In November 2008, the unknown 'Satoshi Nakamoto' mysteriously released a paper titled 'Bitcoin: A Peer-to-Peer Electronic Cash System' via a cryptology mailing list. Also known as the Bitcoin White Paper, this nine and a half page document provided detailed analysis of a peer-to-peer electronic cash system created to combat the Internet's reliance on "financial institutions serving as trusted third parties to process electronic payments."
We do not believe the timing of events to be coincidental. This well-thought "purely peer-to-peer" network cut out the middle man for a reason. As major Wall St. banks began to collapse, Satoshi Nakamoto identified the "inherent weaknesses of the trust based model" and created a currency free from world government manipulations. Nakamoto aimed to put currency back in the hands of the people and restore faith in global commerce.
Bitcoin is unlike any other currency ever invented in that, the future supply can be determined with certainty. As you can see from the chart below, the logarithmic algorithm regulating the mining of bitcoin has a mathematical limit of 21 million. There will never be 21,000,001 bitcoins in existence. This means that once all bitcoins have been mined, there will be no inflation of the currency EVER AGAIN FOR ALL OF HISTORY. A truly amazing characteristic.
If bitcoins can't be "printed" like fiat government-backed currency, how are they released into circulation? To put it simply, they are "mined" by ultra-powerful server networks as they solve complicated computing problems. As of this writing, 15,075,575 bitcoins have been mined, which is roughly 75% of the eventual outstanding circulation.
Bitcoins have a built-in, predetermined rate of inflation. Currently, the currency is inflating at a rate of 25 BTC for every block added to the Bitcoin 'blockchain', as that is the current reward to miners for attaching a new block. As you can see from the chart below, we've been at a 25 BTC / Block inflation rate since November 2012, the last time the rate halved.
After bitcoin 15,750,000 is mined something interesting happens. The inflation rate drops from 25 to 12 BTC / Block and continues to halve after smaller and smaller increases in bitcoin circulation. Essentially, we are beginning to reach the plateau of the supply curve, a fact that will become more apparent after 15.75 million BTC mined.
With a truly finite supply, the question is, how strong will demand be in the future? Is speculative investment driving bitcoin exchange activity or are citizens of the world putting their trust in the currency? Can society make the transition from fiat cash and plastic cards to personal, encrypted wallets? We believe there will be significant insight gained from analyzing the price reaction to the 12 BTC / Block reward. Stay tuned for further discussion.
The Coinage Act of 1965 eliminated silver from the composition of U.S quarters and dimes and reduced the amount of silver in the half dollar to 40%. Until that point, half dollars, quarters, and dimes were all 90% silver. When the U.S Mint decreed that U.S. coins would be comprised of less valuable metals, they effectually lowered the real value of future coins printed by the Mint. Pre-1965 dimes and quarters quickly disappeared from circulation as citizens stockpiled the now historic coins for their metal value. This caused a coin shortage in years to follow, Gresham's law at work once again.
What happened to the composition of the U.S nickel? It remains the same, 75% copper / 25% nickel. Comprised of common industrial metals, the U.S nickel has a measurable underlying raw metal value that fluctuates with the market prices of nickel and copper. We believe current political and market trends make the U.S nickel an interesting investment consideration for all U.S. citizens.
In February 2011, with high commodity prices, the raw metal in a nickel was worth 7.38 cents, 148% of its value. This meant the U.S. Mint was losing money on the production of each nickel, even before considering overhead costs. The U.S Mint quickly became aware of this situation and began considering solutions to ensure the underlying value of the U.S nickel remained below 5 cents. See this 2012 report released on their analysis of possible alternatives.
With the current extended bear market in commodities, the raw metal in a nickel is now worth 2.77 cents. This has taken pressure off of the U.S Mint, however if the prices of copper and nickel were to rise, the rising underlying value of the U.S nickel will likely quicken the U.S. Mint's efforts to change the composition of the coin.
We believe that similar to pre-1965 dimes and quarters, U.S. nickels would drain from circulation if the composition was altered to a less valuable alloy. An investor who holds stores of U.S. nickels may someday see the underlying value of these coins skyrocket as they gain intrinsic value years down the road, similar to pre-1965 dimes and quarters today. In addition U.S nickels provide indirect exposure to both the copper and nickel markets, as it is currently illegal to smelt legal U.S tender.
To follow up on our recent "Paper Markets in Metals" article, we at TFL Holdings decided to take a look at the forces shaping supply and demand in the silver market. We believe there to be a disconnect between the physical silver market and the market for silver future contracts on COMEX. As you will see below, growth of the global silver supply is constrained with evidence that demand for physical silver is increasing, yet prices remain relatively static.
Silver is a rare geological deposit with many industrial applications. Unlike gold, the majority of silver produced each year is consumed by industry. Based on the supply and demand data provided below, there was a net physical deficit of 253.7 million ounces of silver during the years 2005-2014, not including inventory changes. In 2015, the price of silver continued to fall. Most estimates place the all-in cost of producing an ounce of silver well-above the current market value, forcing a further slide in production as mining operations shut down. This downward pressure on supply has been compounded by similar decreases in the prices of other metal ores mined concurrently with silver. See "Something Broke in the U.S. Silver Market" for a full analysis of the supply issues at hand.
Beyond changes to supply and demand in the physical market, recent developments in the silver futures market may also serve as a catalyst for price shocks going forward. As you can see from the chart below, registered silver is leaving the COMEX at an alarming rate. How is this trend playing out in recent weeks? COMEX registered silver plunged 10%, or roughly 3.5 million ounces, on January 4th, 2016, reflecting year end movements. This could be interpreted as Gresham's Law taking effect, as physical silver (good money) is chased out of the highly-leveraged futures market (bad money).
The point here, is that even though there is accelerating demand for physical silver with a probable supply crunch in coming years, the market price isn't rising. We believe this is due to large short positions held by institutional commodities traders in the futures market.
The same institutional traders who are grossly short silver may have recently woken up to the underlying shift in market sentiment and are quietly taking delivery of as much physical silver as possible at these artificially low prices. Knowing the futures market will seize on the slightest increase in deliveries, they are then removing this silver from registered inventories and therefore, potential delivery on their short bets. If the market crashes up, and their shorts need to be covered, they can then shrug their shoulders and say they don't have the silver to deliver, settling their losses in cash. Sound like thievery? This is within the rules. Pay attention to all the new COMEX disclaimers popping up in 2015..
I would like to take a second today to discuss a developing trend in metals future markets that I find very disturbing. I will use Gold Futures (GLD) as an example, but this situation presents itself in silver, platinum and palladium markets to differing degrees of severity.
A "future contract" is defined as a financial contract obligating the buyer to purchase an asset (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price. In today's market, there is a growing disparity between the amount of gold being traded via these future contracts and the physical store of gold backing the transactions.
Of the 415,220 gold futures contracts open on COMEX as of year end, 279,966 are set to expire in February (almost 70% of the total). This represents transactions for 27,996,600 troy ounces of gold settling in one month alone. Obviously this number is dynamic, meaning that as the February exercise date draws near, the vast majority of these contracts will be closed. This is due to traders utilizing gold futures as a hedge against various market risks with no intention of ever receiving physical gold.
Due to the use of gold futures as derivatives by traders, a historic average of around 1% of all open contracts are physically delivered. To meet these deliveries, COMEX holds both "registered" and "eligible" physical gold stock. Eligible gold is any physical gold held at one of the COMEX-approved warehouses (HSCB Bank, Brinks Inc., Scotia Mocatta Depository). This gold is eligible for the settlement of gold future contracts, however it isn't set aside for that purpose. In other words, stores of 'eligible' gold may be intended for a purpose completely unrelated to settlement of future contracts open on the exchange. It is highly unlikely that 100% of eligible gold would be available for settlement in a crisis. Registered gold at COMEX is eligible gold that has been specifically delivered onto the exchange for settlement. See the below graph.
As you can see, levels of "registered" gold in COMEX vaults have been diving ever since Germany made its first gold repatriation request in 2013. As of 12/31/15 there are only 275,915 troy ounces of registered gold on hand at COMEX. Backed by 6,137,571 ounces of "eligible" gold at member banks, this totals roughly 6.5 million troy ounces of gold available for delivery in the best case scenario. However since eligible gold can still be utilized as collateral for other debt, it's highly unlikely it will be available for settlement in a crisis.
Under current conditions, gold futures are utilized by traders as a hedge against market risk. They do not anticipate delivery on these contracts and close them before the exercise date.
There is currently 1 ounce of "registered" gold on hand for every 150 ounces traded via open future contracts. Even if only 1% of the currently open February contracts deliver, the delivery would be equal to the entire registered reserve at COMEX. I am not saying that delivery on gold futures will default in February, but the chance of deliveries on gold future contracts exceeding the amount of "registered" gold reserves in any one month is increasing.
If conditions ever warrant a change of sentiment with regards to the delivery of physical metal, this market is sure to see a "run on the bank" scenario as parties default on delivery under their contracts.
If you are an individual investor interested in owning gold, make sure to acquire physical coin and bullion, not a piece of paper.
Tyler Logsdon is a CPA and Registered Securities Representative located in Newport Beach, California. He is actively employed in the blockchain industry.
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