It was reported yesterday that the US Mint has run out of silver coins. Some have interpreted this as an indication that the US Mint has run out of silver. That is false. The constraint is not a raw supply shortage, but a manufacturing bottleneck.
By no means does this exonerate the US Mint from culpability for their habitual "shortages".
The mint carries relatively little stock, and even in boom times annually produces only about 1 (one!) silver coin for every 9 people in the United States. (See attached infographic). Consider those numbers for a moment. The entire annual silver production from the US Mint can be purchased for ~$750M! (2014 statistics), which is a rounding error in the equity markets, let alone the bond markets.
However, it is important to understand how and why supply constraints occur during periods of falling prices, and why precious metals premiums consequently spike. Let’s use an extreme example to illustrate the nature of how the physical metals markets move.
a. Let’s assume the spot price of silver is $15 and subsequently falls to $10.
b. Let’s assume the annual average demand for physical silver is $1B.
In this scenario, if the demand in dollar terms remains flat, the manufacturing output would need to increase by 50%. The mint would need to increase minting capacity from 66.67M coins to 100M coins - a huge increase.
Now, if the silver spot price fell by 33% in a condensed time frame, you can be certain that demand would increase precipitously. If we assume demand (in dollar terms) doubles, the mint would need to increase production from 66.67M coins to 200M coins. What if demand triples or quadruples? You get the idea. Over the long term, the US Mint might be able compensate, but certainly not in the short term. No manufacturing operation could. Manufacturing is inelastic with respect to short term scalability.
Then you have the domino effect:
- The US Mint goes on “allocation", limiting supply to authorized purchasers.
- This supply constraint, in the midst of rising demand, forces dealers to raise premiums.
- Rising premiums on US-minted product induces buyers to purchases other sovereign coins, like Canadian Maples, or privately-minted products.
- The increase in demand for these products creates the same manufacturing constraints for these organizations that are affecting the US Mint.
- The problem compounds and lead times extend until demand cools, supplies increase, and the coil unwinds.
These reverberations in the market are Economics 101. The physical precious metals market is minuscule relative to all other asset classes, and small shocks can create major supply shortages.
As of this writing, we have seen premiums rise on Silver Eagles and a few other products, but not widely across all product lines. If prices remain stable for the next few weeks, we would expect a retreat in premiums and supplies to normal levels. With increased volatility comes the increased likelihood of prolonged shortages and elevated premiums.
CEO, Texas Precious Metals