The Curious Widening of the Bid-Ask Spread in Silver

Last week, I wrote about a curious development in silver. The bid-ask spread widened in November and December. My article concluded:

 

One should regard this as another type of rot in the core of the system. The point of my dissertation is that narrowing spreads is a sign of increasing economic coordination, and widening spreads is a sign of discoordination. And now we have widening spreads in one market for one of the monetary metals.

This is not good.

 

I received a lot of email in response to this. Everyone wanted to know what I meant, and if this predicts a rising or a falling silver price. I think the price is likely to fall, though that prediction is not based on the widening spread. It’s based on my supply and demand analysis. My standard caveat is: never naked short a monetary metal. Look at the sharp rise in silver for no reason on Friday, when a disappointing payroll report was released. A 60-cent rise would hit naked shorts in the shorts (if I may be permitted a rude analogy).

 

If a widening-spread has any impact on price, it won't be in direction but in volatility. Let’s look at the mechanics. When Joe comes to the market to buy, he pays the ask price. When Sue comes to sell, she is paid the bid price. If the bid-ask spread is a penny, then the trace on your screen moves up one cent and then down one cent, first moved by Joe and then by Sue. Supposing the spread widens to 20 cents (it has gotten nowhere near that yet, but just for example),  then your screen will show a 20-cent move for one tick. That is a 1% move.

Not only does one more tick increase the move to 2%, but there are many momentum traders watching for a price breakout. With them piling on, and with a 1% move per tick, silver could easily have 10% or 15% moves in a day.  How will the market makers respond to this? Most likely by widening the bid-ask spread, to give themselves a safety margin for big price swings. And how will most traders respond to this? They’ll pile onto big moves they see developing,  but set tight stop-losses.

Volatility will beget volatility.

Before I explain what I meant by my last comment “this is not good,” I want to say something important. I don’t regard the rising price of gold and silver as good, though I argue that it’s inexorable. I remind everyone that it’s not gold going anywhere, but the dollar going down. The price of the dollar must be measured in gold, though by force of habit we presume to measure gold in dollars. As an analogy, think of having a rubber band in your left hand and a meter stick in your right. Which can be used to measure the length of which?

It currently costs about 25mg of gold or 1.6g of silver to buy one dollar (keep in mind a paperclip is one gram). The price has been lower in recent years, and it will go much lower than that in the not too distant future. Why? Not because of the dollar’s quantity. The problem is its falling quality. The dollar is backed by debt, and as that debt moves closer to default, the dollar moves closer to its high-velocity rendezvous with zero.

In the end, it will come to a race between a rapidly rising dollar-denominated price of gold and the onset of permanent gold backwardation. There is no way to predict what the last gold price will be, before gold goes off the board, though I think it will be a highly non-linear process at the end.

It should be obvious why a collapse of the dollar is bad.

Now, on to my parting remark last week. A widening bid-ask spread is evidence of rot in the heart of the system. It’s definitely not good.  Why not? I alluded to my dissertation, the theme of which is that narrowing spreads mean increasing coordination and widening spreads mean decreasing coordination.

What does coordination mean in the economy? It means cooperation, the division of labor, specialization, efficient production and distribution, economies of scale, and the extension of credit. It means that you can have confidence that prices and terms won’t change tomorrow, that things are stable, and that everyone realizes it’s better to work productively and trade with others than to become a parasite who lives by attacking others.

What could cause economic coordination to go in reverse? The government can.

The single most important thing in the economy is money. If the government distorts the meaning and value of money, then rot inevitably sets in. Activities that add value, that people demand, that produce wealth, may appear unprofitable as measured in dollars. Other activities, which destroy or consume wealth, may appear to be quite profitable as measured in dollars.

An unstable and distorted dollar, with an unstable and falling interest rate imposes massive perverse incentives. Whether this causes prices, as measured in terms of the defective dollar,  to rise is a whole separate question. I answered this question “sometimes, but not necessarily” in my theory of interest and prices.

Whether prices rise, stay flat, or fall, damage is still being done. One way to look at the damage more closely is to look at spreads. This is the approach I take in my supply and demand analysis of gold and silver. I study two spreads between metal in the spot market and the futures market. By seeing whether there is an increasing or a decreasing spread to carry or warehouse metal—to buy physical metal in the spot market and sell it forward in the futures market—we can glean a lot of information about the current state of the markets. If metal is flowing into the warehouse, we know that the marginal demand for metal is to be carried.  Sooner or later this will reverse, and this source of demand will disappear to become the marginal source of supply (I plan to publish more about the gold markets, arbitrage and warehousing in the near future).

Another way is to look at the bid-ask spread of something. In my article last week, I noted that the bid-ask spread in silver futures had widened. I discussed why this might be occurring. It is heavy buying at the ask, and at the same time selling on the bid—in a market with fewer and fewer market makers.

Now let’s address why this is bad.

The bid-ask spread is the loss one will take to get into and out of an asset. In the case of a silver future, let’s say the bid is $20.15 and the ask is $20.16. Then you could buy and sell and lose only 1 cent per ounce. On the other hand, if the bid drops to $20.10 and the ask rises to $20.20 then your loss would be 10 cents.

Another way of looking at the bid-ask spread is liquidity. Commodities with narrower spreads are more liquid than those with wider spreads. For example, gold is more liquid than platinum and platinum is more liquid than molybdenum.

The monetary metals became money, as I argue in this article, because they had the narrowest bid-ask spreads. Now we see evidence that silver’s spread is widening. This is tantamount to saying that silver may be losing some of its 'moneyness'. Though it should be emphasized that this is not happening in the spot market for silver, but the futures market. I think it may not be silver losing its 'moneyness' so much as the futures markets becoming less efficient.

Along with too much focus on price, I think too many people look at the futures market in terms of how many ounces are in the warehouses vs. how many ounces are under contract. They expect the market to blow up by a failure to deliver metal when demanded at contract maturity.

A different kind of worry, which is completely off the radar at the moment, is if the futures market seizes up due to lack of liquidity. If the spread were to continue to widen significantly more (this is a big “if”), then we should expect to see falling trading volumes. At some point, the bid-ask spread could widen to the point where either silver stops trading or silver trading is forced into another venue. It’s far too early to make predictions about this.

So who is impacted by wider bid-ask spreads? Producers and consumers are hurt. Wider spreads reduce the profitability of silver miners and recyclers, and any other producer or hedger who must sell future production or inventory on the lower bid. It also reduces the profitability of jewelers, electronics manufacturers and other silver users who must buy future production at the higher ask. It will also hit those who must buy and sell futures to hedge inventory like bullion dealers. They typically sell futures short when they buy inventory, and buy those futures back as the inventory sells through to the consumer.

The only beneficiary is the surviving market maker. Unlike everyone else, who experiences the bid-ask spread as a cost, to him it’s a profit because he buys at the bid and sells at the ask.

 


 

chart-silver basis-cobasisChart via Monetary Metals – click to enlarge.

 


 

Since I wrote A Curious Development in Silver, the silver basis for most contracts has risen about to its level of the third week of November (the March contract is beginning to spiral into the gravity well of temporary backwardation). It seems that the widening bid-ask spread cancer has gone into remission for now, though it bears watching.

Just before I hit send, comes this piece from Bloomberg. It makes an interesting postscript. “The Federal Reserve is planning to release a notice seeking information on ways to curb banks’ ownership and trading of some commodities,” it says. Here’s the money quote, “Senator Sherrod Brown, an Ohio Democrat, has raised concerns that banks may have a conflict of interest when they own and trade both physical commodities and instruments tied to them.” That would seem to target carrying metal—buying spot and selling it forward. Forcing banks out of this business will cause the basis spread to become wider and more volatile.

 


 

Dr. Keith Weiner is the president of the Gold Standard Institute USA, and CEO of Monetary Metals.  Keith is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads.  Keith is a sought after speaker and regularly writes on economics.  He is an Objectivist, and has his PhD from the New Austrian School of Economics.  He lives with his wife near Phoenix, Arizona.

 


 

 
 

Emigrate While You Can... Learn More

 
 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • The Coming Debt Reckoning
      Licking the Log American workers, as a whole, are facing a disagreeable disorder.  Their debt burdens are increasing.  Their incomes are stagnating.   There are many reasons why.  In truth, it would take several large volumes to chronicle all of them.  But when you get down to the ‘lick log’ of it all, the disorder stems from decades of technocratic intervention that have stripped away any semblance of a free functioning, self-correcting economy.   Happy...
  • How to Stick It to Your Banker, the Federal Reserve, and the Whole Doggone Fiat Money System
      Bernanke Redux Somehow, former Federal Reserve Chairman Ben Bernanke found time from his busy hedge fund advisory duties last week to tell his ex-employer how to do its job.  Namely, he recommended to his former cohorts at the Fed how much they should reduce the Fed’s balance sheet by.  In other words, he told them how to go about cleaning up his mess.   Praise the Lord! The Hero is back to tell us what to do! Why, oh why have you ever left, oh greatest central planner of all...
  • India: Why its Attempt to Go Digital Will Fail
      India Reverts to its Irrational, Tribal Normal (Part XIII) Over the three years in which Narendra Modi has been in power, his support base has continued to increase. Indian institutions — including the courts and the media — now toe his line. The President, otherwise a ceremonial rubber-stamp post, but the last obstacle keeping Modi from implementing a police state, comes up for re-election by a vote of the legislative houses in July 2017.  No one should be surprised if a Hindu...
  • The Triumph of Hope over Experience
      The Guessers Convocation On Wednesday the socialist central planning agency that has bedeviled the market economy for more than a century held one of its regular meetings.  Thereafter it informed us about its reading of the bird entrails via statement (one could call this a verbose form of groping in the dark).   Modern economic forecasting rituals.   A number of people have wondered why the Fed seems so uncommonly eager all of a sudden to keep hiking rates in spite...
  • What is the Buffet Indicator Saying About Gold?
      Chugging along in Nosebleed Territory Last Friday, both the S&P 500 and the Nasdaq composite indexes closed at record highs in the US, with the Dow Jones Industrial Average only a whisker away from its peak set in March. What has often been called the “most hated bull market in history” thus far continues  to chug along in defiance of its detractors.   Can current stock market valuations tell us something about the future trend in gold prices? Yes, they actually...
  • Moving Closer to the Precipice
      Money Supply and Credit Growth Continue to Falter The decline in the growth rate of the broad US money supply measure TMS-2 that started last November continues, but the momentum of the decline has slowed last month (TMS = “true money supply”).  The data were recently updated to the end of April, as of which the year-on-year growth rate of TMS-2 is clocking in at 6.05%, a slight decrease from the 6.12% growth rate recorded at the end of March. It remains the slowest y/y growth since...
  • The 21st Century Has Been a Big, Fat Flop
      Seeming Contradiction CACHI, ARGENTINA – Here at the Diary we have fun ridiculing the pretensions, absurdities, and hypocrisies of the ruling classes. But there is a serious side to it, too. Mockery makes us laugh. And laughing helps us wiggle free from the kudzu of fake news.   Is it real? Is it real? Is it real? Above you can see what the problem with reality is, or potentially is, in a 6-phase research undertaking that has landed its protagonist in a very disagreeable...
  • A Cloud Hangs Over the Oil Sector
      Endangered Recovery As we noted in a recent corporate debt update on occasion of the troubles Neiman-Marcus finds itself in (see “Cracks in Ponzi Finance Land”), problems are set to emerge among high-yield borrowers in the US retail sector this year. This happens just as similar problems among low-rated borrowers in the oil sector were mitigated by the rally in oil prices since early 2016. The recovery in the oil sector seems increasingly endangered though.   Too many oil...
  • Will Gold or Silver Pay the Higher Interest Rate?
      The Wrong Approach This question is no longer moot. As the world moves inexorably towards the use of metallic money, interest on gold and silver will return with it. This raises an important question. Which interest rate will be higher?   It’s instructive to explore a wrong, but popular, view. I call it the purchasing power paradigm. In this view, the value of money — its purchasing power —is 1/P (where P is the price level). Inflation is the rate of decline of...
  • Rising Oil Prices Don't Cause Inflation
      Correlation vs. Causation A very good visual correlation between the yearly percentage change in the consumer price index (CPI) and the yearly percentage change in the price of oil seems to provide support to the popular thinking that future changes in price inflation in the US are likely to be set by the yearly growth rate in the price of oil (see first chart below).   Gushing forth... a Union Oil Co. oil well sometime early in the 20th century   But is it valid to...
  • Silver Elevator Keeps Going Down – Precious Metals Supply and Demand
      Frexit Threat Macronized The dollar moved strongly, and is now over 25mg gold and 1.9g silver. This was a holiday-shortened week, due to the Early May bank holiday in the UK. The lateral entrant wakes up, preparing to march on, avenge the disinherited and let loose with fresh rounds of heavy philosophizing... we can't wait! [PT]   The big news as we write this, Macron beat Le Pen in the French election. We suppose this means markets can continue to do what they wanted...
  • Warnings from Mount Vesuvius
      When Mount Vesuvius Blew   “Injustice, swift, erect, and unconfin’d, Sweeps the wide earth, and tramples o’er mankind” – Homer, The Iliad   Everything was just the way it was supposed to be in Pompeii on August 24, 79 A.D.  The gods had bestowed wealth and abundance upon the inhabitants of this Roman trading town.  Things were near perfect.   Frescoes in the so-called “Villa of the Mysteries” in Pompeii, presumed to depict scenes from a...

Support Acting Man

Austrian Theory and Investment

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com