31 August 2008

FUD. Fear, uncertainty, doubt.

“FUD. Fear, uncertainty, doubt. Salesmen, politicians, markets thrive on it and create it whenever possible” - TinyTim, 28 Aug 02:12 PM, comment on Sorry, There Is No Silver Conspiracy

A fine little dispute has recently been stewing on the net around what is happening in the gold and silver market, prompted by the heavy correction in their prices. I’ve been following it here:

The Disconnect Between Supply and Demand in Gold & Silver Markets – James Conrad, 18 Aug
Gold Refining Squeezes Silver Bar Production? – Jason Hommel, 21 Aug
The Strange Case of Dr. GLD & Mr. Bullion – Graham Summers, 22 Aug
Ignoring the Free Market Causes Shortages – Jason Hommel, 23 Aug
The Disconnect Between Supply and Demand in Gold and Silver Markets, Part II – James Conrad, 25 Aug
Sorry, There Is No Silver Conspiracy – Otto Rock, 27 Aug
Independence Day: Decoupling Gold and Silver from the Dollar – James Conrad, 27 Aug
The Great Gold, Silver Conspiracy Explained – Mike Shedlock, 27 Aug
How to Explain Fiat Currency to Silverbugs – Otto Rock, 28 Aug
Conspiracy Theory Psychology – Mike Shedlock, 28 Aug
Gold Sale Spurs Manipulation Talk – Mike Shedlock, 30 Aug
Where are the insider admissions about gold? Right here – Chris Powell, 30 Aug

People seem to sit on either end of a number of propositions (doesn’t seem that shades of grey or agnostic positions are accepted), some agreeing with all, some disagreeing with all, some picking and choosing:

  • There is a shortage of retail forms of gold and silver.
  • Prices for retail forms of gold and silver are high.
  • COMEX price is different from retail prices, therefore COMEX price is “fake”.
  • Conspiracy to manipulate the gold and silver markets (by bullion banks for profit, by bullion banks on behalf of central banks).
  • Etc, etc

A lot of the hype stems from the interpretation that because it is difficult to get hold of retail forms of gold or silver (e.g. 1oz coins, 100oz silver bars) that there is a “shortage” of gold and silver. I think it has now been accepted that there is no shortage of gold and silver in the wholesale markets (that is, for 400oz gold and 1000oz silver bars). This should be obvious if you consider the fact that miners churn out 2000+ tonnes a year. What we have is a shortage of retail forms. It is also worth noting that demand and supply is also localised in the gold and silver markets. So you really need to be specific instead of just saying “shortage” – you need to indicate of what form and in what location.

Anyway, this is understandably frustrating for the retail buyer and naturally leads to questions, and attempted answers, as to why this has occurred and why manufacturers are not responding, say by auctioning off the limited quantities they have, or increasing production. I mean, they are profit seeking entities, are they not? Why would they be missing out on extra profit from all this demand?

Now one thing I can agree on is “profit seeking”, these businesses are not going to pass up profit. So how to explain their behaviour? For those who are puzzled, they only explanations can seem 1) they are idiots or 2) they are part of some conspiracy. Let me suggest an alternative explanation (and I use gold here to also include silver).

The gold industry's production capacity, distribution networks, and client base is set up to service a certain ratio of retail versus wholesale volumes. This is to be expected - if you are making big dollar decisions on equipment you will do so based on past demand patterns. There are long-term relationships in place with major distributors and clients. Production processes are set up to service this demand and with a bit of flexibility to service the shifts in this demand in response to price movements.

Now I don’t doubt for a moment that the demand has increased for retail forms of gold – there is plenty of proof of this in the above articles and discussion forums. With a sort of fixed production plan at the source manufacturers and some lead time/delay from source to end buyer, it is not surprising that retail coins and bars can run out from time to time. Now don’t get offended if you are a retail buyer, but in the big scheme of things all of your purchases added up are not that important volume wise. So the initial response by the industry is, short-term blip, it has happened before, production will catch up with demand, backlog orders will be cleared and thing will be back to normal before too soon. From my side of the fence, I’ve seen these surges in demand occur (plenty of times without running out of stock) and then subside. This is the nature of the market, it responds to prices, or drives them. It is difficult to compare this market to other goods (eg milk), because their prices don’t fluctuate like precious metals. When demand is stable, so are prices and so is supply.

OK, so based on past experience, people in the industry don’t get all excited when they run out of small coins and bars. This explains their lack of response to the initial demand. Then the demand continues, and the backorders increase, delivery times increase. Why does the industry not respond now? Well they are still not sure if this increase in demand will be sustained. Also consider that they don’t spend their time reading all these commentaries or watching ebay, so they don’t see the initial increase in premiums. The price signals are not getting through. But even if they are aware of the increasing interest in retail forms of gold (and increasing prices), they still don’t response. Why?

Manufacturers of gold and silver have long-term customers who buy in volume. Maybe the price they are receiving from these customers is lower than what they can sell their retail products at, but they have a difficult decision. Sure they could sell to retail buyers, or make their long-term customers compete at auction for their production with the retail buyers, but they worry that when the demand declines (as they have seen occur in the past) you retail buyers won’t be there anymore but their long-term customers will, and they will remember how the manufacturer “screwed” them and they will either take their business elsewhere or screw them back in turn. So the manufacturer, based on past experience of the fickleness of retail demand, decides to continue to supply their long-term customers. You also have to consider that some may have supply agreements, either for volume or at a price, that they cannot break.

Some manufacturers may have relatively flexible production processes and can switch production capacity to retail forms, but there is still a cost involved. Again, the delay in responding may be a result of the executives of these firms not being sure about the longevity of the demand and switching capacity also means that they have to cut back on some other products, products that they supply to their long-term customers.

What about putting on extra capacity? As you can imagine, capital expenditure decisions and bringing on new capacity is not like turning on a tap, there is a big lag in getting additional the machines delivered and operational. Again, the question that executives in the refineries and other manufacturers would be asking themselves is whether the increase in retail demand is permanent or temporary. If temporary, they don't want to waste money on capacity that will be left idle.

Given the above, the question then becomes: how long before the industry responds? This is hard to say. I see us at a crossroad - the future will take one of two paths:

Scenario 1

Given the natural conservatism described above and the continuing retail demand we see continuing shortages of retail forms of gold and silver, probably occurring in a stop/start fashion as one supplier catches up and then another runs out. This erratic supply increases premiums for retail bars and coins. This fans further hysteria about "shortages", driving more retail demand. Industry executives see the demand and premiums and finally see profit and decide to ramp up production. During the delay in getting capacity online (some quicker than others depending on how their production process are set up) the hysteria continues, increasing retail physical demand.

The retail shortage “story" is picked up by more commentators and increasingly by mainstream media, who in their ignorance create the perception of a shortage of wholesale physical. Fanned on by retail dealers who are making a killing from marking up bars and coins, conspiracists who think this will be the straw that will break the (short) camel’s back, and those who recommended investors into gold and silver, this drives average investor and speculators into the ETFs (because they are comfortable with this investment form and don’t have any idea how to buy physical even if they wanted to) which drives the gold price even higher. Eventually capacity will come online and retail bars and coins are supplied and stories of shortages dry up. Now there are two possible end games:

a) The hysteria process reverses as product is easily available. Perceptions change, there is now "oversupply" of gold, talk of similarities with the 1980s bubble, demand contracts and price drops, savagely. Lots of egg on certain faces.

b) Product is easily available but that has no effect. Retail demand is at a new level and remains there, the “shorts” have been broken, gold has moved to a new “level”, reclaimed its inflation adjusted price. The public are aware of the gold and silver again, distrustful of fiat currencies. A new Golden Age has dawned. Lots of egg on certain faces.

Scenario 2

Retail demand for gold and silver, while significantly higher than in the past, is not significant compared to the wholesale physical market to really move the physical spot price. Combined with the possibility that suppliers may be more flexible in production capacity than we suspect, product is brought onto the market in a few months. "Shortage" stories dry up, retail demand drops. Lots of egg on certain faces.

Either way, someone is going to be wrong. Unfortunately, only time will tell so we will have to wait to find out who. The second half of 2008 will certainly be interesting.


  1. Thanks, Bron. I always appreciate your knowledge and insight.

  2. Bron,
    All your scenarios involve lots of eggs ! My course is clear - buy eggs ahead of the coming shortage ! I'll clean up.

    On a more serious note, it was a very useful article - lots of insights into the refiner/manufacturer issues.
    It is quite understandable that refiners will give priority to the high volume side of their business, and this little retail guy is not offended. I would expect that contractual obligations would play a big part in the decision making, as would obligations under LBMA licencing.
    Another element to the puzzle of retail problems in the US seem to be to do with outsourcing of various steps in the production sequence, and possibly an inappropriate managerial application of just in time inventory control for each step along the way. A more integrated refiner/manufacturer would at least be able to take more decisive and coherent action.


  3. Yes, just in time concepts probably have some responsibility to take.

    A lot of Mints don't do blank manufacturing, it is more complex than just stamping an image on to a blank disc. The biggest issue comes around weight control, chemical solutions pickleing off small amount of metal, annealing etc etc. As a result it does have benefits but one of the negatives is the lags it puts into the overall production time if you run out of blanks.

  4. What disturbs me is the arguments like this one refuting any so called shortages is that they are people that have a vested interest in selling Perth Mint shares which in itself are just paper promissary notes....The simple fact is there are ' shortages ! " whether from production, blanks, wholesale buyers...I could not find silver eagles for the last 3 weeks. I can formulate a dozen scenarios to add to the above, but the bottom line is I can not find the physical silver I wish to buy...Ordering, and waiting 4-6 weeks for my order filled is not my idea of delivery upon payment..At least here I can add my 2¢. Most of the pundits making this arguement on Kitco etc. do not allow comments or discussion. For that ...Thanks

  5. This is Jason Hommel. Good article. I believe I've been painting the picture as you have said it. Seems we agree on facts, but not on interpretation.

    You write that JM probably has supply agreements that they cannot break. Exactly! Another word for that would be collusion, or futures contracts, which distort markets, you just don't seem capable of admitting that takes place, even though you yourself write it as an excuse.

    You also wrote, "Now don’t get offended if you are a retail buyer, but in the big scheme of things all of your purchases added up are not that important volume wise." Exactly. I've been saying that for YEARS now, that investors are a tiny fraction of the silver market $1 billion, and thus, any significant increase in investor demand due to widely recognized inflation which will drive $14,000 billion in the banks into silver and gold will really change the industry, as it is!

    You also write, to explain why JM is not ramping up production, "The price signals are not getting through." That's because JM is BLOCKING THEM! By making investors wait in line, they are allocating by rationing, not by price! I've spoken with a man who spoke with one of the head traders at JM, and he is supposedly furious about the backlog and the turning away of orders; as that's not good business.

    You also write, "switching capacity also means that they have to cut back on some other products, products that they supply to their long-term customers." Excuse me, does this not imply that there is a fixed amount of physical silver, and that if investors buy more, then there will be less for industry and jewelers, which has been my point for 10 years now, that there must come a bidding war for silver at some point.

    The point here, which is obvious, is that JM is thwarting that bidding war. Thanks for providing room for comments.

  6. macsx - I agree there are shortages and that is a problem. During the bear years up to 1999 my view is that the distribution network for bullion contracted and now that demand has returned it cannot react and service that properly.

    I also don't write what I do to defend the Perth Mint or its Depository, it applies to any Mint really. Note that the Perth Mint also sells bars and coins as well, not just its Depository stuff, so if I am indeed doing this to promote the Mint, I should be feeding the FUD so we can sell heaps more physical at huge profit.

    The Mint has been selling a lot of physical recently, I was just speaking to our Shop manager last week who did a 5000 x 1oz silver coin deal to a guy (who is probably reselling them on ebay!). We've got the stuff, but that is of little comfort to you over there I know.

    Quite honestly this situation does concern me, the industry really should be able to respond and supply product to customers.

  7. Good to hear from you Jason.

    Firstly, I am talking generically and not about JM or Perth Mint.

    When i say supply agreements, I did not mean futures or collusion. For example (hypothetically), a Mint might go to a refiner and say "look, PM demand is volatile but I know I sell at least 10,000oz a month so can you guarantee to supply me with that amount of silver granules per month for the next 12 months" (just agreeing to supply, not forward fixing the metal price, that can be done each month as the delivery is made). The refiner (talking 12 months ago before these shortages) considers that demand is moderate at the moment, they have an opportunity to lock in sales and profit but has to weigh this up against the potential in the future to make more money if demand picks up.

    Some will say yes, some will say no to the deal, but I don't consider it collusion, or that the purpose reason for doing that is to restrict supply of other product, or to lower the price. Collusion is defined as "secret cooperation between people in order to do something illegal or underhand"

    It is just one business person trying to lock in some certainty around (premium) revenue and another certainty around supply, with the end objective to eventually supply some sort of silver product to the market. However, my point is that the unindended consequence is to reduce the industry's respondability (if that is a word).

    Regarding your comment about "imply that there is a fixed amount of physical silver", my statement just says that there is fixed capacity and doesn't imply fixed supply of physical. I would contend that supply of silver or gold is somewhat variable in nature in that higher prices should make some holders sell, bringing additional supply into the market. It is also fixed as well, in that there is only so much mine supply (new mines cannot just be brought into operation just like that) and there is only so much above ground stocks that can be brought into the market.

    What I suppose the point of this blog is that even if a higher price brings more held supply into the market (eg 1000oz silver bars are being sold by big investors), if it is not in the form investors want the limited production capacity of the industry may mean that this additional supply cannot be converted into the forms people want. This is what is occuring now.

    What I disagree with is concluding that because we have a retail shortage that this means there is a wholesale shortage. From where I sit you can always get silver or gold in 1000oz or 400oz bar form, that is what the over the counter spot price represents - as long as you pay the price, you can get it.

    What we have is a capacity shortage, not a shortage of silver as such. But I do agree that this does impact the price of silver/gold as it means that physical silver is not being taken off market as quickly as it could be if industry capacity was up to servicing it.

    All very well, but as macsx says he can't get what he wants now, and that is all that matters.

  8. bron, thank you for replying so quickly.

    You wrote, "From where I sit you can always get silver or gold in 1000oz or 400oz bar form, that is what the over the counter spot price represents - as long as you pay the price, you can get it."

    Yes, but where do you sit? Where are those 1000 oz. bars that kitco and perth can't seem to be able to find for customers who want them? Why do Perth/Kitco have a shortage of 1000 oz. silver bars?

    You know, if you are going to say "it's available" when you KNOW hundreds of people are saying "we can't find any", why don't you tell us where we can go and get it? Source? Web link? Telephone numbers, etc.

    (Aside: while you may define collusion as something illegal, others may define it as anything that is against free market principles.)

    I would like to trade bullion in a free market manner, but it seems most everyone else want to "lock in" a guarantee of some sort or another.

  9. Bron, You wrote something very insightful:

    "OK, so based on past experience, people in the industry don’t get all excited when they run out of small coins and bars."

    It's been my experience that people in the industry, the coin dealers, over-value their own direct personal experience, and have trouble seeing the big picture.

    They see the public selling silver to them, and thus, from their view, there is a "glut". From a statistical global investor's point of view, that is called an "unsustainable supply source" that is necessary to fill a "supply/demand" gap, which will require a reversal of price to the upside. But the dealers don't see that, they just see people selling to them.

    Thus, they got caught flat footed when the public turned from seller to buyer at $1000 gold and $20 silver, where public buying increased ten fold, and they've been turning away customers, and trying to buy from refineries, instead of sell to them, in all of 2008.

    There is an expression used to describe such a viewpoint. They can't see the forest because the trees are in their way.

  10. I've replied to Jason at this new blog: http://goldchat.blogspot.com/2008/09/jason-hommel-has-made-some-comments-to.html

  11. I have found silver at the northwest territorial mint. with a ten day shipping time frame. I ordered some two weeks ago and received it when they said I would. These were pan American corp bars.

  12. excellent! i read nearly exclusively "gold bug" news (and jason), and not once has the supplier/buyer relationship been raised. i do appreciate that, it is an essential part of business.

    however, i would urge you to consider this issue ted butler keeps raising, which i do not believe is applicable to the contents of this post.

    here is a link to one of the most factual posts of ted's since i've been reading:


    ps- i have added this blog to my RSS feeds

  13. Thanks for the Ted Butler link, I have seen that. At the moment I am working on a blog about confiscation, but I have put that article in my blog to-do (or is that to-comment) list.

    I may not be able to give much insight into the COMEX. There is no futures market for precious metals in Australia, it is basically a spot market. I've never had experience of futures either, as the Perth Mint only deals in the over the counter market.

    It is important that any exchange based "instrument" is operated fairly, be it stock or commodity. If there is a requirement for sellers to have 90% of actual commodity, then it should be audited regularly to ensure rules are being followed.

  14. While I know that you can't just Print up Gold or Silver but the next best thing is Gold and Silver ETF or "Fiat Gold" and "Fiat Silver" which like paper money can be as worthless as Confederate Dollars when discretionary income evaporates.

    While I am fairly new to PM's and have little money to put in to PM's I have watched PM's from time to time, it has only been in the last 8 months that I have taken an active interest in the market.

    Yet, I sat up and took notice when Kitco last month talked about delays in Deliveries and I saw silver rounds being bought over spot rather than below spot, yet I have never seen prices artificial pushed down when demand outstripped supply. The "Spot

    The only problem that I see even though I think that I read that Silver Contracts are 30 times the existing annual production.

    Until laws change, and as long as contracts can be sold, on goods that can't be physically delivered, which is fraud in my eyes. Until a Class Action Lawsuit forces a change or bankrupts some of these "Pools".

    Then contract provision such as below will be the Escape hatch that they can hold your cash and/or PM hostage. Until someone forces the issue and makes someone deliver on the contracts. The Market will be manipulated.

    We have a "virtual Bretton-Woods system". The ETF's artificially suppress the price. What the companies are doing is like the Diamond Cartel.

    So if forced delays continue and the US and Global Market continues to erode on the pace, then you will see either a black market, with a true reflection of prices.

    Until someone breaks the "Paper Gold and Silver System" The Market price will be able to be manipulated, once the contracts disappear then you will see the market reflect the true price an values in the metals. Then PM prices will rocket.

    That or when investors, freak out when the first house of Cards of Silver or Gold ETF sellers collapses, ( How I don't know outside of a Lawsuit )

    "Force Majeure
    In the event of adverse conditions in the metals markets or other factors outside the control of XYZ , including, but not limited to, acts of God, national emergencies, adverse governmental actions, the suspension by U.S commodity exchanges of trading of gold, silver, platinum or palladium futures contracts or the delivery of the commodities underlying such contacts, or the failure or delay of suppliers, the maximum time for delivery of such commodities may be extended indefinitely during the period of such adverse circumstances.

    XYZ will not be responsible for delays or failures in the transmission, receipt or execution of orders, payments, deliveries or information due to the incapacity or failure of computer or communications equipment or facilities which are outside the control of XYZ.

    That is a Great way to retain all that Metal - as well as hedge an Over leveraged position.

  15. Dang, I'm just a poor Montana boy looking to buy a couple dozen 10 oz or maybe a few 100 oz silver bars, and I can't find 'em ANYWHERE without a $3-$4 premium over spot. Today on eBay10 oz Engelhard bars are selling for $185-

    I did a bit of metal casting back in the 70's, using both sand and metal molds, and it sure seems to me that, in this day of incredibly precise EDM, a mint could order a few extra molds, have them machined/delivered within 2 weeks, lay on a 2nd and even 3rd shift, and start picking off some of that easy premium money.

    If one 100 oz bar would fetch a $300- premium, 10 new molds and only 4 heats per shift would generate $12,000 daily in extra gross profit per shift. 3 shifts per day rather than one-hmmm-just a lousy 36K/day x 5 days/week x 52 weeks = $9,360,000/yr...nah, why would anyone even bother for such chicken feed?

    Molds can't be THAT expensive, the furnace output capacity is not the production-limiting factor and even paying 4 guys [which is probably 1 too many-after all, we're talking about melting and pouring only 4,000 oz here-barely 250# avoir] $50 USD/hr each [with bennies] for extra shifts still leaves over $10K/shift on the table.

    Sorry, Bron, but I just don't buy that "mints are reluctant to make capital investments which may sit idle" story...unless they're afraid they will sit idle due to lack of metal to melt-wait a minute, that sounds like Jason Hommel's idea...

  16. Dean,

    agreed, great insight - but the real production-limiting factor - is the real physical metal -

    Their is more money to be made on the fiat Silver - until that house of cards collapse -

    It is paper silver - which can be made at many 1,000 oz per minute. As long as you have ink and trees and high paid lawyers to right up bullet proof delivery contracts - that allow them to hold your cash FOREVER.

    I think that it is fantastic that the shortage is driving up the price the greater the spread - between real silver and paper silver then the people who hold the contracts will think that they can cash in on the black market for silver and start calling the contracts in for delivery - then the cookie will start to crumble and prices will explode -

  17. Dean, I was never saying that "mints are reluctant to make capital investments which may sit idle" was the one and only reason for the shortage of retail silver, just a factor. The minting process for coins is a little more involved than that for bars, but most mints I would assume would have spare capacity.

    For bars I will agree with you, it is not a massive cost issue. I think the problem is more around managers in refineries and other manufacturers doing something about it.

    By the way, the Perth Mint extrudes its silver bars.

  18. Hi Guys!
    I am the manager of the Australian Bullion Company in Sydney.we sell 1kg, 5kg,15kg and 30kg silver bars as well as grain. We currently cannot keep up with the demand for investment bars however we back all our sales with physical fine silver grain. so although we may have a 4 week wait on some bars we do not have any supply issues on physical silver only a problem that we do not have more resources to manufacture the bars faster! We should have physical bars to sell in four weeks. We welcome any new business. Please visit our website www.ausbullion.com.au



  19. With respect Janie, why would anyone want to buy silver from a country which requires a DNA sample before delivery of product? And besides, have you even LOOKED at the premium which your firm charges over spot?

    According to your website http://www.ausbullion.com.au/liveprices.html you charge AUD34 for a 1oz silver coin.

    With AUD/USD at today's average of 0.82 that is a whopping great US$ 27.88 per ounce of silver? But the XAG spot price as I write is US$12.22. Let's see now, that means we have a premium over spot of 128%!!! WoW!

    And then we have to wait 4 weeks? AND supply a DNA sample before we take delivery?

    When you Aussies prostituted your personal freedoms for socialism, did you also surrender your common sense as well?

    4 weeks waiting time? No resources to manufacture? 128% premium over spot? What shortage - right?

    What a crock!


  20. RockJaw - 1oz coins are always going to have a terrible markup premium in percentage terms.

    I state again, Perth Mint has 100oz silver bars for AUD $74, which is circa 5%.