Costata's Silver Open Forum

Listen up all you brave silver warriors. Uncle Costata has a story to tell you. In our first-ever guest post written exclusively for this blog, Costata lays it all out in stunning detail. And he invites you all to hit him back with your very best shot. Enjoy! -FOFOA


Has the silver market been cornered.... AGAIN?
by Costata

This open forum has one main purpose. To place a narrative before you, a story of a market cornered, to discuss, dissect and critique. If you read on you will see that I’m not without competition in the weaving of stories about silver and the silver market.

All works of fiction require “a willing suspension of disbelief”. As Samuel Taylor Coleridge suggested, if a writer could inject "human interest and a semblance of truth" into a tall tale, the reader would suspend their skepticism concerning the implausibility of the story.

So, in order to make my narrative worthy of your indulgence I have to present a sound case that it is possible. Otherwise why would anyone “willingly suspend disbelief”? At the same time I must cast doubt on the tales of the other storytellers. You see, my story is based on a view of the silver market that is diametrically opposed to theirs. To suspend disbelief in my story requires that you disbelieve theirs entirely.

But before we proceed, I want to make something crystal clear. This is a story about a corner of the flow of silver, not the aboveground stock.

The comments are open and un-moderated. All are welcome to discuss this story and, if you wish to do so, the other storytellers offerings.

What is a corner?

I have made a few changes to the definition offered by Wikipedia in order to make it more directly applicable to physical silver. You can see their original wording here.

To “corner the market” is to control enough of a particular commodity to allow the price to be manipulated…..The corner operator hopes to gain control of enough of the flow of the commodity to be able to set the price for it.

If you are looking to corner the flow in a market one of the risks that needs to be evaluated is the possibility that any existing stockpiles could be mobilized against you. Obviously it would be very helpful if any stock was highly immobile. More on this below.

A quick review of the history of attempted market corners offers two lessons. Most attempts at a corner fail and those that were successful lasted for a short period of time. Let’s take a brief look at a recent, reportedly successful commodity market corner. Again from Wikipedia (with my edit in bold):

On July 17, 2010, Armajaro purchased 240,100 tonnes of cocoa. The buyout caused cocoa prices to rise to their highest level since 1977. The purchase was valued at £658 million and accounted for 7 per cent of annual global cocoa production. The transaction, the largest single cocoa trade in 14 years, was carried out by Armajaro Holdings, a hedge fund co-founded by Mr Anthony Ward…… This example demonstrates that 7 per cent of a perishable good is enough to allow profit taking via cornering a market provided demand is inelastic and the need for the commodity is time sensitive.

Obviously this hedgie with the sweet tooth was targeting industrial cocoa users to deliver his profit either directly or indirectly (from other speculators). Presumably the industrial users could not pull their bids and wait him out. They had to accept higher prices.

This too is a story about a corner of a physical commodity. "Paper silver" plays a part in the price manipulation strategy and in booking profits, but the corner itself is in the physical metal.

The Hunt Brothers

Let’s stroll down memory lane and revisit the Hunt brothers' silver market corner. I won’t recount that fascinating tale just now but you can read about it here.

Instead I want to focus on how it ended for the Hunts. So let’s ask someone who was there, an expert trader, the one and only Jim Sinclair. (My emphasis)

(Posted: Jan 16 2011 at jsmineset.com)
"The Comex board of directors unilaterally declared their written silver contract null and void. That is exactly what occurred when the Comex went to "sellers only" on Silver at a $53 bid, offered at $55 (Yes, that was the floor spread). With no transactions accepted that were buyers and sellers orders only, it left the Comex members to make the bids. Silver simply collapsed and platinum started its $1000 daily limit moves on the downside. It was that which collapsed gold…

Position limits are a joke compared to "sellers only," meaning nothing to any commodity traded worldwide. All position limits will do is reduce the volume on US exchanges. It is so easy to get around that with non-US subsidiaries. The international non-US exchanges will celebrate this development.

Ouch! The rules are already on the CFTC books that empower them to protect the Comex members, and the exchange itself, from any would-be manipulator let alone someone operating a full blown corner. All they would need is the will to use them.

(Incidentally, many people seem to forget that Comex is not a major physical silver exchange. It’s a paper price discovery mechanism that handles less than 5 per cent of the physical silver traded annually. The Perth Mint on its own accounts for around 10 per cent. That’s right, double.)

In this narrative the Comex paper silver contracts are one of the “legs” in the strategy to manipulate prices and book profits. The LBMA is also an important part of this story in both a paper and physical silver context. More on the LBMA below.

Back to the Hunts. So, the moral of the Hunts’ travails is that if you are going to include the Comex in your plans to corner a market you had better make sure the regulators aren’t going to intervene.

Regulatory capture?

Is it possible that regulators in some markets could be under the thumb of the operators they are supposed to regulate? While you ponder this question, a few links to pass the time.

>> Ex-Advisor To GS’ Charitable Giving Unit To Direct TARP Funds
>> Congress Shares Secret With America, Goldman At Fault In GFC
>> JP Morgan Finances Jefferson County Into A Sewer
>> Wachovia Joins Mile High Club
>> Bank Of America Does Laundry On Mexican Housekeeper’s Day Off
>> Morgan Stanley Stores Silver - In Parallel Universe
>> Goldman Sub-Primate
>> Abacus Adds Up Losses, For Some
>> New Volcker Rule, Don’t Allow Yourself To Be Used As Stage Prop
>> Bear Stearns Wishes It Had Made Bigger Campaign Donations
>> 50 US AGs Prepare To Robo-sign Settlement Agreement
>> MERS Reduces Banks’ Costs, Economizes On Truth Too Judge Finds
>> Bernie Madoff Goes To Jail, Wall Street Doesn’t
>> AIG Begins To Resemble Insurance Company Again
>> ENRON Auditors To Spend More Time With Family
>> Ratings Agencies’ Verdict: “Pirates Of The Caribbean” AAA
>> Lehman Brothers Fulds Despite Repo 105
>> JP Morgan Asks “Bernie Who?”
>> JP Morgan Visits Milan, Milan Wishes It Hadn’t
>> Bush, Clinton, Bush Deny ’Revolving Door’ In Washington Jobs
>> Obama Promises Change – Teleprompter Fired For Lying

The Silver Market – Stock and Flow

When I offered a definition of a corner I mentioned that “it would be very helpful if the stock was highly immobile”. If the silver stock is immobile all the aspiring operator of the corner has to worry about is the flow of physical silver.

There is heated argument about the correct estimate for the total amount of aboveground silver. Bob Moriarty of 321gold.com weighs in here with his estimates which are similar to the conclusions of this analyst. Others argue these estimates are way too high. You will have to do your own investigation in order to decide whom to believe. As a quick 'n dirty tip, if they cannot show you their methodology, look elsewhere for information.

From my research it seems to be a safe bet that the number is in the billions of ounces when you include silverware, old silver coins, jewelry, bullion coins, small bars and ETFs. In other words, more than enough to overwhelm a corner if it flowed freely. However, most of the owners of the silver stock either hold it for its utility (use value) or they are “buy and hold” investors.

Will this silver stock flow? I hope we can agree that the answer is ‘No’ unless the price is high enough to overcome sentimental attachment or the individual owners of that silver experience a sharp decline in their income and/or standard of living. So for the purpose of this story we are assuming the bulk of the aboveground silver stock is not mobile at the present time. No immediate threat to a corner operator.

This wrap up of the World Silver Survey by Mineweb says: “Last year world silver fabrication demand grew 12.8% to 878.8 million ounces…”. According to Eric Sprott, in 2010 the total supply of mined and scrap silver amounted to 951 million ounces. We’ll take Sprott’s figure as the size of the flow that is central to this story of a market cornered.

In passing I would also like to point out that when analysts talk of “consumption” of silver they should mean “total industrial demand minus recycling”. This silver is consumed insofar as it is not financially viable to reclaim it (at present). Other holders of silver variously hoard, wear or utilize it in some way but it is not “consumed” and remains part of the aboveground stock. While the stock remains immobile, this non-consumption demand also competes for the flow with the consumers of silver – the industrial silver users.

Another issue I hope we can agree on is that silver, like a host of other commodities, has been and remains in a commodities bull market. The primary trend since 2002/2003 has been upward. Within that upward trend there has been lots of price volatility and potential profits for a savvy trader on both the up and down price movements. A corner operator could have dramatically increased their profits by accentuating the moves in both directions. The central theme of this narrative is market manipulation, not price suppression.

Silver Price Suppression

The belief in a scheme to suppress the price of silver is pervasive among silver bugs. If suppressing the price of silver was the sole objective of a silver market manipulator then my narrative collapses. (You will see why shortly.) So before we proceed further a few brief remarks to the “suppression” camp.

Analysts such as Ted Butler have been sounding the suppression klaxon since 1989 but I ask: Why look for a complicated explanation when supply and demand offers a simple, perfectly adequate explanation?

Throughout the period, such sell-offs that did occur, as well as announcements of planned sell-offs, caused immediate declines in the price of silver. Indeed, the Wall Street Journal reported in September 1976 that "[w]hen the US government makes noises about selling silver from the federal stockpile, futures traders start unloading futures contracts in speculation that such a sale would depress prices.”

Silver was a natural short play in the 70s, 80s and 90s. There were, collectively, huge amounts of silver overhanging the market in the form of old coins, national reserves, public and private stockpiles. That silver stock was mobile. The low price of silver over many decades had also made primary silver mines uneconomic. The silver that did come from the miners was mainly a by-product of their pursuit of other ores. Hence the silver was extracted and sold with little regard to the price of silver. All in all, a short seller’s dream come true.

I would argue that 2002 was the watershed year for silver, the year when the US Defense National Stockpile was nearing depletion as a result of the Silver Eagle coin program. That opened the way in 2003 for silver to join the long cycle commodity uptrend along with other industrial metals, agricultural commodities and so on. This in turn created the opportunity for a well-resourced trader to safely play either side (long/short) of the silver market without fear of a sudden influx of metal.

In this story, the end of the supply overhang also opened the way for an attempt to corner the flow of physical silver as the remaining stock was becoming increasingly immobile while demand from industrial users was growing strongly.

Ted Butler (and, to be fair, many others) allege massive naked shorting on the silver Comex. Ted lays out his case here. From what I have read it appears that in Ted’s narrative this massive naked short position is held, primarily, by JP Morgan and perhaps HSBC. This is how Ted’s tale ends—the Comex shorts will be chased over the “cliff” by the longs in a massive short covering squeeze - just like these bison:

“Head-Smashed-In Buffalo Jump bears witness to a custom practiced by native people of the North American plains for nearly 6000 years. Thanks to their excellent understanding of topography and of bison behavior, they killed bison by chasing them over a precipice and subsequently carving up the carcasses in the camp below.”

I want to be upfront with you. I think Ted and his cohort may prove to be dead wrong, finding themselves in a role reversal falling head-first with the bison and anyone else beguiled by their story. We will return to Ted’s story a little later when we consider the lack of transparency in the silver market and why the circumstantial evidence suggests that Ted and his cohort are dead wrong.

Let’s deal with another allegation which has been floating around, that JP Morgan inherited a huge naked short position in silver with their Bear Stearns acquisition. I’m not going to dwell on this for long. The fact that JPM was indemnified by the Fed on unknown terms for losses on this acquisition makes this a non-issue in my opinion. If there are losses I think we can safely assume that they will be picked up by Wall Street’s best little buddy, the American taxpayer.

The Central Characters and the “Supporting” Cast

The main characters in this story are the Bullion Banks, Miners, ETFs, Refiners, Mints, Retail Investors and the Industrial Silver Users. As this narrative unfolds it should be quite obvious that the only silver market operators with the capacity to make this story come to life are the international bullion banks. All that would be required of the other market participants is that they behave predictably. Their co-operation would not be needed by a manipulator. Let’s face it, the less people “in the know” the better.

(Incidentally if any reader needs an introduction to the precious metal fabrication and supply chain, Bron Suchecki of the Perth Mint has provided an excellent series of posts you can access here - top left of screen.)

The jewelry makers are peripheral to our story except insofar as the rising gold price has resulted in the increased substitution of silver for gold in the fashion jewelry business. So this segment of the market has added to the demand pressure on the flow of silver as well. In my opinion the gold jewelry market is much smaller than the official figures suggest. As Jim Sinclair has often pointed out gold jewelry in many Eastern countries is sold by weight and purity – it’s wearable ‘bullion’, not simply a fashion statement.

Miners have seen the price of silver rise to over US$40.00 per ounce while the Mineweb report (linked above) indicates that cash costs are currently $5.27 per ounce. Others estimate their average cost, by the time the silver is on its way to the refiner, at up to $15.00 per ounce. (The cost estimates put out by miners are notoriously unreliable. There are plenty of financial incentives for a mining company to understate their costs. Murray Pollitt discusses this issue here.)

The predictable behaviour a corner operator would expect from the miners is a desire to lock in some of their profits on silver through hedging. If a corner operator also advised the miners, provided finance and banking services to them and facilitated their hedging strategies it would give the operator a huge ‘edge’, a vastly superior information feed compared to other players in the silver market and more opportunity to influence the directional flow of silver.

A savvy corner operator might also see “the writing on the wall” in these high profit margins of the silver miners. A pointer to the “use by” date for their physical silver corner. Over the last few years silver ore bodies and old workings that were not economic for half a century have become financially viable.

Refiners produce a range of products in addition to the standard larger bar sizes. They produce flake, shot etc… to meet the specific needs of their fastest growing, and largest, customers - the industrial silver users. (Make no mistake, the industrial users are the most important customers in this market.) The challenge of matching their output to the demands of customers, with quite different needs, makes the refiners a potential choke point (a supply bottleneck) that a well-connected corner operator could exploit opportunistically.

The retail investor demand for silver has also been growing strongly. It has been reported that last year this segment accounted for around 10 per cent of total fabrication demand. Physical silver investors are price sensitive but many tend to just accumulate over time, dollar cost averaging their original stash. Many of these investors are “buy and hold” folks. From a corner operator’s perspective retail silver investors help to immobilize the stock, compete for the flow and they are somewhat predictable.

Institutional investment in silver generally flows into the ETFs, ETPs and mining shares for a simple reason. Many of these investors are prevented from holding physical metal by their investment mandates. Even if they wanted to they could not hold physical. I concede that mandates, and the laws that give rise to them, can be amended. (In order not to get bogged down in a “will too, will not” argument I hope others will concede that I have described the status quo.) Overwhelmingly pension funds and their ilk tend to the long side of markets they invest in. You know what I am about to say don’t you? They are predictable.

You are probably getting sick of the word ‘predictable’ by now but just try to imagine that you are a character in this story too. Imagine for a moment that it’s real. Behaving predictably might not be such a great idea if you are attempting to trade or do business in a cornered market.

Ed Harbuz CEO of the Perth Mint explains here why running a Mint is such a challenging, customer-driven business. Despite unsubstantiated allegations to the contrary the large Mints, by their actions, can be seen to be honest, conservative, generally prudent and not inclined to speculate.

The Mints' demand for silver is ultimately driven by retail and wholesale customers. Mints tend to have a “feast or famine” sales pattern that makes it difficult to forward plan capital expenditure programs. They certainly cannot expand their overall production capacity quickly. Hence they are also highly predictable and another potential choke point that could be exploited in a corner.

Industrial silver users are the single biggest market for silver, purchasing approximately half of the annual flow of silver. As mentioned earlier, this large market is growing strongly. A corner operator can rely on industrial users for profits when prices are rising. Here’s why:

“An important factor to understand in the case of silver is that demand from the industrial sector tends to be quite inelastic. This means that buyers have few options and have to pay at prevailing prices.”

In this story the industrial users would be the main target (victim?) of a corner operator.

When production bottlenecks occur at the Mints and/or the Refiners a corner operator could take advantage of the ignorance of most retail investors and play on the widespread belief that there is a shortage of silver. (I’ll return to this topic later.) The corner operator could also rely on many (all?) of the dealers to talk up any rumour or urban myth that sells silver. With premiums like these the dealers have every incentive to support the hype, hope and hysteria that often surrounds the retail silver investment market these days.

The Exchange Traded Funds (ETFs) are a segment of the market we should pay close attention to in our unfolding corner narrative. The ETFs that offer redemption in physical silver tend to have a minimum redemption quantity that is much higher than most small investors can easily afford. In most cases the shares trade freely but the metal in many of these ETFs sits still. Consequently these ETFs add to the stock while increasing its tendency toward immobility and they compete for the flow of silver. As Kitco reports here ETFs have become a huge part of the silver market (my emphasis).

The Web site for SLV shows that as of May 1, 2006, the amount of silver in the trust was a modest 653.17 metric tons. Flash forward to Thursday, and the Web site showed total holdings stood at 11,053.2 metric tons, or 355.4 million ounces, with total assets listed at $17.3 billion.

Through April 21, CPM Group put global silver holdings in 13 precious-metals ETFs around 605 million ounces…….For 2010, additions to global ETF holdings were 123 million ounces, Rannestad reported. In 2009, ETF holdings rose by 155 million ounces.

The ETF additions in 2010 represented 12.4% of total global supply of silver of 987 million ounce (including not only mine output but other sources such as recycling), Rannestad reported. Much silver is consumed by industrial uses. Excluding all fabrication demand, the amount of available silver was 142 million, meaning the ETF demand accounted for some six-sevenths of this.

SLV stands out from the other ETFs in three enormously important ways. Firstly, its structure and prospectus allow it to impact on both the physical and paper silver markets in ways that most other ETFs simply cannot. It’s also vastly larger than any other silver ETF or ETP. Lastly the SLV silver is literally both a stock and a flow at the will of the Authorized Participants. To illustrate, you may have heard Saudi Arabia referred to as the “swing producer” in the oil market. The Saudis are said to have the spare capacity to keep supply and demand in balance. SLV can fill that same role in the market for physical silver. In this story it does precisely that, with a slight twist. It is used pro-cyclically by a corner operator to amplify volatility in both directions, up and down.

Okay, I know that some observers confidently claim the SLV is just a paper façade with no actual physical silver. No amount of audits or bar lists will ever convince some of you otherwise. So be it. For those readers with an open mind, I invite you to consider the possibility that they have the physical silver they claim. For the purpose of this story it doesn’t matter if that physical silver is encumbered with multiple claims nor if SLV holds some paper silver for periods of time. In a corner the crucial issue would be who has the strongest claim to that SLV silver stock and the most influence and control over the flow of physical silver into and out of SLV. The industrial silver users obviously had some concerns about SLV’s potential clout. By the end of this narrative they might wish it had been drowned at birth.

Prior to its launch, the industrial silver consumers lobbied hard to try and convince the SEC to deny approval for this new physical-silver ETF. The Silver Users Association, whose members process 80% of all the silver used in the US, wrote a letter to the SEC in February 2006. It warned the SUA ‘opposes the creation of a silver ETF because of the concerns that doing so will require the holding of physical silver in allocated accounts, thus removing large amounts of silver from the market.’

And indeed the industrial silver consumers’ fears have come to pass. In mid-December 2010, SLV’s holdings hit an all-time high of 352.5m ounces of silver bullion! To put this into perspective, global silver production in 2009 ran about 700m ounces. American stock investors, by buying shares in SLV, have already absorbed the equivalent of half a year’s worth of all the silver mined in the world. (My emphasis)

As I said earlier SLV is different to other ETFs. Below FOFOA replies to a question I posed in February when we were discussing the idea of a silver open forum.

”Very interesting. Considering that ‘demand’ exerts no pressure on an ETF to grow in size, one has to wonder. Physical contributions are the ‘will’ of an owner or purchaser of physical silver to encase it in SLV in exchange for easily tradable shares. The price-tracking function is simply a matter of market arbitrage. But of course this fact is not understood by the public. Very interesting.”

The custodians for SLV are HSBC and JP Morgan. Authorized Participants create and redeem baskets of SLV shares. You can find a list of them here (on page 27).

Before we end this examination of ETFs, and SLV in particular, I would like to leave you with a question to ponder. Has the price of silver become more volatile since SLV and the other ETFs started to gain traction in the silver market?

Martin Armstrong describes the typical behaviour of commodities as they move through an uptrend in the extract about wheat from this essay.

"In other words, we are about to make another thrust upward into a new trading band where the $6-7 level should become the floor. This is how commodities ratchet themselves higher that some call inflation. What is actually taking place, there is a very broad trading range that becomes the normal volatile swing between the peaks and the lows. The commodity will bounce off the floor and ceiling of this range until it starts to finally expand the trading ranges." (My emphasis)

Now let’s examine the Bullion Banks as we look into a would-be corner operator’s three most lethal weapons (aside from unlimited ‘free’ money) – opacity, reach and information.

Opacity, Reach and Market Intelligence

Since the repeal of the Glass Steagall Act some international banks have become monoliths in banking, broking, dealing, commodity trading, derivatives, research, private exchanges and OTC markets. Even a vigilant, well-resourced regulator would struggle to prevent “regulatory arbitrage” by banks, traders and speculators operating in multiple exchanges and markets in a number of legal jurisdictions. And vigilant, well-resourced regulators appear to be a little thin on the ground these days. The global activities of these banks are opaque to regulators.

The bullion banks have the very best ‘intel’ on the silver market. They have connections into every nook and cranny of this market from miners to Mints to margin traders. They also have the opportunity to make use of their own unallocated pooled silver accounts through fractional reserving. You can read about how the bullion banks are able to leverage these pools here.

As we mentioned earlier the Comex is basically a paper silver market. The leverage in this market has been widely discussed since the revelations early in 2010 by the team at GATA and CMP group’s Jeffrey Christian. (It is less widely known that ANOTHER revealed, thirteen years earlier, that the leverage in the LBMA was routinely 100:1.)

Let’s clear up another popular misconception. This one concerns the LBMA. As Bron Suchecki explains here, the LBMA is not an exchange. It is an association. Transactions among LBMA members and their clients are private. Bron also reminds everyone that the LME does not trade physical silver. For anyone interested here is a list of the Market Making members of the LBMA.

Some silver market analysts focus on Comex reports and the BIS bank participation report in order to draw conclusions about the positions of the bullion banks, and others, in the silver market. Ed Steer of Casey Research writes:

"The third graph is the number of US and non-US banks...and you can see the point that the CFTC began to withhold the number of banks so that they could protect JPMorgan. They started withholding this data when Ted Butler discovered the Bank Participation Report back in 2008...and within months, the CFTC pulled the data………… and the last graph is just the two US banks on their own....and their respective long positions [non-existent] and their monstrous short positions. It's easy to see that JPM runs the silver price show." (My emphasis)

Let’s assume that the information Ted Butler pounced on was as valuable as Ed Steer and Ted Butler seem to think. That line in Ed’s report I highlighted in bold prompts me to ask: What does it tell you about the rest of the public data feed if useful data you unearth is “pulled”?

The allegation that JP Morgan, HSBC etc have massive naked short positions in the silver market rests on a range of published data from regulators and bankers but primarily on the Comex reports. As mentioned earlier the silver Comex is a market that accounts for only around 5 per cent of the physical silver traded annually.

One of the tactics recommended by some analysts to break the Comex shorts is for all of the longs to stand for delivery. So readers may be interested in this explanation of trading between longs and shorts on the Comex from Metal Augmentors’ ‘silverax’. Here are a couple of snippets:

“…. the longs cannot force delivery on the shorts, but the shorts can force delivery on the longs. Yes, most everybody has it bass ackwards!”

“…..the delivery timing is almost entirely dependent on the short. It is the short that announces an intention (notice) to deliver and it is the long that is obligated to accept delivery. Not the other way around.”

If any reader, with an intimate understanding of the Comex, has the time to read the ‘silverax’ essay and post a comment here I’m sure we would all appreciate an explanation of how longs standing for delivery could force the shorts to deliver. Assuming, of course, if anyone did try to force the shorts into a physical default that the Comex would not intervene on behalf of their most powerful members - like they did with the Hunts.

The volume of physical silver, and other commodities, traded on the public exchanges is dwarfed by the trade conducted in wholesale transactions, private deals with banks (eg. members of the LBMA), through OTC markets and other parts of the shadow banking system. These alternative markets are both huge and totally opaque to outsiders. As this analyst notes:

"....the big players in banking and finance are using the OTC system and have a turnover 12 times that of the “public” markets..." (My emphasis)

It appears that the volume in the OTC markets and shadow banking “dark pools” comes at the expense of both liquidity and stability in the public exchanges. As a result the price discovery function of the public exchanges may be seriously compromised. At the same time the off-exchange trading must reference, at least to some degree, the prices "discovered" on the public exchanges. What a fricken mess! But an ideal environment for market manipulation.

David Galland of Casey Research had an interesting discussion with Dr. Andrew Bogan (here) on the subject of short selling in ETFs. Apparently some of the stock ETFs have short selling levels up to 1,000% (compared to, say, IBM stock at around 1.4% short). In order to put their discussion in context, Andrew Bogan explains how ETF shares are created:

Shares can be created at the end of any day if someone delivers a basket of underlying stocks to the ETF through an authorized participant. And shares that are not wanted in the marketplace can be redeemed in kind for the underlying stocks – or in some cases cash. That's all been carefully structured and works smoothly. The issue is what happens when short-selling dominates the trading. (My emphasis)

This is the part of the interview I think we should pay close attention to, where they discuss GLD. Keep SLV in mind as you read this. Andrew Bogan again (my emphasis):

The tracking of an ETF's price with the fund's NAV, which historically has been extremely close, is totally dependent on an arbitrage mechanism. The arbitrager can make money by continuously pushing the price of the ETF toward its NAV.

The short position in GLD isn't nearly as large as it is for some equity funds – but we have looked at GLD, and it has the same structural issues, just to a lesser extent, at least for now. The short interest in GLD has fluctuated around 20 million shares. Now, GLD is a pretty big fund. With 20 million shares short, it is roughly 95% fractionally reserved…… But GLD does not have to stay at 95% fractionally reserved.

DG: Could they just say, "From here on, we're not issuing any more shares"? Would that stop the short-selling?

AB: Not necessarily, because, you know, the short-sellers are selling – in fact, it would probably exacerbate the short-selling. So as long as a fund is issuing shares, aggregate buying demand can be satisfied by expanding the fund. If they stop issuing shares, aggregate demand would get satisfied by short-sales of existing shares. So, if anything, closing the issue window should make the problem worse, not better.

…….. The bigger challenge might be if there were an actual redemption wave. If that happened when GLD was already substantially fractionally reserved, then you're back to an 1800s gold bank problem. Fractionally reserved banks can be hit with a run………You know, one of the big risks, by the way, that no one has really discussed much, is if an ETF were to have a big redemption run in panicky market conditions and halted redemptions……. it's quite possible that if redemptions were halted for any length of time, the arbitragers wouldn't be keeping the share price in line with NAV. We already know from the Flash Crash that significant price departures from NAV are quite possible for ETFs.

In his new book Matt Taibbi discusses the spectacular growth of commodity market speculation.

"We know the amount of speculative money in commodities exploded, that between 2003 and 2008 the amount of money in commodities (Ed: derivatives?) overall went from $13 billion to $317 billion, and that because virtually all investment in commodities is long investment, that nearly twenty-five-fold increase necessarily drove oil prices up around the world, putting great gobs of money into the coffers of the SWFs." (My emphasis)

In this recent post Adrian Ash quotes a figure from Barclay's Capital of $412 billion as the level of global investors' holdings of "raw materials" at the end of March this year.

Most of these predictably long funds are up against speculators and the prop trading desks of banks with near-zero cost money and virtually unlimited leverage. Opponents who will play both the long and the short side. To make matters worse, by being in these paper markets in the first place, these long side speculators expand the derivative markets to the point where they can dwarf the actual physical commodities traded. Hence the paper derivatives may be unduly influencing prices in the physical plane. ThyssenKrupp CEO Ekkehard Schulz appeared to think so in this interview with Der Spiegel (my emphasis):

Schulz: (Ed: talking about new entrants into the iron ore market) But we now know of a few major investment banks that are painstakingly preparing to enter the ore market. One of them is JP Morgan. They have been buying up big in this sector.

Later in the interview:

SPIEGEL: Who are they, and how are they preparing?

Schulz: I don't want to mention any names here, but they are banks that were also involved in other big speculative bubbles. They are currently active in our markets, hiring natural resource specialists, buying trading companies and leasing storage facilities at major ports, where they can temporarily warehouse ore for speculative purposes. They see an opportunity to make billions in profits.

SPIEGEL: By driving up prices on the ore market?

Schulz: By disconnecting prices from the real economy and the natural resources from real consumption. This has already happened with nickel. Speculators and banks are already turning over 30 times as much nickel in the markets than is actually consumed in steel processing and other areas. In the process, the price per ton fluctuates between €10,000 and €50,000. Imagine a situation like this in a large-scale natural resource market like that of iron ore. The consequences would be devastating.

Putting all of this together, the presumption that the positions of JP Morgan, HSBC etc can be known from publicly available data is beyond incredible. To suggest that you can know they have a massive naked short position without knowing what other positions they are holding outside of the Comex and how their overall books are structured, is, in a word, absurd.

Before we take a look at how some of the price action in the silver market over the past few years could have been very profitable if a corner was in place it would be remiss of me to sidestep Max Keiser’s “Crash JP Morgan” campaign. Here’s why:

1. From the Max Keiser website (here):

(Note: I changed some of the paragraph breaks to compact this but the words are unchanged. I suggest you read the comments on this post as well. My emphasis in bold.)

Dear Max and Stacy,

My local dealer,, has been running OUT of Silver,, over and over again. Gold is available,,but SILVER is in HOT demand. I cleaned him out this time.. had to go so far as buying up the sterling silver flatware,, but hey,,silver is silver. Had some Kruggerands and Eagles (Au),, sold them and bought Silver. I have NOT liked the way Gold is not climbing up as silver has been doing,, so I finally got OUT of gold.

I didn’t know that I had so much gold,, been sitting on it.. so for me,,it was like buying $9k of silver,, for only $5k out of pocket…and now,, my “metal” will be rising even faster. But I hope I never have to stoop to buying any silver ”tea sets”..as they are just TOO bulky to fit in the under-floor safe. Hahaha… I’d have to SLEDGE HAMMER them into a small ball of ugly junk…but I’m OK with that. Silver is silver. Millionaires already have all the ”tea sets” they want.

Craig.

2. This extract is from an e-mail issued by Bix Weir of The Road To Roota. Sent: 1/3/2011 (My emphasis)

“Let me give all you "Newbies" a hint...by the time you finish researching and comparing silver to all the other investments out there you will go ALL IN!

When I say "All In" I mean swapping EVERY other investment alternative for PHYSICAL silver in your pocket. Stocks, bonds, pension plans...everything. This means gold too. This means other silver investments also...ETF's, silver mining stocks, silver certificates... everything.”

3. Museice is a frequent contributor to the comments here at FOFOA blogspot. This is an extract from a comment he posted recently after deciding to roll his physical silver for physical gold.

For any Silverbugs out there (I was one)….. My conclusion: What does the GSR have to do with Freegold? Absolutely nothing! If you understand anything FOFOA has been writing you will bail on silver. Not because it has hit its peak. I don't care how high it goes. You will switch because you are holding the wrong metal. End of story.
(February 18, 2011 8:19 PM)

4. In the video below Michael Maloney of GoldSilver.com responds to that old chestnut “There isn’t enough gold” with “Baloney”. He then goes on to explain why. As I watched this for the first time the question on my mind was: “If gold can do the job on its own why do we need silver?” I had already started to have reservations about the silver we were holding. This video was one of the ‘nudges’ that prompted me to dig a little deeper (well, actually, a lot deeper). It should start playing at the 3:50 mark automatically:



Later I came across a few videos of presentations by Robert Kiyosaki. (I think he wrote a book called “Rich Dad, Thanks To Your Dad” or something like that.) The video quality on this clip is terrible so I am just going to provide you with a link . It is set to start at the 4:20 mark. Kiyosaki is asked if he is adding to his positions. He talks about silver among other things and then goes on to mention who will take his positions off his hands “just before it blows” – the “suckers”. Michael Maloney, one of Kiyosaki’s advisors, is in the background stage left. Who are the suckers? I’m going to suggest a candidate for that role at the end of this post.

And wow, that Bix Weir is certainly confident when he talks to newbies, isn’t he? Quite at odds in his thinking to many of the people who frequent this blog. Some of these folks have been delving into the matters we discuss here since 1997 when ANOTHER was posting his Thoughts. I don’t remember seeing anyone here give such bold advice as Bix about gold, especially not to inexperienced newcomers. So before we look at Max Keiser’s recent exploits, let’s revisit the issue of silver shortages in order to see if Bix Weir and some of the other silver experts may be a tad overconfident about the rarity of silver.

The Silver Shortage

First a few words to explain why I keep linking to Bron Suchecki’s posts and the Perth Mint in this story. Bron has made a huge effort to educate people about the precious metals and their markets over the past few years. The Perth Mint has recently launched its own blog and updated website. They have made a real effort to increase their transparency and to communicate with their customers and the general public. Some other Mints have a mixed record in this area. This report about a recent Congressional Panel makes for interesting reading if you follow the activities of the US Mint.

The Perth Mint is also a unique ‘animal’ in the gold and silver markets. As I mentioned earlier it accounts for around 10% of the annual trade in physical silver. Around 90% of their fabricated product is exported. Roughly half their pooled and allocated customers are outside Australia. They are also an integrated operation having their own refinery. Lastly they refine anywhere from 300 to 400 m/t of gold each year while Australia’s local production is around 250 m/t. They are a big player with excellent ‘intel’ on the silver market both locally and internationally.

Back to the shortage issue. All through the recent huge increase in the price of silver the usual suspects were talking about shortages. Well, someone forgot to tell the folks at the Perth Mint. All through the “shortages” they frequently confirmed that there was “no shortage of metal”. You can read their updates on their blog. Production bottlenecks? Sure, but no shortage. In fact they are seeking to expand their market into China.

Who was talking about shortages and tight supplies of silver? Dealers and Bullion banks, apparently. The following quote was attributed to Dave Madge director of sales at the Royal Canadian Mint by Eric King over at the KWN blog:

"We are anticipating it to become even more difficult to secure supplies in the future. This is based on what we are seeing firsthand and what our suppliers are telling us. We work closely with these banks to secure silver and they tell us there is a lot of competition.” (My emphasis)

Alex Stanczyk of the Anglo Far-East Bullion Company mentions these reported comments by Dave Madge here. Here are a couple more links discussing the mythical metal shortages: link, link.

In response to this claimed shortage the Perth Mint is spending millions of dollars expanding its capacity to fabricate silver products. You can read about it here. Recently the Perth Mint did something that should help to convince you that there is no shortage of silver.

For many years the Perth Mint funded their gold and silver inventory through a certificate program backed by unallocated pools. The deal was simple, they got their inventory funded (less capital tied up) and the certificate holders got safe, free storage of their metal. The certificates could be exchanged for fabricated metal or cash. Recently the Perth Mint announced a change to this program which you can read about here and here. If you want to be part of the pooled unallocated silver program in future you will have to pay them storage fees. Let me break this down for the stragglers, they have plenty of silver, perhaps much more than they need and they don’t foresee any shortages in the near future.

Not enough for you? Okay, let’s take a look at recycling. Another frequent claim from the shortage spruikers is that most of the silver which is consumed cannot be reclaimed. It is not economic to recycle most of the products sold that contain minute quantities of silver. This is absolutely true. But never, say never. The viability of recycling is a question of price, proximity and technology PP&T). Let’s take a look at just one product for now - the cell (mobile) phone.

According to this USGS fact sheet (2006) there is a mere 0.35 grams of silver in the cell phone they based their study on. But this cell phone also contains “copper, iron, nickel and zinc” with “even smaller amounts of aluminium, gold, lead, manganese, palladium, platinum and tin”. Cell phones also contain plastics that become increasingly expensive when the price of oil rises.

Lastly, most of the cell phones, and other electronic devices, which make their way into waste streams end up in landfills. In many countries landfill is becoming prohibitively expensive in both financial and environmental terms. These devices are a pollution issue. Schemes proposing to add a deposit or bond to the selling price of new electronic devices, in order to subsidize the cost of recycling them at the end of their life, have been fiercely resisted by industry groups. Thus far the industry groups have prevailed.

Is there likely to be a huge increase in the amount of recycled silver from electronic devices any time soon? I, for one, doubt it but it is an issue of PP&T for several metals and other recyclables in these products, not just silver. So never, say never.

Here’s another potential headwind for the “silver to the moon” guys - the industrial silver users themselves. The manufacturers of the devices which use much of the consumed silver are in cutthroat competitive markets. They have to work hard to remove costs from their products. That includes silver of course. Higher silver prices give them even more incentive to focus on cutting down the silver content or replacing it with a lesser alternative such as copper. FOFOA has an anecdote about one such manufacturer that has already eliminated silver from his process. That said, I will concede that the expanding industrial uses for silver and increasing global demand for products containing silver may fully offset any reductions that the industrial users can make.

Finally don’t forget about the potential for increased supply from the silver miners. As I mentioned earlier “over the last few years silver ore bodies and old workings that were not economic for half a century have become financially viable” at higher silver prices.

Now I know these arguments won't be enough for some of you. Read on, we will touch on this “shortage” issue one more time from an angle that might surprise you.

Max Keiser was one of the earliest, most outspoken critics of the appalling behaviour of the Wall Street banks. I believe Max coined the evocative phrase “financial terrorists” to describe them. He was also one of the first media figures to advocate owning gold bullion to protect your wealth. Kudos to Max for his bravery and willingness to speak out. This aired September 18th, 2008, and the video should automatically start at the 1:44 mark.



Since gold advocacy started to become increasingly fashionable it seems that Max decided he needed a little “brand differentiation” and followed the political dictum If you want to be a leader, find a parade and get in front of it. In an apparent attempt to capitalize on the growth in silver investment, last November Max launched the “Crash JP Morgan” silver campaign. He too argues that JPM has a massive naked short exposure in silver. He claims that they can be brought down through the purchase of physical silver by retail investors.

Nowadays Max is the self-styled leader of a movement calling itself the Silver Liberation Army (SLA). Apparently the expectation is that untold millions of people will each buy some silver and the ensuing supply squeeze will cause JP Morgan catastrophic losses on their supposedly naked short position as the price of silver goes to figures as high as US$500 per ounce. I hope earlier parts of my story have given you serious doubts as to whether anyone can be sure that JPM is even short at all (naked or otherwise).

Max and his SLA give us an ideal opportunity to conduct an extremely important thought experiment and to revisit the notion of a shortage of silver (one last time). This experiment is extremely important if you are holding silver because the outcome may force you to conclude, like Museice, that you are holding “the wrong metal”.

Now, for reasons best known to themselves, the “pin-up girl” of ‘Colonel’ Keiser’s SLA happens to be Blythe Masters of JP Morgan. As I said from the outset this is a story of manipulation, not suppression. But to please the SLA we’ll make ‘Blythe’ the main character in A Scenario: Profiting From A Silver Market Corner which we will come to shortly.

Position Vacant: Corner Operator – Silver Market

I realize that we have covered a lot of ground already so before we proceed any further I’m going to summarize the key attributes, resources and capabilities that I think we could expect to see in a successful silver corner operator. As a major international bullion bank JP Morgan would certainly tick all the boxes below in terms of their capacity to breathe life into this narrative (or some version of it). But then so would HSBC, I imagine, and some of the other bullion banks, or a combination thereof.

• An information advantage over other silver market participants.

• Control/influence over a vehicle like SLV that can be used to hoard a large quantity of physical silver which can then be used to affect the flow of silver.

• Intimate connections with the silver miners and insights into their finances and hedge books.

• The ability to trade against clients, produce research that encourages investors to take the opposite side of your trades and access to media outlets that are receptive to your “press releases”, research bulletins and expert commentary.

• Sufficient capital to finance the corner.

• Captured regulators.

• The ability to keep other market participants in the dark about your activities, the structure of your book, where and how you are taking profits.

• Intimate knowledge of the choke points (Mints and refiners).

A Scenario: Profiting From A Silver Market Corner

As I promised the SLA, I’m going to make Blythe Masters of JPM the central character in this scenario. (For other readers, where I have used the word ‘Blythe’ please read Blythe Danner or BB trading desk, favoured clients and likeminded BBs.)

After the GFC hit in 2008 the industrial silver users pulled their bids for silver and ran down their inventories. The price of silver collapsed to around $9.00 from its previous high over the $20.00 mark. During this period ‘Blythe’ took profits by shorting the paper silver market into the ground knowing there was no solid floor under silver until the industrial users came back in. ‘Blythe’ began to build a long (that’s l.o.n.g) position in silver as the price bottomed and began to recover.

Some of the savvy traders and speculators came in at the lows because the GSR was way above the median of the last 10 years and they saw a panicky market that they were happy to take a contrarian position in.

Once it became clear that demand from the industrial silver users was reviving, ‘Blythe’ made the final preparations for her next play, a short squeeze in physical silver with the industrial silver users as the target. As we noted above these natural longs had run down their inventories. As sales of their products picked up they had to buy, regardless of price, or their production lines would have ground to a halt.

‘Blythe’ added to the pressure on the flow, and the price, by using SLV [1] and the other levers at her disposal outside the public exchanges to drain physical silver from the market. She sold down her long silver position into the rising demand from the industrial users at increasingly higher prices.

‘Blythe’ knows the refiners are a choke point. When they shifted their production focus to their industrial clients, they cut back on their bar production for the Mints and the wholesale market. This eventually started to cause some delivery delays in London on LBMA good delivery bars. [2]

‘Blythe’ knows that when there’s a surge in demand at the retail level, at some point, the Mints aren’t able to keep up. As silver approached its previous high the retail investors started coming in. Speculators moved in too, cautiously at first, pushing up the paper silver price.

The coin dealers and the silver perma-bulls started beating the drum about impending shortages. Eventually the Mints were struggling to keep up with the surge in demand due to the limitations in their fabrication capacity. As rumours of shortages and delivery delays made the rounds, the demand from the retail silver buyers went into overdrive. [3]

‘Blythe’ squared her books after the long physical play ran its course and she was neutral (neither short nor long). The speculators had started to pile into paper silver. So ‘Blythe’ got ready for her next play – a pump and dump in paper silver.

By this time the refiners had shifted their focus to bars as demand from the industrial users slowed. Wherever possible, the Mints had ramped up production and increased their output. Both of these choke points had begun to open up again.

‘Blythe’ had another ace up her sleeve. She knew the silver miners’ dormant hedging programs were about to come back to life long before the market knew. The miners were making noises to other parts of the JPM empire about hedging at these high prices. [5] Perfect set-up for ‘Blythe’. She piled on the shorts into the run-up to the blow off top in silver while she took the other side of the hedges put on by the miners. (That’s a future long physical position if she decides to hold onto it. It doesn’t bother her either way. She can always offload/offset it with SLV.)

The industrial silver users had begun to pull their bids as well. The traders and speculators, who took advantage of the high GSR, took advantage of the multi-year record lows and rolled some silver for gold. (Not all of it, no way. This game wasn’t over.) The coin dealers started to get nervous as their silver inventories began to build. The small fry were getting nervous about buying at record prices. The Mints ceased to be a choke point. Almost time for the dump.

‘Blythe’ painted the tape at the Comex with ever higher prices on thin volume [5] while she piled on shorts. All ‘Blythe’ needed now was a catalyst to turn the nervousness among the leveraged speculators into fear. ‘Blythe’ didn’t know or care what the catalyst was. Margin hikes, whatever [6]. As soon as sentiment shifts Blythe runs every stop she can. She tries to accentuate every dip until something puts a floor under the price. What, for example? “Who cares,” ‘Blythe’ replies, “I’m a trader."

After the dump ‘Blythe’ is neutral (neither short nor long). She’s just cruising, scalping small profits on the normal trading activity of clients while she looks for her next big opportunity. With this in mind she is watching gold very, very closely right now because she knows something most of us don't ......

What’s next? As a blogger known as London Banker used to say: “Wash, Rinse, Repeat.”

Trading

Some of you have made a lot of money trading gold and silver over the past few years. There are some enormously savvy traders out there. Newcomers who might be tempted by the profits in trading these metals should take a look at the charts and commentary that Nigam Arora provides here. That’s some volatility in those ETFs isn’t it?

So newcomers, for a moment, please pay attention to an old fool who has made every costly mistake you can think of (and some you probably haven’t). Please, do your homework. If you go stumbling around in these markets with your head full of nonsense and misinformation, margined to the eyeballs ‘Blythe’ will, sooner or later, take your head off at the shoulders. These are zero sum games that are being played. In order for ‘Blythe’ to win others must lose. This isn’t just my opinion. It’s a fact, Jack!

As I said earlier there are some savvy traders out there. I’m not one of them. I don’t have the skills or the temperament for it. Yet, I was able to predict the paper silver market’s behaviour and to get the timing just about right by drawing on this insight into rigged markets – “those who can be screwed, will be screwed” (it is a zero sum game after all).

Even if you are not a trader it also helps to read the writing of savvy traders and analysts like (in no particular order) Ben Davies, Tom Szabo, Adam Hamilton, Gene Arensberg, Trader Dan Norcini, Jim Sinclair, Alf Fields, Martin Armstrong and Stewart Thomson. There are others. Some of these fellas have subscription services. If you want to trade or invest under their guidance you can read their archives before you dive in and see the calls they have made. In some cases, over years. (If you want to put forward your own recommendations. the ‘comments’ are wide open.)

Many visitors to this blog have said that at some GSR level they are going to roll their silver into gold. Some of these high ‘rollers’ will be thrilled at the returns they make compared to plodders like me. However, I would like to point out a potential pitfall in attempting to play the GSR that I recently shared with one of my best buddies at the FOFOA blog.

There are serious risk assessment issues that need to be addressed if you are holding physical or paper silver with a view to rolling into physical gold at some desired GSR; in other words, if your aim is to obtain (via a GSR arbitrage) physical gold as your ultimate destination.

Let's walk through the risk assessment together. These days the GSR is generally calculated based on the Comex spot price of paper silver and paper gold.

To the unthinking, the GSR seems to imply some kind of direct exchange. As in 34 ounces of silver for 1 ounce of gold. Obviously this can happen by way of direct barter. But in most cases it is an indirect exchange. You have to transition through currency, selling one metal for an amount of currency and exchanging that currency for the other metal. The fact that you have been able to do this simultaneously and reliably in the past does not guarantee that you will be able to do so in the future.

Many here anticipate the eventual failure of the paper gold market. The paper GSR could be 1:1 if there is a systemic failure in the paper gold markets but that would be a currency ratio not a metal exchange ratio.

In a recent essay Eric Sprott made many interesting observations including this one:

"Now, it’s true that another potential source of supply is the very silver that investors already own......."

I agree, Eric, some of that stock could mobilize. In fact I know that some of it has already joined the flow and more of that stock intends to flow at some point. As Robert Kiyosaki told us in that video I linked earlier, that is his plan.

For those who have physical gold as our ultimate destination, the key risks are obvious. You have to weigh the risk that no dealer will want our physical silver because many other silver holders are trying to exit at the same time. Secondly, you have to weigh the risk that when you want to exchange silver for physical gold there are no sellers of gold at the paper GSR price, or even worse, no sellers at all.

I realize I may have tested your patience and forbearance with this very long post. If you aren’t yet convinced that silver is merely a ‘trade’, or an item for barter in a world gone completely mad, please take a little more time to share a thought experiment with me. You can let me know in the comments if you still feel the same way at the end of it.

A Thought Experiment

As I said earlier Max and his SLA give us an ideal opportunity to conduct a thought experiment. This experiment might lead you to conclude that in holding silver you are holding “the wrong metal” to carry you through a transition into a new monetary and financial system. If anyone wants to argue that the current system isn’t ‘terminal’ please jump right in with your comments and links. There are many ruinists* here of the hyper-inflation school (*h/t Rick Ackerman for that word). As promised we will also revisit, obliquely, the claim that there is a shortage of silver.

I’ve read a lot of the comments by Max Keiser and his SLA supporters about their campaign. Obviously I don’t believe for a moment that they can ‘crash’ JP Morgan by buying silver coins, teapots and small bars (or large bars for that matter). However, I don’t think that invalidates a thought experiment which treats the SLA as a proxy for the silver advocates and JPM as a proxy for the current system.

Many of team SLA, and other vocal advocates for silver, seem to be convinced that it will return to prominence in a new international monetary system. Others simply see it as “real money” returning to its rightful place in the world economy. Some, like Bix Weir, seem to see that rightful place as the pre-eminent “money”, the “people’s money” that will lift the yoke of a corrupt monetary regime from the necks of the citizens. I can see how firmly held beliefs such as theirs lead them to such passionate advocacy for silver.

What I can’t seem to find anywhere is a roadmap, a ‘battle’ plan from any of these silver advocates showing how they get to their ultimate goal. Will silver achieve their aims spontaneously? Is it likely to be unopposed by our proxy for the status quo, JPM? As the saying goes “if you don’t have a plan, plan to lose”. So as a thought experiment I would like to sketch out such a plan in order to test the achievability of the aims of the silver advocates.

Let’s recall that definition of a corner.
To “corner the market” is to control enough of a particular commodity to allow the price to be manipulated…..The corner operator hopes to gain control of enough of the flow of the commodity to be able to set the price for it.

The ‘military’ objective of the SLA is to corner physical silver. They want to control enough silver to set the price a lot higher and break JPM in the process. How are they going to do that if they don’t get a corner? Likewise if silver isn’t monetized how can it be part of any new monetary system they are advocating? They’re not going to get any support from the establishment. This will have to be done solely through people power.

The SLA’s war will have to be fought on three fronts. They will obviously have to corner the flow, but what if the stock begins to flow as well? Obviously I think it will flow. And more on this ‘third’ front at the end of our thought experiment.

Is there any precedent for this type of military adventure? As luck would have it, yes there is - gold. A similar war has already been fought in gold. So we can examine the recent history of gold and glean some lessons for the SLA plan and the topography of the battlefields they will be fighting on. Along the way we’ll identify some similarities and some differences in the circumstances of the two metals.

After WWII gold was effectively cornered by the US government. Over the next several decades that gold became more evenly distributed into the asset reserves of other central banks, governments and private hands. The stock of gold flowed freely during this post-war period despite the general public, in most countries, being prevented or discouraged from owning gold.

Fast forward to the present. Somewhere around 30,000-33,000 m/t of gold is in CB and government coffers while the balance, over 130,000 m/t is ‘out there’ in private hands - right now. (Whose hands? That’s one of the issues we discuss at this blog.) In this thought experiment it doesn’t matter whose ‘private hands’. Only two things matter. Firstly, this stock has not flowed despite a fivefold increase in the price of gold since the first Washington Agreement signaled the end of central bank leasing of gold to the bullion banks. This gold stock is not giving any indication that it will join the flow, quite the reverse in fact. The gold stock has become highly immobile. It is in the strongest of strong hands.

The investment demand for gold has had to compete solely for the flow of gold in recent years. This flow has been supplemented by a huge increase in the supply of scrap gold which was readily absorbed by investors. (Gold scrap topped out about a year ago.) The gold fashion jewelry market is a shadow of what it was. The demand for gold displaced in this market, by silver and other materials, had to be absorbed by gold investors as well. They did, comfortably.

According to some estimates there was a single digit increase in mine supply last year. The only countries with substantial increases in their (already large) mine production (mainly China and Russia) have also been adding to their own reserves. Gold investors have demonstrated their ability and willingness to fully absorb all of this flow by continuing to bid the price of gold up.

The gold investors also now have some extremely powerful de facto “allies” that the SLA does not. The Central Banks and Treasuries are net gold buyers again. These are fantastic allies to have. They issue their own fiat currencies so there is no objective limit to how high they can bid the price of gold. They can never “run out” of that currency either. They just need sound reasons for bidding for gold and those reasons are the raison d’etre of this blog. Now why would gold investors want this competition for the flow? For the stragglers, “over 130,000 m/t is ‘out there’ in private hands - right now.” This de facto alliance is between the private and public owners of the stock, not with those investors who are now competing for the flow.

Now let’s try to apply some of the lessons from gold’s experience to the silver advocates game plan. The SLA has a de facto ally (but a very unwilling one) in the industrial silver users. Because their demand is inelastic they have to pay the going price. They will, whether they like it or not, help the SLA with one of their key objectives—to increase the price of silver—by competing for the flow.

The SLA will need to expand its share of the annual flow of silver into the market to a level where they can take control of the price of silver. The existing SLA silver holders must hold and continue to buy in ever increasing amounts or the SLA will need a constant stream of new recruits. Rising silver prices and altruism (or anger and resentment toward JPM) are the only recruitment strategies they have, as far as I can see.

Based on gold’s ‘battlefield’ experience, in order to achieve their ultimate goals the SLA (and retail silver buyers in general) will have to continue buying as each of the following events unfolds (but not necessarily in this order).

At some price level, some of the stock of silverware and all the old coins will begin to flow into bullion. The SLA will have to absorb this flow and bid the price up. At some price the silver fashion jewelry market will collapse. There are other white metals and alloys and there is no silver bullion jewelry market to speak of. The SLA will have to absorb this flow and continue to bid the price up. At some price the scrap silver market will turn into a flood (just like it did for gold). The SLA will have to absorb this flow and continue to bid the price up. Then the going will start to get a little rough for them.

If I am right about SLV being used as the “swing producer” in the physical silver market it is already part of both the stock and flow. At some point the silver in the other physical silver ETFs will also start to flow. The sponsors of these ETFs cannot prevent this. If enough shares are presented they must tender the physical silver. If the SLA absorbs all of the flow described above, while bidding the price up consistently, they will demonstrate to speculators that there is a rock solid arbitrage opportunity. Speculators will pull this silver out of the ETFs and coin it to sell to the SLA. The silver ETFs are not ‘strong hands’. They are the weakest hands of all.

Then another problem will emerge. There are silver “traitors” outside the SLA and troops in the SLA ranks planning to “desert” at the first whiff of grapeshot. People who have no intention of holding silver indefinitely. Some, like Robert Kiyosaki, are waiting for the right time to offload to the “suckers” as he calls them. Others have a target for the GSR. When reached they intend to roll their silver for gold. Perhaps the SLA can keep up the pace of recruitment so that it adds new recruits to replace the deserters and continue expanding its forces. Another problem may emerge (later rather than sooner) for the SLA: increased mine supply.

The silver advocates take comfort in the fact that silver is used in such small quantities in each product that the industrial silver users sell, that high prices, even incredibly high prices, will not deter them from buying. That is most probably true. Score that one for the SLA. However, the SLA may have completely misunderstood the threat. The price may be irrelevant. Earlier in this thought experiment they cornered the flow and the stock. The political heat from the industrial users, including the military-industrial complex, will be ferocious if the SLA threaten the supply lines of these users. (Recall the recent controversy over China’s corner in rare earth metals.) Perhaps the politicians will stay firm. Perhaps they will only sequester the silver mine supply on national security grounds. If so, the SLA is still in the game.

If the SLA can overcome all of the challenges that have been listed so far and “bullionize” all of this silver into retail product, it will then be confronted with the most terrifying enemy it has faced in this war. Their third front – 160,000 m/t of gold. Michael Maloney explained why (indirectly) gold and silver are enemies. There is enough silver too. If necessary it could be the sole monetary metal, even if that meant dividing it into atoms. Do you understand the implications?

You see this phrasing all the time “gold and silver”. There is no “and silver”. In this thought experiment the correct perspective is “gold or silver”. If the SLA and the other silver advocates are successful in making silver the premier monetary metal then gold won't just be less valuable, it will be worthless to everyone, everywhere. Superfluous. Redundant. Just like silver is now in the monetary system. Gold now has no other purpose than being the crème de la crème of monies. If silver wins this contest gold will have no value at all except for a small range of industrial applications and as cheap jewelry. Hooray for the SLA.

Hold it right there SLA. This thought experiment isn't over yet.

The SLA needs to ask itself a few questions as we conclude this thought experiment: Who is holding this gold? Why are they holding this gold? How much power and influence do they have? What are their options and capacity to respond to the threat you pose?

If the SLA gets carried away with delusions of grandeur and the silver advocates start to achieve their aims, then the governments and Giants who hold this gold will respond. You can understand that, can’t you? The moment that silver presents a ‘clear and present danger’ to their interests, they will understand this threat. The threat that their gold is soon to become worthless. They will squash the silver bugs – like a bug. Silver would then be a losing bet for political reasons. If the SLA is clearly going to fail then the silver holders will be perfectly safe. The gold holders will simply ignore them. Silver will be a safe losing bet until game theory kicks in.

Let’s wrap this up with a final question: Are you holding the right metal?

…………………………………………………………………

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Footnotes:
[1] January 14, 2011 (Link) “Provocatively about 1/6th of SLV’s total silver hoard was acquired in less than 5 months between late-July and mid-December 2010. SLV’s holdings shot up 18.9% during silver’s massive 76.0% autumn rally we saw last year. This is no mean feat! The 55.8m ounces of silver this ETF had to buy over this short span is staggering.”

[2] Delivery delays (Link) “The industrials, when they see that there is tightness or delays in shipping, will then go out and stockpile silver so their assembly lines are not shut down. We would then be talking about potentially tens of millions of ounces required for delivery to these industrial users in a short period of time. The banks have told these industrial users for years that there is no problem with silver supplies. When these industrial users lose faith in the banks, they will move right away to secure stockpiles.”

[3] Record sales of silver eagles (Link) “The US Mint sold 6,422,000 Silver Eagles in January 2011 – half as many (again) as were sold in the previous record-setting month of November 2010.”

[4] Miners hedging again (Link) ”Raymond Key, head of metals trading at Deutsche Bank, estimates that about 100m ounces of silver has been hedged in the past two months. That compares with total outstanding hedges, called the global "hedgebook", of 20m ounces in late 2010 and annual mine production of about 700m ounces, says precious metals consultancy GFMS.

Michael Jansen, metals strategist at JPMorgan, said 2011 was "probably the year of the producer hedge". He added: "This bull market in commodities is maturing to a point where, as much as supply is under pressure, you can say with a bit more certainty that in two to three years it's going to be different."

[5] Paper silver graph (Link) h/t Market Ticker

[6] Margin hikes (Link) “The maintenance margin to trade silver with leverage is now $15,000. If you bought at $4 an ounce, the cost to buy 5000 ounces, fully paid for, would have been $20,000. The value of 5000 fully paid ounces of silver is now almost $250,000.

I believe leveraged trading of silver will end before the silver bull market ends. Silver fell $7 an ounce on Sunday night. That’s a $35,000 move per contract, and more than double the margin put up by the average leveraged player.”

FOFOA

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