Supply and Demand in the Gold and Silver Futures
Markets
By Paul Craig Roberts and Dave Kranzler
July 28, 2015 "Information
Clearing House"
- This article establishes that the
price of gold and silver in the futures markets in which cash is the
predominant means of settlement is inconsistent with the conditions
of supply and demand in the actual physical or current market where
physical bullion is bought and sold as opposed to transactions in
uncovered paper claims to bullion in the futures markets. The supply
of bullion in the futures markets is increased by printing uncovered
contracts representing claims to gold. This artificial, indeed
fraudulent, increase in the supply of paper bullion contracts drives
down the price in the futures market despite high demand for bullion
in the physical market and constrained supply. We will demonstrate
with economic analysis and empirical evidence that the bear market
in bullion is an artificial creation.The
law of supply and demand is the basis of economics. Yet the price of
gold and silver in the Comex futures market, where paper contracts
representing 100 troy ounces of gold or 5,000 ounces of silver are
traded, is inconsistent with the actual supply and demand conditions
in the physical market for bullion. For four years the price of
bullion has been falling in the futures market despite rising demand
for possession of the physical metal and supply constraints.
We begin with a review of basics. The vertical
axis measures price. The horizontal axis measures quantity. Demand
curves slope down to the right, the quantity demanded increasing as
price falls. Supply curves slope upward to the right, the quantity
supplied rising with price. The intersection of supply with demand
determines price. (Graph 1)
A change in quantity demanded or in the
quantity supplied refers to a movement along a given curve.
A change in demand or a change in supply refers to a shift in the
curves. For example, an increase in demand (a shift to the right of
the demand curve) causes a movement along the supply curve (an
increase in the quantity supplied).
Changes in income and changes in tastes or
preferences toward an item can cause the demand curve to shift. For
example, if people expect that their fiat currency is going to lose
value, the demand for gold and silver would increase (a shift to the
right).
Changes in technology and resources can cause the
supply curve to shift. New gold discoveries and improvements in gold
mining technology would cause the supply curve to shift to the
right. Exhaustion of existing mines would cause a reduction in
supply (a shift to the left).
What can cause the price of gold to fall? Two
things: The demand for gold can fall, that is, the demand curve
could shift to the left, intersecting the supply curve at a lower
price. The fall in demand results in a reduction in the quantity
supplied. A fall in demand means that people want less gold at every
price. (Graph 2)
Alternatively, supply could increase, that is, the
supply curve could shift to the right, intersecting the demand curve
at a lower price. The increase in supply results in an increase in
the quantity demanded. An increase in supply means that more gold is
available at every price. (Graph 3)
To summarize: a decline in the price of gold can
be caused by a decline in the demand for gold or by an increase in
the supply of gold.
A decline in demand or an increase in supply is
not what we are observing in the gold and silver physical markets.
The price of bullion in the futures market has been falling as
demand for physical bullion increases and supply experiences
constraints. What we are seeing in the physical market indicates a
rising price. Yet in the futures market in which almost all
contracts are settled in cash and not with bullion deliveries, the
price is falling.
For example, on July 7, 2015, the U.S. Mint said
that due to a “significant” increase in demand, it had sold out of
Silver Eagles (one ounce silver coin) and was suspending sales until
some time in August. The premiums on the coins (the price of the
coin above the price of the silver) rose, but the spot price of
silver fell 7 percent to its lowest level of the year (as of July
7).
This is the second time in 9 months that the U.S.
Mint could not keep up with market demand and had to suspend sales.
During the first 5 months of 2015, the U.S. Mint had to ration sales
of Silver Eagles. According to Reuters, since 2013 the U.S. Mint has
had to ration silver coin sales for 18 months. In 2013 the Royal
Canadian Mint announced the rationing of its Silver Maple Leaf
coins: “We are carefully managing supply in the face of very high
demand. . . . Coming off strong sales volumes in December 2012,
demand to date remains very strong for our Silver Maple Leaf and
Gold Maple Leaf bullion coins.” During this entire period when mints
could not keep up with demand for coins, the price of silver
consistently fell on the Comex futures market. On July 24, 2015 the
price of gold in the futures market fell to its lowest level in 5
years despite an increase in the demand for gold in the physical
market. On that day U.S. Mint sales of Gold Eagles (one ounce gold
coin) were the highest in more than two years, yet the price of gold
fell in the futures market.
How can this be explained? The financial press
says that the drop in precious metals prices unleashed a surge in
global demand for coins. This explanation is nonsensical to an
economist. Price is not a determinant of demand but of quantity
demanded. A lower price does not shift the demand curve. Moreover,
if demand increases, price goes up, not down.
Perhaps what the financial press means is that the
lower price resulted in an increase in the quantity demanded. If so,
what caused the lower price? In economic analysis, the answer would
have to be an increase in supply, either new supplies from new
discoveries and new mines or mining technology advances that lower
the cost of producing bullion.
There are no reports of any such supply increasing
developments. To the contrary, the lower prices of bullion have been
causing reductions in mining output as falling prices make existing
operations unprofitable.
There are abundant other signs of high demand for
bullion, yet the prices continue their four-year decline on the
Comex. Even as massive uncovered shorts (sales of gold contracts
that are not covered by physical bullion) on the bullion futures
market are driving down price, strong demand for physical bullion
has been depleting the holdings of GLD, the largest exchange traded
gold fund. Since February 27, 2015, the authorized bullion banks
(principally JPMorganChase, HSBC, and Scotia) have removed 10
percent of GLD’s gold holdings. Similarly, strong demand in China
and India has resulted in a 19% increase of purchases from the
Shanghai Gold Exchange, a physical bullion market, during the first
quarter of 2015. Through the week ending July 10, 2015, purchases
from the Shanghai Gold Exchange alone are occurring at an annualized
rate approximately equal to the annual supply of global mining
output.
India’s silver imports for the first four months
of 2015 are 30% higher than 2014. In the first quarter of 2015
Canadian Silver Maple Leaf sales increased 8.5% compared to sales
for the same period of 2014. Sales of Gold Eagles in June, 2015,
were more than triple the sales for May. During the first 10 days of
July, Gold Eagles sales were 2.5 times greater than during the first
10 days of June.
Clearly the demand for physical metal is very
high, and the ability to meet this demand is constrained. Yet, the
prices of bullion in the futures market have consistently fallen
during this entire period. The only possible explanation is
manipulation.
Precious metal prices are determined in the
futures market, where paper contracts representing bullion are
settled in cash, not in markets where the actual metals are bought
and sold. As the Comex is predominantly a cash settlement market,
there is little risk in uncovered contracts (an uncovered contract
is a promise to deliver gold that the seller of the contract does
not possess). This means that it is easy to increase the supply of
gold in the futures market where price is established simply by
printing uncovered (naked) contracts. Selling naked shorts is a way
to artificially increase the supply of bullion in the futures market
where price is determined. The supply of paper contracts
representing gold increases, but not the supply of physical bullion.
As we have documented on a number of occasions
(see, for example,
http://www.paulcraigroberts.org/2014/12/22/lawless-manipulation-bullion-markets-public-authorities-paul-craig-roberts-dave-kranzler/
), the prices of bullion are being systematically driven down by the
sudden appearance and sale during thinly traded times of day and
night of uncovered future contracts representing massive amounts of
bullion. In the space of a few minutes or less massive amounts of
gold and silver shorts are dumped into the Comex market,
dramatically increasing the supply of paper claims to bullion. If
purchasers of these shorts stood for delivery, the Comex would fail.
Comex bullion futures are used for speculation and by hedge funds to
manage the risk/return characteristics of metrics like the Sharpe
Ratio. The hedge funds are concerned with indexing the price of gold
and silver and not with the rate of return performance of their
bullion contracts.
A rational speculator faced with strong demand for
bullion and constrained supply would not short the market. Moreover,
no rational actor who wished to unwind a large gold position would
dump the entirety of his position on the market all at once. What
then explains the massive naked shorts that are hurled into the
market during thinly traded times?
The bullion banks are the primary market-makers in
bullion futures. They are also clearing members of the Comex, which
gives them access to data such as the positions of the hedge funds
and the prices at which stop-loss orders are triggered. They time
their sales of uncovered shorts to trigger stop-loss sales and then
cover their short sales by purchasing contracts at the price that
they have forced down, pocketing the profits from the manipulation
The manipulation is obvious. The question is why
do the authorities tolerate it?
Perhaps the answer is that a free gold market
serves both to protect against the loss of a fiat currency’s
purchasing power from exchange rate decline and inflation and as a
warning that destabilizing systemic events are on the horizon. The
current round of on-going massive short sales compressed into a few
minutes during thinly traded periods began after gold hit $1,900 per
ounce in response to the build-up of troubled debt and the Federal
Reserve’s policy of Quantitative Easing. Washington’s power is
heavily dependent on the role of the dollar as world reserve
currency. The rising dollar price of gold indicated rising
discomfort with the dollar. Whereas the dollar’s exchange value is
carefully managed with help from the Japanese and European central
banks, the supply of such help is not unlimited. If gold kept moving
up, exchange rate weakness was likely to show up in the dollar, thus
forcing the Fed off its policy of using QE to rescue the “banks too
big to fail.”
The bullion banks’ attack on gold is being
augmented with a spate of stories in the financial media denying any
usefulness of gold. On July 17 the Wall Street Journal declared that
honesty about gold requires recognition that gold is nothing but a
pet rock. Other commentators declare gold to be in a bear market
despite the strong demand for physical metal and supply constraints,
and some influential party is determined that gold not be regarded
as money.
Why a sudden spate of claims that gold is not
money? Gold is considered a part of the United States’ official
monetary reserves, which is also the case for central banks and the
IMF. The IMF accepts gold as repayment for credit extended. The US
Treasury’s Office of the Comptroller of the Currency classifies gold
as a currency, as can be seen in the OCC’s latest quarterly report
on bank derivatives activities in which the OCC places gold futures
in the foreign exchange derivatives classification.
The manipulation of the gold price by injecting
large quantities of freshly printed uncovered contracts into the
Comex market is an empirical fact. The sudden debunking of gold in
the financial press is circumstantial evidence that a full-scale
attack on gold’s function as a systemic warning signal is underway.
It is unlikely that regulatory authorities are
unaware of the fraudulent manipulation of bullion prices. The fact
that nothing is done about it is an indication of the lawlessness
that prevails in US financial markets.
Paul Craig Roberts, Ph.D., is a former
Assistant Secretary of the U.S. Treasury.
Dave Kranzler is a University of Chicago MBA
and is an active participant in financial markets.