FUD. Fear, uncertainty, doubt.
“FUD. Fear, uncertainty, doubt. Salesmen, politicians, markets thrive on it and create it whenever possible” - TinyTim, 28 Aug 02:12 PM, comment on Sorry, There Is No Silver Conspiracy
A fine little dispute has recently been stewing on the net around what is happening in the gold and silver market, prompted by the heavy correction in their prices. I’ve been following it here:
The Disconnect Between Supply and Demand in Gold & Silver Markets – James Conrad, 18 Aug
Gold Refining Squeezes Silver Bar Production? – Jason Hommel, 21 Aug
The Strange Case of Dr. GLD & Mr. Bullion – Graham Summers, 22 Aug
Ignoring the Free Market Causes Shortages – Jason Hommel, 23 Aug
The Disconnect Between Supply and Demand in Gold and Silver Markets, Part II – James Conrad, 25 Aug
Sorry, There Is No Silver Conspiracy – Otto Rock, 27 Aug
Independence Day: Decoupling Gold and Silver from the Dollar – James Conrad, 27 Aug
The Great Gold, Silver Conspiracy Explained – Mike Shedlock, 27 Aug
How to Explain Fiat Currency to Silverbugs – Otto Rock, 28 Aug
Conspiracy Theory Psychology – Mike Shedlock, 28 Aug
Gold Sale Spurs Manipulation Talk – Mike Shedlock, 30 Aug
Where are the insider admissions about gold? Right here – Chris Powell, 30 Aug
People seem to sit on either end of a number of propositions (doesn’t seem that shades of grey or agnostic positions are accepted), some agreeing with all, some disagreeing with all, some picking and choosing:
A lot of the hype stems from the interpretation that because it is difficult to get hold of retail forms of gold or silver (e.g. 1oz coins, 100oz silver bars) that there is a “shortage” of gold and silver. I think it has now been accepted that there is no shortage of gold and silver in the wholesale markets (that is, for 400oz gold and 1000oz silver bars). This should be obvious if you consider the fact that miners churn out 2000+ tonnes a year. What we have is a shortage of retail forms. It is also worth noting that demand and supply is also localised in the gold and silver markets. So you really need to be specific instead of just saying “shortage” – you need to indicate of what form and in what location.
Anyway, this is understandably frustrating for the retail buyer and naturally leads to questions, and attempted answers, as to why this has occurred and why manufacturers are not responding, say by auctioning off the limited quantities they have, or increasing production. I mean, they are profit seeking entities, are they not? Why would they be missing out on extra profit from all this demand?
Now one thing I can agree on is “profit seeking”, these businesses are not going to pass up profit. So how to explain their behaviour? For those who are puzzled, they only explanations can seem 1) they are idiots or 2) they are part of some conspiracy. Let me suggest an alternative explanation (and I use gold here to also include silver).
The gold industry's production capacity, distribution networks, and client base is set up to service a certain ratio of retail versus wholesale volumes. This is to be expected - if you are making big dollar decisions on equipment you will do so based on past demand patterns. There are long-term relationships in place with major distributors and clients. Production processes are set up to service this demand and with a bit of flexibility to service the shifts in this demand in response to price movements.
Now I don’t doubt for a moment that the demand has increased for retail forms of gold – there is plenty of proof of this in the above articles and discussion forums. With a sort of fixed production plan at the source manufacturers and some lead time/delay from source to end buyer, it is not surprising that retail coins and bars can run out from time to time. Now don’t get offended if you are a retail buyer, but in the big scheme of things all of your purchases added up are not that important volume wise. So the initial response by the industry is, short-term blip, it has happened before, production will catch up with demand, backlog orders will be cleared and thing will be back to normal before too soon. From my side of the fence, I’ve seen these surges in demand occur (plenty of times without running out of stock) and then subside. This is the nature of the market, it responds to prices, or drives them. It is difficult to compare this market to other goods (eg milk), because their prices don’t fluctuate like precious metals. When demand is stable, so are prices and so is supply.
OK, so based on past experience, people in the industry don’t get all excited when they run out of small coins and bars. This explains their lack of response to the initial demand. Then the demand continues, and the backorders increase, delivery times increase. Why does the industry not respond now? Well they are still not sure if this increase in demand will be sustained. Also consider that they don’t spend their time reading all these commentaries or watching ebay, so they don’t see the initial increase in premiums. The price signals are not getting through. But even if they are aware of the increasing interest in retail forms of gold (and increasing prices), they still don’t response. Why?
Manufacturers of gold and silver have long-term customers who buy in volume. Maybe the price they are receiving from these customers is lower than what they can sell their retail products at, but they have a difficult decision. Sure they could sell to retail buyers, or make their long-term customers compete at auction for their production with the retail buyers, but they worry that when the demand declines (as they have seen occur in the past) you retail buyers won’t be there anymore but their long-term customers will, and they will remember how the manufacturer “screwed” them and they will either take their business elsewhere or screw them back in turn. So the manufacturer, based on past experience of the fickleness of retail demand, decides to continue to supply their long-term customers. You also have to consider that some may have supply agreements, either for volume or at a price, that they cannot break.
Some manufacturers may have relatively flexible production processes and can switch production capacity to retail forms, but there is still a cost involved. Again, the delay in responding may be a result of the executives of these firms not being sure about the longevity of the demand and switching capacity also means that they have to cut back on some other products, products that they supply to their long-term customers.
What about putting on extra capacity? As you can imagine, capital expenditure decisions and bringing on new capacity is not like turning on a tap, there is a big lag in getting additional the machines delivered and operational. Again, the question that executives in the refineries and other manufacturers would be asking themselves is whether the increase in retail demand is permanent or temporary. If temporary, they don't want to waste money on capacity that will be left idle.
Given the above, the question then becomes: how long before the industry responds? This is hard to say. I see us at a crossroad - the future will take one of two paths:
Scenario 1
Given the natural conservatism described above and the continuing retail demand we see continuing shortages of retail forms of gold and silver, probably occurring in a stop/start fashion as one supplier catches up and then another runs out. This erratic supply increases premiums for retail bars and coins. This fans further hysteria about "shortages", driving more retail demand. Industry executives see the demand and premiums and finally see profit and decide to ramp up production. During the delay in getting capacity online (some quicker than others depending on how their production process are set up) the hysteria continues, increasing retail physical demand.
The retail shortage “story" is picked up by more commentators and increasingly by mainstream media, who in their ignorance create the perception of a shortage of wholesale physical. Fanned on by retail dealers who are making a killing from marking up bars and coins, conspiracists who think this will be the straw that will break the (short) camel’s back, and those who recommended investors into gold and silver, this drives average investor and speculators into the ETFs (because they are comfortable with this investment form and don’t have any idea how to buy physical even if they wanted to) which drives the gold price even higher. Eventually capacity will come online and retail bars and coins are supplied and stories of shortages dry up. Now there are two possible end games:
a) The hysteria process reverses as product is easily available. Perceptions change, there is now "oversupply" of gold, talk of similarities with the 1980s bubble, demand contracts and price drops, savagely. Lots of egg on certain faces.
b) Product is easily available but that has no effect. Retail demand is at a new level and remains there, the “shorts” have been broken, gold has moved to a new “level”, reclaimed its inflation adjusted price. The public are aware of the gold and silver again, distrustful of fiat currencies. A new Golden Age has dawned. Lots of egg on certain faces.
Scenario 2
Retail demand for gold and silver, while significantly higher than in the past, is not significant compared to the wholesale physical market to really move the physical spot price. Combined with the possibility that suppliers may be more flexible in production capacity than we suspect, product is brought onto the market in a few months. "Shortage" stories dry up, retail demand drops. Lots of egg on certain faces.
Either way, someone is going to be wrong. Unfortunately, only time will tell so we will have to wait to find out who. The second half of 2008 will certainly be interesting.
A fine little dispute has recently been stewing on the net around what is happening in the gold and silver market, prompted by the heavy correction in their prices. I’ve been following it here:
The Disconnect Between Supply and Demand in Gold & Silver Markets – James Conrad, 18 Aug
Gold Refining Squeezes Silver Bar Production? – Jason Hommel, 21 Aug
The Strange Case of Dr. GLD & Mr. Bullion – Graham Summers, 22 Aug
Ignoring the Free Market Causes Shortages – Jason Hommel, 23 Aug
The Disconnect Between Supply and Demand in Gold and Silver Markets, Part II – James Conrad, 25 Aug
Sorry, There Is No Silver Conspiracy – Otto Rock, 27 Aug
Independence Day: Decoupling Gold and Silver from the Dollar – James Conrad, 27 Aug
The Great Gold, Silver Conspiracy Explained – Mike Shedlock, 27 Aug
How to Explain Fiat Currency to Silverbugs – Otto Rock, 28 Aug
Conspiracy Theory Psychology – Mike Shedlock, 28 Aug
Gold Sale Spurs Manipulation Talk – Mike Shedlock, 30 Aug
Where are the insider admissions about gold? Right here – Chris Powell, 30 Aug
People seem to sit on either end of a number of propositions (doesn’t seem that shades of grey or agnostic positions are accepted), some agreeing with all, some disagreeing with all, some picking and choosing:
- There is a shortage of retail forms of gold and silver.
- Prices for retail forms of gold and silver are high.
- COMEX price is different from retail prices, therefore COMEX price is “fake”.
- Conspiracy to manipulate the gold and silver markets (by bullion banks for profit, by bullion banks on behalf of central banks).
- Etc, etc
A lot of the hype stems from the interpretation that because it is difficult to get hold of retail forms of gold or silver (e.g. 1oz coins, 100oz silver bars) that there is a “shortage” of gold and silver. I think it has now been accepted that there is no shortage of gold and silver in the wholesale markets (that is, for 400oz gold and 1000oz silver bars). This should be obvious if you consider the fact that miners churn out 2000+ tonnes a year. What we have is a shortage of retail forms. It is also worth noting that demand and supply is also localised in the gold and silver markets. So you really need to be specific instead of just saying “shortage” – you need to indicate of what form and in what location.
Anyway, this is understandably frustrating for the retail buyer and naturally leads to questions, and attempted answers, as to why this has occurred and why manufacturers are not responding, say by auctioning off the limited quantities they have, or increasing production. I mean, they are profit seeking entities, are they not? Why would they be missing out on extra profit from all this demand?
Now one thing I can agree on is “profit seeking”, these businesses are not going to pass up profit. So how to explain their behaviour? For those who are puzzled, they only explanations can seem 1) they are idiots or 2) they are part of some conspiracy. Let me suggest an alternative explanation (and I use gold here to also include silver).
The gold industry's production capacity, distribution networks, and client base is set up to service a certain ratio of retail versus wholesale volumes. This is to be expected - if you are making big dollar decisions on equipment you will do so based on past demand patterns. There are long-term relationships in place with major distributors and clients. Production processes are set up to service this demand and with a bit of flexibility to service the shifts in this demand in response to price movements.
Now I don’t doubt for a moment that the demand has increased for retail forms of gold – there is plenty of proof of this in the above articles and discussion forums. With a sort of fixed production plan at the source manufacturers and some lead time/delay from source to end buyer, it is not surprising that retail coins and bars can run out from time to time. Now don’t get offended if you are a retail buyer, but in the big scheme of things all of your purchases added up are not that important volume wise. So the initial response by the industry is, short-term blip, it has happened before, production will catch up with demand, backlog orders will be cleared and thing will be back to normal before too soon. From my side of the fence, I’ve seen these surges in demand occur (plenty of times without running out of stock) and then subside. This is the nature of the market, it responds to prices, or drives them. It is difficult to compare this market to other goods (eg milk), because their prices don’t fluctuate like precious metals. When demand is stable, so are prices and so is supply.
OK, so based on past experience, people in the industry don’t get all excited when they run out of small coins and bars. This explains their lack of response to the initial demand. Then the demand continues, and the backorders increase, delivery times increase. Why does the industry not respond now? Well they are still not sure if this increase in demand will be sustained. Also consider that they don’t spend their time reading all these commentaries or watching ebay, so they don’t see the initial increase in premiums. The price signals are not getting through. But even if they are aware of the increasing interest in retail forms of gold (and increasing prices), they still don’t response. Why?
Manufacturers of gold and silver have long-term customers who buy in volume. Maybe the price they are receiving from these customers is lower than what they can sell their retail products at, but they have a difficult decision. Sure they could sell to retail buyers, or make their long-term customers compete at auction for their production with the retail buyers, but they worry that when the demand declines (as they have seen occur in the past) you retail buyers won’t be there anymore but their long-term customers will, and they will remember how the manufacturer “screwed” them and they will either take their business elsewhere or screw them back in turn. So the manufacturer, based on past experience of the fickleness of retail demand, decides to continue to supply their long-term customers. You also have to consider that some may have supply agreements, either for volume or at a price, that they cannot break.
Some manufacturers may have relatively flexible production processes and can switch production capacity to retail forms, but there is still a cost involved. Again, the delay in responding may be a result of the executives of these firms not being sure about the longevity of the demand and switching capacity also means that they have to cut back on some other products, products that they supply to their long-term customers.
What about putting on extra capacity? As you can imagine, capital expenditure decisions and bringing on new capacity is not like turning on a tap, there is a big lag in getting additional the machines delivered and operational. Again, the question that executives in the refineries and other manufacturers would be asking themselves is whether the increase in retail demand is permanent or temporary. If temporary, they don't want to waste money on capacity that will be left idle.
Given the above, the question then becomes: how long before the industry responds? This is hard to say. I see us at a crossroad - the future will take one of two paths:
Scenario 1
Given the natural conservatism described above and the continuing retail demand we see continuing shortages of retail forms of gold and silver, probably occurring in a stop/start fashion as one supplier catches up and then another runs out. This erratic supply increases premiums for retail bars and coins. This fans further hysteria about "shortages", driving more retail demand. Industry executives see the demand and premiums and finally see profit and decide to ramp up production. During the delay in getting capacity online (some quicker than others depending on how their production process are set up) the hysteria continues, increasing retail physical demand.
The retail shortage “story" is picked up by more commentators and increasingly by mainstream media, who in their ignorance create the perception of a shortage of wholesale physical. Fanned on by retail dealers who are making a killing from marking up bars and coins, conspiracists who think this will be the straw that will break the (short) camel’s back, and those who recommended investors into gold and silver, this drives average investor and speculators into the ETFs (because they are comfortable with this investment form and don’t have any idea how to buy physical even if they wanted to) which drives the gold price even higher. Eventually capacity will come online and retail bars and coins are supplied and stories of shortages dry up. Now there are two possible end games:
a) The hysteria process reverses as product is easily available. Perceptions change, there is now "oversupply" of gold, talk of similarities with the 1980s bubble, demand contracts and price drops, savagely. Lots of egg on certain faces.
b) Product is easily available but that has no effect. Retail demand is at a new level and remains there, the “shorts” have been broken, gold has moved to a new “level”, reclaimed its inflation adjusted price. The public are aware of the gold and silver again, distrustful of fiat currencies. A new Golden Age has dawned. Lots of egg on certain faces.
Scenario 2
Retail demand for gold and silver, while significantly higher than in the past, is not significant compared to the wholesale physical market to really move the physical spot price. Combined with the possibility that suppliers may be more flexible in production capacity than we suspect, product is brought onto the market in a few months. "Shortage" stories dry up, retail demand drops. Lots of egg on certain faces.
Either way, someone is going to be wrong. Unfortunately, only time will tell so we will have to wait to find out who. The second half of 2008 will certainly be interesting.
Comments
Post a Comment