Crazy Market Thoughts: Only Half the Story

In a recent interview conducted by Jeff Clark of Casey Research and self-declared as The Best Gold Interview of 2010, Andy Schectman of Miles Franklin discusses the future supply situation in the retail bullion market. Unfortunately, most people who have been around the block in the gold market will not find his views to be particularly insightful or surprising so we’d like to spice things up a bit by adding our own contrarian arguments and twisted perspective.

Among Mr. Schectman’s not-very-extraordinary claims is that the apparent shortage of gold and silver bullion and the resulting premiums that arose during the financial crisis in 2008 were caused by extremely strong demand from panicked retail buyers. Mr. Schectman then warns us that we should expect more retail shortages in the future. We can’t really argue with his logic but we believe he is only telling half the story given that many dealers were in fact rationing their existing inventories as a result of low bullion prices. Simply put, the dealers were unwilling to sell the shelves bare at prices so terribly low.

While it is true that bullion dealers are running a business like everybody else, most of them are also gold (and/or silver) bugs and consequently have much of their wealth sunk into their business in the form of bullion inventory. That way when the eventual and inevitable price spike to $5,000 gold and $500 silver comes, they can sell it all and retire as billionaires. This might not be the case for the large corporation-style dealers or the tiny numismatic coin shop mom-and-pops but there are a lot of dealers between those two extremes. Their inventories are typically not hedged or only slightly so. More to the point, these dealers are expecting the big score along the way and would only sell out at a loss under desperate circumstances.

So, what’s our point? That retail demand is only half the story: even without it, we’d see dealer inventories disappear during severe price declines. Consequently, we won’t share Mr. Schectman’s enthusiasm unless we see widespread, sustained retail shortages while gold and silver trade at record high prices. Call us crazy if you must, but so far the shortages during high prices have been regional or of very limited duration. And while logic dictates this will not always be the case, logic is not the same thing as reality.

One instance of reality is that the bull market peak in late 1979 and early 1980 brought a veritable flood of retail selling even while buying was at record levels as well. The retail selling was significant enough at times that many bullion products didn’t command a premium but rather sold at a discount. The highest bidder was often the refinery. With the purported market price of silver near $50 per ounce, for example, junk bags of 90% U.S. silver coins exchanged hands at a price closer to $30. Not coincidentally, that $30 also happened to be the melt price the refineries were paying dealers. Many a bag of old U.S. silver coins, not to mention bona fide numismatics including rare Morgan silver dollars, thus met their end in the Great Silver Melt of 1980. In fact, the “best” form of bullion to have owned during that bull market peak was actually COMEX deliverable bars since they could be sold (by futures exchange for physicals) at the same price that COMEX futures contracts were trading. Indeed, only people holding COMEX deliverable bars had a reliable chance to cash in anywhere near $50 silver or $850 gold during the 1980 peak.

This time around the situation could prove to be radically different — sellers will probably not be lining up in droves in front of dealer shops — but it might be because of something that Mr. Schectman does not mention: the development of “P2P” exchanges such as the auction site eBay that could eventually cut dealers completely out of the secondary market. So far these retail exchanges have been a mere annoyance to the dealers although sometimes you can find dealers who will sell and even buy on eBay. Such retail exchanges could, however, eventually dominate the secondary bullion market especially if we are to believe the outrage from gold dealers about the “hidden tax” in the recently enacted health care legislation.

Indeed, we find it difficult to reconcile dealer complaints about the new transaction reporting requirements with Mr. Schectman’s suggestion that going forward there will be little if any supply available from retail sellers. If that were true, there should be little actual impact from a new “tax law” that requires virtually all bullion purchases from the public to be reported by dealers to the Internal Revenue Service. It appears to us that either the complaining dealers are right or Andy Schectman is right.

Alternatively, they could both be telling only half the story: the likely outcome is an acceleration of the secondary bullion market’s transition to P2P bullion exchanges that offer retail investors the most privacy, the widest selection and the best prices. If so, generic auction services like eBay are likely to be joined by several new offerings in the near future while recent P2P applications dedicated to the bullion market such as SeekBullion and the Nucleo Exchange at Bullion Direct are likely to expand significantly. For this to happen, however, there is a need for independent bullion escrowing and verification services that enable trusted transactions to take place between individuals while avoiding new transaction reporting requirements. Another option would be P2P exchanges being set up within member-based organizations where escrow and verification could be handled internally.

A credit union can, for example, set up a private bullion exchange for its members and even Metal Augmentor can set up a private bullion exchange for our subscribers. All it would take is a very simple software platform (even a user forum or mailing list would suffice), a basic template for the business process and some training in bullion authentication. In fact, we’ve already drafted a conceptual business plan on the back of a napkin and would be willing to work with anyone interested in developing it into a viable business  opportunity. There’s probably not much money to be made initially but it is exceedingly simple and would help ensure a healthy secondary bullion market in the U.S. (or any other country for that matter). After all, gold and silver need to be more widely owned and must also be exchanged from time to time instead of merely accumulated and hoarded as a prerequisite to their acceptance in future monetary regimes.

It’s a pipe dream to think that any kind of gold standard could reappear without the public first becoming reacclimated to gold and silver and the best way to do that is often to just let people simply hold a gold coin or silver bar. We don’t see bullion dealers, many of whom are “out there” in terms of political thought, conspiracy mongering or ethics (we’re thinking of Goldline International in particular since they specifically target their aggressive upsell to people who are unfamiliar with bullion), as being effective tour guides to introduce the public to the marvels of gold and silver. Grassroots P2P exchanges potentially can, however, be an excellent introductory mechanism, especially as long as GATA and other agenda-driven organizations can manage to keep their paws off.

The other thing we think will start happening more and more is gold and silver bullion being used in private transactions. This actually became fairly common in the late 1970s and early 1980s so there is some precedent for it. We suspect it is only a matter of time before something like this is no longer uncommon in the classifieds or Craigslist: “Boat for Sale. 1998 Sea Ray 17 footer, perfect condition with trailer. Price: 3 Gold Eagles, firm.”

In conclusion, we see a bit of a silver lining in the new transaction reporting regulations “hidden” in the new health care law and we welcome the possibility that dealer involvement in the secondary bullion market could evaporate soon.