Alasdair Macleod – 15 April 2010
Silver is an interesting commodity, having both industrial and precious metal status. Unlike gold, it does not just accumulate as a hoarded asset, it also disappears into a range of products and applications including electronic equipment, clothing and a wide range of anti-bacterial applications. The amount that can be recycled is limited, since much of it is lost as nanoparticles and recoverable amounts from electronic equipment are small. Unlike gold, most silver is mined as a by-product of other metals, such as lead tin and zinc, so below-ground supply is heavily dependant on demand for other metals, rather than the price of silver itself. Supply is therefore more inflexible than that of gold, and in a deep recession is likely to contract even if silver prices rise materially.
Global production is estimated by the Silver Institute/GFMS Limited to be about 680 million ounces, which has increased by only 90 million ounces since the beginning of the decade. Annual demand exceeds this by 200 to 250 million ounces, and has been doing so for the last ten years. The shortfall has been made up by government sales from strategic reserves, coinage and recycled scrap. Total stockpiles in the form of identifiable silver stocks and inventory have fallen from 1,400 million ounces in 1990 to only 152 million ounces in 2008, and have probably dropped further since, due to the very tight supply situation.
While it is prudent to take statistical details such as these with a pinch of salt, it is clear that there is a significant shortage of physical silver both above and below ground, even before considering investment demand. Silver is popular with small investors, with the US Mint having produced silver bullion coins worth $372m in 2009 alone. For public investors silver offers several advantages compared with gold:
- People are generally more familiar with silver as money, while gold is increasingly the preserve of the wealthy.
- Its price makes it more accessible and therefore more useful in transactions.
- It is harder for governments to restrict its ownership, while governments in the past have banned the use of gold by their citizens, and even confiscated it.
- In the event of a hyper-inflation, governments are more likely to restrict gold markets, because gold is a pure “money substitute”.
- Governments are less likely to interfere in a commodity with widespread industrial use than one that operates as a pure “money substitute”.
- At 64 times the ratio between the price of silver and that of gold indicates silver is relatively cheap. For reference, the US ratio of statutory rates between the two is 32.66 times.
The principal market for physical silver bullion is London, and for futures Comex. The overwhelming bulk of silver in London is held in unallocated accounts, so account holders with silver deposited at the bullion banks in these accounts have no entitlement to silver, rather they are exposed to counter-party risk for the cash equivalent. The bullion banks run these deposit accounts on a fractional basis, with perhaps less than one tenth of this customer liability actually covered by bullion. Comex trades futures and options, where the bullion banks have a substantial net short position, currently 270 million ounces comprised of shorts totalling 446 million ounces and longs of 176 million ounces.
This short position is significant in the context of annual production of 680 million ounces, and global reserves and inventory of perhaps less than 150 million ounces. . The dealers in the bullion banks might argue with justification that the majority of the long positions are held by hedge funds and other ephemeral bulls; but these large shorts have been in place for some time, being rolled as they mature; a process that can theoretically continue, so long as physical delivery is not demanded. Some ephemera.
There are two notable cases of physical delivery being demanded, the Hunt Brothers attempt to corner the market in 1979, and more recently, Warren Buffet in 1997. The Hunts bought over 200 million ounces on Comex and insisted on delivery, forcing the price to hit $54. Warren Buffet bought 130 million ounces through Comex and took delivery, forcing silver up from $5 to $7.40. The Hunts were eventually bankrupted as Comex controversially changed the rules, and Buffet is said to have been persuaded by the authorities to back off.
Today sales of coins and growing investment demand are withdrawing physical supply from the market at an accelerating rate, and there is no one individual behind the squeeze. This is a process that is just starting, and so far involves amounts considerably less than those acquired by the Hunts and Warren Buffet. Today’s shortages are the result of falling public confidence in economic events, which is very different from market speculation, and public investors are a new and growing burden for regulators as well, who can no longer hide behind a caveat emptor policy.
This reality perhaps helped persuade the US Commodity Futures Traders Commission to convene last month’s hearing, which gathered evidence about possible market manipulation of gold and silver on Comex. After the Madoff scandal, where the SEC for ten years ignored compelling evidence from one Harry Markopolous, a humble accountant, that accurately described Madoff’s ponzi scheme, regulators have to be sensitive to public outcry. GATA’s protestations over the years are eerily similar to Markopolous’s, and appear if anything to be more authoritative. In turn, the CFTC’s interest in this subject is likely to limit Comex’s scope to continue to sanction market manipulation by the bullion banks.
It is too early perhaps to conclude the bullion banks are cornered on Comex, but it is hard to see how they can increase their shorts materially without attracting more unwelcome interest from regulators. This regulatory interest neutralises Comex’s ability to act as it has in the past: it cannot change the rules to protect its vested interests as it did with the Hunts, nor can it have a quiet word with large investors, because they are not involved.
As with gold, the traders at the bullion banks do not take into account the fractional banking liabilities of the unallocated accounts in London. If they did, they would be long of futures, not short. Consequently, the overall short position, given the public’s growing interest in owning the physical, is leading towards systemic insolvency. The statistics – inaccurate as they may be – suggest the bear squeeze will be more acute in silver than in gold. And interestingly, this may be being reflected in the withdrawal of 11 million ounces of physical in seven large tranches from the US ETF (SLV) since 26th February.