Financial Sense

Buying Silver When There is None Left to Buy

by Jim Otis, the Optimist | March 24, 2008

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Did I say that?

Some people with less class than the Optimist might worry that because the precious metals markets plunged just a week after I published my commentary saying I was taking some profits, I would chortle �I told you so! I told you so!!!� Fear not. That type of grandiose bragging is not my style, and I have no intention of saying what I just said. Also, I like to keep the quality of my work on a higher and more erudite level. Also, I managed to sell only a small fraction of my portfolio on Friday, 3/14. My firm plan was to sell higher percentages into the projected sharply rising prices during the week of 3/17. Whoops! Robert Burns said it well: The best laid schemes o' mice an' men gang aft agley'!

Opportunity found

Oh well, at least I had some spare fiat FRNs from the portion of my portfolio that I did sell before the deluge last week. When life gives you lemons, make some lemonade, right? What could be better last Thursday than to buy some silver at less than $17 per ounce? Just a few days earlier, silver was more than $21, so by Thursday it was trading at almost a 20% discount! What better time could there be to convert depreciating fiat paper into real, beautiful, solid, dependable, and best of all, now cheap physical silver! With joyful anticipation, I logged into the website of my favorite dealer, and I tried to fill my shopping cart with silver.

Some shining opportunities are only a mirage

There was an unusual problem with putting the dealer�s silver into my shopping cart, so I figured the Internet messed up again. Fortunately it takes only a few seconds to call my dealer on the phone and have them lock in prices for me. So I called the phone number, but I must have misdialed because I got a busy signal. I double checked the number and called again. And again. And again. Busy. Busy! Busy!!! Fortunately I am as persistent as I am optimistic so I kept calling, and finally the phone rang. After an unusually long time on hold, the dealer answered and asked how he could help me. Still irritated at the earlier difficulties with placing my order, I blurted �I want to buy some metal.�

�Great!� he said.

�How much gold do you want, and how would you like it?�

�I always buy silver!� I snapped back at him. �How much silver do you have in each type!�

�Sorry�, he apologized. �We sold the last of our silver yesterday, and we have not yet been able to replace it. We do have a good selection of gold to choose from. Unfortunately, we are really busy right now, so I can’ttie-up the phone line to talk. Tell me what gold you want and we will ship it out to you.�

In retrospect, I may have been a little rude, but I was still irritated and I was a little abrupt. I couldn't believe that he was refusing to sell his silver to a good customer. I thought about telling him that I am the one and only, world famous and highly influential, Optimist so he would change his mind and give me his business, but I decided I was too angry to explain his inevitable remarks about why I would call myself an optimist, and who could be optimistic while prices were plunging, and he never heard such nonsense before, so I just let the whole thing slide with only a lame �Goodbye.� If that dealer didn't want to sell silver to me, I would just buy it from someone else!

Paper prices do not real physical silver make

With similar delays in getting connected, several other dealers told me essentially the same thing. They had enough gold to sell to me, but almost no silver. A few other dealers did have a little silver left for sale, but selections and quantities were limited and their prices were significantly higher than the current spot price which is determined in a tag team effort by COMEX futures and SLV. I learned that the U.S. Mint temporarily(?) stopped making Silver American Eagles. It slowly became clear to me that the supply chain which feeds silver to dealers so they can sell to the public was strained, and there was a serious deficiency in availability of silver that the public could purchase.

Fortunately there was still an abundance of silver being sold on eBay, so I scoped out the auctions I wanted to bid on. I input the spot price into my homemade spreadsheet so it can apply the usual premium and tell me how high to bid. Most of the auctions ending soon were already significantly more expensive than the amount I calculated for my maximum bids, so I placed bids instead on many that would sell later in the weekend. �Sorry, but you have been outbid,� was the repeated message I saw. The eBay bottom line was that one had to bid almost as high with spot silver quoted at $17 as would have been needed to win comparable auctions the week earlier with spot silver at $21!

The sharp price plunge in silver last week caused very high demand which overwhelmed the limited supply of real physical metal and resulted in a temporary lack of silver that could be purchased by the public. It became clear that the price of COMEX futures and the SLV ETF only sets the spot price of paper, and influences the prices of silver mining stocks, but it cannot supply the silver needed to meet the high demand for the real thing. As the price of silver rises over the next few weeks, hopefully demand will subside and supply will increase so that we can buy real silver once again. I strongly encourage readers to take advantage of that opportunity to own more silver. Don't forget to safely store your precious metal in a secure place where you can get to it without the permission or the assistance of anyone else.

The silver phoenix will rise again

So, is last week the start of the predictable summer slump? I am going to climb out on a limb and guess that we will look back on last week and think of it as little more than another example of rising volatility in precious metals prices. I am hopeful that the prices of silver and gold will rise again without serious interruption to new highs by May. As previously promised, I plan to sell as much as a quarter of my portfolio into that rise.

For the benefit of other amateur Elliott wave people, I am guessing that the sharp sell off last week was a short but not sweet fourth part of wave 3. If that guess is right, I hope the fifth part will be almost a replay of the first part which increased the price of silver by $4.70 over a timeframe of 12 weeks. Adding $4.70 to the $16.80 low last week, in a timeframe of 10 to 12 weeks, points to approximately $21.70 or more in early to mid May. After that, fifth waves have the Energizer Bunny ability to keep on extending, and extending, and. . . By sometime in May, I expect a large lady to start singing about the end of wave 3 and I will be satisfied that I sold some before May and went away. The music has stopped for the precious metals cakewalk each summer since 2001, and I have no reason to expect this year to change that pattern. If we do get a sell off in May , I hope to find a reasonable spot in that likely two month long wave 4 to buy back the mining shares that I plan to sell into the rising prices in April.

How can you buy real silver when there is none left to buy??

If my best laid plans for the next month do not gang aft agley again, I hope to also have some surplus profits from selling in April and going away by May. The projected profits are already (and hopefully not too prematurely!) earmarked for purchasing additional real silver. So, just like last week, I hope for silver prices to drop sharply sometime in May so I can buy lots of silver at bargain basement low prices! What a great plan!! Just like last week!!! But wait a second. Last week, sharply lower silver prices caused very high demand for a limited supply of silver, with the predictable result that I was not able to buy silver at the sharply lower prices. I do not want to be stuck holding a surplus of fiat FRNs earning 1% annual interest (before taxes!) while real inflation is destroying the value of those FRNS at a double digit rate. What to do?

I got it! I'll call my friendly dealer and ask him to pretty please set aside a bunch of very valuable silver, and not to sell it to anyone else no matter that they are willing to pay a premium to buy it, until we agree on a low sale price at the spot price when I call him sometime in May, and then to hold it for me until I mail him a check sometime in June. Hopefully, none of my readers will be surprised when the dealer responds: �In God we trust. All others pay for silver in advance!�

My dilemma is that I want to buy silver when prices are low, but high demand and supply constraints make it impossible to buy at low prices when everyone else wants to buy. The solution to that dilemma is easy by using the Optimist�s version of physical futures! Decide soon about how much silver you will want to buy at hopefully sharply lower prices later this summer. Then buy that silver in April or May when rising prices reduce demand and increase supply so there is an ample selection to choose from. Call your favorite dealer, lock in your purchase details at the then current spot price (which will be higher than you want to pay), and pay for your purchase as you normally would. At nearly the same time as your call to buy silver from the dealer, use a stock account (which you previously established and funded so you can buy and sell the SLV ETF) to sell a corresponding value of SLV. At that time, you go long real physical silver and short the same value of SLV, with both at the then current spot price of silver. The net result of that pair of transactions is that you will be neither long nor short silver because the subsequent gains (or losses) on the silver will be exactly balanced by the equivalent losses (or gains) in the corresponding short SLV paper trade.

Since the dealer will be busy shipping silver coins or bars to you, this is different than the traditional paper spread transactions you might do in a financial market. Even though you will neither gain nor lose net value while you have the silver the dealer will send to you, and have the comparable short position in SLV, you will have effectively entered into a contract to buy the silver (that the dealer is busily sending to you) at some time and price in the future. You then �complete� the contract by simply buying back the SLV you previously sold short whenever the spot price of silver reaches the level at which you want to purchase the silver (that you have likely already received from the dealer). When you buy the SLV to close your short position, you will effectively buy your silver from yourself!

Example 1 � buy real silver first

Let's run through an example to see how it could work. Let's assume that on Friday April 18, the spot silver price is relatively steady and will close at $20, and that SLV is still trading but will close very close to $200 (because one share of SLV is equal to 10 ounces of silver). With your tax return already completed so that you are sure you have sufficient funds to complete both sides of the Optimist physical futures trade, and having already confirmed that dealers have an ample quantity and selection of silver, and with your stock account already activated and fully funded so that you can sell SLV short, you are ready to roll.

Decide how much silver you want to buy (and that you can afford to fully pay for). Suppose, for simplicity in this example, you decide to purchase 100 ounces of silver. It will not matter yet whether you want one 100 ounce bar, or ten 10 ounce bars, or a hundred 1 ounce rounds or bars, or any combination that adds to a total of 100 ounces. Use your stock account to sell short 10 shares of SLV at our assumed current spot price of 200 per share. If SLV and the spot price of silver are still trading, you would quickly contact your dealer to lock in the price of the physical silver and commit to purchase 100 ounces of real physical silver in whatever form you prefer. If you time your sale of SLV to be almost at the Friday close so that the price of silver will be fixed for the weekend, you can take most of the weekend to shop around among dealers for the best deal to get the 100 ounces of silver at closest to spot price. After you lock in your silver purchase, send payment to the dealer and have him proceed to deliver the silver to you.

You are now fully hedged by being "long" the 100 ounces of silver the dealer is shipping to you, and short the same value with the SLV trade in your stock account. If the price later increases and you decide to close the position at a higher price of silver, you will lose money on the short SLV, but you will gain the same amount of equity by having paid the dealer less by the same amount. If the price later decreases instead, and you decide to close the position at a lower price of silver, you will gain "profits" on the short SLV, but you will lose the same amount of equity by having paid the dealer more by the same amount. Either way, the net will be the same*** as if you had purchased the physical from the dealer at the price that you paid to buy back the SLV to close the short position. You will have the 100 ounces of silver the dealer shipped to you, and your net payment will be the same*** as the price at which you later bought the SLV.

***The fine print: In addition to the premium and shipping costs that the dealer will charge for the silver, there will also be additional transaction costs and tax consequences and funding issues including settlement times related to selling and buying the SLV. Kids, do not try this at home until you are a trained professional who has mastered all the details related to this type of brokerage selling and buying activity. A good rule of thumb is to avoid playing in any game that you do not know all the rules about.

I call this physical futures because it is analogous to buying a COMEX futures contract (at full price. Never use leverage!!!), and then taking delivery later. The similarity is that you can decide on what silver you want to buy when there is an ample selection to choose among. An advantage is that you �take delivery� from yourself at the time you buy back the SLV short leg, because you would have already received the real silver the dealer sent to you. A big disadvantage is that it is necessary to both pay the dealer for the silver, and also to fund the stock account in which you will short the corresponding SLV, so this approach will require a double amount of capital for the duration of the SLV short position.

Does an Optimist or a Pessimist plan for lower prices??

Perhaps you think I am too pessimistic in expecting (or too optimistic in hoping for??) lower prices this summer, and you prefer to lock in your purchase of silver now, immediately, as in really right now! Sorry, as I patiently explained a few thousand words ago, there is precious little real physical silver left in the supply pipeline to buy at the current prices which are sharply reduced from the previous week. You will be happy to know, however, that the Optimist�s physical futures can solve your problem too. Don't waste the bandwidth to talk to your dealer first, because his shelves are still empty. Simply buy the corresponding number of SLV shares when they are at the spot price that you wish your dealer would sell real physical silver to you. Then wait impatiently until the spot price of silver moves higher, and thereby proves that your investing timing is much better than mine. As the price of silver continues to increase, the higher prices will work to reduce demand so the supply pipeline can refill the dealer�s stock and increase his inventory. At any time that your dealer has in stock the variety and quantity of real silver that you wanted when you bought SLV instead, then complete the purchase of silver from the dealer, and at the same time sell the SLV that you previously purchased. It will not matter what the spot price is when you complete the purchase of real silver from the dealer because the net will be adjusted by the companion sale of SLV at the same time and spot price.

Example 2 � it is easier to buy paper first

As an example of this type of trade, assume that you decide one day that you want to buy 180 ounces of silver at the price paper silver is then trading at, but the dealer is temporarily out of stock again. You would be happy to pay the current spot price to buy the metal, but there is no available source to get it from. You could instead purchase 18 shares of SLV in your brokerage account when silver is trading at the spot price that you would be willing to purchase the metal instead. There is no need to call your dealer again for now, and he will be happy to have a few moments of silence between angry exchanges with other disappointed buyers. Days, or weeks, or even months later, the dealer may again have in stock silver you wanted to buy when you bought the SLV instead. The price of the silver will certainly be different than the price you paid for the SLV, but ignore that for now. Sell the 18 shares of SLV during the trading day, and quickly lock in the purchase of silver from your dealer at the same spot price as the SLV sale.

If the spot price at which you bought the silver from the dealer is higher (or lower) than the price you previously paid to buy the SLV, then you will gain (or lose) the same*** difference from the SLV, so the net is that you get to buy real physical silver at a later date, but at the earlier spot price when you bought the SLV but really wanted to buy the silver instead.

***The fine print: In addition to the premium and shipping costs that the dealer will charge for the silver, there will also be additional transaction costs and tax consequences and funding issues including settlement times related to buying and selling the SLV. Kids, do not try this at home until you are a trained professional who has mastered all the details related to this type of brokerage buying and selling activity. A good rule of thumb is to avoid playing in any game that you do not know all the rules about.

As will be further discussed below, this example in which you buy paper SLV first with the plan to buy real silver later is different than the previous example in which you bought the silver first, and closed out a paper SLV short position later to complete the silver purchase. The key difference is that buying paper SLV first only protects your subsequent purchase of silver if there is real silver available that you can buy later.

Using this approach, you can buy as much silver as you want, at the same*** price you pay for the SLV you bought first (plus whatever premium your favorite form of silver adds to the cost, plus the additional transaction costs related to the SLV). You can begin that process whenever you want to purchase the SLV, regardless of the availability of silver at your favorite dealer. You lock in the purchase price when you purchase the SLV, and you complete the process when the dealer has the real physical silver that you want.

Sweet! You get the silver that you want (but that will not be available until later), and you get to pick the price you want to pay (by deciding when and at what price to purchase the SLV). How could anything be better?

but paper is NOT silver!

The above idea of purchasing SLV first to lock in the current price, and then getting the silver you want later when your dealer has an abundance will probably work out OK. Maybe! There is a risk that you need to be aware of. Let me illustrate that risk with an example. Suppose you married in 1985, and you want to mark your 2010 Silver anniversary by giving your loving husband a sealed Monster box of 200 Silver American Eagles dated 2010. Having read some of the Optimist�s earlier work, you reasonably think that the price of silver should be higher by then than it is now, so you would really like to buy the 2010 Monster Box now at current prices. �Simple,� you now say, �and thanks Optimist for the tip about physical futures.� Just buy 50 shares of SLV at today's price, and then sell the SLV in two years when the 2010 Monster Boxes are available to purchase. That sounds like good plan, until you realize the implied assumption that there will be real physical silver that you can buy in 2010. The fact is, however, that there is an enormous short position in paper silver, and the supply problem over the last week proves that there is not a surplus of capacity in the supply of silver to the market. Manufacturers who use silver in their production will likely see the supply problems of last week as a warning shot across their bow. Their just in time mode of acquiring the raw materials for their business cannot tolerate significant disruptions in the availability of the supply they need, regardless of how cheap the paper price may be. Imagine Kodak advertising that their color and black & white film got cheaper with the drop in silver prices last week, but they can�t get enough real silver to continue manufacturing, so they have no film to sell at any price. At some point, Kodak will likely decide that they should insure their continued operation by having more silver in their warehouse than the just in time model would predict. Now multiply that decision by millions around the world, and quickly the amount of silver in the supply pipeline will obviously be insufficient. When that realization triggers panic accumulations by manufacturers who must have real physical silver to stay in business, the futures market will lock into a delivery only mode with everyone demanding to buy but no one willing to sell, the paper shorts will be unable to deliver, and real silver will be impossible to obtain.

If you plan to wait to get silver until you see the signs that the silver market is beginning to lock up, then I recommend that you stay awake at nights, because the entire tsunami could start in Asia while the USA is asleep, and be essentially over in Europe before most of us wake up. Silver that was cheap when you went to sleep may unavailable at any price by the time you wake up in the morning.

For those lovely ladies who want to get silver for their husbands, don't delay while waiting for your favorite form of silver to become more available. This Optimist strongly recommends that you get whatever real physical silver is available as soon as you have the fiat FRNs to buy it with. Cheers!

Readers are invited to add their questions and answers in the forum. Cheers!

Copyright © 2008 the Optimist
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Disclaimer: This commentary presents only the viewpoints of the Optimist and it is intended only for perspective and entertainment. Please do not interpret any portion of this work as investment advice. If any of the concepts discussed here appeal to you, then you must do the work to decide if and when and how you should invest. The Optimist does not ask for any profits you make, and he cannot be liable for any losses incurred as a result of your investment decisions. The Optimist wishes you the best of luck in whatever you decide to do or not to do.

The Optimist cautions all readers to not base their buy or sell decisions on this work alone. This is useful input, however, when determining whether markets are low and green, or high and red, or yellow in between! The Optimist expects that this will inspire many questions and comments. He encourages all readers to add their questions, answers, and comments to the forum sections at the bottom of each page in the Optimist site. Cheers!

Jim Otis, is an author, active investor and retired engineer.

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