Are the Physical Gold and Silver Markets in NZ Decoupling From the Paper Markets Too?

Well it has been a week or so of action to say the least. The plummeting prices have bought plenty of people out of the woodwork the world over it seems and New Zealand has been no exception. We’ve had the busiest week ever in terms of the actual number of people placing orders so hence it’s been hard to sit down and come up with something sensible to write.

We expected to see a flood of purchasing at some stage but thought it would be at higher prices rather than at much lower prices. As generally the most buying occurs on a rising market – with the fear of missing out.

So the massive buying going on has caught us and many others by surprise. But then again so did the fall.

What to Make of the Plunge in Prices?

Well to be honest we’re a bit stumped too as we’ve read so many opinions as to the cause of the fall.

These included:

• Cypress selling their somewhat measly gold holding (although not as measly as New Zealands holdings of zero ounces!). Thus scaring people that the likes of Italy and Spain may be forced to do the same down the track.

• Massive volatility in the Japanese Bond market forcing holders to meet margin calls and therefore dump gold to get the cash. More on this angle here.

• Large hedge funds shorting heavily to bust through the technical support levels at US$1540 and make money buying back their shorts at lower levels after the herd has forced the price lower.

• Ambrose Evans-Pritchard thinks it was caused by the Fed and Bank of Japan and we are looking at a bout of deflation before the Fed is forced to give up on it’s talk of easing back on the currency printing.

• Another theory cited that the london physical market had a problem and froze while the price was falling sharply, so those long gold in the futures market who would normally buy physical since it had dropped so much to counter their loss in the futures, were instead forced to short gold as well in the futures market.

Gold Ambush at the COMEX Corral

Darryl Schoon in an article posted on the website this week thinks it was orchestrated as a last ditch defence against dwindling physical supplies in bullion bank depositories. He notes that the gold basis and silver basis were in backwardation – meaning that the nearest futures price was cheaper than the spot or cash price. Put simply this means traders were not prepared to give up physical to make a risk free profit by buying the futures contract. Read more at the link below

GOLD AMBUSH AT THE COMEX CORRAL

You might recall that in an email 2 weeks ago we had said that premiums were rising on silver maples.  So it  seems the argument of dwindling stocks at the depositories has some merit and a run on physical metals was beginning as a result of the lack of trust brought about by the Cyprus haircut policy?

Prof Fekete on Gold’s Fall: Who Said the Hydra Would Take it Lying Down?

We’ve also posted a few other must read articles this week that all share a similar theme – that of paper versus physical price. It seems Professor Fekete may now be convinced that precious metals prices may at times be manipulated too. We’ve posted his latest article written just after the price plummet.

Prof Fekete on Gold’s Fall: Who Said the Hydra Would Take it Lying Down?

Physical Gold vs. Paper Gold: The Ultimate Disconnect

Likewise Bud Conrad of Casey Research also seems to think something smells very fishy in the gold futures markets. He has written a must read piece on the plunge as well.

Physical Gold vs. Paper Gold: The Ultimate Disconnect

Why the Western Banking Cartel’s Gold and Silver Price Slam Will Backfire

JS Kim also has similar thoughts on price manipulation and paper versus physical and how you can protect yourself what he thinks is the inevitable blowback.

Why the Western Banking Cartel’s Gold and Silver Price Slam Will Backfire

Ann Barnhardt Foresaw Market Decoupling

Interestingly Bill shared with us a recent post by Ann Barnhardt. You may recall she was the head of Barnhardt Capital Management that closed her brokerage business in the wake of MF Global as she “could no longer tell [her] clients that their monies and positions were safe in the futures and options markets”.

What she wrote back in 2011 may well be coming to pass now. Here is what she reposted on her blog on April 14th. It’s quite long but you need to read all of it really. Interestingly she discusses the basis as Professor Fekete does in his article posted above:

REPOST I: ESSAY ON MARKET DECOUPLING

POSTED BY ANN BARNHARDT – APRIL 14, AD 2013 8:33 PM MST

First, a repost of a piece I wrote months ago on cash markets decoupling from the futures and derivatives markets, specifically in the context of metals. I have not changed anything, but I have bolded the key, key points.

For all of you Bitcoin fans, you are now realizing the massive flaw in the Bitcoin paradigm. You have no cash commodity to arbitrage. All you were ever dealing with was zeroes and ones on computer servers. I am hard-pressed to think of ANYTHING more vulnerable.

As I have been saying all along, if you can’t stand in front of it with an assault weapon and physically defend it, then it isn’t yours, and probably never was.

(Ahem. Cough. 401ks. Cough.)

Originally penned and posted on December 15, AD 2011, seven weeks after MF Global.

3. Finally, a very simplistic explanation of how the cash commodity markets are soon going to decouple from the futures markets. This is a little complex, but stay with me. I think this is important to understand because none of us who have lived our whole lives in the U.S. have ever seen a market disintegrate.

The threat (or promise) of delivery upon expiration is what keeps the futures markets tethered to the cash markets. Up until now, if an unreasonably wide spread between the futures price and the underlying physical commodity market got too out of whack, a process called “arbitrage” would kick in. Arbitrage is when a party simultaneously buys and sells on two separate but related markets in order to capture an inefficient spread between those two markets.

I’m going to use precious metals as my example commodity because there are alot of metals guys reading this, and because the metals markets will be the big tell in term of when decoupling and thus total futures market disintegration is upon us. But these examples apply to all of the physical commodities.

Let’s say that the physical silver market is trading far lower than the silver futures price. This is what is called a WEAK BASIS. The BASIS is the relationship between the cash market and the futures market and is very simply defined as (CASH minus FUTURES). If cash silver can be bought at $25.00 per ounce and the futures are at $30.00 per ounce, the cash is $5.00 under the futures. When cash is under the futures, this is called a WEAK basis.

Up until now, what would a metals trader do? In very simple terms, he would buy the cash silver at $25.00 per ounce and then simultaneously sell the futures at $30.00. Because he has short-sold the futures, he could hold the contract to expiry and then deliver the $25.00 cash silver he bought to make good on the contract and receive his $30.00 price. So his simple net profit would be $5.00 per ounce. As many traders saw this spread and simultaneously executed this same strategy of buying the cash and selling the futures, what effect would this have? Right. It would cause the cash-futures spread to move back in toward convergence by pushing the futures price down (lots of sellers) and propping the cash market up (lots of buyers).

Now the opposite scenario: a STRONG basis. Let’s say cash silver is trading at $32.00 and the futures are trading at $28.00. A trader might take physical silver that he has in inventory and sell it in the cash market, and then immediately take those proceeds and buy back and equal number of ounces in the futures market and take delivery. Since the same number of ounces in the futures market cost $4.00 per ounce LESS, he would end up with the same number of ounces in his inventory PLUS $4.00 per ounce in CASH in his pocket. If he and many other traders saw this condition and they all sold cash silver and bought the futures, this would, again, converge the spread between the cash market and the futures market.

The lynchpin that is holding this dynamic together and keeping the futures markets tied to the underlying cash market is the fact that the futures contracts are deliverable, and a trader can either deliver or take delivery of actual physical silver via his futures position.

Are we seeing a problem yet? The futures markets have lost their viability and trustworthiness because of the MF collapse and theft.At some point in the not-too-distant future, people everywhere are going to realize that the delivery mechanism is not reliable. Heck, just holding cash and/or positions in a futures account is no longer reliable. The the market itself is not reliable, traders will no longer attempt to arbitrage these basis spreads because the risk to the trader that the rug will be pulled out from underneath them is simply too great.

And in the metals markets, the delivery process itself is . . . um . . . shall we say, easily corrupted? When you “take delivery” of physical metals, it doesn’t get sent to your house. All you get is a certificate saying that X number of ounces are being held in a certified vault somewhere with your name on them. After the MF collapse, that sounds like a joke, right? A CERTIFICATE with my NAME ON IT? Yeah. That really is how it works.

When the arbitrageurs finally lose all confidence in the markets, the cash market will decouple from the futures because no one will be willing to take the risk of having their money, positions and/or physical metals stolen/confiscated. If no arbitrageurs are willing to trade these spreads – no matter how wide they may become – and thus there is no force causing the cash and futures to converge, we will see the basis spreads become extremely wide. As people flee the futures markets, the futures prices will drop, while the cash markets hold steady or even diverge and actually rise as all of the former paper players realize that physicals are the only remaining game to be played.

Watch for this. Watch for the gold and silver futures to sell off as people walk away from paper while the online cash dealers, seeing that market demand for their physical inventory is robust, begin to ignore the futures prices and hold their prices steady or even raise them. When you see this basis decoupling and absence of arbitrage, lo, the end is nigh. A parabolic spike is coming.

But all these really remain theories. The gold and silver futures markets are opaque to say the least and we’re not going to know what the cause was for sure. However the 400 tonne sell order that caused the first plunge is very suspicious as who in their right mind wanting to sell 400 tonnes would place the order in one hit?

What we do know is that just like in 2008 the paper or futures price of both gold and silver are not being reflected by the physical price of metals over the past week. So it could be that we are in the early stages of what Ann Barnhardt wrote about in late 2011.

This fits in with what London Trader Andrew Macguire reported earlier last week on King World News that “What people are seeing now has nothing to do with the physical market. In fact the physical market is literally on fire right now.”

We recall that in late 2008 the NZ Mint was selling silver for over 30% above the local spot price as the price plummeted in the futures market. The same occurred the world over where sellers weren’t prepared to give up their bullion for the price quoted on the futures exchange.

We haven’t seen premiums rise as high as that although since 2008 there are a lot more options for people to buy precious metals in NZ so competition may be a factor. Plus it could be early days yet. However, premiums have risen markedly on Canadian Maples and American Eagles in particular.  Many dealers offshore have sold out (or at least aren’t choosing to sell at current prices). Locally a number of dealers seem to be out of the likes of Canadian Silver Maples too.

(We still have access to them but premiums have increased and delivery times have increased out to an estimated 4 weeks. Visit our order page for indicative pricing)

Those in the US that do have stock have raised their prices markedly over the past week. We’ve seen premiums above spot in the US for these well recognised silver coins in the 20% area which is very high for the US.

Locally refined gold and silver is still available at the same premiums above spot price but delivery time on these from the suppliers is longer than the few days it was previously, now at 8-10 days and could get longer yet it seems. Rest assured you will get your silver and gold, they are just having trouble keeping production up with demand.

Also Swiss PAMP products are delayed until early to mid May.

Thus far locally refined gold and silver product premiums have not risen like they have on Canadian Maples and American Eagles. So presently there is perhaps an opportunity to buy local gold and silver without the markups seen on the products from the US and Canadian Mints? Thereby getting gold and silver for closer to the now much lower paper price of gold.

So the coming weeks will be very interesting to see if demand keeps up, what happens to the premium on local NZ gold and silver? Will the physical price decouple on local gold and silver to the extent it has on Canadian and US Mint coins? Time will tell but our guess is they will.

What do you think? What is likely to happen in the physical precious metals market here in New Zealand? Will local gold and silver decouple from the futures price? Show us you’re alive and leave a comment below!…

>> Related: Paper Gold vs Physical Gold – What Should You Buy?