Got Gold Report – Gold, Silver Demand White Hot

By Gene Arensberg
29 Sep 2008 at 02:11 PM GMT-04:00

Demand for gold and silver ETFs is transmitting a signal to the paper-contract-dominated spot bullion markets.
ATLANTA (ResourceInvestor.com) -- With on-the-street demand white hot, an unnatural shortage has developed in the physical gold and silver market (especially silver) because the paper-futures-contract-dominated spot price was panic-driven way too low. However, furious demand for gold and silver exchange traded funds is sending a clear signal back to those paper futures markets right now.

Most bullion dealers will tell you the main problem at the moment is that few people are selling bullion and many more people want to buy with current spot market pricing. Increasingly investors are turning to metal ETFs because they cannot find metal at current spot pricing.

Physical Metals Command High Premiums in the U.S.

Widespread reports of bullion dealers large and small running out of physical gold and silver products in the U.S. are true. Premiums are the amount over the spot price paid or charged by dealers.

The condition of scarce availability for actual silver and gold metal and very high premiums escalated over the past week as members of Congress argued over whether to adopt an emergency banking rescue plan proposed by Treasury Secretary Henry Paulson and Fed Chairman Ben S. Bernanke. The scarcity of metal escalated despite substantial recoveries in the spot prices for both of the most popular precious metals.

Past plunges for precious metals prices saw a flood of metal back into the market as investors took profits or sold metal in fear of lower prices. That allowed new buyers the chance to add metal at more reasonable premiums even though the spot price had fallen. This time, however, not only has there not been the usual flow of metal back into the market, dealers report that there are many more new investors that want to buy than usual.

So, we have more buyers for less actual metal. That means that any gold or silver inventory secured by dealers now commands very high premiums over current spot pricing, because some buyers are willing to pay the high premium for immediate delivery even if some are not. That’s of course if the buyer can actually find a bullion dealer that has inventory to deliver.

It is not that dealers are gouging customers with higher than normal premiums. To the contrary, they are also paying higher than normal premiums in order to get inventory. The actual physical bullion market is seeking its own pricing equilibrium more according to genuine supply and demand metrics and less according to the spot price in other words.

The issue is partly what physical investors want as opposed to what is readily available. Currently the demand is very strong for all popular bullion coins and bars which have become increasingly difficult to source. One-ounce bullion gold and silver coins are the most popular of all and currently command the highest premiums.

For example, a spot check of several online bourses shows gold one-ounce bullion coin premiums on the offer side of between 3.7% and 6.8% with gold in the $870s. ($32.30 to $60.00 over spot depending on the dealer and type of coin). However, some dealers warn that buyers should expect delays in delivery (measured in weeks) at those prices and therefore may not actually have the metal to sell.

Popular Physical Bullion Market Sends a Signal

The largest bullion items, such as those traded on the COMEX or the London Bullion Market are readily available for institutional and large private buyers if they are inclined to go to the trouble of buying them there.

Anyone with a large enough bank account and an appetite for enough gold or silver can open a futures account, buy and take delivery of larger quantities of gold or silver on either the COMEX or similar futures bourses. But the problem there is that it isn’t very practical or convenient to work with the very large bullion bars traded on those outlets.

For one thing, unless the trader intends to leave the bars on account with an exchange approved warehouse, taking actual delivery of large bullion bars instantly destroys their provenance. In fact, the instant a bar leaves the protection of the warehouse it is no longer acceptable for trade until it has re-qualified.

Each large bar is subject to being re-checked and assayed by a trading warehouse (or any careful buyer before they would consider buying it) and that means they are less liquid outside the facilities that store and trade them. The bars are still valuable – they are still gold or silver – but removing them from an exchange approved warehouse changes them from easy to trade to a hassle to trade, not to mention the additional expense of re-assay.

Some frustrated would-be physical buyers, put off by premiums of 3% to 7% on gold products and up to $4.00 an ounce for some silver products, have chosen to buy gold and silver ETFs instead. The evidence of that is in the very large additions to the ETF metal holdings. More about that just below.

For now, there does appear to be sufficient supply of the largest bullion products such as average 1,000-ounce silver bars and 400-ounce gold bars which the ETFs are stockpiling in record amounts. That’s a good thing because demand for them, through the ETFs, is pretty intense at the moment.

Increasing demand for precious metal ETFs is therefore transmitting the on-the-street demand for physical metal back to the paper market that so strongly mispriced it in a liquidity panic to the downside a few weeks ago. Perhaps the only surprise is that it has taken this long to do so.

Gold ETFs

SPDR Gold Shares, [GLD], the largest gold exchange traded fund, reported yet another very large addition of 45.03 tonnes, to 724.63 tonnes of gold bars held by a custodian in London for the trust. Since September 16, GLD has added a stunning 110.28 tonnes of gold metal to its holdings (about 3.5 million ounces).

Source for data SPDR Gold Trust.

So that the price of each share of GLD tracks very closely with the price of 1/10 ounce of gold (less accumulated fees), authorized market participants (AMPs) have to add metal and increase the shares in the trading float when buying pressure strongly outstrips selling pressure. The reverse occurs when selling pressure overwhelms buying pressure.

As GLD consolidated in a range between $85.01 and $90.17, volume remained strong as 117,540,624 shares changed hands for the week just ended. As mentioned in the last Got Gold Report, from the very large amount of metal added over this past week on record volume, we can conclude that buying pressure very strongly overwhelmed selling pressure for the largest and most liquid gold ETF.

Gold holdings for the U.K. equivalent to GLD, LyxOR Gold Bullion Securities Limited, edged 2.58 tonnes lower, to 115.28 tonnes of gold held. Barclay’s iShares COMEX Gold Trust [IAU] gold holdings added 1.07 tonnes, up to 62.85 tonnes of gold held for its investors.

For the week ending Friday, 9/26, all of the gold ETFs sponsored by the World Gold Council showed a collective increase of 43.97 tonnes to their gold holdings to 878.51 tonnes worth $25.4 billion.

SLV Metal Holdings

For the week, metal holdings for Barclay’s iShares Silver Trust [SLV], also increased strongly, adding another 173.64 tonnes to show 6,901.41 tonnes of silver metal held for its investors by custodians in London.

Source for data Barclay’s iShares Silver Trust.

As SLV consolidated in a much more narrow range than the last few weeks (between $12.83 and $13.62) volume remained elevated with 45,709,724 shares traded for the week.

One of the reasons that SLV is seeing so much demand is continued scarcity and very high premiums for actual physical metal as discussed in the introduction above.

To put the recent additions of silver metal into context, the chart below shows silver metal additions by SLV by month for 2008.

Source for data Barclay’s iShares Silver Trust

Interestingly, just during the month of September SLV has added 427.37 tonnes of silver to its holdings. The trust has added more silver and increased the trading float more in September than in any other single month since the first two full months of operation in 2006.

Since July 2, as silver moved from the $19s to as low as $10.28 (on the cash market) and rallied back up to the $13s, SLV added 901.39 tonnes of new silver to its holdings (just under 29 million ounces). Clearly there has been considerably more buying pressure than selling pressure for the largest silver ETF during the period.

Gold COT Changes

In the Tuesday 9/23 commitments of traders report (COT) for gold metal the COMEX large commercials (LCs) collective combined net short positions (LCNS) jumped 38,254 contracts or 37.13% from 103,022 to 141,276 contracts net short Tuesday to Tuesday as gold popped $112.42 or 14.42% from $779.48 to $891.90.

Gold versus the commercial net short positions as of the Tuesday COT cutoff:

Source for data CFTC for COT, cash market for gold.

One interesting gold COT development as of Tuesday is that long-term October 2009 and beyond contracts only amount to 47,266 out of the total open of 368,254, or a still very low 12.84%. Although the near active contract apparently saw a big jump in commercial net short positioning over the last week, the longer term contracts only increased in open interest by 3,084 lots.

The chart below compares the COMEX commercial net short position with the total open interest (LCNS:TO).

Source for data CFTC for COT, cash market for gold

Normally such a dramatic jump higher in the LCNS:TO would be a bit of a red flag very short term. However, times are anything but normal at the moment and there has been more than normal turnover in open interest figures this trading week.

Silver COT

As silver re-corrected $2.78 HIGHER or a significant 26.53% COT reporting Tuesday to Tuesday (from $10.48 to $13.26 on the cash market), the large commercial COMEX silver traders (LCs) actually REDUCED their collective net short positioning (LCNS) by 3,863 (10.37%) to 33,372 contracts of net short exposure, while the total open interest on the COMEX fell 7,937 contracts to a relatively low 104,403 COMEX 5,000-ounce contracts.

Source for base data CFTC for LCNS, London Silver Fix for silver from LBMA until 2-26-08 then cash market

Normally a significant drop in LCNS on an important increase for the metal is more bullish than bearish short term, but again times are anything but normal at the moment.

For context, the chart below compares the silver LCNS to the total number of open contracts on the COMEX, division of NYMEX.

Source for base data CFTC for LCNS, London Silver Fix for silver from LBMA until 2-26-08 then cash market

Even though the price of silver snapped back up to the $13s from the $10s the amount of commercial net short positioning as a percentage of the total open interest actually declined a little, from 33.14% to 31.96%.

Part of that can be explained as the two U.S. banks which crushed the silver market are probably now covering the very large short positions they took in July as the Got Gold Report reported in August. According to a report by Carolyn Cui of the Wall Street Journal, the CFTC enforcement division is looking into the matter.

Small Mining Share Market Dysfunctional

With so much uncertainty in the global financial markets the current pricing for many small companies that mine or explore for gold and silver are meaningless. Virtually all risk is currently being avoided, more now than ever, and that means that there is practically no functioning market for the “little guys.”

Until there is more clarity and more confidence by investors that the global financial system isn’t about to collapse, the flow of liquidity will continue to be outbound from the smaller, more risky issues. However, once there is a hint of clarity and even a small return of confidence, … once investors think they can safely put risk money to work again, the flow of liquidity will reverse course from outbound to inbound. When that occurs those who did well betting on the downside will add fuel to help those looking to the future with many promising, but now strongly undervalued companies.

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