Spot price is not arbitrary, it involves many types of players

derryb

From another thread:

@HJP said:
So, in essence the spot price is an arbitrary number based on the opinions of 5-6 bullion traders- who are also buying / selling future contracts ?

The spot price for precious metals (PMs) is determined on the commodity futures exchanges by actual buyers and sellers of futures contracts who bid the price up or down by actually purchasing long and short positions on future delivery based on that day's spot prices. Delivery in most cases never actually occurs.. The big and important difference between the futures market and all other "normal" PM markets is that the futures exchange does not require the "promise to deliver" (the contract) to be backed by actual physical metal that is held in the exchange's vault. Think of it as a legal ponzi scheme.

Some "good for delivery" bars are held in the vault to fill the few contracts that are held to expiration and the demand for physical is declared. Most contracts are more than tradeable promises that never reach expiration and therefore never require physical fulfillment or backing. Because of this the exchanges get away with not having to have physical metal in the vaults to cover all of the contracts. In reality, their vaults holds very little physical metal in relation to the contracts sold. This allows for an unlimited number of contracts to be actually sold. Imagine what happens to price when supply is unlimited.

Exchange traders include speculators (banks, hedge funds, individuals) as well as hedgers (suppliers, miners, brokers, manufacturers who need silver, etc.). The commodities exchanges were actually created to provide much needed stable prices for the hedgers, both producers and consumers, for all types of products (i.e. corn, metals, oil, pork bellies, etc.). Speculators eventually saw it as a way to control price and create profits.

The spot price and the physical price are not the same. Why is the spot price important when it comes to physical metal? Because the spot price determines the minimum base price of physical metal. Sellers of physical metal add their "premium" over spot to the spot price when pricing their physical products. Things that are included in the premium are fabrication costs, shipping costs to and from the seller and various overhead expenses. Additionally, premium will include a fluctuating cost that is determined by current supply and demand for the actual product. Remember, unlike the futures (paper) market, the physical market is actually backed by limited supply and real demand (buyers who have to put real money up and actually take delivery). Physical buyers, unlike futures buyers, have to see the transaction to its end.

It is the speculators, primarily banks obligated to and in cahoots with the Federal Reserve Bank (Fed), who are believed to be the ones artificially holding down the price of physical PMs by holding down the spot price with contracts that don't require physical backing on the exchange. Why? It is believed the Fed does not want precious metals competing with the financial products it wants to see investors choose such as dollars, stocks, and bonds.

Since contracts on the futures exchange require no physical backing - which allows for "fractional" trading - more paper can be sold than is actually backed by physical metal in the exchanges' vaults. Because of this it is believed/hoped by many PM investors that an exploding physical price will someday create a run on the exchange’s vaults and once and for all break the exchange, putting an end to the believed manipulation.

Unfortunately most contracts do not reach expiration as they are sold before it is time to turn the paper contract into delivered physical metal. Those that are held until expiration are usually settled with cash in lieu of the actual product. Until the physical product is in such great demand that holders of contracts will accept nothing but their actual metal, there will always be less metal removed from the exchange vault than expired contracts require. The day that the majority of these contract holders demand conversion to physical metal (that is not in the vault) is the day the futures exchange for that metal breaks/defaults. This is another reason why speculators that do the bidding of the Fed must keep the price from exploding. The same speculators are also allowed to make heavy profit on their contracts by temporarily driving the price up, selling at a profit, and then pushing the price back down. This Wash, Rinse, Repeat play has created massive wealth for heavy players such as J. P. Morgan and destroyed investor profiting that is based on actual fundamentals of the underlying investment.

TwoSides2aCoin

Great read.

Smudge

Good article. Unfortunately I am more of a sandlot player than a big league player.

derryb

not an article, my own understanding of the market which may or may not be correct. Feel free to correct me.

HJP

Thanks for the details derryb - I have a general understanding of the basics of the bullion market.

I think we humans make things more confusing when trying to justify our behavior patterns. Those who are in a position to influence the spot price of precious metals are also trying to protect their own vested interests. This market is not objective in this manner - it is subjective and to a large degree (IMHO) "guided".

ricko

@derryb....Thank you for a very informative post. I have been aware, generally, of the larger picture, but this clarifies it. Cheers, RickO

isaiah58

Thanks for the information. I know this is not exactly the same, but the old "pork bellies" discussion is comparative. Back when farmers brought their harvest to the local exchange, be it the mill or a commerce center, buyers came to bid on and purchase physical products, Be it tobacco, grain, whatever the market the farmers were in. Consumers did not expect to know what the producers paid for the raw products, they only understood what they paid for the end products. Be it frozen vegetables available at their market, pork bellies at the butcher or market, cigarettes, cereal, and so on.

The real disconnect today is lack of research despite that huge number of internet resources. No one wants to prove their opinion to be wrong.

No one here would expect to buy raw ore, process it, smelt it, cast it, then sell it - for what the raw ore cost them. When the spot process today, as was explained is purely speculative and not based on physical ownership, exceeds costs to provide an end product then premiums are very low. It is still a business. To that end, I do not see any sustained discussions as to silver being too expensive when it goes over final costs. I see occasional posts on how much it costs the mines to produce the ore, those also forget to add costs from transportation to the eventual end product.

In essence, I am sure it is easy to buy raw PM bearing ore at the lowest price possible. The PM market is not based around ore though, it is based on end products. Maybe the commodities market should be based on raw ore, then we would see if anyone would be interested in futures contracts.

The true PM market is what buyers and sellers agree upon. eBay is a good cross check based on auctions with no reserves and low opening bids. The second level is buyers buying at offered prices which is easy to see.

derryb

Speculators (financial institutions and hedge funds) should be banned from trading on the futures exchanges. If they want to bet on a commodity they should be limited to ETFs and stocks that involve the desired commodity.

topstuf

At least someone went to Google.

derryb

@topstuf said:
At least someone went to Google.

If that's an accusation of plagiarism please back it up. As I posted earlier the OP is MY understanding of how the market works and may not be entirely correct. If the level of writing makes you question its originality let's blame that on my years as a journalist.

I go to google to learn many things, even how to correctly spell "plagiarism." As my posts over the years have shown, when I quote another source I try to provide a link to that source and include the quote in quotation marks as well as in italics.

On the other hand, it that's a compliment on how to use google to gain knowledge and form one's own opinion, then thank you very much. Those years as a journalist taught me how to research - it was much tougher then as there was no Google.

cohodk

Google can be your friend derryb!! Awwww. Just making a joke. Everyone calm down now,

I really still want to know what mom and pop coin dealers and pawn shops are paying over the counter for 90% or generic rounds right now.