Back in March 2009, I wrote about a pending surge in the price of silver and noted, as one of the bases of my opinion, that prices were then in heavy backwardation. The prediction was correct. Some time later, in November 2009, with the backwardation gone, and with the appearance of a temporary surplus from increased secondary production of silver resulting from Chinese base metal demand, I wrote that silver prices were about to fall. Within the time frame outlined by the November article (before the end of March 2010), silver had slumped to $14 per ounce, from about $17.5, and the prediction was correct.
But, on March 25, 2010, something happened that I think may have changed the market for silver forever. Shocking revelations about massive silver market manipulation was revealed, at a CFTC meeting, referencing a whistle-blower from a major investment bank. A former Goldman Sachs' precious metals trader alleged that certain bank traders had been leading a massive silver manipulation for many years. Within a few months, silver investment demand began to skyrocket even far above the elevated levels they were already at. By the end of December 2010, silver prices were edging into the $30 + per troy ounce range.
Prices have come down since then. However, as a result of the price drop at the futures exchanges, silver is now in complete backwardation, and even futures deliverable 4 years from now are selling for a price that is lower than the price of silver for immediate delivery.[i] In some commodities, this might be bearish. However, in silver, because of its status as an imperishable metal, as opposed to a consumable commodity, such a situation is as bullish as it gets.
Backwardation in precious metals tend to indicate that people do not trust that future delivery of exchange traded and/or OTC forward contracts, are certain to happen. It usually means an extraordinarily tight physical market filled with fears that short-sellers might default on future obligations. It means that market participants are taking the old saying "a bird in hand is worth two in the bush" very seriously. That implies that there is not enough silver to meet current needs, for whatever reason. As a result, it is now fairly clear that the silver market is about to explode. If a large number of long buyers at COMEX stand for delivery in March, or if a large number of so-called "unallocated" silver accounts at the LBMA are converted to "allocated" status, it will be curtains for the short-selling banks, whoever they may be.[ii]
Secondary reports on actual delays in delivery and shortages of physical metal mean that the problem is not limited to COMEX or the LBMA. Scotia Mocatta is a huge bullion bank, for example, which specializes in selling precious metals, including silver. It sells them commercially and also directly to the public. One would think they have a vast supply. Yet, the Canadian bank recently sold out of most retail forms of silver. Many smaller silver retailers are finding it hard or impossible to source enough product.
Even the wholesale market for 1,000 ounce bars is tight as a drum. Both James Turk and Eric Sprott, who deal in 1,000 troy ounce bankers’ bars, report that it is taking a very long time to get delivery if you can find anyone willing to sell. This supports what the backwardation is telling us. The fact that the futures price is lower than the spot price might also indicate something else. If people are not expecting default on the part of short-sellers, someone with a lot of market power is trying to reduce the spot price artificially using the futures market.
It is relatively easy to panic futures market speculators simply by raising performance bonds, while selling enough new contracts to flood artificial supplies into the market, lowering the price until undercapitalized traders see their "stop loss" orders triggered. That usually induces a temporary selloff and a panicked market, allowing short sellers to exit positions. But, again, the fear of default still comes into play. Large price drop on the futures markets are normally reflected in the spot price shortly thereafter. This is because people tend to believe in the certainty of taking delivery on forwards and futures, and are usually willing to part with physical metal on expectation that it can be replaced easily. But, they are not willing to do that now. Why not?
Backwardation indicates that the assumption of easy and sure 1 to 1 replacement by a futures or forward contract has changed. I don’t want to sound like a conspiracy theorist, but, frankly, we’ve seen all the elements of a probable silver manipulation take place over the past few weeks and months. But, the games that are being played may well not be directly related to COMEX at all. More likely, they are an attempt to escape from tens of billions of dollars worth of OTC short positions by using the much smaller, but intensely visible, exchange traded COMEX market to reduce prices. But, in a successful market manipulation, the futures market should always be priced higher than the spot market. That has not happened this time. Based on the existence of the backwardation phenomenon, it seems clear that the best laid plans of futures market manipulators can and do go astray.
But, the likelihood of market manipulation is irrelevant to the idea that it is a good time to take a position in silver. Once delivery time start being forced, at COMEX and/or LBMA, no amount of market manipulation will be sufficient to create physical metal out of thin air. Short sellers will be forced to buy real metal, and they will have to pay the price. That means much higher prices, or a default. If they default, they will pay an even bigger price, however, because the situation in silver will be duplicated in all the precious metals. If necessary, I am sure that the Federal Reserve will print enough dollars to pay whatever price is needed to keep the futures markets functioning.
This is a wild guess, but I think that if people begin to demand actual delivery, and I think they will, either at COMEX or at the LBMA, the price of silver is going to go ballistic. It is always risky to put a specific price target on something, especially if you attach that price target to a specific time period. But, it seems to me that silver prices will go above, maybe significantly above, $50 per troy ounce, and it won't take much longer to do it. That, of course, is a speculation. But, the surrounding circumstances support the estimate.
Whether or not the price of silver continues to explode upward, anyone who isn't holding an interest in silver, might want to consider buying some. If you happen to have enough cash to buy one or more deliverable March silver futures from COMEX, and can pay for them in full, and stand for delivery, that might form one heck of a nest egg for retirement given that the world will be running out of the stuff at anything close to the current prices within the next 20 years. The backwardation makes futures prices cheap compared to spot.
I am relatively sure that COMEX, as an exchange, will not default on its obligations, no matter where the price of silver might zoom to. After all, if the Federal Reserve is willing to bail out individual banks, as "too big to fail", certainly, it would bail out the organization of banks that is the CME exchange. We may see more game playing with performance bond amounts, with sudden sharp raises for the purpose of shaking out undercapitalized long buyers, and those who aren't paying attention. But, if you pay for your contract in full, when push comes to shove, the short selling banks will have to deliver the physical metal to you, no matter how much it may cost them by the end of March to do that.
The beauty of speculating in silver, on the long side, is the fact that, even if the price of silver doesn’t explode in the short run, it is still a very sound investment for the long term. It is a very volatile. And, it has gone up very fast and very far, in the last few months. Normally, that would be a negative that would convince me not to invest in something. However, I think that silver prices still have a long way to rise both in the short and long run. This is because silver investment demand is continuing to explode, and, based on the revelations made at the March 25th, 2010 CFTC hearing, the price appears to have been artificially suppressed for many years.
It has been reported that the U.S. Mint has sold 6,422,000 ounces worth of silver bullion coins in January, 2011, alone, which is the largest amount ever reported. That is an incredible amount of silver for one mint to use. If demand elsewhere has heightened to a point anywhere similar to this, the backwardation becomes understandable. All the pieces are now in place for an intense short to medium-term silver price explosion which will be likely to start in the very near future.
[ii] Many silver market enthusiasts have pointed the finger at HSBC and J.P. Morgan Chase and/or hedge funds associated with these two banks. However, such accusations are unproven. People are presumed innocent until proven guilty.
Disclosure: Long silver