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The Silver Shock

2010 may go down in history as the most important year in the history of silver since 1973, when it was revealed that Nelson Bunker and William Hunt were leading a silver pool to corner the market in the white metal. From the start of that corner in 1973 to 1980, the silver price went from roughly 2 dollars to (briefly) 50 dollars, and small cap mining stocks made even larger moves. While the nominal high in silver of 50 dollars (reached for not more than a day) was not breached in 2010, silver has now spent far more time above 20 dollars than it did in 1980. For this reason, I would argue that we have a “breakout” in the price of silver, and anyone who knows their market history will understand that certain market participants wait for precisely this kind of momentum to begin to storm the gates of those on the short side of the trade.

 The “natural corner,” physical delivery, and sleeping giants

            2010 must be a year of at least partial vindication for Ted Butler, who has spent the better part of three decades protesting the way in which silver is priced at the COMEX exchange. This past year, Butler’s complaints began to go mainstream, and he has recently reported that the four largest banks, in his view, have begun to reduce their short position in a manner consistent with the beginning of a short covering (the four largest banks are short 130 million ounces of physical silver, likely one third of all available bullion bars on the planet.) Perhaps of more importance, Butler now believes he has a friendly regulator in Bart Chilton of the CFTC, presumably meaning that Chilton is going to pay closer attention to the ability of the major banks to come up with the silver they are selling short. Butler has also long contended that once the four largest shorts decide to cover, there are few entities (such as jewelers or base metal producers) who would dare short silver at these prices. So you could easily see the emergence of airpockets in the upward trajectory of the silver price.

            Mr. Butler’s contention has always been that it is the responsibility of large banks to behave in a responsible manner and not aid in the mispricing of an important strategic and industrial metal (to say nothing of its monetary value.) Butler has also held large banks, such as JP Morgan, responsible for the possible creation of massive shortages in silver. Other analysts have pointed out that individual ordinary people have the right, if not the duty, to take physical delivery of their silver, and not simply be content for “exposure” to the silver price. In other words, individual investors should stop indirectly allowing price manipulation to occur: if you can’t touch it, you don’t own it. David Morgan, of, and longtime advocate for bullion silver ownership, similarly maintains that individual people have the power to end the silver price suppression occurring through the paper markets if they would simply take delivery.

            In March of 2010, Andrew Maguire made headlines by protesting metal manipulation at CFTC hearings, and around the same time, internet financial journalists such as Max Keiser, Alex Jones, and Michael Krieger helped to launch the “Crash J.P Morgan Campaign” encouraging thousands of people to take money out of their bank accounts and buy physical silver bullion. Perhaps on a more serious note, Eric Sprott, a legendary hedge fund manager, opened his Physical Silver Trust (NYSEARCA:PHYS), which can be purchased with a brokerage account, but which does allow people to take delivery of silver, stored at the Royal Canadian Mint. All of these actions, and others not mentioned, are beginning to open the eyes of the world to what has been called “The Silver Story.”

 The Silver Story

            I believe that the perspective provided by a look at the past is one of the most powerful ways to understand the future. This certainly applies to the silver story. Bottom line: throughout history, silver has likely never been as rare as it is today. Where once you could assume a ratio of existing silver to gold stockpiles of anywhere from 10:1 to 40: 1, now that ratio (including silver jewelry and silverware) is less than 5: 1. If you look at coinage and bullion, the ratio is actually reversed in silver’s favor! (Roughly 3:1 gold to silver). 

            The assumption among different contemporaries from the seventeenth through the nineteenth centuries was that the below ground ratio of silver to gold never strayed that far from the monetary relationship. I realize how this may be something of a chicken or egg argument, but the assumption nonetheless speaks to silver’s relative abundance to gold throughout history. For example, as John Galbraith remarked, it was always taken as an insult that Jesus was betrayed for 30 pieces of silver and not three pieces of gold. Silver was generally more abundant than gold long before the active demonetization of silver in the late 1860s, a demonetization which is all but complete now. Currently, governments hold well under 2,000 tonnes of silver, whereas they hold over 30,000 tonnes of gold. If you are a gold-only investor, you may want to think about this. As ridiculous as official gold sales seem to goldbugs (myself included), you are vulnerable to them as a holder of gold: not so if you are a holder of silver. But the official dumping of silver- which only really stopped in the last decade- played a role in misleading average people regarding the ability of ever larger amounts of cheap silver to be brought into the market. Silver is not abundant: according to 2009 USGS data, the ratio of below ground silver to gold is perhaps the lowest in modern human history, at a mere 5.7 ounces of silver to 1 ounce of gold. The USGS estimated 18.3 billion ounces of silver, and 3.21 billion ounces of gold left in the world When one considers how in the last precious metals’ bull market (roughly 1930 to 1980) mine production was increasing dramatically (annual increases of 5% for several decades), you get a feel for why many are pounding the table regarding the potentially enormous price appreciation for gold and silver.

            Since silver is primarily thought of as an industrial metal, it is worth asking how much of the projected 18 billion ounces below ground might be made into coins or bullion bars. A possible answer is less than 10%, based on historical data as well as from CPM Silver Outlook and USGS reports, and likely less than 5%. (Of course it is impossible to know whether the source for coins is above ground stockpiles or mining, but new coinage is nonetheless a small part of demand.) I would doubt that coin or bullion stockpiles could grow much beyond 2 or 3 billion in the future, and that is almost certainly overly optimistic. If anything, given the strategic and industrial importance of silver, wouldn’t the silver users (who have their own association) demand that mints stop “wasting” silver on coins or bars for purposes of hoarding? The same argument can be made for the roughly 20-22 billion estimated ounces of jewelry and silverware above ground- the largest single stockpile of silver. If and when people scrap these (and I have to wonder if they will), do you really think mints will get priority over industrial users?  Silver has more utility than gold: this is part of the reason why governments dumped their stockpiles. Ironically, this dumping reinforced a popular delusion regarding the unimportance and irrelevance of silver as an investment.

             People from ordinary investors to hedge funds have only just begun to buy silver in any meaningful amount. Most people have forgotten what a silver coin looks like, but as the price surges higher, and as the silver story gets out, I predict all of that will change. As Roy Jastram, one-time UC Berkeley professor and author of Silver- The Restless Metal (1981) put it nearly three decades ago: “an increase in the silver price by any given percentage, once touched off, will result in a less than proportionate increase in supply and a less than proportionate diminution of demand. Such a market is highly unstable in an upward direction.” (p.153)

             No kidding.






Disclosure: I am long SIL.

Additional disclosure: I am also long silver bullion