EPM Banner Update 8_12

Welcome to the August 2013 edition of my monthly Gold Letter.

We're seeing some rays of sunshine after a few dark months of price declines. The markets are waiting with bated breath for indications of the Fed's medium-term policy direction.

It takes an Austrian School understanding to see why any tightening would be politically disastrous. Sure, it could happen - just like Obama could suddenly decide he wants a free market in medicine - but it is almost impossible to fathom in today's Keynesian climate.

Many of our customers have wisely used this opportunity to increase their holdings. In my commentary, I explain why the dynamics of this correction are setting us up for a meteoric rally to new highs.

One of my Precious Metals Specialists, Dickson Buchanan, gives further evidence by examining some key technical indicators.

Also in this issue, our focus on silver continues with an article from Jeff Clark on booming solar panel demand out of Asia. Then, our FAQ teaches you how to calculate junk silver prices when buying, selling, or bartering. For a complete perspective on the investment merits of silver, read my new special report on the subject, The Powerful Case for Silver. Free download here.

And, as always, we have a clever comic from Lampoon The System and summaries of major stories to hit the precious metals markets this past month.

Remember, investing requires courage and clarity. Gather insights, make judgments, and then don't be afraid to act.


Peter Schiff
Euro Pacific Precious Metals

p.s. There is an opening in my office for a qualified junior sales rep. Click here for details.
By Peter Schiff

Peter SchiffI've been emphasizing for months that the current correction in the gold price is a result of speculative money fleeing the market and not any reflection of gold's long-term fundamentals. Unfortunately, there is so much money to be made (and lost) by day trading that my cautions have once again fallen on deaf ears.

Well, it looks like the so-called "technicals" are starting to support my theory, and so this month I'm going to depart from my typical discussion of market fundamentals and take a look at the COMEX gold futures market. It turns out that the same paper markets that helped drive the price of gold down are beginning to run into the hard reality of physical gold demand; their reversal may push gold to new highs.

Reading the Futures

The world of futures contracts is often confusing for ordinary investors. It is mainly the domain of institutions seeking to hedge and professional speculators. I do not recommend passive investors get involved in futures trading, but it is helpful to understand how these financial instruments affect gold's spot price.

In its most basic form, a gold futures contract is an agreement to buy a set amount of gold at the current spot price with delivery guaranteed at a future date. The attractive part is that you don't need to pay the full price up front. You can put a down payment on 100 ounces of gold today, knowing that you will only have to complete the payment when the contract comes due. If the price of gold rises in the intervening time, you've made a nice profit, because you end up paying today's price for a product that is worth more in the future. Of course, the person who sold you the contract takes a loss for the same reason. The person buying the contract is said to be "long" gold, while the seller is "short."

One of the reasons gold futures are so risky is because of the sheer quantity of gold that transactions represent. When you buy a single COMEX gold futures contract, you gain control - and responsibility for - 100 troy ounces of the yellow metal. So when the gold futures market was said to have made "big moves" this last April, that was an understatement - on April 12th, it opened with a sell off of 100 tons of gold!

It gets worse. Traders often leverage (borrow cash) to buy futures contracts, with the down payment they supply known as the "maintenance margin." The minimum maintenance margin for a single futures contract is only $8,800. If spot gold is at $1,300, then a trader can gain control of $130,000 worth of gold with less than 7% down! Depending on a combination of luck and experience, this massive leveraging can lead to either amazing profits or devastating losses.

Let's walk through an example, keeping in mind that my figures are very simplified, because a futures contract is not exactly equal to 100 times the current gold spot price. Most of the time, futures prices are a little higher than spot gold.

Say gold is at $1,300, which means a COMEX gold futures contract gives the investor control of about $130,000 worth of gold. A trader buys a contract with only a $8,800 margin. If the price of gold goes up to $1,500, the futures contract is now worth $150,000. The trader can now sell that contract and pocket the difference. He just netted about $20,000 with only $8,800 in seed money. If the trader had simply bought $8,800 worth of physical gold, he would have only earned about $1,350 in the same time period. It is not hard to see how futures trading can seem exciting and profitable on its face.

But what if the price of gold goes down in this scenario? The more the price of gold drops below the contract price of $1,300, the more the investor will be required to add to his margin to maintain the same ratio of down payment to loan value. This is required as assurance that he will not abandon the contract. In the worst case scenario, the trader cannot put up the additional funds and the entire position is liquidated by his broker.

So far, this example is of a trader "going long" with a futures contract. It can be risky, but the potential losses of a long futures trader are nothing compared to the losses someone shorting the market might experience.

Consider the same scenario above, except this time the trader has a short contract. He is desperately betting that the price of gold will drop enough for him cover his short position (buy back the contract he sold) at a lower price. After all, he can not hold the contract to maturity, as he does not actually own any physical gold, and thus would not be able to deliver to the buyer.

The key difference between long and short traders is that shorts are forced to add to margin when the price of gold goes up. Unlike a drop in the price gold, which can only go so low, there is theoretically no limit to how high the price of gold can rise. Someone betting on gold's demise with short futures contracts when gold enters a big bull market can be completely devastated by their margin calls.

It's risky enough leveraging into a deal as aggressively as futures traders do, but if traders don't understand the fundamentals of the asset underlying the contract (in this case, actual physical gold), they can get into a lot of trouble and in turn distort the price of the commodity they are trading. This is precisely what is happening now.

The Short Squeeze

When gold began its price drop in April, we saw a rush of paper gold flee the market, including record-high ETF outflows. Major money managers and hedge funds began selling their gold positions, issuing lower and lower forecasts for the year-end gold price. All of this became a major signal for futures traders to short gold.

The selling feeds on itself as the traders seek to cut their losses, or retain some of the paper profits the earned on the way up. Sometimes the selling is fueled by "stop sell orders," which are orders on the books that are automatically triggered when prices decline to a specific level, in many cases just below key technical support levels. Stops generally become market sell orders as they are hit, accelerating the decline and thereby triggering even more stops as prices fall lower. Some stops represent long positions being covered; others represent new short positions being established.

This ongoing shorting of gold builds a cycle that feeds on itself. The shorts see others fleeing the market and so continue to short. Meanwhile, the fund managers see the net-short positions increasing and so they continue to sell gold.

This cycle continued right up until gold's rebound - in July, the gold net-short positions reached record highs.

When gold began to rebound last month, a massive number of shorts were left exposed and many still remain exposed. Gold shorts are stuck holding the losing bet on an asset that is going to do the opposite of what they anticipated.

If the price rally continues, these traders will feel increasing pressure to unwind their shorts before their losses become catastrophic. This "short squeeze," as it is known in finance, will reverse the vicious cycle and could send gold dramatically higher than when the correction started.

An Unbalanced Ecosystem

To understand this short squeeze, imagine a brand new predator entering a pristine natural ecosystem. The newly introduced predator finds a smorgasbord of prey that have never learned to outrun, outsmart, or avoid this particular predator. Before long, the predator becomes "invasive" and begins to devastate the natural population of its easily-captured food source. Thriving on the newfound resources, the population of the invasive predator surges to new highs - until the prey population collapses.

This is akin to what has happened with gold shorts in the past three months. The more the price of gold (the prey) was driven down, the more gold speculators (invasive species) entered the market to profit from this trend, which only served to drive the price down further.

However, as in a natural ecosystem, this relationship is unsustainable. Eventually there are so many predators that they run out of enough prey to share. This forces the predators to starvation, and eventually the population drops to a sustainable level while the prey manage to grow back to a natural equilibrium.

The overwhelming problems for the shorts is that the gold they sold on the way down will not likely be for sale on the way up. My guess is that the buyers who previously stepped up to the plate were not short-term traders like the speculators who sold. These were buyers who bought gold to own it, not to trade it. For these buyers, like foreign central banks, the gold they bought is not for sale at any price (at least not a price the speculators can afford to pay). The buyers over the past few months have been lying in wait for this opportunity for years.

The result of this price decline is that gold has moved from weak hands to strong. In addition, the weakness in the price of gold has caused gold miners to shut mines, reduce capital expenditures, and limit exploration/development. So gold that was once on the market will be gone, and future supply coming from new production will be diminished. So when the market turns around, how will the shorts cover? Where will the gold they need to buy come from? When traders want back into the ETFs, where will the ETFs get the physical gold they need to buy? How much higher will prices have to rise to bring that supply back onto the market? I really have no answers to these questions, but it sure will be fun for the longs, and painful for the shorts, to find out.

What you and I can really hope for is that this massive short-squeeze becomes the impetus to focus the market back on gold's fundamentals and begins to drive the yellow metal back toward its previous highs. If I'm right that gold is still grossly undervalued, then this might be the beginning of the biggest rally we've yet seen.

Peter Schiff is Chariman of Euro Pacific Precious Metals.

If you would like more information about Euro Pacific Precious Metals, click here. For the fastest service, call 1-888-GOLD-160.
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By Dickson Buchanan of Euro Pacific Precious Metals

Pic: Mike Finger With gold recouping some losses in its most recent trading sessions, many are asking whether or not the bottom has finally formed for the yellow metal. Most of these gains have been simply chalked up to short-covering and dovish remarks by Bernanke during the recent Federal Open Market Committee meetings; however, there are some key indicators for gold which are overshadowed by the media hubbub. Two of them in particular are important to understand, because they reveal a renewed investment demand for physical gold over paper gold or fiat currencies.

Gold Backwardation

The first indicator to note is called "gold backwardation," which occurs "when the price of a futures contract is lower than the price in the spot market."1 This means that traders are willing to pay more for gold that is available for delivery today, rather than lock in a futures contract at a discount for gold that is delivered months later.

Taking this one step further, if gold stays in backwardation for some time, it means that no one is taking advantage of a risk-free arbitrage opportunity by simultaneously selling physical gold at spot and buying a futures contract. In such a scenario, traders can keep not only the spread between the spot rate and the futures rate, but also their original position in gold. This is known as "de-carrying gold." Now, if enough traders were to take advantage of this risk-free profit, gold would be pushed out of backwardation into its normal trading state (i.e., "contango," when the price of a futures contract is higher than the physical spot price). The fact that this is not occurring, and that gold remains in backwardation, implies that gold is more and more decoupling from the dollar - a trend that, if continued, could raise the dollar price of gold and other assets significantly.1

Backwardation is quite common in other commodities like crude oil or copper, but in gold and even silver it should be exceedingly rare. Why? Because unlike the aforementioned commodities, the above-ground inventories of precious metals are mostly not consumed - they simply trade hands. Therefore, a sudden shortage of gold is not likely - it gains value by staying stable while currencies depreciate. Nonetheless, when gold does go into backwardation, it signals that there is not enough gold for sale to meet market demand. In other words, gold becomes "scarce."

This is precisely what is happening with gold now, and has been happening intermittently since 2008. Yet more recently, gold has been going further into backwardation (deeper spreads) and staying there longer (longer contract times).


The second important indicator of the demand for gold is a negative Gold Offered Forward, or "GOFO," rate.

"GOFO is calculated by subtracting the gold lease rate from the London Interbank Offered Rate [LIBOR], the average rate banks charge each other for loans. Note that normally, given the positive GOFO rate, people will employ gold to get their hands on dollars. In other words, gold is normally used as collateral to secure a dollar loan with interest."2

But what happens when the rate goes negative? A negative GOFO rate means that traders would rather give up dollars in order to secure gold bullion immediately and are willing to pay an interest rate to do so. Similar to gold backwardation, a negative GOFO rate signals that the demand for gold is overwhelming the available supply.

A Replay of 2008

So what's the big deal? Why are these somewhat obscure signs so important? There are at least two reasons you should pay attention.

First, there is history. The last time we saw gold in backwardation and a negative GOFO rate was in 2008, right before gold went into its largest and longest rally - setting record highs.

Keep in mind that the broader macro-economic factors that were instrumental in the financial crisis of 2008 (bailouts, aggressive bond-buying programs, and suppressed interest rates) have not dissipated at all, but rather increased. The Fed has maintained a relentless inflationary program since 2008 (QEI, II, III, and so on). This strongly indicates that what lies ahead for gold could potentially dwarf its post-2008 rally.

Second, the negative GOFO rate and backwardation of gold are important because they represent a clear measure of the demand for gold. They report to us without bias that the demand for gold is growing while the readily available supply is shrinking. What's more, they show a simultaneous decline in the demand to hold US dollars in favor of gold. This is perhaps the most striking takeaway from these indicators.

Ben Bernanke recently admitted that he doesn't understand gold. Peter Schiff likened this to a miner not understanding the role of the canary - an early warning indicator for dangerous gas leaks. Gold backwardation and a negative GOFO rate paint a picture as clear as a dead canary - investors are taking physical gold much more seriously.

1. Source: Keith Weiner, CEO of Monetary Metals, www.monetary-metals.com
2. Source: Peter Tenebrarum ,"Gold slips into Backwardation," www.acting-man.com/?p=24578

Dickson Buchanan is a Precious Metals Specialist at Euro Pacific Precious Metals. He received his MA in Austrian Economics from King Juan Carlos University in Madrid, Spain, and is currently enrolled in the doctorate program. Dickson joined the Euro Pacific Precious Metals team in 2012 after returning from his economic studies abroad.
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Cartoon: Chairman Bernanke serves up endless QE at Ben's Diner
(Click to enlarge)

Jon Pawelko publishes the web comic Lampoon The System to poke fun at insane economic policies and educate the public on sound economics.

Click here for more cartoons and information on his just-updated anthology book, available for only $15.
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By Jeff Clark of Casey Research

Last month, big news came out of China. It may have gone unnoticed by most investors - and there's really no reason why it would have been covered extensively by mainstream media - but it's important if you're a silver investor. China raised its target for solar generating capacity to more than 35 gigawatts by 2015, a stunning increase of 67% above the previous target.

China's State Council announced on July 4th that installed capacity for solar electricity would grow about 10 GW per year until it reaches the newly set target. The country's previous target was 21 GW; installed capacity in 2012 was about 7 GW, so this would translate to a 400% increase. Moreover, if one looks at the rate at which it keeps raising the target, we may well see even more solar capacity by 2015 - and quite possibly double that by 2020!

What does this mean to us as precious metal investors? A simple answer would be that growing demand could crimp supply and push up prices. But let's take a deeper look to see if that's the case...

Inner Workings of the Solar Industry

The backbone of the solar industry is photovoltaic technology, which is used to generate electrical power by converting solar radiation into direct-current electricity through the use of semiconductors. A typical photovoltaic solar panel uses a fair amount of silver - roughly two-thirds of an ounce, or about the same amount as 80 cellphones or 20 laptops. So a substantial amount of metal goes toward producing these technological wonders.

The photovoltaic industry didn't even start to show up on silver-demand charts until the year 2000, when it consumed roughly 1 million ounces of the metal. This was a miniscule slice of the demand pie, and it's fair to say that few investors saw this tiny use for silver becoming an important driver anytime soon.

But that had changed by 2008, when the solar industry consumed nearly 19 million ounces of silver. Since 2000, the amount of silver used by solar-panel makers has risen by an average of nearly 50% per year, with demand exceeding 47 million ounces in 2012. Photovoltaic consumption now represents 5.6% of all industrial use of silver.

Silver Fabrication Demand By Industry
Click to enlarge

The largest end user of solar panels in 2012 was Germany, but that's changing. In fact, a number of major European governments have reduced subsidies for solar panel installations, pushing photovoltaic silver demand down 12%. This was the first time demand from the sector declined since 2000.

Silver Demand from Solar Panel Industry
Click to enlarge

But the future of photovoltaic demand doesn't rely on Europe; more important are the emerging giants in the East. In addition to China, India plans to increase its solar output to 20 GW by 2020, starting essentially from scratch. On a worldwide basis, solar power generating capacity is projected to be 20 to 40 times the amount of current capacity by 2020.

Catching Sun Rays in China

China is a principal solar panel manufacturer and exporter, supplying 53.6% of global silver photovoltaic demand in 2012. While this demand declined 14.2% last year due to fewer solar panel installations in Europe and oversupply from excess production, the future for Chinese photovoltaic demand looks anything but bleak.

China's Silver Demand for Solar Panel Industry
Click to enlarge

Again, according to the rules released by the State Council, China should add an average 10 GW of capacity from 2013 through 2015 - that's a pretty solid basis for expecting growth in the sector.

Meanwhile, Chinese authorities have also said they will offer tax breaks to solar companies that expand and reorganize their operations, as well as urging banks to lend to the producers. Many in China hope that this will reenergize its solar industry and effectively reduce its dependence on the need for exports.

What It Means for Investors

It's estimated that over 50 million ounces of silver will be devoted to just the solar industry this year. China's proposed boost from 7 to 35 GW in capacity would translate into a global increase of 27%, from 102.2 GW last year to 130.2 GW in 2015. Meanwhile, Japan is expected to overtake Germany as the world's largest solar energy user. An estimated 5.3 GW of generation capacity - the equivalent of five nuclear reactors - will be added this year, according to a report from HIS Inc., a US-based research firm.

All this extra capacity could have a significant impact on the silver market. According to the Silver Institute, approximately 80 tonnes of silver are required to generate one GW of electricity. With 5.3 GW of new capacity in Japan in 2013 and 30 GW from China, a staggering 2,824 tonnes, or roughly 91 million ounces of silver, will be required over the next three years for just this industry. This amount is nearly two times current worldwide demand from the photovoltaic industry. Demand from China and Japan alone could consume up to 11% of global mine supply. And that's only if the world continues to produce as much silver as it did last year, a questionable assumption given currently lower silver prices and increasing difficulties getting mines permitted.

To this analyst's eyes, silver is a strong buy right now.

Jeff Clark is the editor of BIG GOLD, Casey Research's monthly advisory on gold, silver, and large-cap precious metals stocks.

Worried about your dollar dominated assets and want to know more how to diversify your wealth outside of the US? Check out Casey's free webinar, Internationalizing Your Assets, featuring Peter Schiff.

How Do I Calculate the Value of Junk Silver Coins?

You may have heard of the increasing scarcity of "junk" silver, which generally refers to pre-1965 US dimes, quarters, and half-dollars that contain 90% silver. The scarcity indicates people are stockpiling, and so it might not be long before you get the opportunity to actually transact some barter business with junk silver. Some clients have asked us to walk them through the process of calculating the actual value these old coins.

Let's start by using the round number of $20 for the silver spot price. The spot price reflects troy ounces, which measure about 31.1 grams. A Mercury dime contains 90% silver and weighs 2.5 grams.

2.5 grams รท 31.1 grams = 0.08
The dime is about 8% of a troy ounce.

0.08 x $20 = $1.60
If the dime were 100% silver, it would be worth about $1.60.

0.9 x $1.60 = $1.44
At 90% silver, the Mercury dime is worth about $1.44 when the silver spot price is $20.

You can do these same calculations for the silver quarter when you know that it weighs 6.25 grams, about 20% of a troy ounce:

0.20 x $20 = $4.00
0.9 x $4.00 = $3.60

At a silver spot price of $20, a pre-1965 silver quarter is worth about $3.60.

Keep in mind that the other 10% of these coins is composed of copper, which is also an expensive metal, if relatively cheap compared to silver. If you're doing a bigger transaction with junk silver, you might want to add the value of the copper to your calculations.

Of course, for most people, doing these sorts of calculations on the fly is cumbersome and they'd prefer to use a calculator. If you're dealing with someone unfamiliar with the use of silver, then the transaction can become even more tedious as you walk him or her through the process.

A much more straightforward alternative to junk silver is fractional silver rounds. These are privately minted rounds that come in weights such as 1/2, 1/4, or 1/10 of a troy ounce. They are made of .9999 pure silver and clearly labeled.

Because of this, their value is far easier to calculate. For example, with the 1/2 troy ounce rounds found in our new Silver Barter Bags, you only need to know the spot price of silver and divide it by 2 to figure out the value of a single round. Easy! 

Take a moment to view Peter Schiff's live video demonstration of the Silver Barter Bags:

Junk Silver Is History: Peter Schiff's New Silver Barter Bag
Junk Silver Is History:
Peter Schiff's New Silver Barter Bag

Want to learn more about junk silver or Silver Barter Bags?

Please call 1-888-GOLD-160 (1-888-465-3160) to speak with a Precious Metals Specialist, request a callback at a time convenient for you, or click here to chat with a Specialist right now.

Singapore Opens 200 Metric Ton Silver Vault
Bloomberg - Malca-Amit Global Ltd. added a 200 metric ton silver vault to its five existing gold vaults at the Singapore FreePort. The new silver vault will be an affordable storage alternative for the less expensive white metal, since the gold vaults are already fully reserved due to ongoing demand for physical precious metals from wealthy Asians. The number of Asia-Pacific high-net-worth individuals increased by 9.4% last year, and 43% of global economic growth from 2007-2012 is attributed to China. Singapore has been rebranding itself as a bullion-trading hub, with UBS, Deutsche Bank, and JPMorgan Chase also opening Singapore metals vaults over the past few years.
Read Full Article>>

China May Become World's Biggest Gold Consumer
Reuters - Chinese gold demand could reach a record 1,000 metric tons this year, surpassing India as the largest global bullion consumer, according to the World Gold Council. India's gold demand is expected to reach about 850 metric tons. The Shanghai Gold Exchange delivered more physical gold in the first half of 2013 than in all of last year, even in the face of huge premiums. While jewelry will be the larger Chinese demand segment, the fastest growing will be investment demand. "Jewelry demand is likely to increase globally this year as a proportion of overall gold demand for the first time in 12 years," said Marcus Grubbs, managing director of investment for the WGC.
Read Full Article>>

New "Stretchy" Gold Developed for Medical Implants
Wired - Chemical engineers at the University of Michigan have invented a stretchy material made from gold and polyurethane that could be used for pacemakers or brain implants. Unlike traditional circuits, this new material can still conduct electricity when stretched. The stretchy gold could solve the engineering problem of implanting electronic systems into the curved and irregular surfaces of the human body. The research team plans to test prototype implants in rat brains.
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Detroit Files for Record-Breaking Bankruptcy
Toronto Star - Detroit has filed the largest municipal bankruptcy, both in terms of debt and city size, in the history of the Unites States. Since the 1950s, a mere 60 Chapter 9 municipal bankruptcies have been filed. The municipal bond market, public unions, and other struggling cities will carefully watch how Detroit structures its debt reduction and recovery plan. In particular, the restructuring of retirement benefits could set an important precedent in municipal bankruptcies. Detroit's debt is estimated to be as high as $20 billion, and the bankruptcy process could take years to complete.
Read Full Article>>

Brazilians Protest Sky-High Consumer Prices
New York Times - Sparked by unusually high public transportation fees in Sao Paolo and Rio de Janeiro, Brazilian consumers have been protesting extremely high consumer prices. Some smart phones cost twice as much as in the US, Ikea-like furniture costs six times more, and a cheese pizza can run $30. The high prices are blamed on protectionist manufacturing policies, transportation bottlenecks, and a tax system that favors consumer taxes over income taxes.
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Employment Opportunity
Do you have a firm understanding of the Euro Pacific investment strategy? Would you like to earn a living by promoting sound money and a fundamental investment approach? Euro Pacific Precious Metals is looking for a new assistant to train into a junior broker. If interested, please submit your resume and cover letter to jsosnay [at] europacmetals [dot] com.
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In This Issue
What Doesn't Kill Gold Makes It Stronger
- Peter Schiff
Futures Markets Signal Gold Ready to Erupt
- Dickson Buchanan Jr.
Ben's Diner
- Lampoon the System
A Solar Silver Bull in China
- Jeff Clark
Questions From Our Customers
This Month in Gold
EPPM Employment Opportunity
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