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    Do You Understand How Bullion’s Price is Determined Today?

    Posted on August 31, 2015

    July 31, 2015 by James Anderson

    Silver & Gold Bullion’s Pricing is Illogical & an Opportunity for LongTerm Value Investors

    I’ve invested and worked firsthand in the physical silver and gold bullion markets for a decade now. Today’s collapsing spot prices, coinciding with dwindling deliverable physical bullion inventories and rising product premiums . . . none of this is new under the sun.

    In this post, I am going to explain (1) how the silver and gold price discovery mechanism is illogical today; and (2) why it won’t last due to real supply, demand, and mathematical constraints.

    Most people remain confused about silver and gold “spot prices” and how bullion dealer pricing for physical product inventory operates. I remain convinced that, if enough people actually did understand the perverse price discovery inputs at play right now, there would be no physical inventory to buy at these current prices.

    The confusion on silver and gold pricing is totally understandable, by the way. In today’s over financialized world, many current commodity real-world supply and demand fundamentals don’t apply when determining prices (not just in precious metals).

    Corroborating what I am about to tell you, watch about 7 minutes below with the former Assistant U.S. Treasury Secretary Dr. Paul Craig Roberts as he explains how spot prices are not based in fundamental realties today. When asked why this is happening he cites greed plus the maintenance of political and economic order as the likely 2 motivating factors.

     

    So how are Today’s Silver & Gold Prices Found?

    Future’s Exchanges24 Hour Spot PriceReal World

    If we added up all the real world bullion buying and selling throughout the year, and compared it to the amount of virtual silver and gold contracts bought and sold on futures exchanges (where spot prices are derived), we’d be looking at a needle (the real world’s bullion volumes) and a hay stack (silver and gold paper derivative trading volumes).


    silver price chart

    Today’s silver and gold sold spot prices, for instance the one you see on the chart above or constantly quoted on bullion dealer websites, etc. These 24-hour precious metal spot prices are determined by futures exchange prices.

    And those futures contract prices are, by in large, dictated by the world’s biggest commercial banks and leveraged speculators who, in over 99% of their futures trades, never physically exchange nor deliver real world gold or silver anywhere (many speculators even trade futures naked, meaning they don’t even own an ounce of deliverable bullion).

    Real world silver and gold suppliers like miners + refiners + mints + bullion dealers – the people finding, moving, buying, and selling the real shinny stuff – they don’t dictate spot prices in the markets today! Speculators do.

    It wasn’t always like this.

    The original use of futures contracts was to mitigate the risk of price movements by allowing parties to fix prices in advance for future transactions. This could be advantageous for hedging and ensuring one’s profits. For example, when a gold miner or a high volume bullion dealer (like JMBullion) expects to receive payment for inventory in the future and wishes to guard against an unfavorable movement in the price of gold or a currency in the meantime, futures contracts can be utilized to hedge price volatility in the interval before payment is received. The exact same can be said for silver or non-monetary commodities like coffee, oil, etc.

    But futures contracts also offer opportunities for speculation by traders who predict short-term price movements by buying or selling futures contracts at a price which, if the trader’s prediction is correct, will yield a profit in the future.

    The problem is, for every silver or gold futures contract on futures exchanges hedging real world inventories or product, there are hundreds more contracts being traded among speculators perverting the prices of precious metals in the real world. Thus, 24-hour spot prices are being dictated by speculators with virtually unlimited future contracts (again, many trading their contracts naked, with no real inventory at all). Hence, as a direct result, today’s spot “price discovery mechanism” is illogical. But, it is also an opportunity for value investors with long-term horizons through bullion buying and physical in-hand ownership.

    The following is a 5 minute video on a 2011 silver futures market trade resulting in $3,600,000,000 profit for a still anonymous silver trader(s). The strategy utilized to knock the futures price of silver down overnight in spring 2011 was very similar to the same strategy utilized by this month’s dramatic $50 oz gold spot price drop overnight in China. Over-sized trades executed during overnight low volume hours triggering massive stop loss waterfall declines in futures contract prices of silver or gold.

     

    silver in US dollars 100 years
    Going up longterm?

    Source: MacroTrends.com

    I do suggest speculators won’t rule silver and gold price discovery nor their ultimate appreciating values long term.

    How am I so confident?

    A couple of reasons dealing with real market and mathematical constraints.

    1)

    Historically, periods of excessive financialization coincide with periods of national economic setbacks (i.e. Habsburg Spain in the 16th century, the Dutch trading empire in the 18th century, and the British Empire in the 19th century). The USA is not very different today.

    The focus by elites on “making profits out of financialization” rather than making real goods and services eventually leads to wealth for a very small few, but, overall, results in national economic decline.

    Over-leverage eventually backfires to real-world supply and demand limitations.

    Artificially derived prices, especially artificially suppressed ones like silver and gold, eventually give way to shut down mine supplies and real-world shortages.

    Only about 1,000,000,000 oz of physical Silver and 129,000,000 oz of physical Gold are supplied to the world each year through mining and scrap refining.

    bloomberg paper silver and gold
     

    Source: Bloomberg

    Basic arithmetic using Bloomberg’s annual multi-TRILLION dollar market figures above shows leverage of +100s of times paper derivative contracts to underlying real world physical ounces. With further bank crisis ahead in our future and real world silver shortages beginning, today’s downward spot price pressure stands to revert violently.

    Although about 95% of gold mined remains with us in bullion or jewelry, the same is not so for silver. Silver is mankind’s essential precious metal, second only to oil in the amount of critical life supporting items we use it in. We have to have it.

    Today, real-world physical silver remains in short supply both for industrial use and as a long-term physical buy and hold investment. Just see below how we continually are running silver supply deficits year after year.


    Silver supply deficit

    Source: 3 Year Silver Supply Deficit

    As spot prices are artificially set low for silver, it builds further demand pressure as many rabid bullion buyers know the fundamental case to own silver bullion long term and are taking action with their pocketbooks.

    With silver’s recent spot price plunge, we again have wholesalers paying premiums to further melt and refine pre-1964 90% silver coins to meet the still small (in terms of worldwide investors) but growing demand for .999 fine deliverable silver bullion.

     

    With the recent dramatic downturn in gold and silver spot prices, we are seeing some recent buying pressure on silver bullion supplies with physical bullion demand hitting record summer levels (e.g. over 5 million Silver Eagle Coins sold in this month alone).

    Supply, refiner, and mint infrastructure shortcomings are also apparent with the American Silver Eagle coin program having to halt sales this month, as well as one of the largest private silver bullion product suppliers in the world halting wholesale sales of its private branded products, most likely to catch up supplying the silver planchets required for the U.S. Mint’s American Silver Eagle coin program.

    The silver bullion industry is very small.

    It stands no chance of adequately serving the masses when they eventually begin demanding bullion in mass quantities.

     

    It was no surprise to see the recent rise in silver bullion product premiums leading off with the U.S. Mint’s American Silver Eagle coin sales halt (the public’s #1 demanded silver bullion product).

    We are also seeing product premium increases bleeding into other bullion products (sovereign coins, bullion bars, private bullion mint rounds).

    Even with a 3 week sales halt, that's an all time American Silver⬆ Eagle coin sales record for the month of July.
    Even with a 3 week sales halt, that’s an all time American Silver Eagle coin sales record for the month of July.

    2)

    My second macro mathematical reason for being confident that this downward pressure on silver and gold’s dollar price will end shortly deals with the U.S. dollar’s value which has been dramatically dropping for over 100 years now.

    When one crunches the numbers of the United States Federal Government’s growing debt and unfunded liabilities (in other words, the nominal promises the gov’t has made), it becomes clear that it is mathematically impossible for the government to deliver good on said promises without either currency debasement or the invention of a time machine.

     

    Sure, in the short run, the U.S. dollar has surged in strength relative to other debasing fiat currencies, but this short-term purchasing power rebound will give way to the fact that every fiat currency by design loses its value long term.

    Like death and taxes, the U.S. government will further debase & devalue its currency. Count on it.

    It is the only way to actually nominally pay off its debts and promises made.

    Here is one of the smartest money managers in the world (Kyle Bass) saying just that in so many sophisticated words.

    My suggestion to you is to learn about what is going on behind the scenes within the world’s banking system and perhaps take advantage of this silver and gold mis-pricing madness while it still exists today.

    You can get our FREE BULLION INVESTING GUIDE ⬇ right now.

    Thanks for taking the time to read my thoughts. I wish you and yours the very best.

    Research provided by James Anderson on behalf of JMBullion.com.

    All Market Updates are provided as a third party analysis and do not necessarily reflect the explicit views of JM Bullion Inc. and should not be construed as financial advice.