Anatomy of a short squeeze

The shortage of gold and silver is the driving force behind the bull markets in these metals. Quite simply, the outstanding obligations in these commodities exceed the stock available. I vividly recall a rare example of a similar situation during my stockbroking days, which will serve to illustrate this point.

In the UK’s property crash of 1974, the shares of property companies fell by as much as 90%, but one share that resisted this trend was London Bridge Securities. LBS shares remained stubbornly high, because as it turned out, the directors and their cronies were buying them. Eventually, however, they were swamped by short-sellers, and the share price fell heavily. The directors of London Bridge Securities then realised that they and their friends owned more than 100% of the company. This state of affairs arose because the short-sellers were unable to deliver any scrip, and none of the existing shareholders were prepared to lend them any. The result was a buying-in procedure involving an auction on the floor of the stock exchange, where the price was bid up to a level where holders of the shares were prepared to sell.

The short was closed out at about three times the share price of earlier that morning. The squeeze on the bear position had nothing to do with the company’s underlying value: it occurred because one big speculator got into an impossible position that had to be resolved. And that more or less is where gold and silver appear to be today.

Silver offers the closer parallel with the London Bridge example. There are a few banks with large short positions in silver on the US futures market in quantities that simply cannot be covered by physical stock. The outstanding obligations are far larger than the stock available. The lesson from the London Bridge example is that prices in a bear squeeze can go far higher than anyone reasonably thinks possible. The short position in gold is less visible, being mainly in the unallocated accounts of the bullion banks operating in the LBMA market. But it is there nonetheless, and the bullion banks’ obligations to their bullion-unallocated account holders are far greater than the bullion they actually hold.

But there is one vital difference between my example from the property market of 1974 and gold and silver today. The bear who got caught short of London Bridge Securities was right in principal, because LBS went bust shortly afterwards; but in the case of gold and silver, the acceleration of monetary inflation is underwriting rising prices for both metals, making the position of the bears increasingly exposed as time marches on.

Perhaps the most important lesson we can learn from the LBS situation – and highly applicable to the situation today in precious metals, which could be developing into the largest short squeeze in history – is that very few other people in the investment community actually understand what is happening. This is something to bear in mind when taking investment advice.

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Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm. Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director. For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

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