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Silver fell a dollar, or over 4%, on Wednesday. Some voices in the precious metal press want you to believe that there is only one possible cause. We should coin a term for this form of logical fallacy: argumentum ad ignorantia. This is an argument of the form: “The cause must be XYZ, I can’t think of anything else.”
Same old song and dance
In this case, XYZ is that the alleged cartel, bullion banks and / or central banks, sold silver futures en masse. In addition, masses allegedly feared for inflation are buying physical gold.
What if the price of futures were pushed down while the price of physicals were pushed up? We’re going to be charitable and say physical just went up a dime. Let’s give a hint:
Basis = future spot (given as an annualized percentage)
So if the future were pushed down a dollar and the spot pushed up a penny, the base would go down. Much. How much? Well, yesterday the price of silver was around $ 22.50. A change of $ 1.01 is about 4.4%. However, this is valid for less than 3 months (for the December contract). Extrapolated to the year it is about four times higher, ie 18%.
If the conspiracy theory were true the base would have decreased by 18%. Not 18 basis points, 1,800 basis points!
Let’s just say … that didn’t happen. Instead, here’s a graph that shows what did happen.
Silver Fundamental Analysis – Silver Basic Analysis
The base has actually sunk. It fell from -0.35% to -0.83%. That is a decrease of -0.48%. 48 basis points. About 2.7 cents.
Think about it.
Put aside claims of selling paper that is half the world’s silver supply in an instant. Just look at the fact above. The spread (future spot) changed by less than three cents.
This drop in prices was definite LED from paper sellers. But people were selling physical metal almost as much.
The market sold paper silver AND physical silver
How much metal sales does it take to push the price of futures down by a dollar? And how much sales does it take to push the price of physical metal down by $ 0.9975?
The market maker is no weather. He does not speculate on the price, let alone on a falling price. He wears silver – buys metal and sells futures short at the same time. Why? To earn the base spread, which is usually positive. That said, this is usually a profitable trade.
If he doesn’t care about price, what does he care?
Spread!
The wider the base spread, the more it jumps into the market. You can see an increase in open interest (in the “Commitment of Traders†report). Commentators often get this wrong by portraying market makers as short sellers that it is benefit to push the price down and / or perk up lose money push the price down.
The market maker creates more contracts when the profit to carry silver increases. That is, when the base rises. And if the base goes down or the co-base even goes positive, an additional profit is made to close the position. That means buying the future and selling the spot. So the open interest is declining.
Spread> Price
This explanation is prosaic. The mechanics are pretty simple, albeit unknown to many retailers. Most retailers care more about price than the seemingly esoteric spread. Our mission in these reports is to demystify the spread (the video is a bit out of date, but what we said was true then and still applies today). It shouldn’t be more esoteric than friction in automotive engineering.
Note, by the way, that our co-base reading for Wednesday is 0.00%. That means there have been many moments when it has been positive. And you can bet that the market makers took advantage of these moments to close their positions.
Kobasis = spot – future
To close a silver carry position, you need to sell the spot and buy futures. If the spot price is above the future, it is profitable – in addition to the profit already made by carrying it. And you can now take this profit with you without having to wait until the delivery month.
The not-so-sexy truth about silver
Prosaic explanations are sometimes less popular than fantastic explanations. People once believed that rags in a damp closet gave birth to rats, that the sun and planets revolve around the earth, and that witches cause infant mortality.
Fortunately, some heroic men risked their lives to tell the truth (back then, heretics could be tortured and killed), and most people no longer believe these things. When was the last time you saw a witch bewitch a baby?
We definitely support buying gold and silver (our business is paying interest on gold and silver so investors can increase their total ounces!). But please be careful if you are buying for the right reasons.
The price will go up, but for other reasons such as a relative shortage of silver in the market. And of course macroeconomic factors.
Owning the dollar looks crazier these days. At least for those who have savings and a choice of how to hold them (unfortunately, debtors have to hold large cash balances, which is one reason the dollar isn’t collapsing).
Monetary Metals does research and fundamental analysis of gold and silver prices that you literally cannot find anywhere else. And all for free! To receive the supply and demand report as soon as it is published, subscribe to our mailing list.
Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure the accuracy of the information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is for informational purposes only. It is not an invitation to exchange goods, securities or other financial instruments. Kitco Metals Inc. and the author of this article assume no responsibility for any loss and / or damage that might arise from the use of this publication.
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