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Nearly
three years ago, I wrote an article for the public called “Silver
to Zero.” The basic premise
of that piece, published on October 20, 2000, was that silver is
being depleted at a fairly rapid rate – which will, sooner or later,
cause the world to begin experiencing a shortage of silver.
Many of my facts
came from the CPM Group, acknowledged for its extensive research
in all metals. CPM’s Silver Survey for the year 2000 had reported
that at least 1.3 billion ounces of silver were used during the
prior ten-year period, well in excess of the quantity mined. Now,
CPM has issued its Silver Survey 2003, and guess what? That’s right
– not much has changed. The world still uses more silver than it mines – a condition that has persisted
now for 14 consecutive years.
That should translate
into higher prices – but it hasn’t!
As a result, silver bulls are getting a bit impatient – and
who can blame them? After all, I recognized this obvious disparity
way back in my first article, asking: “Why aren’t silver prices
reflective of the true fundamentals of the market?” However, I also
predicted the silver price would not show any significant strength
until we see silver inventories near zero.
Now, three years
later, that bold statement certainly seems to have been validated,
as does the reasoning on which I based it – reasoning that still
fully applies: The paper market controls the price.
Over the past three
years, both the CFTC and the Comex have been queried numerous times
about the silver situation, with probing questions posed about both
commodity law and possible market manipulation. Their responses
are clouded in the typical bureaucratic mumbo-jumbo, but one thing
stands out clearly: The only manipulation that really concerns the
CFTC is in the near, or spot, month. That’s the only trading arena
where definitive rules are in place that the exchange officials
can enforce.
To clarify, here’s
a direct quote from one CFTC letter in response to a question about
steps taken to prevent manipulation:
“The market surveillance group also monitors compliance
with the Commission’s and the exchanges’ position-limit rules, which
help prevent traders from accumulating concentrations As we said, mumbo-jumbo
– so let’s do a little translation. First of all, a hedger is a
seller – or, as more commonly
known, a short seller. And, these good ol’ boys are exempt from
limits. Yep, sure enough! The CFTC even says they are, by golly.
As such, they are allowed to sell as much silver as they want on
paper. The sky’s the limit! Heck the moon is the limit! In fact,
there is no limit!!
So, as a hedger, one
can sell as much “paper” silver as one cares to. But, if you want
to stand for delivery – i.e., if you want to buy the actual physical
metal – then you are subject to limits and, if you try to buy a
tad too much, you face the full investigative powers of the CFTC.
This situation is similar to the one George Orwell described in
Animal Farm: ”All animals are created equal, only some animals
are more equal than others.” In
other words, the CFTC says hedgers are exempt – but, “We are watching
anyone that might disrupt the real physical silver market.”
This is a somewhat contradictory stance since an earlier CFTC
letter essentially said that excess selling by hedgers was controlled
because, if short sellers drove silver prices to an undervalued
level, all buyers had to do was “stand for delivery” and the resulting
demand for physical silver would push prices back up. However, as
the above quote stated, that notion is apparently invalid since
any commodity trader who actually buys too much silver in any given
spot will fall under the immediate scrutiny of CFTC regulators.
That regulatory inconsistency
provides the answer to a question I’ve received numerous times in
recent years, which is: “With silver so undervalued, why doesn’t
someone just buy up all the silver on the Comex and be done with
it?”
In other words, the
answer is they can’t – the CFTC is
watching for just such a “problem.”
So, in summary, here’s
how the CFTC regulation works: Sell all the silver you want, if
you don’t really have it, and it’s no problem. In fact,
you can do it with unlimited abandon. But, contract for and ask
to actually receive even one more ounce than the limit – and it’s a BIG PROBLEM!!
It’s because of this
rule that I have a slightly different take on the term “stand for
delivery.” On the back of the dust jacket for Paul Sarnoff’s book, Silver
Bulls, there’s a picture of William
and Nelson Bunker Hunt
appearing before Congress, hands raised, swearing to the truth of
their testimony about their own efforts to corner the silver market
in the late 1970s. Called on the carpet in front of Congress – that’s
my idea of the true meaning of “standing
for delivery!”
Of course, now that
I’ve explained why someone doesn’t just buy up all the silver on
the Comex and be done with it, I have to expand slightly on my answer:
Actually, in spite of the CFTC rules, someone ALREADY
HAS bought up the bulk of the market’s available silver.
That person is none
other than Mr. Warren Buffett himself. Not very long ago, Mr. Buffett bought
nearly 130 million ounces of silver – and the impact was far from
subtle. In fact, if you look at the Comex inventory before and after
the Buffett announcement, you will notice a very rapid depletion
of Comex silver.
1 The result is a very interesting situation on the Comex. The overall silver inventory currently stands at about 106 million ounces. However, the eligible category has now climbed to roughly 60 million ounces, while the registered category stands at just 46 million ounces. This is the only time in recent history I can recall that the eligible category has been greater than the registered category. If you follow the market closely, you know that this is quite significant. Most analysts agree the eligible category is held by long-term investors who are willing to wait. These investors expect much higher silver prices, and their inventory is merely resting in the Comex warehouses. In simple terms, this means the traders and dealers have a mere 46 million ounces; the rest is more or less for display purposes only.
Obviously, this is
a bit of an overstatement on my part. While the eligible silver
is currently on display and cannot be delivered, all it takes is
some minor paperwork to place it back in the registered category.
Thus, at some higher future price, this silver can and likely will
be sold. Only the long-term holders who currently control this silver
know what that higher future price actually will be, based on their
own objectives. However, I firmly believe it will prove to be far higher than the current price!
When Nelson Bunker Hunt tried cornering the silver market,
what he actually took off the Comex was 50 million ounces. Given the above numbers, we can clearly see
that, if Mr. Hunt where to appear in the silver market today, he
would be unable
to acquire 50 million ounces from the registered category. Although this is a subtle and not well-recognized
shift in silver inventories, I’m nonetheless sticking to my basic
premise that the Comex physical deliverable
supply is dwindling.
As far as I know,
those who follow my work – as well as the work of others who comment
on the silver market – are tired of hearing about the fundamentals
of silver supply and demand over and over again. Let's face it, how many times can you tell
people that we've had a silver deficit for 14 consecutive years? The investor says: “Thank you. That’s a very
nice piece of information – but it’s done nothing for the price! All it has done is frustrate me as I've been
holding silver for quite some time, and these facts just don’t seem
to matter to the market.”
So, in response to this, I’d like to provide some alternate
insights – which will hopefully encourage the bulls one more time.
This time, I want to examine the silver market from a slightly different
perspective, focusing on VALUE! Value investing is a cornerstone of long-term growth and asset accumulation. Investors with patience survive the ups and downs of the market and are more likely to emerge wealthy than those who try to ride the market’s short-term swings. Let’s begin by looking at a few definitions of value.
Value: Relative
Worth
The relative worth of silver is very difficult to determine.
However, if we look at monetary history, we can find very
clear evidence that silver was valued at about 1/12th
the price of gold for several hundred years. Why is this? Although it cannot be proven, this is what I call the natural ratio
– the ratio at which silver and gold appear in the earth’s surface.
In other words, for every ounce of gold that has been mined, twelve
ounces of silver have been mined.
It seems the market determined this natural ratio as the
equivalent exchange rate between the two metals when both were used
as money. Comex rules can be changed, but this historic ratio of
silver to gold is a historic fact and cannot be changed.
Value: Fair Return,
or the Equivalent in Exchange for Goods, Services or Money
Again, you'll have to bear with me while I talk a little bit
more about monetary history. First,
there was once a syndicated cartoon series in several major newspapers
called “Another Day, Another Dollar.”
This cartoon series illustrated the struggles of everyday
life. Although the cartoons had nothing to do with silver, it did
have an interesting title: “Another
Day, Another Dollar.” What’s
so interesting about this is that, at one time, one silver dollar
was one average working man's daily wage. If silver were priced
at today’s minimum wage, we would see that a day is worth almost
$50US. However, silver is priced at just one-tenth that amount.
That obvious devaluation is further understated by the fact that,
relative to the time when this cartoon was popular, the silver supply
is considerably smaller, while the dollar supply is substantially
greater.
Value: Industrial
Importance, or Rate of Usefulness
Many of us determine the worth of something based on how useful
or needed the service or good may be. For example, food and gasoline
are basic to most of the world, a fact few would argue. Silver is
also essential for modern life – but almost everyone is asleep to
this fact. Indeed, this is where silver shines – no pun intended.
The industrial importance of the metal is almost beyond definition,
with the uses for silver far too numerous to list for the purposes
of an essay of this size. However, as a reminder, the metal has
applications in medicine, photography, computers, cell phones, electronics,
batteries, switches, jewelry, coins, and environmental protection
– to name just a few.
One argument that
personally annoys me is what I call the situational economic scenario.
This contention goes like this: If you were in the Mojave Desert
and dying of thirst, then a glass of water would be more valuable
than gold. This, of course, would be true – but it’s a very specific
case. Logic demands that, to truly determine value, we examine all
cases and only then draw our conclusion. In many parts of the world,
water is far more abundant than gold; therefore, it’s less valuable.
The area most of
the human race is concerned with, however, goes beyond survival,
stretching to include security. Generally, as we age, security becomes
more and more important to us as individuals – and, in civilized
societies, security is largely a function of financial survival.
We may not think of investing as financial survival, but anyone
who has suffered a tremendous loss in an investment will likely
agree with this assessment.
Traditionally, cash
savings have been the safest and most certain way to achieve financial
security – less risk than any other asset class and minimal potential
for loss of principal. As an illustration, people with cash generally
survived the Great Depression economically, while people with stocks
– or, even worse, assets financed with debt – did not.
The problem with
cash savings lies in the value of the currency in which it is held.
From a historic perspective, all paper money has proven worthless
over time – and now is no exception, with the roster of world currencies
littered with paper of questionable value. The only “currencies” to have remained valuable for thousands of
years are gold and silver.
Even the markets
for paper securities themselves support this contention. For example,
only a few of the stocks that made up the Dow Jones Industrial Average
100 years ago are even in business today. However, one that did
survive (until its recent acquisition) was the Homestake Mining
company – a company whose assets were denominated almost entirely
in gold and silver.
Thus, there can be
little question that silver stands tall when assessed on the basis
of value. It’s just a matter of time until the market snaps to and
translates that value into higher prices.
1 The Silver-Investor
has a special white paper on Buffett and Silver which is available
free to new subscribers.
David Morgan has
been a private economist for over two decades. His background in
engineering with an advanced degree in Economics/Finance gives a
unique perspective to the financial markets that pure business majors
often miss. He applies the discipline of logic to verify the basics
of economic law. Mr. Morgan has been published in The Herald Tribune,
Gold Newsletter, Resource Consultants, Contact, News Gurus, Common
Ground, Resource World, Investment Rarities and The Idaho Observer.
His work has appeared on the internet at Silver-Investor.com, Financailsense.com,
321Gold, Le Metropole Cafe, Goldseek, Gold-Eagle, Howe Street, and
Silicon Investor. He has been interviewed on Don McAlvany's radio
talk show, Financial Sense Newshour, Hard Money Watch, Truth Radio,
Tiger Financial and appeared on television in both Canada and the
United States. He hosts a weekly precious metals wrap-up on internet
radio every Saturday with Jim Puplava. Mr. Morgan was published
in the global investor regarding ten rules of silver investing.
His private email newsletter is $99.00 U.S. by email. It includes
12 issues per year, plus email updates as required at no additional
charge.
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