Silver Lease Rate Patterns
Thoughts for Tom @ silveraxis.com
by Rhody. July 5, 2006
I have recently discovered your web site, Silver Axis and find it extremely interesting. I was particularly intrigued by your analysis of basis and futures spread. I commend your inclusion of lease rates as a major factor in silver market liquidity. Here is the lease rate graph from your own web site. You say that the lease rates have been remarkably restrained and level of late. This is true, but the spread between the one month and one year is shrinking, even as the overall levels seem to be declining. Appearances can be deceiving!
Take a look at the one year lease rate trend below. By widening our window on lease rates we can better display the pattern and put the present in more revealing context. We see that actually, silver lease rates are significantly higher, even as the spreads tighten. I interpret this to mean there is significant liquidity stress in the silver market. Notice how the lease rates on the graph below suffer a "spasm" at the end of 2005. This coincides with the beginning of the massive withdrawals from COMEX warehouse stockpiles.
None of this lease rate data can hold a candle to the rates that silver reached during the Buffett purchase in late 1998, but the trend is in that direction. This gets us to the other comment that you made on your website concerning owners of silver seeking yield have supplied lease supply and lowered rates. Quite a while ago, I came to the conclusion that COMEX warehouse stockpilers must be the source of much of the leased silver hitting the markets. This makes sense from a number of standpoints.
Firstly, COMEX charges a lot of storage fees for holding on to an investor's silver, so there is going to be considerable inducement to lease to offset this storage cost. Secondly, COMEX is the last big stockpile of above ground silver bullion, so there are few alternatives for lease supply, apart from London's Silver ETF hoard (but that's another story). Finally, there is the lease rate pattern itself: Back in 1998, Buffett was doing two things to the silver market. He was buying futures in silver and taking delivery. This pushed silver prices to $7.50, but pushed lease rates from 1% to 70% in the one month term.
Why did Buffett's buying add 50% to the spot price but add 7000% to lease rates? The answer is that silver owners on COMEX couldn't lease their silver out and deliver it to Buffett at the same time. Buffett created a huge shortage in the lease silver market by calling for delivery. So why aren't lease rates surging to 70% now? I think the offtake (COMEX stockpiles of silver have declined about 15% over the past 6 months) is not so severe, and has been spread out over a longer time period, and the new owners of the silver may also be leasing out metal. The new Silver ETF almost has to be a major new supply of lease silver given that JPMorgan is the vault manager.
The encouraging development for silver investors, is that despite all this new leased silver supply, silver prices have still managed to triple since Buffett bought and removed his silver from COMEX. It is unfortunate that Buffett couldn't have chosen a safer place to store his metal than England. Storing silver in England is like placing an ice cube in Hell. Enough! My original purpose in sending this message is this: If COMEX is a big lease supply for silver, then just as Central Banks have leased out most of their gold reserves, I strongly suspect that that much of the silver in COMEX vaults is stacks of paper lease contracts. That means, that as deliveries of COMEX silver continue, there will be a default as owners withdraw their metal from the vault. The default should occur first in the lease market, where it will be hidden from public view.
Kind regards, Rhody
© 2006 Rhody
Toronto, Ontario, Canada