Gold and Silver Dealer Hedging
Gold, silver, and platinum prices have been known to fluctuate significantly. Just last year, for example, the gold price dropped $110 in just one day (April 15th). Later on in 2014, the typically more volatile silver jumped 17% from its intraday lows in the course of a day (Dec 1st).
The largest precious metals dealers buy and sell millions of ounces of bullion each month, which means they have to be careful that they are not on the wrong side of one of these big price swings. Large price movements, both up and down, can potentially wipe out or endanger smaller dealers that aren’t careful with their inventory.
Over time, bullion dealers have developed a way to hedge against these market risks, to make business safer and more predictable for both them and their customers.
What is Hedging?
Hedging is the process of playing both sides of a market to provide protection against the market’s fluctuations.
For bullion dealers, hedging means that the dealer has to offset all of their long positions with short positions, and vice versa. By ensuring they never have a long or short overall position in the market, the dealer ensures they are immune to market movements, and lock in their margins between their purchase premiums and sale premiums.
Long positions: Any inventory the bullion dealer holds or has priced/ordered from a supplier. The dealer benefits from upwards price movement in the gold or silver price.
Short positions: Any orders that the bullion dealer has yet to fulfill. The dealer benefits from downwards price movement in the gold or silver price.
Net house position: Equal to the bullion dealer’s long position minus short position.
A Sample Situation
A gold dealer holds 5,000 ounces of physical inventory bought at a spot price of $1,200/oz plus wholesale premium. The dealer has 3,000 ounces worth of open customer orders, sold at a spot price of $1,200/oz plus retail premium. This leaves the dealer with a net long position of 2,000 ounces bought at $1,200/oz spot.
With no hedging, the dealer has a net long house position of 2,000 oz.
With hedging, the dealer offsets this position by shorting 20 gold futures contracts for 100 oz gold each, for a total short of 2,000 oz.
If the price of gold swings $200, it will have an unanticipated $400,000 positive or negative effect on the dealer who does not hedge. For the dealer that hedges the net long position with short futures contracts, everything will be a wash. This allows the dealer to not have to worry about swings, and instead to focus on making margin on premiums alone.
A Sample Situation
Since markets are not open on weekends, online dealers typically estimate their weekend sales and take an offsetting long position into the closing bell on Friday, with the hopes of selling exactly that much metal between closing Friday and opening Sunday evening.
Some larger wholesalers will make weekend markets with widened spreads to allow dealers to buy or sell metal on the weekend as needed. The market maker in this scenario takes additional price exposure into the Sunday open, in exchange for the widened spreads throughout the weekend.
To Hedge or Not to Hedge
Dealers hedge to ensure that even if spot plunges very quickly, they are still financially stable and secure.
Dealers that do not hedge, or are not big enough to trade futures contracts, run the risk of being wiped out by big and unanticipated market movements.
Hedging large bullion inventories is not the norm for all silver and gold retailers. Many local coin dealers and even online sellers do not fully hedge their positions.
The Silver Series: The Start of A New Gold-Silver Cycle (Part 1 of 3)
As the decade-long bull run shows signs of slowing, is it time for precious metals to shine? Here’s why it could be the start of a new gold-silver cycle.
The world has experienced a decade of growth fueled by record-low interest rates, a burgeoning money supply, and historic debt levels – but the good times only last so long.
As the global economy slows and eventually begins to retract, can precious metals offer a useful store of value to investors?
Part 1: The Start of a New Cycle
Today’s infographic comes to us from Endeavour Silver, and it outlines some key indicators that precede a coming gold-silver cycle in which exposure to hard assets may help to protect wealth.
Bankers Blowing Bubbles
Since 2008, central bankers around the world launched a historic market intervention by printing money and bailing out major banks. With cheap and abundant money, this strategy worked so well that it created a bull market in every sector — except for precious metals.
Stock markets, consumer lending, and property values surged. Meanwhile, the U.S. Federal Reserve’s assets ballooned, and so did corporate, government, and household debt. By 2018, total debt reached almost $250 trillion worldwide.
Currency vs. Precious Metals
The world awash in unprecedented amounts of currency, and these dollars chase a limited supply of goods. Historically speaking, it’s only a matter of time before the price of goods increases or inflates – eroding the purchasing power of every dollar.
Gold and silver are some of the only assets unaffected by inflation, retaining their value.
Gold and silver are money… everything else is credit.
– J.P. Morgan
The Perfect Story for a Gold-Silver Cycle?
Investors can use several indicators to gauge the beginning of the gold-silver cycle:
- Gold/Silver Futures
Most traders do not trade physical gold and silver, but paper contracts with the promise to buy at a future price. Every week, U.S. commodity exchanges publish the Commitment of Traders “COT” report. This report summarizes the positions (long/short) of traders for a particular commodity.
Typically, speculators are long and commercial traders are short the price of gold and silver. However, when speculators and commercial traders positions reach near zero, there is usually a big upswing in the price of silver.
- Gold-to-Silver Ratio Compression
As the difference between gold and silver prices decreases (i.e. the compression of the ratio), history suggests silver prices can make big moves upwards in price. The gold-to-silver ratio compression is now at high levels and may eventually revert to its long-term average, which implies a strong movement in prices is imminent for silver.
- Scarcity: Declining Silver Production
Silver production has been declining despite its growing importance as a safe haven hedge, as well as its use in industrial applications and renewable technologies.
- The Silver Exception
Silver is not just for coins, bars, jewelry and the family silverware. It stands out from gold with its practical industrial uses which account for 56.1% of its annual consumption. Silver will continue to be a critical material in solar technology. While photovoltaics currently account for 8% of annual silver consumption, this is set to change with the dramatic increase in the use of solar technologies.
The Price of Gold and Silver
Forecasting the exact price of gold and silver is not a science, but there are clear signs that point to the direction their prices will head. The prices of gold and silver do not accurately reflect a world awash with cheap and easy money, but now may be their time to shine.
Don’t miss another part of the Silver Series by connecting with Visual Capitalist.
Why Gold is Money: A Periodic Perspective
Gold has been used as money for millennia. People often attribute this to beauty, but there are basic physical properties for why gold is money.
Why Gold is Money
The economist John Maynard Keynes famously called gold a “barbarous relic”, suggesting that its usefulness as money is an artifact of the past. In an era filled with cashless transactions and hundreds of cryptocurrencies, this statement seems truer today than in Keynes’ time.
However, gold also possesses elemental properties that has made it an ideal metal for money throughout history.
Sanat Kumar, a chemical engineer from Columbia University, broke down the periodic table to show why gold has been used as a monetary metal for thousands of years.
The Periodic Table
The periodic table organizes 118 elements in rows by increasing atomic number (periods) and columns (groups) with similar electron configurations.
Just as in today’s animation, let’s apply the process of elimination to the periodic table to see why gold is money:
- Gases and Liquids
Noble gases (such as argon and helium), as well as elements such as hydrogen, nitrogen, oxygen, fluorine and chlorine are gaseous at room temperature and standard pressure. Meanwhile, mercury and bromine are liquids. As a form of money, these are implausible and impractical.
- Lanthanides and Actinides
Next, lanthanides and actinides are both generally elements that can decay and become radioactive. If you were to carry these around in your pocket they could irradiate or poison you.
- Alkali and Alkaline-Earth Metals
Alkali and alkaline earth metals are located on the left-hand side of the periodic table, and are highly reactive at standard pressure and room temperature. Some can even burst into flames.
- Transition, Post Transition Metals, and Metalloids
There are about 30 elements that are solid, nonflammable, and nontoxic. For an element to be used as money it needs to be rare, but not too rare. Nickel and copper, for example, are found throughout the Earth’s crust in relative abundance.
- Super Rare and Synthetic Elements
Osmium only exists in the Earth’s crust from meteorites. Meanwhile, synthetic elements such as rutherfordium and nihonium must be created in a laboratory.
Once the above elements are eliminated, there are only five precious metals left: platinum, palladium, rhodium, silver and gold. People have used silver as money, but it tarnishes over time. Rhodium and palladium are more recent discoveries, with limited historical uses.
Platinum and gold are the remaining elements. Platinum’s extremely high melting point would require a furnace of the Gods to melt back in ancient times, making it impractical. This leaves us with gold. It melts at a lower temperature and is malleable, making it easy to work with.
Gold as Money
Gold does not dissipate into the atmosphere, it does not burst into flames, and it does not poison or irradiate the holder. It is rare enough to make it difficult to overproduce and malleable to mint into coins, bars, and bricks. Civilizations have consistently used gold as a material of value.
Perhaps modern societies would be well-served by looking at the properties of gold, to see why it has served as money for millennia, especially when someone’s wealth could disappear in a click.
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