For those of us who have seen volatile markets multiple times over the decades, it is entirely understandable that when the spot prices in the “paper” commodity markets suddenly plummet, the premiums for actual physical gold and silver coins and ingots can soar.
To give one example: At the COMEX close on March 11, 2020, with the spot price of silver at $16.78, the company where I work was selling $1,000 face value bags of U.S. 90 percent silver coins at $17.03 per ounce, a premium of just 1.5 percent.
As I type this in the early afternoon on March 17 before the COMEX close, the silver spot price is at $12.59, down $4.19 (25 percent) from the COMEX close six days ago. Yet, right now our company is offering to sell the $1,000 face value bags of U.S. 90 percent silver coins at $17.94 per ounce, up 91 cents per ounce from last Wednesday, with a current premium of 42.5 percent! Our price is still well below what several other national bullion dealers are presently quoting.
For those who have not been through volatile markets such as this, they would tend to expect the prices of the physical product to decline when the spot prices sink sharply. If the decline was slow and gradual, that would almost certainly be true. But when major spot price moves are abrupt, that may not happen.
The key point to understand is that the spot refers to the trading of paper contracts on commodity futures exchanges. These exchanges almost exclusively involve trading in the price of the metal rather than trading in the physical metals. The trading volumes are so high that it dwarfs trading in the physical metals. For example, on March 16, 2020, the COMEX silver market traded 155,868 5,000-ounce contracts (representing 779.34 million ounces). In this one day of trading, the COMEX traded almost as much silver as the annual global output of all primary and secondary silver mines!
In the futures commodity markets, sellers can offer an almost unlimited quantity of “paper silver” for sale, knowing that there is almost no chance they will be required to deliver physical metal.
In contrast, the physical market trades in the actual product. Dealers cannot offer something for sale without being able to eventually deliver it. Therefore, in order to acquire the products to sell to customers, they must be purchased from another party who owns it and is willing to sell it at some price. The prices at which current owners are willing to sell it may or may not have any relation to the “paper silver” commodity futures market spot price.
There have been multiple previous times when the spot price of silver sank sharply and the retail premium at which U.S. 90 percent silver coins exceeded 30 percent. Two examples were in June 1982 and toward the end of 2008. These coins have not been in production since the mid-1960s. Unlike ingots, it is not simply a matter of waiting for the refineries to produce more inventory. When the silver spot price drops suddenly, those who own physical silver are discouraged from liquidating, at the same time that retail demand soars.
In theory, one way to try to purchase physical silver would be to purchase a 5,000-ounce COMEX futures contract, wait for it to mature, then tell the short-seller on the other side of the contract that you want delivery. The short-seller then has four options to fulfill their obligation. They could 1) deliver the actual physical silver, 2) settle for cash, 3) deliver sufficient shares in silver exchange-traded funds equal to the amount of the silver contracts, or 4) settle through a process called “exchange for physical” which involves the payment of some cash to the contract holder plus a futures contract in the London market for the same ounces of silver. Of these options, the least expensive would be to deliver the physical silver and the most expensive would be the exchange for physical choice. Unfortunately, in both the COMEX gold and silver futures markets a high percentage of maturing contracts called for delivery are being settled by the expensive exchange for physical option.
The large number of maturing COMEX gold and silver contracts being settled by exchange for physical is a major signal of a huge shortage of physical metals. Short-sellers can only offer to sell just so many paper contracts until the parties on the long side wise up and a high percentage of them start demanding delivery of the physical metal.
This has happened before. Warren Buffett’s Berkshire Hathaway accumulated 129.7 million ounces of silver futures contracts in late 1997 and early 1998. Most of them matured in March 1998. Those who sold contracts to him assumed that they would be liquidated back onto the market before maturity, so no delivery of physical metal would be required. Instead, Buffett announced that he wanted the delivery of physical silver. In the two months before the deadline, the resulting physical supply squeeze resulted in the spot price rising about 20 percent (from around $6.00 to $7.20). This resulted in enormous losses to the short sellers of these silver contracts. My understanding from rumors (I have not seen official confirmation of this) is that Buffett allowed some short-sellers who could not come up with the physical metal by the contract maturity date to have a few months extension to deliver so long as they paid 50 cents per ounce in cash by the maturity date.
Since the silver market is significantly lower dollar value than that of gold, physical silver products have experienced larger premium increases in the last week than has occurred for physical gold coins and ingots. But the premiums are up for just about all gold products as well.
There are other examples in the physical gold and silver markets of rising premiums as the spot prices drop. As the spot prices rise, today’s higher premiums will subside. This has happened in the past and is bound to occur this time around.
Patrick A. Heller was honored as a 2019 FUN Numismatic Ambassador. He is also the recipient of the American Numismatic Association 2018 Glenn Smedley Memorial Service Award, 2017 Exemplary Service Award 2012 Harry Forman National Dealer of the Year Award, and 2008 Presidential Award winner. Over the years, he has also been honored by the Numismatic Literary Guild (including twice in 2019), Professional Numismatists Guild, Industry Council for Tangible Assets, and the Michigan State Numismatic Society. He is the communications officer of Liberty Coin Service in Lansing, Michigan and writes Liberty’s Outlook, a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Some of his radio commentaries titled “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 AM Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and become part of the audio and text archives posted at http://www.1320wils.com).