As of September 2010, it appears that physical silver is today potentially the most explosive precious metal play in history. A combination of factors – chronic scarcity, inelastic demand, and expanding consumption has created potentially one of the most profitable opportunities ever seen. The following analysis presents the base rationale for purchasing silver. Furthermore, significant evidence exists to point towards downward manipulation of the silver market by large bullion banks, further compressing the market. It is this author’s opinion that a parabolic top in silver could easily surpass the 20x rhodium price increase from $500 to $10,000 over a five year period as the market realizes the supply shortage. Silver’s supply and demand are analyzed below to provide a background for the reader.
II. A Scarcity of Silver
Total world silver production from the prehistory to the end of 2001 was estimated by the USGS to be 1.26 million metric tons, or 40.5 billion troy oz. The Silver Institute reports that 5.1 billion oz have been mined from 2001-2009. In total, 45.6 billion oz have been mined in history, with roughly 1/9 of that total in the last decade. The Silver Institute and GFMS conclude that approximately 800 million oz existed in total above ground official stocks (governments, COMEX, other dealers, and ETFs combined) as of the end of 2008. Assuming that jewelry and other private stocks are unaccounted for, let us assume that an additional arbitrary 200 million scrap oz can be recovered. Furthermore, there is no justification for ETFs to be included in silver stocks – in theory, the ETFs are supposed to hold investor’s silver and to include investor silver in inventories would be to double-count them. Recall that the Hunt Brothers’ silver squeeze in the 80’s pushed many to liquidate scrap silver, implying that individuals today probably either 1) did not sell at $50/ounce in 1980, and probably would not sell now, or 2) sold their silver in the 1980’s and have only silver acquired since then. In summary, a base could rationally assume potentially 1 billion ounces exist in the market today.
Note: Jewelry should not be included in the aforementioned supply. A 5-gram sterling silver ring, for example, has 0.148 troy oz, costing $25 on Amazon as of July 2010. As silver is roughly $20 for one troy ounce including premiums, rationally speaking, silver prices must reach substantially over $100 (potentially $120) in order for a buyer to sell that ring at melt value for a profit. However, as Cash For Gold has shown, some individuals are willing to sell below market value, so the actual liquidation value should be assigned a discount – arbitrarily, assume any price above $50/ounce would bring in scrap sales.
Furthermore, silver production is directly tied to the world economy – the Silver Users Association stated that 70% of silver in 2004 was produced as a by-product of mining for lead, zinc, copper, and gold mining. Should the economy take a turn for the worse, silver mining will be cut significantly as demand for other commodity metals decline. Furthermore, it is commonly known that US government stockpiles of silver in the 1950’s and 1960’s numbered around 3 billion oz (the largest single stockpile in history), and the US government literally has none today. From 2000-2009, silver’s fabrication demand has exceeded new mining at an average rate of 200 million oz/year according to calculations based on Silver Institute statistics. At current run rates in a normal economic environment, known world stocks will be depleted within this decade.
III. The Changing Nature of Silver Demand
In addition to the increasing scarcity, silver demand is drastically changing. Silver’s usage is increasing dramatically as it being used in a number of nanotech applications, including most tech products, inks, medical technology, and clothing. While some controversy surrounds the usage of silver in clothing and medical technology for anti-bacterial purposes, silver products continue to increase in popularity. Silver is used in virtually every electronics product. Most importantly, silver is used in trace amounts in virtually all of its industrial products – should the price increase by multiples, overall input costs of silver on a per-product basis will remain negligible. For example, a new silver-laced sports shirt has a miniscule amount of silver. Should the price of silver rise significantly, the cost of the silver in each shirt would be pennies on the dollar compared to the other costs of production. Silver appears to have an inelastic demand curve.
IV. Pricing Silver
In summary, silver is a commodity with 1 billion ounces under a base case scenario, with potentially 200 million ounces being irretrievably used each year. As the price increases, industrial demand will not diminish. In light of the above facts, a fair value for silver would be difficult to establish. It is entirely possible that figures for silver are vastly understated compared to actual supply. However, even assuming that 5 billion ounces of silver are readily available at higher prices, it is important to keep in mind that a similar metal – gold – has 5 billion ounces above-ground. In other words, the supply of silver under a conservative scenario equals the supply of gold, and in an optimistic case, is 5x rarer than gold. Yet, gold is 60 times the price of an ounce of silver (assuming $1.200 gold and $20 silver). Given that the historical ratio of gold to silver in the earth’s crust is around 1:14 or 1:15, an upward revaluation to the price of silver must occur. While it is true that higher silver prices would increase mine production, recall that 1) 70% of silver mining is from by-product, and 2) new mines take from 1-3 years to start up production. Even after silver’s necessity is recognized by the public, it will be years before new production would be able to match the soaring demand from a shortage.
When considering that much silver demand at present is industrial, the amount of silver available for investment is necessarily much smaller. Furthermore, when the shortage becomes known to the public, a massive squeeze must occur as people “panic buy” at the same time silver-users also attempt to place larger-than-normal orders to ensure business continuity. Possible prices may be left to the reader to predict.
V. Evidence of Manipulation
In addition to the fundamental supply/demand imbalance noted above, a further element favoring the supply shortage must be introduced. Many silver investors believe two statements about silver: 1) elements of the Western governments – i.e., central banks – are working with large bullion banks to purposefully suppress the price of silver, and 2) certain precious metal ETFs and exchanges are fraudulent. These issues will now be addressed.
- “Central banks stand ready to lease gold in increasing quantities should the price rise.” – Alan Greenspan, July 24, 1998 in testimony before the Committee on Banking and Financial Services. The full market manipulation theory states that large bullion banks, specifically, JPM and HSBC, enter the London market and the COMEX to manipulate silver prices downward. The mechanism by which this is done is through “paper shorting” – the banks allegedly issue thousands of precious metal contracts (not backed by the actual metal) in a short time period to overwhelm the market and force liquidation by technical funds and speculators.
The CFTC’s own Commitment of Traders (COT) report has been analyzed by Theodore Butler on a weekly basis. As an example, he submitted a letter with details to the CFTC, indicating that 4 or less banks control the commercial short position. The fact that the market is concentrated so heavily in these hands appears to constitute prima facie evidence that manipulation is in fact possible.
As to whether manipulation occurs in fact, a CFTC hearing on position limits in metals was held on March 25. During that meeting, 2 items of note were revealed.
1) Bill Murphy of GATA alleged that he had a whistleblower on JPM’s manipulation of the markets. Andrew Maguire, a former Goldman Sachs employee, is a metals trader in London. He claimed that 1) he was told by traders from JPM that they manipulate the price of silver. He sent information to the CFTC predicting the time and patter of a silver price crash 2 days in advance.
2) Jeffrey Christian of the CPM Group agreed that certain precious metals have been leveraged by 100 to 1 in the London and COMEX markets (time 4:21). Leverage that high means in fact that should 2 out of 100 ask for delivery, the market would collapse as “price discovery” is attempted.
The following week, Dennis Gartman, a well-known trader, went on the record (time 1:22) grudgingly admitting that silver market manipulation was a possibility.
Not directly related to silver, but to manipulation – The UK Telegraph has reported the controversy about “Brown’s Bottom” – Gordon Brown’s decision as Chancellor to sell 400 tons of British gold when gold reached historic lows “is regarded as one of the Treasury’s worst financial mistakes and has cost taxpayers almost £7 billion.” The stated reasoning at the time was to “generate cash” – but in addition to generating relatively little, the sale was pre-announced, causing the price to decline before the sale and inconsistent with obtaining a good price. Speculation exists that the sale was a secret bailout of banks short precious metals.
2) Some investors believe that the popular metals funds, GLD and SLV, are one of the means by which JPM and HSBC defraud investors. Known issues with these funds are numerous: 1) These two banks are both the largest short-sellers and the custodians of the GLD and SLV funds – a clear conflict of interest. 2) The funds pay no premium for physical metal – all other precious metals funds with verifiable stocks have at times charged large premiums – Sprott Asset Management has charged up to a 30% premium during times of tight delivery, but GLD and SLV have never had any real premium increases. 3) GLD has grown from virtually nothing in 2004 to being in the top 10 holders including official government stocks in 2010. Similarly, if SLV is actually backed by silver, as of 7/16/2010 the fund is stated to hold 9,185.29 tonnes of silver – equivalent to 295 million oz. Based off of the known supplies from the Silver Institute reviewed earlier of 800 million oz, SLV owns ~3/8 of total world supply – not including COMEX silver contracts, warehouse receipts, etc. What are the odds that this group holds almost half of the world’s supply in their vaults? It appears highly unlikely that both the COMEX shorts and SLV are backed by the precious metals. 4) Legal hedges in the prospectus for both absolve the ETFs from any responsibility for ensuring that the custodians actually possess the silver in question. An analysis has of their legal structure has been completed and document various suspicious activities and legal loopholes in the prospectus that could allow for the trusts to hold paper derivatives instead of physical silver. To conclude that SLV is a fraud is not unreasonable, considering that in 2007 Morgan Stanley settled a class action lawsuit accusing them of charging storage fees on precious metals that they did not actually possess.
With the above allegations of manipulation, it appears that silver could literally surpass the value of gold. If above ground stocks have been or are near depletion, for a period of at least one year, silver prices higher than gold could be justified. If manipulation and fraud in the silver markets are discovered, the resulting panic rush would create the largest short squeeze in history – unless a force majeure situation is declared, and cash settlement at an unfair price for longs is effected. Even in that case, however, the demand for silver still rises – holders of the physical metals will be untouched while ETF holders will not profit.
VI. So What Does This All Mean?
1. Silver is hands down the best physical investment you can make, barring lead for bullets. If you want to increase your wealth, you do not buy gold – you buy silver.
2. The day that silver prices explode is probably also close to the day that TEOTWAWKI will occur because that implies that the Western governments have lost control. Currently, the situation can be pictured like this: Western governments can keep putting gold and silver into the market to keep the price down. However, their supply of silver is far smaller than their supply of gold, so silver will run out first. When that happens, the economic system must collapse or be realigned. A failure to realign it quickly means TEOTWAWKI.
VII. Recommendations for Action
Individuals can enter the silver market, demanding physical delivery through dealer purchases or through metal exchanges. In particular, bullion blanks or popular coins such as American Eagles should be bought from reputable dealers. I would avoid all numismatic coins which have a higher premium.