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NEW YORK (TheStreet) -- These are extraordinary times for the precious metals markets. And not just because of the headline price action. Underlying developments in the supply-and-demand fundamentals for physical gold and silver are extraordinary in their own right.

If recent trends could be summed up in one word, it would be bifurcation. On one hand, the paper market (i.e., futures contracts) continues to be heavily pressured in a bearish direction by extraordinary levels of institutional short-selling. On the other, the physical market is heating up with robust investor buying and increasingly bullish long-term supply/demand prospects.

It's been extraordinarily difficult for some investors to keep their conviction and hold on to real value while paper markets relentlessly discount it. But most bullion investors recognize the extraordinary buying opportunity at hand. That's evidenced by the fact they are rushing to buy, not sell, gold and silver bullion products at discounted prices.

1. Investment Demand for Gold and Silver Coins Surges

The first (and perhaps most important) extraordinary development now taking place in precious metals markets is a surge in demand for bullion coins, bars, and rounds. The U.S. Mint suspended sales of Silver Eagles for most of July because it couldn't keep up with demand. The Mint's sales of Gold Eagles in July reached their highest monthly total in more than two years.

Australia's Perth Mint reports its inventories are being cleared out by surging demand, especially from Asia. "Everything we get in is going straight out the door as soon as we refine it," said Perth Mint Treasurer Nigel Moffatt in a Bloomberg interview.

Private mints are swamped as well, pushing out delivery for weeks while scrambling to obtain raw silver for minting so they can keep the manufacturing process running at full tilt.

2. Supply Tightness Drives Rising Premiums

When demand for refined precious metals products exceeds available supply, the inevitable consequence is rising premiums. The premium over spot prices attached to Silver Eagles hit multiyear highs in July.

Premiums on pre-1965 silver coins and other popular bullion products are also on the rise. Even privately minted rounds and bars that are normally plentiful in the market are becoming harder to come by. In short, the physical bullion market is beginning to decouple from the paper price-setting market.

3. Bearish Sentiment Toward Spot Prices Hits Extremes

The paper market for precious metals has been subjected to relentless selling pressure from exchange-traded fund liquidations and futures traders who make naked bets on lower prices. Sentiment on the futures exchanges has reached a bearish extreme. Hedge funds are as heavily committed to the short side as they've ever been.

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Meanwhile, newsletter writers and analysts who pen commentaries in the mainstream financial media are shunning precious metals in anticipation of still lower prices. The thing investors should keep in mind is that consensus opinion is always wrong at major turning points. Market tops are characterized by mass optimism, and bottoms by mass pessimism.

Don't succumb to the herd mentality when making investment decisions. Charles Mackay, author of the classic book Extraordinary Popular Delusions and the Madness of Crowds (1841), wrote, "Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."

4. Unprecedented Leverage Ratios Raise Odds of Violent Short Squeeze

Traders making bearish bets on gold futures are selling an ever-increasing quantity of gold ounces that don't exist. Open interest on the Comex relative to registered gold inventories has reached record levels. In other words, record amounts of leverage are being applied to the gold market.

This sets up the potential for a physical default (in which holders of long contracts who want to take delivery of physical metal are offered only cash settlement). It also sets up the potential for a massive short squeeze (in which short sellers are forced to "cover" their positions by placing buy orders).

Holders of physical precious metals fully paid for can take comfort in knowing they will never face the prospect of a contract default, or margin calls, or any of the other hazards inherent in derivative markets.

5. Collapsing Mining Industry Points Toward Supply Shortfall

Things are extraordinarily bad for the base metals and precious metals mining industry. There are a number of reasons for the industry's woes, but at root most mines simply can't make money selling their mined products at today's low spot prices.

Frank Holmes of U.S. Global Investors talked about the mining industry's troubles in a recent interview. "I think that this is going to be the bottom trough year for mining companies where they're going to cut and slash everything they can to survive in this troubled market," he said.

Mining for precious metals has always been a difficult business. And now mining companies must shrink dramatically in order to survive. Fewer mines, fewer mine workers, less capital investment, and virtually no exploration. That translates into fewer ounces being discovered and mined going forward. In the coming months, you're likely to hear the terms "peak gold" and "peak silver," as mining output heads down.

If supply contracts and demand holds study, then prices will ultimately have to rise. It's Economics 101. If supply contracts and demand for metals picks up markedly (whether due to increasing investor interest or industrial uses), then look out above.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in any stocks mentioned.