A Popular Delusion Called Cheap, Industrial Silver
From the beginning of the financial crisis in 2008, contrarian investors began murmuring about getting into gold and short term Treasuries. It was almost a mantra: gold and Treasuries… gold and Treasuries. Something missing? There certainly was from the perspective of the silver bugs. But the conventional wisdom, among goldbugs at least, was that silver was a mere “industrial metal” that would easily drop in a weak economy. And those who referred to silver as an “industrial metal” seemed to be backed up by the COMEX exchange in 2008, where the price of silver was basically cut in half, from twenty dollars to below ten. This takedown may have seemed justified at the time because the super rich were not loading up on bulky thousand ounce bars of silver, but smaller, more portable, easily stored amounts of gold. Silver was left out, ignored, shunned, and that seemed to be just the way the market worked.
I remember thinking in the fall of 2008 that part of this push into gold and Treasuries really was motivated by memories of what people did between 1929 and 1932. You see, the last time we had a Depression “gold and Treasuries” was the common sense move to protect assets. Silver in 1930? Silver was practically a base metal, it was in the coinage you used to buy a hot dog. Remember that at the depths of the Depression the mine supply of silver was nearly 5 TIMES the domestic US demand for both industry and coinage!! Things were so bad for silver that western Senators demanded that the U.S. prop up the silver price after it dropped to under 50 cents an ounce! Needless to say, few Americans in the last Depression thought of silver as the go-to monetary metal to protect wealth against a shattered banking system.
Fast forward 45 years and the view of silver as an abundant, cheap industrial metal would be further reinforced in the aftermath of Silver Thursday in 1980. This is because the price spike in the mid to late 1970s was not coming from industrial demand- that peaked about six years earlier, in 1974. Rather the price surge was coming from the Hunt Brothers’ Corner on the COMEX: in other words, investment demand. All that was needed was for the COMEX to change the rules on the Hunts- a kind of capital control against the longs- and the price collapsed. As the price collapsed over 60% in the 1980s (with the help of government dishoarding), and as mine supply increased, once again the perception continued that silver was some sort of easily extractable, base metal. Gold was the money of the bankers- “he who has the gold makes the rules” was the tried and true saying. Silver? A distant second as far as those trying to insure their assets were concerned.
Suffice to say, most people in the investment world have been conditioned to believe that a silver shortage is impossible, in addition to being fixated on gold as the only insurance you need for your portfolio. This is the power of recent history, of the language that is used to describe silver (its industrial), and a view that is still encouraged by some gold dealers. While I haven’t done a poll, I would bet many in the gold industry assume that a genuine silver shortage for industrial purposes is highly unlikely. This perception is largely reinforced by the major world market maker in the white metal, the COMEX division of the New York Mercantile Exchange.
COMEX and thin ice on the Hudson
In my mind, the COMEX is simply a warehouse and storage center for silver. A large warehouse, yes, but a warehouse that is, frankly, living off of its former glory: once the exchange legitimately had access to hundreds of millions silver ounces that could be sold, but now it likely has less than 50 million ounces for sale (this data is almost a year old), or about 1.5 billion dollars. And given the lack of government stockpiles, and how little new mine supply goes into bullion, this 50 million ounces is in many ways irreplaceable. (I will address jewelry and silverware stockpiles below). To further show how small this 50 million silver ounces number is, the COMEX has less silver for sale than is stored by a well-known gold and silver closed-end fund, the Central Fund of Canada (the COMEX also has much less silver than the SLV ETF, but I realize many question what this ETF actually has under its direct control.) So why does the COMEX have such sway in the silver market? Because the COMEX enables big players to buy on paper, with big leverage- I guess what they call “liquidity” in the world of finance. On any given day the COMEX trades millions and millions of these paper “ounces” of silver. The vast majority of these contracts are not settled in physical silver- it is impossible to do so! But the volume of money passing through and over this silver warehouse is what makes the COMEX the alpha dog, the leader of the pack in terms of setting the world price in silver.
But in this era of uncertainty regarding our financial system, the paper leveraged nature of the COMEX leads many to question its viability as the world market maker in silver. Because at the end of the day, the paper game played on the COMEX demonstrates how floating exchange rates allow for the irresponsible mispricing of important strategic and industrial assets like silver (but the list could be included to other commodities.) Worse, there is a motive for banks in league with the Federal Reserve to use as many of their Federal Reserve Notes to play the short side of the paper game, even though these banks know full well they could not deliver on what they are selling short. But banks likely play this game to maintain the image that the fiat dollar is doing just fine: large price moves higher in gold and silver are a warning light regarding the end of the fiat dollar. However, the lower the silver price is kept by large banks and their naked short positions, the more silver is consumed in spite of a tightening physical market. The silver paper market, in other words, is completely and totally disconnected from the realities of supply and demand on the ground.
The casino-like quality of this paper market is related to the fallacy that you can just print more and more money and not have incredible shortages erupt in goods that cannot be printed. We are already seeing shortages for real things in places like Tunisia- we all have to wonder how long before these kinds of shortages come to the western world. But the FED is convinced that it can solve the employment problem with cheap money, and will continue to pretend the looming inflation problem does not exist. And the FED is not only showing disregard for poor people whose budgets are easily consumed by food increases. The callous attitude of the Federal Reserve System also extends toward the holders of capital- epitomized with the zero percent interest rate policy. This attitude is an expression of the fallacy that the holders of capital will always be relied upon to invest capital into risk taking ventures such as mines or other productive enterprises. This is a very dangerous, stupid assumption. What if those holders of capital feel abused by the banking elite and government authorities and refuse to take the risks necessary to provide the resources needed for the American economic model of growth at all costs? And what if those holders of capital decide to put their money into something unprintable- like silver? So, in my mind, the COMEX is one more, very important symbol of an unsustainable economic and monetary model. The implications of the COMEX running out of silver, or trying to institute capital controls when it fears a run on silver, could not be more bullish for the holders of the white metal.
For now, though, the COMEX price is generally honored by dealers. Yes, there are premiums for small amounts of silver, but there are not yet significant premiums for larger bars of silver. There are hundreds of thousands of major bullion dealers who aren’t big enough to rock the boat of COMEX pricing- at least not yet. But what happens if the silver inventory at the COMEX keeps dropping- irreplaceable inventory as far as I’m concerned- and all the leveraged paper players try to convert their paper into silver. If there are eighty more paper contracts settled in paper for every one settled in bullion, you get the idea what will happen when the other 79 try to rush into a silver market where the silver does not exist. In other words, the COMEX is susceptible to a bank run.
This is an important point: the silver market does not need any new “investors” for the price to go higher- it simply requires people holding paper silver (which is plentiful) to try to convert it into physical (which is scarce).
Although the physical scramble could occur by the populace who do not deal with the COMEX, at this point it is much more likely to be initiated at an institution such as the COMEX. When capital controls are put into place at the exchange to end the delivery of silver bullion to investors, there will be hundreds of billions of dollars trying to land on a pile of silver outside the exchange in the single billions of dollars. At some point, some of the estimated 20 billion ounces of jewelry and silverware may come into the market, but likely only at much higher prices. Think about it- how much does women’s silver jewelry cost when compared to its scrap value? In other words, silver prices will have to launch significantly higher before this jewelry comes out of hiding. And then, I predict, the Silver Users Association will make sure that it gets first dibs on what is being scrapped, leaving investors in the cold. Quite possibly, silver in coin and bullion will never be as plentiful as gold coin and bullion, even though some people still claim that there is some large overhang of silver which could make the amount of silver bullion equal to that of gold.
The trend is your friend
As a final point of fact, the above ground stockpile of silver- around 22 to 25 billion ounces and mostly jewelry and silverware at this point- has not changed much over the last half century. (Mind you, at the moment less than 1 billion are silver coins or bullion.) However, the above ground stockpile of gold has grown substantially from under 1 billion to nearly 7 billion ounces over the same time frame. Beside the fact that the above ground ratio of all silver to gold is less than 4 to 1 (and not 50: 1 as currently expressed in the price), the trend in physical gold and silver is clearly toward parity, or at least something close to it. And yet here we are with silver having recently “corrected” in price to a mere $27.50 an ounce, while gold is $1350. Silver- which could one day get awfully close to the price of gold- remains very much a screaming buy.