SILVER, GOLD BECOMING GIFFEN GOODS / MACLEOD FINANCE

Silver, gold becoming Giffen goods

New York futures out of action probably doesn’t help. But silver hits new highs in volatile conditions. In this report, we look at the factors driving gold and silver higher still.

ALASDAIR MACLEOD

During Thanksgiving week (US markets closed on Thursday) the bullish running has been made in Asia. 

In European trade this morning, gold was $4,173, up $90 from last Friday’s close. 

Silver at $53.85, up $3.87 on the same time scale was making the running. 

Overnight in Shanghai, spot silver spiked as high as $55.13 surpassing previous highs, and the February future closed at $56.

The situation is complicated by Comex trading halted overnight, it is said due to cooling issues at a data centre. 

It may or may not have contributed to silver spiking higher. 

But the real problem in markets is an acute shortage of deliverable silver.

So far this year, 12,834 tonnes have been stood for delivery. 

As a source of silver bullion, Comex exceeds the combined output of Mexica, China, Peru, and possibly Chile — the world’s four largest producers. 

We don’t know how much of this is no longer available in the form of market liquidity, but with liquidity clearly stretched it will require higher prices, probably far higher to find out.

The chart below, which shows the relationship between the silver price and open interest encapsulates the problem.

Particularly since the beginning of this year, while silver has been rising open interest has declined. 

In a reversal of normal supply and demand relationships as the price rises, selling dries up. 

Normally, we look at speculator activity on the buy side to drive prices. 

But instead, there is a growing reluctance of sellers to supply additional futures contracts to buyers. 

That is why speculator interest is declining presumably with quotes widening, despite an obvious bullish momentum which normally attracts hedge fund interest.

The problem is not confined to Comex, with persistent backwardations between London spot and Comex futures, which have only disappeared since the March contract has become active. 

An additional difficulty for New York and London is that demand is increasing in China, with silver on the Shanghai Futures Exchange (SHFE) closing at $56 for the February contract while bullion stocks in the SGE and SHFE have declined to dangerously low levels. 

SHFE open interest and volumes are telling the same story as western paper markets, both of which still appear relatively subdued despite a soaring silver price:

Normal supply and demand analysis inadequately explains the situation in silver. 

After years of price suppression, evidenced by global supply deficits relative to increasing industrial demand, there is a dawning of the consequences. 

Worse for industrial users long accustomed to cheap supplies, silver has the characteristics of a Giffen good, where a rising price creates further scarcity: the scarcity being the “investor category”, in the Silver Institute’s annual surveys no longer prepared to cover supply deficits from industrial demand.

There is a similar situation in gold, as the next chart of the price and Comex open interest demonstrates:

There have been three phases of the relationship. 

As the price rallied in the first quarter, speculative interest boomed. 

That was when it was thought that the newly elected President Trump would impose trade tariffs on US gold imports. 

Gold then consolidated for about five months while speculative interest declined, only picking up briefly when gold broke out above its consolidation phase. 

But in late-September, open interest began to decline despite a rising price.

Clearly, gold is not being driven by speculators, but by the paper gold establishment’s attempts not to get caught short.

Gold is a far larger market than silver, but like silver it looks like becoming a Giffen good, as a rising price deters selling and at the margin attracts buyers who are missing out. 

What it tells us about the relationship between metallic money and fiat currencies is ringing alarm bells. 

But that topic is beyond a precious metals market analysis.