Physical Bullion Demand on Fire

Late last week and into the early part of this week, gold and silver prices experienced some of the largest daily price drops, both on a dollars and cents basis and on a percentage basis, than has been seen in years or decades.

Normally, prices drop because of an actual or an anticipated glut of supply. But that isn’t what is happening with physical gold and silver right now. There are reports out of Japan of people trying to get rid of their yen (which the government is promising to depreciate rapidly) and into assets like precious metals that will hold their value – and having to wait in line as long as three hours to be able to buy gold and silver.

Yesterday in our store, the further price drop brought out even more eager buyers of precious metals. Even though we recently moved to much larger quarters (the size of the showroom quadrupled and we added several phone lines), customers were waiting as long as 30-60 minutes to be served. Many people simply could not get through on the telephone lines because they were jammed with calls.

The premium over silver value on $1,000 bags of U.S. 90 percent silver coin topped 20 percent. Dealers and wholesalers have almost nothing in stock for immediate delivery and premiums are rising across the board.

Because of slowing deliveries on bullion-priced physical gold and silver coins and ingots, we had to implement a limitation of $5,000 in sales to new mail-order customers. We accepted orders from established mail-order customers and from in-store customers who were ready to made immediate payments. (Note: there is value in having a relationship with a coin dealer who will take care of you on days like today rather than risking not being able to trade at all because a dealer doesn’t know you.)

I’ve heard all the technical and chart signs that several commentators refer to in saying that gold and silver prices are due to decline. However, just charting price movements without examining why prices are moving only gives you half the story. That leaves you at risk of making incorrect decisions that will cost you dearly in the future, simply because you don’t understand what is going on today.

Here’s what I seen going on in the physical market. In COMEX trading, silver demand has soared to near record levels, meaning that there are a huge number of buyers as the price has been dropping for more than the past six months. This continuing strong interest in purchasing precious metals puts the value of the U.S. dollar at risk. If people are trying to get out of paper currencies that are falling as a result of worldwide currency devaluation wars, their ability to do so only accelerates the decline of major currencies.

For the U.S. government, issuer of what until now has been the international reserve currency, this risk of a falling dollar would normally push up U.S. interest rates for all debt, including U.S. government debt. Therefore, the U.S. government has a strong incentive to tell its trading partners and allies to clobber the prices of gold and silver. In theory, if the prices can be suppressed enough that they break down through key technical trading points, investors with long positions can be intimidated into selling their holdings. Since much of the trading on the COMEX market involves leveraged trading up to about 20 times the cash investment, it isn’t that hard to create a string of temporary margin calls that will force holders of long positions out of the market.

That is exactly what has happened with traders of paper contracts on a large scale in the past week. Depending on which expert you talk to, last Friday, Merrill Lynch supposedly sold between 3.4 and 4 million ounces of gold contracts at the COMEX open. Total paper gold sales last Friday totaled from just under 13 to 16 million ounces. These quantities amount to $20 billion or so of gold sales, that leveraged sellers could accomplish with the use of barely $1 billion in funds.

Yesterday, there was a large early sale of about 2.25 million ounces and a total of almost 5 million ounces of paper gold sold into the market in the hour before the London fix. Sales of so much gold had the desired effect to benefit the U.S. government – lots of investors with long positions sold out. As these long positions were closed, that put even more downward pressure on prices.

At some point, gold prices could fall so low that primary mines will not be able to operate, which would cut supplies. There are some large gold mining operations with cash costs now exceeding Monday’s $1,360.60 closing gold price. Most silver is produced as a co-product or by-product of other commodities. With declining copper prices this year, some mine operators have recently announced plans to trim output, which also means that new silver supplies will decline. One mine’s planned reduction would draw down worldwide silver mining output by 0.5 percent all by itself.

Knowing that the prices of gold and silver have been blatantly suppressed in the past week means that it will be much more difficult to achieve any significant declines in the near future. Prices could drop slightly from where they closed Monday night, or they could stay relatively close to the new lows achieved in the past few days. It is also possible that there will be some degree of rebound, possibly even this week. 

One analyst made a sage observation about why gold and silver prices have been going down when many indicators point to increases. He said, “Gold and silver prices will rise when China and Russia decide that it is time for them to do so.” There is a lot of truth to this sentiment. 

So far in 2013, China has imported about 25 million ounces of gold to go with the world-leading domestic mine output. Russia has also made multiple purchases. Yesterday, while the U.S. government’s trading partners and heavily margined long position investors were selling the nearly 5 million ounces, central banks purchased about 1.8 million ounces. These central banks are seeking to take physical delivery, not paper contracts. But chart watchers and technical traders didn’t take such information into account when making decisions on gold and silver holdings.

In the long-term, it is important to understand that none of the global financial crises have suddenly been resolved, to explain why precious metals prices fell. The outlook for gold and silver 2-5 years out is for extraordinary appreciation. But this appreciation will likely only be enjoyed by those who have physical metals in their direct custody. Unfortunately, this longer-term outlook doesn’t tell you what will happen with prices in the next month.

Patrick A. Heller is the American Numismatic Association 2012 Harry Forman Numismatic Dealer of the Year Award winner. He owns Liberty Coin Service in Lansing, Mich., and writes “Liberty’s Outlook,” a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at www.libertycoinservice.com. Other commentaries are available at Coin Week www.coinweek.com and www.coininfo.com. He also writes a bi-monthly column on collectibles for “The Greater Lansing Business Monthly” (www.lansingbusinessmonthly.com/articles/department-columns). His radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 a.m. Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at www.1320wils.com).