And why does the US Mint struggle to meet silver coin demand…?
FOUNDER of CPM Group and frequent market commentator Jeffrey Christian explains the triggers behind heavy selling of gold last week and why there really isn’t a silver shortage at the US Mint in this interview with Hard Assets Investor.
Hard Assets Investor: What was the catalyst behind last week’s historic downward moves in gold?
Jeff Christian: There were two big groups selling. One was what we call “nervous longs,” people who were still long gold and silver. They had bought it because monetary accommodations could be hyperinflationary and Europe and the banks were going to collapse. None of that stuff has been happening. And the price of gold had come from $1,900 to $1,600 to $1,550, and they’re saying, “Gee, maybe all these gurus are wrong, because there’s no hyperinflation.”
The other group was “emboldened shorts.” Even before last week, even before April, if you go and look at the Commitment of Traders reports from March 26, you had a sharp increase in February and March of gross short positions on the Comex gold and silver contracts. For 12 years these guys said, “I’m not so foolish as to short gold.” But they had been willing in the first quarter of this year to build up short positions sizes not seen since the bear market of 1990s.
So you had a lot of people who were more and more willing to go short gold in the expectation of lower prices already. Then on Friday you had the price just sort of pancake down, dropping below $1,530, which brought in a round of sell orders both from nervous longs and fresh short selling. That took the price below $1,500 where another round of [sell] orders cascaded in. And it was just like stories of a building cascading—pancaking on top of each other.
HAI: How have the last few days changed your view, if at all, on not just gold itself, but also in regard to your price range of between $1,400 and $1,700? Do you feel that needs to be adjusted?
Jeff Christian: We had been using $1,700, $1,750 as a high just on the idea that there could be an outlier. We were saying we didn’t think it would necessarily get there. And really, the last couple days have basically reaffirmed our view pretty much. But the big change is that those highs that we were thinking were possible are probably even less possible now than they were back then.
HAI: Is the gold market too volatile for investors right now?
Jeff Christian: It really depends on the investor. Today [Tuesday, April 16] has been a very constructive day. The question facing investors is: Is today a dead-cat bounce or the buyback? We’re waiting to see the data, but our gut feeling is that what you’re seeing right now is that the last two days were so intense in terms of the selling because the weak hands reflected that nervous-long position, and they probably sold. Similarly, the shorts have probably built up as large of a short position as they dare take.
When I say “dare,” you have to understand two other things. It’s not just what they dare to take; it’s what their banks will allow them to hold given the fact that they use borrowed money. It also has to do with the margins. If you were going to short silver at $28 and now it’s $22 or $23 and the margins are rising, you’ve got to say, “Well, what’s my risk/reward ratio? Maybe I should buy back some of these shorts.”
Investors ask, “What will turn the price around?” The answer is the cessation of price flowing. Because as soon as the price stops flowing, you’ll see some of those shorts liquidating, which will cause the price to rise, and you’ll also see bargain-hunting. You’re seeing some of that today, and our gut feeling, without having the data confirm it, is that we may see that continuing. Yesterday [Monday, April 15] probably saw the lows for gold and silver, and the prices could rise maybe to $1,400 or $1,450 for gold, and maybe $25.50 or $26.50 for silver in short order.
HAI: Do you think that the maturity of the gold ETF market has added a new dynamic to the way the gold price moves?
Jeff Christian: ETF holdings have done two things to gold. One is that it’s made it a lot easier to buy and sell. It’s a simple click of a button. You don’t have a manager on the other side of that button. I’ve seen it in the futures market where banks can assure producers, “Yes, we can handle 400,000 ounces of gold.” And so the producer says “Fine, I want to sell 400,000 ounces of gold.” And the bank says, “Well, we’ve got to work this order.”
But with the ETF, no one is saying, “I’ve got to work this order.” It’s like, “No, I’m selling 400,000 ounces now.” That gold goes off into the system and it cannot be denied. Then it increases the volatility and the prospect for sharp moves on both sides of price.
And the other thing is that the ETFs provide a daily reckoning of physical-investor buying, at least for a small portion of the physical market. You always have daily futures and options data, but there’s never been a good measure of how much gold is being bought or sold on a daily basis in the physical market.
Now, the ETF is still a small portion of the total physical market. Most of the gold is bought in China and India, in the Middle East, and it’s not bought through ETFs. So you still don’t get 80-85 percent of the gold market reflected, but you have at least a measure. And I guess that is bad and good: a) You have a measure; b) You have a measure that’s not necessarily reflective of the total market. But in the absence of a good measure of the total market, a lot of investors will rely on it as a reflection. So it’s a bad barometer, but a measure nonetheless.
HAI: George Soros floated the idea this past month that gold has disappointed the public in the sense of its safe-haven qualities. Do you agree with that?
Jeff Christian: I don’t think gold has changed its attributes in terms of its uses for investors. I always am very cautious to say that I’m disagreeing with George, because I think George is probably more often misunderstood when he makes public comments, especially about gold, than wrong. And one of the points that he was making was that what we’ve seen is the gold prices come off—for example in late 2008 into early 2009—and that, as such, maybe it wasn’t as great of a safe haven.
My view of gold through history is that it does several things for investors. It is a store value, it’s a safe haven, it’s a portfolio diversifier, but it’s also a source of liquidity in times of emergencies and crises. And it’s always been. It’s done that during World War II, World War I, the Napoleonic Wars and it did that in 2008. The price will come off when you get to a point where people all of a sudden need cash, and they liquidate their gold to get at their cash.
In 1997, during the Asian currency crisis, the people who really survived in Thailand were the people who still owned gold. The Thai Baht sold 70 percent against the Dollar in a very short period of time. Those businesspeople who had been doing very well prior to 1997 and converting their wealth into Dollars and Deutschmark and other currencies and investing on a leverage basis of building new factories were crushed. Those people who did that, but kept some of their money in gold, did OK, because the gold price went up 70 percent against the Thai baht. They actually wound up buying the factories that other people were selling in distress.
Gold has always provided liquidity in times of stress. Investors shouldn’t be disappointed if gold does its job. Investors imbue too much expectation in gold and then they get disappointed.
HAI: What is one of the most important metrics that you watch for in gold?
Jeff Christian: We have a proprietary program to develop estimates of supply and demand, and investment demand. We pay a tremendous amount of attention to investment-demand flows. We really want to know what investors are doing. ETFs only represent a small portion of the total gold market. So you can’t just look at ETFs and say, “Well, this is what gold investors are doing. But what we do is we try to be in continual conversation with gold market participants around the world—India, China, the Middle East, Europe, the United States—so that we can get a sense of what investors are doing.
Sometimes it’s anecdotal information. So for example, a week after the Lunar New Year, the gold price fell sharply. One of the reasons was that the sales to investors of gold during the Lunar New Year were disappointing. You had a lot of bullion dealers in China who had stocked up gold inventory in anticipation of very strong sales during the holiday period. The sales didn’t materialize, and a lot of their clients were bad-mouthing gold’s price prospects.
So when the dealers came back, they unloaded their inventories. They don’t have gold options there, so they don’t have an effective way to hedge their inventory. These guys were long and exposed, and they were seeing weaker investor sales, so they sold gold.
HAI: Does that include jewelry demand?
Jeff Christian: One of the problems we have is trying to decipher aggregate-investment demand from gold jewelry. You can to some extent, but there’s clearly overlap. In China and India, you find a lot of gold statues and decorative objects, little trinkets made out of gold. On the one hand, they’re jewelry or decorative objects, but on the other hand, they’re investment demand. So you can talk about the purchase of gold in bars and coins and medallions, but you also have to pay attention to some of the jewelry demand, simply because some of it is quasi-investment.
HAI: What are some of the best reasons to sell gold? Or are you a buy-and-hold gold philosopher?
Jeff Christian: I am a gold agnostic. One of the reasons people would sell gold is because they expect the price to fall. Then you say, “Well, why would you expect the price of gold to fall?” If you see a sharp diminution in the amount of economic and financial uncertainty in the world, that’s a good reason to sell gold.
Another thing to pay attention to is an increase in gold supply. And the third thing goes back to that first one: if you see investors pulling back from the market. One of the metrics that we use, that I didn’t mention earlier, is that we pay attention to the premia that are available for American Eagle gold coins and Canadian Maple Leaf coins. When investors get negative on gold’s immediate price prospects, they’ll actually pull back from buying Eagles, or in some cases, sell Eagles and the premiums will fall.
Over the last 18 months, we’ve watched the premia very closely. When the price spiked down to $1,530 or $1,540, the premia shot up, which tells you that investors are buying gold at those dips. And then when the price would shoot up—as it did three times in late 2011 through 2012—to $1,780 or $1,790 or $1,800 an ounce, you would see the premia fall, which would tell you investors at least are not buying, and in fact they may be selling gold coins. So that’s a good metric.
HAI: Silver production continues to grow despite falling prices. What is really driving silver production? And is there a point where, as with natural gas, the producers are going to say, “We need the price to be higher for us to continue to do this profitably”?
Jeff Christian: The short answer is mine production’s rising because the price of silver is sharply higher. Silver traded between $4.50 and $5.50 for most of the period from the late 1980s until 2005. There were a lot of properties that were not profitable to mine or develop at $5.50 an ounce that are now profitable. And so you’re seeing production rise as a result of that.
Now costs are rising too, but these guys still have on average a pretty good margin. There were some producers that were very high priced, and are really at risk with the price coming down now to $26 and $27 an ounce. If the price continues to fall, there are some guys who are at risk. But the vast majority of the producers are very profitable even at $20 an ounce. So I think that you’ll see that production continue to rise for the next several years.
HAI: Since we have this growing production, why does the US Mint continually run out of silver for its coins?
Jeff Christian: I don’t know the Mint’s operations as intimately as I knew in the ’80s and ’90s when we were advising them. But the Mint doesn’t run out of silver; it runs out of silver blanks. And I think that that’s the key. You have to understand that to have silver inventories tied up in blanks and in struck coins waiting to sell is very costly. The Mint tries to minimize the amount of money it has tied up in working inventories. And that’s why they keep running short.
A lot of companies built capacity to make blanks and rounds and small bars in the 1980s because of the run-up in demand and prices then. By the late 1980s, no one was buying that silver, they were selling it back to the market and these guys were writing off their factories. So when you saw the price started to rise again in 2005/2006, what you saw were a lot of people who make small investment products saying, “I’m not going to make that same mistake again, and build up manufacturing capacity for something that could be gone in 24 months.” Well, it’s been six years now and it’s not gone.
Some companies have given in and they’ve built up capacity, so there is more capacity now than there was in 2008 when they really had problems sourcing blanks. But it’s a matter of very cautious businesspeople in the blanking business saying, “I’m not sure I want to build up capacity for something that could go away for the next 20 years the way it did last time.” And the Mint is saying, “We don’t want to necessarily build up inventories here and then investors turn off their demand for silver.”