Let's Get Physical
By James J Puplava CFP, February 4, 2003
The big story today was written in the precious metals market. It was hard to ignore it. The price of gold exploded with prices surpassing a six-year high. Gold bullion closed just shy of $380 an ounce at $379.90 an ounce. In the after markets, gold is up an additional $2.29 an ounce at $382.19.
Silver rose $0.08 an ounce to $4.90. Gold is now within reach of taking out the $400 an ounce target, a price we haven't seen since October of 1996. After the $400 level is taken out, who knows how high it will go.
The reasons given for gold's advance were fears over the coming war with Iraq. Tomorrow Secretary of State Colin Powell is expected to make the case for war by giving evidence that Saddam is in direct violation of all UN security provisions. In one sense you can say today's rise in the price of bullion has an added war premium that has been tacked on by the financial markets. Wall Street and the financial media are telling investors that the only reason gold has been rising is because of war fears. Once the war is won quickly, gold prices will fall back and it will be "happy days" again for traditional stock investments. In other words, don't take the rise in gold seriously. To these unbelievers, this is just a fluke or sideshow to the real business of investing which is to buy and own stocks for the long run.
Gold Returns as Money
However, there is another element here that isn't discussed as widely in financial circles, and that is gold, once again, is reverting back towards its historical role as real money. In addition, it is also assuming its role as a safe haven and refuge in times of crises. In the last decade whenever a financial crises or geopolitical crises would erupt, investors headed for the dollar. Throughout the 1990s, from the peso crisis in 1994, the Asian crisis in 1997, LTCM and Russia in 1998, Y2K in 1999, to the recession and terrorist attacks of 9-11, the dollar supplanted gold as a refuge of safety providing shelter from the storm. Now the dollar is in a freefall, and this time around investors are putting their money into precious metals, gold, silver, and platinum.
The prices of all three precious metals are rising in response to each new financial or political crisis that erupts. It is also not just a freak occurrence here in the US; it is becoming a global phenomenon. Gold is rising against all major currencies around the globe. It started in Asia where after a decade of deflation and multiple recessions, Japanese investors are pulling their money out of banks and buying bullion. It just isn't investors here in the US, or anyone country in particular; it is everywhere from Latin America, North America, Europe, the Middle East and Asia. This can be viewed from the world gold indices taken from our gold site. Gold is becoming money again and silver will shortly follow with a more explosive upside.
Production Deficits & Dwindling Stockpiles
Yet there is another side of precious metals that will take gold and silver to heights never imagined before. That is the huge short position in gold and silver, both in bullion and in equities. The supply deficits of the last decade have exhausted many of our above ground stockpiles in silver and gold. As Sharefin has so carefully researched, the deficits in gold and silver over the last three decades are as follows:
- Gold deficit over last 30 years is 19,700 tonnes or 633.5 million ounces
- Silver deficit over 20 years is 133,000 tonnes or 4.3 billion ounces
(Most silver is consumed -- not stored or worn as jewelry.)
Most of the deficits listed above have been drawn down from centuries of accumulated stockpiles. The annual deficits each year have been made up from stockpiles that have been drawn down over the last three decades in gold and the last two decades in silver. In the last precious metals bull market in the 1970s, the U.S. government had close to 1.6 billion ounces of silver that had been stockpiled since the Great Depression and World War II. Now the US government has exhausted its silver stockpile and must now go into the market and purchase silver for its silver eagle program. If it were not for the mammoth central bank sales of bullion and bullion leasing programs of the last decade, the price of gold and silver would be much higher today. By selling off much of their gold reserves, the price of gold has been artificially suppressed in the same manner it was suppressed in the late 60's during the infamous London Gold Pool days. We all know what happened to the price of gold and silver afterwards. The only difference between that bull market and the present new gold market is this time around much of our stockpiles have been carelessly drawn down. In the case of silver, it is estimated that above ground stockpiles outside of coins is around 400 million ounces according to CPM group. Silver deficits are averaging around 80-100 million ounces a year.
It just isn't the simple fact that we are running large annual supply deficits in both gold and silver ands other precious metals. It also relates to an ever-growing demand/supply imbalance that is growing larger by the year. The twin decade bear market in precious metals has driven many mining companies out of business or into bankruptcy. Those who have survived have gotten larger or have been taken over by bigger fish in order to survive. Most major mining companies quit exploring for new supplies or have drastically reduced their exploratory budgets. In order to replace their reserves, they have resorted to the same tactics used by the oil majors they are buying their reserves by acquiring smaller independents. The only problem with this approach is that it isn't expanding the supply base. Acquiring the reserves of our gold or silver mining company does nothing to increase supply. As the next four graphs show the gold and silver supply deficits that have occurred over the last three decades in gold and the last two decades in silver have greatly depleted the above ground stockpiles in both precious metals. We in effect have been consuming our seed corn.
Unlike corn or wheat, the supply of gold and silver can’tbe grown overnight. From the time of discovery to the time the precious metal is mined and brought to market, it could take as long as 10 years, especially in today's hostile environmental climate. Finding gold and silver takes time. It takes time to find it, time to drill for it, time to get a mine permitted and approved, and time to build the infrastructure necessary to extract it.
The Short Seller's Nightmare
What is even more important to understand is that these supply deficits occurred at a time when there has been no investment demand for the precious metals. These deficits have occurred as a result of only industrial demand. The precious metals markets are too small to handle worldwide investment demand that is now starting to surface around the globe. In the case of gold, there is always the possibility, but unlikely event that central banks could supply the markets with gold with their last remaining reserves. According to GATA, central bank gold sold or leased out is estimated to range between 10,000-15,000 tonnes of gold. This is about 45% of the central bank holdings of gold. The central bankers are looking pretty foolish for selling off half of their gold reserves at the bottom of the markets. They would look even more like idiots if they were to sell off their remaining reserves in order to keep prices suppressed. A greater possibility is that they begin to start buying it again as they are now doing in the Middle East and in Asia.
In the case of silver, there are no large central bank hoard of silver that has been stashed away that could be easily lent to the market. In the case of silver, it is consumed not stored like gold. The situation in silver is even more dire than gold. Why do you think Warren Buffett owns close to 130 million ounces of the stuff?
The silver and gold deficits have taken place against a background of meager investment demand. If investment demand returns, as I believe it will, the price of silver is going to explode in a more dramatic fashion than the price of gold. Both precious metals are just in the beginning phase of a decade-long bull market. The price of metals is going to go much, much higher and stay there for years until enough new production is brought on board or enough scarp and coin is brought to market as prices explode.
In the meantime, according to the latest Commitment of Traders report on the COMEX, silver short positions are net 66,781 contracts, which equals 333,905,000 ounces of silver sold short against COMEX supplies of around 107 million. From where and from whom will the supplies come from? As Sharefin's research shows in the above charts, supply deficits over the last few decades have been made up from above-ground stockpiles. Where are the stockpiles that will make up the deficits of the next twenty years? Furthermore, what happens if investment demand returns as major fiat currencies around the globe depreciate against the king of all metals? There is simply not enough gold or silver currently in existence at today's prices to handle investment demand.
The Big Squeeze Revisited
There is another element to this market that is even more explosive in both gold and silver, but especially silver. That is the huge short positions that now exist in the bullion and in the stocks. As I wrote last week, the short positions in the gold stocks and in the silver stocks are someone's worst nightmare. In the case of silver, the hedge fund and bullion bankers are short both the metals and the stocks. What is worse is there are no large above-ground stockpiles that come close to matching the short position in silver. In the case of silver, pure silver producing or silver exploration companies can be counted on both hands. There are not more than ten pure silver producing companies in the world. Also with silver, most of it comes to market as result of a byproduct of base metals mining. Currently most base metal mining companies are shutting down mines or are curtailing production as a result of the global recession.
|SHORT POSITIONS IN PRECIOUS METALS STOCKS|
|Company||Symbol||Q1 2002||Q2 2002||Q3 2002||Q4 2002||Jan. 2003|
|Nasdaq MarketData Short Interest Survey|
Listed below are the major silver producing and exploration companies:
Apex Silver (Sil)
Coeur D'Alene (CDE)
Industrias Penoles (IPOF)
Pan American Silver (PAAS)
Silver Standard (SSRI)
There are other smaller and minor companies that are insignificant. There are also gold mining companies whose mines also have large concentrations of silver. For most gold companies, silver is sold as a byproduct and credited towards the cost of gold production. Pure silver companies are as rare as the future position of the metal. It is a very small universe that isn't large enough to contain or handle future demand. It is why there is so much disinformation regarding the metals market. The short position in paper bullion and in the stocks is maintained only through ignorance or disinformation.
If long holders of silver began to start demanding delivery, the paper shorts would be finished as well as bankrupted. At the moment, they are a privileged and protected few that hold their positions at the expense of investor ignorance. That is why if you own a contract you should demand delivery. A day is coming soon when you won't be able to get delivery. How can a short position of 334 million ounces stand against a supply in the COMEX warehouse of only around 107 million of which some of that silver is already accounted for? That short position exists and rests on a steep precipice of investor ignorance. Some day the longs will wake up and demand delivery, realizing their position of strength and the shorts' vulnerability. That is the secret nobody wants to let out of the bag. When that secret is out, some very big players are going to go under. Their identity is kept hidden and you won't know about them until the headlines tell of their bankruptcy. At the moment, they are indeed a protected and privileged group feeding on the backs of poor miners and investors who have been fleeced of their rightful profits. More will be written on this subject in days, weeks, and months to come. Lets just say the "heat is on."
While gold and silver equities along with bullion prices were exploding to the upside, major indexes fell to the downside. Financial shares led today's decline after AIG, the world's largest insurer, wrote off $1.8 billion to add to reserves. Lucent Technologies led telecoms lowers here in the US following an announcement by Alcatel that sales would fall as much as 30% this quarter due to customers curbing spending. There is more and more evidence each day that the much-ballyhooed CapEx spending revival is not going to take place this year. There is still far too much capacity with most companies operating and below normal utilization rates.
Stocks retreated in advance of tomorrow's presentation to the UN by Secretary of State Colin Powell. Powell is expected to lay the case for war due to Iraqi violations of UN covenants agreed upon by Iraq. The major averages lost ground today with all three indexes in negative territory for the year. We have just experienced the worst December and January in many decades -- a time when the major indexes fell back-to-back in normally what is considered the two strongest months of the year for the stock averages. Both December and January have been negative and that's something we haven't seen in a long time. Year-to-date the Dow has lost close to 4%, the S&P 500 3.6%, and the NASDAQ is down 2.2%. This makes for four years of negative returns. And unlike previous downturns, the little investor isn't coming back into the market. Volume on the major exchanges has been falling since last summer. The brief trading rallies we have experienced last summer and fall were the product of intervention and interplay between the hedge fund community and fund managers playing the momentum game. Nobody is holding on to positions anymore. They just trade them in a game of chance and musical chairs hoping they land on something to earn a return.
Volume hit 1.4 billion shares on the NYSE and 1.3 billion on the Nasdaq. Market breath was decidedly negative by 18-13 on the Big board and by 19-12 on the NASDAQ. The VIX jumped 2.72 to 36.70 and the VXN popped 2.27 to 48.31.
European stocks slumped as Alcatel SA cut a forecast for sales of its telecommunications equipment, DaimlerChrysler AG proposed a lower dividend than some investors expected, and Allied Domecq Plc said profit growth will stall this year. The Dow Jones Stoxx 50 Index shed 3.4% to 2205.14, dropping for the first day in six.
Japan's Topix stock index rose, led by mobile phone stocks, as NTT DoCoMo Inc. said spending by subscribers beat its forecast and the Nihon Keizai reported third quarter earnings at rival KDDI Corp. will exceed targets. The Topix advanced 0.8 percent to 844.26 and the Nikkei 225 Stock Average shed 0.2% to 8484.90.
© 2003 James Puplava