with investor buying and increasingly bullish long- term supply/demand prospects. It’s been difficult for some investors to keep their conviction and hold on to real value while paper markets relentlessly discount it. But most bullion investors recognize the buying opportunity at hand. That’s evidenced by the fact they are looking to buy, not sell, precious metal bullion products at lower level prices.
1. Investment Demand for Gold and Silver Coins Surges
The first development now taking place in precious metals markets is a surge in demand for bullion coins, bars, and rounds. The U.S. Mint suspended sales of Silver Eagles for most of July because it couldn’t keep up with the demand. The U.S. Mint’s sales of Gold Eagles in July reached their highest monthly total in more than two years. Australia’s Mint reports its inventories are also being cleared out by demand, especially from Asia. “Everything we get in is going straight out the door as soon as we refine it,” said Perth Mint Treasurer Nigel Moffatt in a Bloomberg interview. Private mints are overwhelmed as well, pushing out delivery for weeks while scrambling to obtain raw silver for production.
2. Supply Tightness Drives Rising Premiums
When demand for refined precious metals far exceeds available supply, the result is rising premiums. The premium over silver spot price for Silver Eagles hit multiyear highs in July. Premiums on pre-1965 U.S. 90% silver coins and other popular bullion products are also on the rise. Privately minted rounds and bars that are normally plentiful in the marketplace are now back ordered.
3. Bearish Sentiment Toward Spot Prices
The paper market for precious metals has been subjected to relentless selling pressure from exchange-traded fund liquidations and futures traders who are betting on lower prices. Hedge funds appear heavily committed to the short side of the market. Meanwhile, newsletter writers and analysts in the financial media are also bearish on precious metals in anticipation of lower prices. What investors might focus on is that consensus opinion is usually wrong at major turning points. Market highs are most often characterized by overzealous optimism, and bottoms by overabundant pessimism. Best not to succumb to the herd mentality when making investment decisions.
4. Leverage Ratios Raise Odds of Short Squeeze
Traders are selling an ever-increasing quantity of gold ounces that physically do not exist. Record amounts of leverage are being applied to the gold market. This increases the possibility of a physical default (in which holders of long contracts who want to take delivery of physical metal are offered only cash instead). It also sets up the potential for a short squeeze (in which short sellers are forced to “cover” their positions by placing buy orders). Holders of physical precious metals fully paid for are able to take comfort in knowing they will never face the prospect of any contract default, margin calls, or any of the other risks inherent in paper markets.
5. Shrinking Mining Industry Points Toward Supply Shortfall
Things are particularly bad for the base metals and precious metals mining industry. There are a number of reasons for the industry’s troubles, as most mines simply struggle to make money selling their mined products at today’s lower spot market prices. Mining for precious metals has always been a difficult business and now mining companies must shrink dramatically in order to survive. Fewer mines, smaller work force, less capital investment, and limited exploration. That usually translates into fewer ounces being discovered and mined going forward. If supply contracts and demand holds steady, then prices will ultimately have to rise. It’s basic Economics.