Showdown: Paper vs. physical markets

The first half of 2021 did not play out as hoped by precious metals investors. Despite the effort to “squeeze” the bullion banks, silver has yet to push through the $30 barrier, and gold remains below the high put in nearly a year ago.

The effort has been valiant. Demand for physical bullion is unprecedented.

However, the paper markets, where price discovery is purportedly done, remain untethered to physical supply and demand.

It will take more than physical demand to break the back of the banking regime which dominates the paper markets.

It will also require a change in investor psychology. A collapse in confidence among those holding paper contracts must happen before they stop walking into the rigged casino and placing their bets.

In the meantime, there isn’t much use in trying to apply fundamental analysis to gold and silver paper markets. The fundamentals will have a much larger bearing on the markets for physical bullion.

The reasons for buying and holding coins, rounds, and bars have been multiplying over the past year and a half. Demand led to historically high premiums and shortages of available inventory.

In recent weeks, however, buyers got some relief. Premiums for many bars and rounds have fallen and dealer inventories are in better shape. Whether or not these trends continue in the second half of 2021, will depend on where demand goes from here.

Here are the forces we expect to drive demand for physical bullion between now and year end.

The first is price inflation. Rising prices have been getting a lot of attention in the financial press. Fed Chairman Jerome Powell assures us that these forces will be transitory, but investors shouldn’t be fooled.

Many commodity prices have fallen over the past month or two. Lumber has fallen dramatically, and some pundits are now wondering if Powell may have been right after all.

We doubt it. Today the price of lumber is still roughly double its average in recent years. Oil prices are 50% higher than where they began the year. Perhaps most importantly, wages are surging higher.

Higher prices are almost certainly on the way and that fact will be hard to hide, even with bureaucrats heavily managing the headline CPI numbers.

The next driver figures to be Federal Reserve dovishness. The central bank cut the Funds rate to zero in March of 2020 and then stepped aside and let Congress provide most of the artificial stimulus needed to keep our addicted markets from collapsing.

Most Americans received a series of direct payments from the federal government. These payments are coming to an end, at least for now.

Look for the Fed to resume a more prominent role in the markets. Officials there are jawboning about reducing stimulus. That could be expected with price inflation taking off and the equity markets at record highs.

But investors should remember the FOMC is expecting to let inflation run hotter for longer given that CPI inflation spent so long below the rate the central planners were targeting. It is unlikely the Fed will do any serious tightening before year end.

The election integrity issue is a bit of a wildcard for the bullion markets. The forensic audit in Arizona has been completed and the findings raise a few doubts. Other states are considering audits of their own. In fact, there is now an organization pushing for audits in all 50 states – even those where Trump won.

Finally, we may see continued (or increasing) civil unrest driving bullion demand. The battle over vaccine passports and re-lockdowns has the potential to heat up as the Delta variant spreads.

Precious metals prices respond well to chaos and uncertainty, and more of both seem likely.