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 backordered.

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.