Short Story on Silver - Part 1
By James J Puplava CFP, October 3, 2002
The paper markets control the commodity markets regardless of the size of the market. Through the use of derivatives, a small amount of capital controls the commodity markets worldwide. That amount is estimated to be somewhere in the neighborhood of around $200 billion. This is a highly-geared market where a small amount of capital controls a much larger market. In this case, it is $200 billion in actual cash money that is leveraged to the tenth degree through paper contracts that control a trillion dollar market for hard commodities ranging from oil to gold. In "Debt & Delusion," Peter Warburton has made a strong case for how central banks have waged war against tangible assets in order to keep their prices suppressed. This is done through gearing the commodity markets whereby a small amount of capital is leveraged into a position of control over a much larger market.
This gearing process, which is facilitated through the use of derivatives, allows sophisticated investors, hedge funds and investment houses in the US and in Europe to control the commodity markets and various asset classes by driving their prices to levels that distort their fundamental equilibrium price. In other words, what we see in commodities is not their fair market value price as determined by free markets. Instead, we see an artificial price determined by paper contracts. This perceived market price is in fact a gross distortion of actual demand fundamentals. Prices have been kept artificially low for so long a period of time, it has given the illusion that there is no inflation. What is not measured or considered in this proposition is that the inflation has taken place in the paper markets as reflected in the current price of paper assets such as stocks, bonds, and currencies.
Low commodity prices, which have been kept low by gearing, are always shown as evidence that there are no signs of inflation.
Gearing Distorts Markets
This whole artificial process of paper market distortion of the commodity markets has allowed prices to deteriorate at the same time that demand has risen and supply has contracted. Prices have been kept low; while demand for products has expanded. This runs contrary to general economic laws of supply and demand. Demand increases, supplies contract and the price of a commodity falls. The fact that nobody questions this is even more astounding. While demand has risen, the supply of particular commodities have fallen off due to disinvestments, divestiture and the general contraction of most commodity-like businesses. Supplies and reserves accumulated over decades have been drawn down in order to meet supply deficits. The gasoline in your car probably came from an oil well that was discovered 25 years ago in the US and over 40 years ago in the Middle East. The silver that is used in your camera is coming from the sale of scrap silver and the depletion of above-ground inventories. Gold deficits are made up from central bank sales and gold leasing. This consumption of above-ground stockpiles of commodities accumulated over decades cannot last forever.
As inventory levels from natural gas, oil, silver, gold and other commodities are drawn down, a supply train wreck or price shock is slowly building momentum. Already we are facing our second oil price shock in three years. Oil prices have been distorted by a combination of political convolutions and derivatives. Once supply stockpiles are depleted, prices will reverse and head higher as demand fundamentals and a loss of confidence in paper overwhelm commodity markets. One day soon Americans and the West in general are going to wake up to find the financial world and the commodity markets aren't as they seem. Supply shortages of key commodities, energy outages and other supply disruptions should become more commonplace. In the case of silver, gold, oil and natural gas, we will see prices rise to their true fundamental value, which by the way is much higher than what is now reflected in the markets.
Short Positions Distort Bullion & Share Prices
A good example of this is the silver markets were short positions on the COMEX and short positions in key silver stocks have acted to suppress the price of the metal and key silver stocks far below their intrinsic value. The following table below shows the growth in short positions in silver stocks that have doubled, tripled, and in some cases quadrupled since May of this year. These short positions have been the key, along with short positions on the COMEX in silver, to keeping the price of silver and silver stock prices suppressed. Yet, nothing has changed fundamentally in the business. According to CPM Group, the silver deficit will be larger this year than last year. And despite a recession and weakening economies across the globe, silver deficits last year were close to 80 million.
|Short Changing The Silver Market: Short Interest on Settlement Date|
|Silver Mining Stock||12-14-01||3-15-02||6-14-02||9-13-02|
|Apex Silver (SIL)||280,036||268,367||614,131||791,665|
|Hecla Mining (HL)||103,500||105,500||1,130,654||2,405,148|
|Pan American Silver (PAAS)||11,672||4,509||519,723||1,002,105|
|Silver Standard Resources, Inc. (SSRI)||37,843||5,060||461,810||874,062|
I recently met with the head CEO of a silver mining company who has been able to increase the reserves of his company significantly over the last four months adding real value for his shareholders. And yet his stock has been sold short and driven down in half as a result of a huge short position. I know most of the key owners of this company and very strong hands hold it. The float is narrow and the short position would take at least 3-4 days to cover at present volume. Nothing has changed fundamentally that would warrant such a short position.
There are very few large silver mines in the world in comparison to gold. And silver stockpiles are running out. At the present rate of deficit, there is approximately 1-2 years left in above-ground stockpiles (not counting silver coins). Pure silver mines are rare since most silver is mined as a by-product of other metals. About 80 percent of the supply of silver comes to the market as a by-product of other base metals. Pure silver companies can be counted on two hands. Silver, as a commodity, is getting rarer even as demand and use for silver increases. Why do you thing Buffett bought silver back in 1997 and still holds on to it? Why have Gates, Soros, Tish, and others bought silver? There is a reason. They think the price of silver is going up. It is becoming a rare commodity in that it is harder to find; while supplies dwindle. Its price is kept down artificially by huge short positions. Note the chart to the right which graphically depicts the total short position noted in the table above.
Investment Philosophy Determines Position
There are two ways in which to look at this situation: one negative and one positive. It all depends on your investment philosophy. If you're a short-term trader, you can skip this part because it will be of no use to you. You can trade into the stocks or metal when it explodes at much higher prices. If you are a value investor and think long-term, you have an opportunity that has been handed to you. You have the chance to accumulate shares of only a handful of pure silver companies in the world at bargain prices. The shorts in effect are subsidizing your investment purchases. I have always used these kinds of opportunities to buy at someone else's expense. As prices head lower, as short positions increase, I can use the opportunity to buy key mining companies, in my case just two, at much lower prices. The shorts will have to cover, and when they do, the very narrowness of the market in pure silver companies will explode. You can see this in the price of the shares back in May, June, and July. As other buyers came into the market, the price of silver mining shares exploded before forming a double top and heading down as short interest increased.
If you are a believer in this metal, based on strong long-term fundamentals, then you are now afforded the opportunity to accumulate shares at much lower prices. Or if you own them, you can acquire additional shares at much lower prices and significantly add to your position. Of course this philosophy only applies to believers in silver's fundamentals and investors who think strategically and outside the box.
Investment success doesn't come easy. If it did, we would all be millionaires. Success comes from hard work, a right attitude and the development of an investment philosophy. Going along with the crowd and the consensus will lead you down the path to mediocrity and below-average returns. Just think of what you been have told by Wall Street and most analysts and economists. You have been told to buy and hold even as they trade, short, and sell. Think of what their advice has brought you. Look at long-term charts of silver, gold, oil, and natural gas. Look at how these markets have performed, then look at your S&P Index fund or your mutual fund and draw your own conclusions. One of these markets is emerging as the new bull on the Street and the other is dissipating in a protracted bear market. Which side of the fence are you on? Isn't it time to cross over to the other side of the street?
You have been afforded another opportunity to buy, buy when prices are cheap. You have also been given another opportunity to sell. Don't listen to the media or Wall Street analysts or economists. They have steered you wrong for the last three years. How many more years do you want to experience the pains of a bear market before most of your hard earned savings are eaten away? Do your own homework, look at the charts and get wisdom and understanding. If you don't have the time, then find someone who does. More importantly, take responsibility for your own finances. This is not the time to play ostrich and bury your head in the sand. Storms are swirling all around you and it is time to get prepared.
Speaking of storms, stocks fell for the fourth day out of five as more earnings warnings turned a short rally into a rout. The financial sector accounted for most of the losses as more financial institutions report lower earnings as a result of bad loans. The plunge in financial stocks indicate that more bad earnings reports will surface in the weeks ahead. Today it was the Bank of New York, which reported a profit shortfall due to bad loans. Shares of bank and financial companies accounted for 80 percent of the drop in the S&P 500. The S&P 500 is now down 29 percent for the year heading for its third consecutive year of losses. The Dow has lost 23 percent this year; while the NASDAQ continues to hemorrhage with a YTD loss of 40 percent. Analysts continue to cut their pro forma earnings forecast for the third quarter down to 6.3 percent.
The financial sector, once considered a safe haven from the stock market storms, is now showing signs of stress as one financial institution after another report greater loan losses. Defaults, bankruptcies, and delinquencies are all in a sharp uptrend as a result of an over leveraged corporate and consumer sector. Next month could bring more financial storms if the leftist candidate in Brazil, Luiz Inacio Lula wins the presidency. A Brazilian debt default could be added to Argentina's debt default to add more financial stress to the financial system.
Tomorrow the government will release the unemployment report for September. Jobless claims have been rising, so the report is not expected to be robust unless it is statically massaged. Most of today's selling was in the financial sector followed by retailing and utilities. On the positive side were oils, biotechs and drugs and select gold and silver stocks. Eventually we may get a recovery in the markets since forecasts have been slashed so dramatically and everyone is using pro forma numbers those forecast could eventually e exceeded. It is all part of the earnings game that is played by wall Street and companies each quarter.
Volume came in at 1.66 billion on the NYSE and by 1.65 billion on the NASDAQ. Market breath deteriorated further with losers beating out winners by 18-13 on the big board and by 19-14 on the NASDAQ.
© 2002 James Puplava