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The shortage of gold and silver is the
driving force behind the bull markets in these metals. Quite simply, the outstanding
obligations in these commodities exceed the stock available. I vividly recall
a rare example of a similar situation during my stockbroking
days, which will serve to illustrate this point.
In the
UK’s property crash of 1974, the shares of property companies fell by
as much as 90%, but one share that resisted this trend was London Bridge
Securities. LBS shares remained stubbornly high, because as it turned out,
the directors and their cronies were buying them. Eventually, however, they
were swamped by short-sellers, and the share price fell heavily. The
directors of London Bridge Securities then realised
that they and their friends owned more than 100% of the company. This state
of affairs arose because the short-sellers were unable to deliver any scrip,
and none of the existing shareholders were prepared to lend them any. The
result was a buying-in procedure involving an auction on the floor of the
stock exchange, where the price was bid up to a level where holders of the
shares were prepared to sell.
The short
was closed out at about three times the share price of earlier that morning.
The squeeze on the bear position had nothing to do with the company’s
underlying value: it occurred because one big speculator got into an
impossible position that had to be resolved. And that more or less is where
gold and silver appear to be today.
Silver
offers the closer parallel with the London Bridge example. There are a few
banks with large short positions in silver on the US futures market in
quantities that simply cannot be covered by physical stock. The outstanding
obligations are far larger than the stock available. The lesson from the
London Bridge example is that prices in a bear squeeze can go far higher than
anyone reasonably thinks possible. The short position in gold is less
visible, being mainly in the unallocated accounts of the bullion banks
operating in the LBMA market. But it is there nonetheless, and the bullion
banks’ obligations to their bullion-unallocated account holders are far
greater than the bullion they actually hold.
But there
is one vital difference between my example from the property market of 1974
and gold and silver today. The bear who got caught short of London Bridge
Securities was right in principal, because LBS went bust shortly afterwards;
but in the case of gold and silver, the acceleration of monetary inflation is
underwriting rising prices for both metals, making the position of the bears
increasingly exposed as time marches on.
Perhaps the
most important lesson we can learn from the LBS situation – and highly
applicable to the situation today in precious metals, which could be
developing into the largest short squeeze in history – is that very few
other people in the investment community actually understand what is
happening. This is something to bear in mind when taking investment advice.
Alasdair
McLeod
Orginally published at Goldmoney here
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