Pandemonium in Precious Metals Market as Fear Gives Way to Command Economy

Last week was another week of wild market volatility for all asset classes, and precious metals were no exception. 

Gold continues to be the least volatile metal.  And it continues to hold up better than the chaotic stock market during most trading days. But it has experienced some downside in recent days. 

Money Metals Exchange and other bullion dealers have experienced an unprecedented surge in demand for silver and gold coins, bars, and rounds.  Many dealers have essentially sold out and/or refused to accept smaller orders because of fulfillment challenges.

The month of March could set an all-time record for sales of Silver Eagles.  That will depend on whether the U.S. Mint is willing and able to supply coins to dealers in volumes that the market demands.

So far, it unsurprisingly failing to keep up with demand – resulting in dealer inventory shortages, rising premiums, and abnormally long delivery windows for most orders.

Money Metals’ premiums have certainly risen sharply, but not as much as our competitors.  But this is not price gouging, because wholesale costs have risen dramatically also due to shortages. 

Prices in the retail market are reflecting the fundamentals of the bullion market – which include massive demand, production bottlenecks, and shortages.  At the same time, dealer bid prices have risen sharply, meaning – if folks are willing – they will be paid a very high premium over spot if they sell their items to dealers.

A growing number of Americans are facing tremendous financial strain and may have no choice but to liquidate assets and raise cash.

The advantage of holding physical silver during times like these instead of futures or exchange-traded instruments is clear.  During the market mayhemover the past couple weeks, some exchange-traded funds began diverging in price from their own underlying assets in cascades of selling. 

One exchange-traded silver product, which trades as PSLV, began trading at a discount of over 10% to net asset value.  That means if you owned shares of this vehicle and had to sell, you would be getting significantly less for your shares than they are supposed to be worth. 

Part of the explanation for anomalies such as these is that markets become less efficient when they are being driven by panic selling and extreme swings in the value of underlying assets.  But a deeper and more troubling potential reason for the large price discrepancies is that investors may have grown increasingly concerned about the layers of credit risk and counterparty risk associated with exchange-traded products. 

A rising perceived risk of default or failure could certainly cause the market to attach a discounted value to any financial instrument.  That’s certainly been the case for a lot of corporate bonds and shares now that many companies are in a cash crunch.

Precious metals in physical form carry no counterparty risk, cannot default, and will never go to zero – although as we’ve seen that their spot prices can still succumb to waves of selling that grip capital markets.

Silver has gone from incredibly cheap to insanely cheap during this coronavirus crisis.  One measure of just how depressed prices have gotten is that on Wednesday the gold:silver ratio closed at a record 125:1. It took 125 ounces of silver to buy a single ounce of gold!

Also this past week, the VIX volatility index for the stock market spiked to an historic high, slightly above the level registered during the peak fear period of the 2008 financial crisis. 

While there is certainly much more damage yet to be inflicted in the economy and quite possibly much lower stock market levels ahead, it’s also likely that many assets that were unfairly put on the chopping block this week have put in their final lows.

Even as the U.S. economy remains on virtual lockdown, demand for commodities is likely to start picking up from China. The COVID-19 new infection rate there has slowed dramatically and nearly flat lined, if you believe government reports.  As, Chinese factories return to production and motorists return to the roads, demand for raw materials will increase.

It may be a many months or longer, before the United States economy returns to something akin to normal.  But when it does, a massive amount of pent up demand will hit the energy sector and commodities more broadly.  Consumers and corporations will also be armed with trillions of new coronavirus dollars that are set to be distributed to them by the federal government.  

We have never seen a bailout attempt like this before.  Certainly not on this large a scale or this wide a scope. 

Hard to believe just a few weeks ago, Americans were feeling grateful to not be living under an authoritarian country like China that can arbitrarily decide to quarantine populations and shut down entire cities.

Americans are now effectively living under a command economy.  Political decisions will now determine which businesses are allowed to operate and which will ultimately survive. Will we ever get back the freedoms we used to take for granted? Or are we in a long emergency that will never see a return to normalcy?

The ultimate consequences of this economic lockdown and the coming helicopter drops of cash are difficult to predict.  This crisis could render government deficits unmanageable, destroy Uncle Sam’s low interest rate borrowing capacity, and force officials to adopt Modern Monetary Theory – essentially bypassing the bond market and having the Federal Reserve print whatever cash the government needs.

As severe as this recent deflation scare has been, the inflationary snapback to come could catch a lot of investors completely unprepared.  And as disappointing as silver’s spot price performance has been of late, it has the potential to deliver truly explosive gains when the pressures now building in the physical bullion market blow the lid off the paper market. 

In the meantime though, please be careful out there.