What's really happening in the physical gold and silver markets

In recent months it's been widely and repeatedly reported that retail demand for physical gold and silver is insatiable. The price may be falling in the futures markets, but retail dealers in North America, Europe, Asia and Africa have all described the situation as 'unprecedented'.

There's a shortage of coins, few people are prepared to sell the coins they have, and manufacturers of coins and bars do not have the fabrication capacity to meet current orders, causing longer and longer waiting times.

This has led to numerous theories about shortages of metal. I wanted to get the 'view from the street', so I spoke to Tony Baird, founder and boss of Baird and Co., the UK's biggest independent coin and bullion dealer

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Demand for coins is enormous

The first thing to note is that retail demand really is unprecedented. Baird founded Baird and co in 1967, and so was dealing bullion and coins as gold fever spread in late 1970s. Yet he describes the last four months as the busiest he's ever known.

"It's been building up over the last two years", he says. "Then it sped up with Northern Rock and Bradford & Bingley. But in the last four months or so since Lehman Brothers, there has been a massive movement of money out of banks and into physical bullion, which people are taking home and putting under the bed. This is the busiest I've ever known."

A quick look at coin dealers' websites in the US, in the UK and in mainland Europe shows that many have run out of coin supply altogether and have had to stop dealing. Baird is among them. "We normally carry millions of pounds' worth of coins," he says. "We're big stockists and our stock has been going one way - and that is out of the door. There is huge physical demand. We're experiencing great difficulty buying coins in any volume anywhere in the world.

"Whether it's America, the UK or Europe, there are no sellers. Our stocks are low and we don't know what replacement premiums to charge. The replacement premium isn't apparent because there are no sellers, so we've stopped taking orders until the market settles down."

I notice even on Ebay that coins are trading hands at huge premiums to the spot price. It is not uncommon for American Eagle 1oz silver coins to sell for more than $20, even in the US where they do not have VAT. That's more than a 100% premium to the spot price of around $9.30! Surely this is unsustainable, in the short term at least?

If things get worse, gold banks will empty

Baird agrees. He describes the last four months as a "mad surge" and his stocks are now slowly building up again. "We should return to normal levels fairly soon". I would agree though with a big 'if'. We may return to normality if this banking crisis doesn't escalate and stock markets find a bottom at these low levels. But if things get worse, this run on the gold banks will leave them empty.

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But here's the biggest question of all. There's certainly a shortage of small bars and coins, but is there a shortage of the actual metal? James Turk of Goldmoney says his firm has experienced no supply problems, as they buy large LBMA bars. Baird concurs: "There is no shortage of metal. We have no difficulty finding physical supplies of large market bars. In small bars and coins there's a hold up. Kilo bars are in short supply because of manufacturing capacity. I haven't experienced any shortage of silver."

It seems that the shortages are not related to metal supply, but refining and manufacturing capacity. Baird says, "Our bars are manufactured by us and the volumes of business have increased so much that our manufacturing capacity is now stretched."

So why has the price of gold and silver been falling?

I spoke at the World Money Show last week and I got the impression that I disappointed a lot of people in the audience because I wasn't as bullish on commodities as Jim Rogers had been earlier in the day.

For the record, I expect some kind of a bounce from here into the spring, perhaps re-tracing 30-50% of the falls. But we have seen in the last five or so months that the impact of global deleveraging - i.e. paying down debt - has caused forced selling in all asset classes. Mr Margin - that's the man who demands you stump up extra cash as your leveraged investments lose value - packs a far greater punch than the supply problems, the China story or any of the other attractive fundamentals behind the commodity story.

In fact, as Baird suggests, it may be that the physical demand is what has stopped the gold and silver markets from collapsing altogether. The magnitude of this credit bubble, this lending bubble, this leverage bubble never ceases to amaze me.

But let's end on a positive note for gold and silver investors - a view from Baird with which I agree: "Eventually when the forced paper sales stop the physical buyers will prevail and gold will take off. And so will silver".

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