AI
Saturday, July 05, 2003 6:43:32 PM
At some point (probably soon) I need to do a re-study on silver to see what has changed and what I might have missed the first time. My concern has always been that silver demand is more closely tied to the economy than the demand for gold, so if I am correct that the economy will continue to weaken, the resulting decline in industrial demand for silver will offset to a significant degree the rise in investment demand.
I will take another look.
Thanks.
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Hopefully, this lengthy but truly excellent treatise on Silver will help put some of the pieces in place for you.
Fwiw, the underlined but non-bolded words are active links on the original page linked below.
Comparitively speaking, picking the Ag stocks should be the easy part.... <gg>
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Storm Watch Update from Jim Puplava
July 2, 2003
SILVER
The Undervalued Asset Looking For A Catalyst
by Jim Puplava
Introduction
When I sat down to write The Perfect Financial Storm in the summer of 2000, my storm analogy was based on three storm fronts colliding with each other. Like the real storm on Halloween 1991, three economic forces were turning into storms fronts. The first and foremost storm was developing in the credit markets as a vast mountain of debt was being created. This ocean of money, which had ignited a boom, was now turning into a bust. In order to avoid the consequences of a deflating credit bubble, the Fed embarked on a massive monetary stimulus program. The Federal Reserve was using all of its powers in an effort to stave off the bust and bring temporary relief by manipulating the financial system with the creation of more credit. The result is that today interest rates are at historic lows and credit expansion within the financial system has accelerated even more.
The Fed is now pulling out all stops from lowering interest rates, monetizing debt and using unconventional means to prop up the markets and the economy. It is believed that “unconventional” equates to intervening in the financial markets. In statements going back to 1989, recent research papers and comments made during FOMC meetings, the Fed has made reference to ”unconventional” measures in case current monetary policy becomes ineffective.
Unconventional in this case may mean buying or monetizing various assets. In the January 2002 FOMC meeting reference was made to buying any kind of asset to pump up the system from US equities, government and municipal debt to real estate and gold mines. If one views the second storm front as a bear market in stocks where we have seen a decline for three straight years and despite twelve rate cuts by 2002, unconventional may also mean propping up the stock market. Injecting reserves into the financial system through Federal Reserve Repurchase Agreements is one method of achieving this. When the Fed purchases securities from primary government bond dealers, it pays for these securities with cash, thereby adding liquidity to the banking system. Member firms then have the available cash to carry out Fed intervention in the financial markets through major purchases made in the futures markets or through the purchase of select market weighted stocks that are included in all three major indexes such as Microsoft and Intel.
Mike Bolser, who contributes to The Golden Sextant, has documented this relationship between the increase in Fed repos and the movement of the markets in the charts below. Readers can follow the movement of the repo market at the Federal Reserve Bank of New York, where they are posted daily. In addition piraz.com charts repos daily.
The Four-Step Rally Process
I have written in the past how intervention takes place in my four-step rally process, which is repeated below. This pattern has been repeated consistently since last summer's July rally.
1) Intervene in the market (done by buying futures).
2) Higher stock prices through intervention forces short covering.
3) Stock prices that lurch higher bring in momentum players.
4) If the rally lasts long enough, John Q may move money into mutual funds. This happens just about the time the rally fades.
It is clear that the current market momentum is based on factors other then economics, earnings and valuations. The reason that intervention isn’t freely admitted—as in other countries like Japan where the government is buying stocks—is because the US professes to adhere to free markets. An English statesman in the 18th century expressed it best by saying,
"The moment that government appears at market, the principle of the market is subverted." ~ Edmund Burke ~
The third and final storm front is the economy, which has weakened again. It is clear from recent economic reports that the economy remains anemic. It appears that another stimulus program and more credit and lower interest rates are necessary to sustain it. The recent cut in interest rates has stimulated another round of mortgage refis and it appears that abundant credit is still keeping the housing market inflated. Outside of housing and government spending, there are few catalysts out there to keep the economy propped up. (See Catalyst Part 1) Therefore it appears that more pump priming, more stimuli and other unconventional means will be necessary. The Fed and the government are now engaged in a multi-front program to keep the economy and the markets from collapsing. This includes lowering short and long-term interest rates, running budget deficits through increased fiscal stimulus—both spending and tax cuts—and eventually if necessary debt relief, debauching the currency and any other measure that is necessary to keep the economy out of a depression.
It is apparent from the current policy of pumping money, debauching the currency, and running massive budget deficits that more economic upheaval and financial disruptions are about to revisit us. The result is that all three storm fronts in credit, the economy, and the financial markets could either collide, batter us one after the other, remain contained or isolated, or unite to form one massive storm front. The monetary jet stream and the speculators and policymakers that drive it will determine the route and direction of these multiple financial storms. Whether all three-storm fronts collide to form The Perfect Financial Storm has yet to be determined. What is abundantly clear, however, is that we are experiencing no ordinary economic storm. The bursting of a stock market bubble, gyrating financial markets, a weak economy, rising unemployment and the failure of rate cuts to reignite the economy and markets is obvious. With conventional policy methods failing to achieve their objective, investors must now prepare for unconventional policy changes and the havoc they may bring.
STORM STRATEGY: PRECIOUS METALS
In writing my Storm Series, I touched upon investment strategies that would work under various storm scenarios. Prominent among them was precious metals. As currencies depreciate, especially the dollar, confidence in paper will evaporate. This will cause a flight to real money, which I define as gold and silver. While I believe that both gold and silver will do well under any storm environment, I believe that silver has far more upside potential. From a value perspective, silver has many attractive attributes that are hard to overlook. There are eight, which taken together, add up to explosive upside potential regardless of what happens to the financial environment. They are listed below.
Silver Catalysts
* Supply side deficits now into the 14th year.
* Decreased investor selling.
* Diminishing supply stockpiles.
* Declining institutional and investor interests.
* Large paper short positions.
* Expanding uses for a scarce metal.
* The return of silver as money.
* The dollar and credit crises
Catalyst #1 Supply Side Deficit
Demand Outstrips Supply
One of the most astonishing aspects about silver as a commodity is that demand has outstripped supply for nearly fourteen years, including projected deficits for 2003. Annual silver deficits have run as high as 200 million ounces in boom years and as low as 40-50 million ounces in years of recession. Even in years of economic stress, as in the recession of 1991 or more recently in 2002, demand continues to outstrip supply.
Demand for silver in all categories of use has increased substantially since silver began running annual deficits back in 1990. The largest use of silver comes from photography, jewelry and silverware. Although photographic and silverware demand have edged lower due to a worldwide recession, this demand is still higher today than where it was in 1990.
During recessionary periods, demand for photography, jewelry and silverware may decrease, but supply can also decease since 80% of silver produced is a byproduct of copper, gold, lead, and zinc mining. A good part of last year's decline in mine production was the result of planned closures of copper, lead, and zinc mining operations. The production of these metals is influenced more by economic trends than the price of silver. Photographic demand also influences silver supply since much of the secondary scrap supply is refined from photographic film and chemicals. A decline in photographic demand would also impact secondary scrap supply.
Few Pure Producers
Another aspect about silver supply that is important is that there are very few pure silver producers. In fact you could count them on two hands. This handful of silver producers along with a few governments account for the other 20% of silver mine supply. With the exception of mines in Mexico, Peru and a very few other locations, it has simply been uneconomic to produce silver at these historic low prices. A few junior mining exploration companies have chosen to acquire silver properties and sit on them until such time that sustained prices make it economical and profitable to mine.
Silver Prices "Controlled"
I can think of very few other commodities, besides gold and energy, where low prices continue to persist despite rising demand. Under normal economic circumstances greater demand than supply would lead to higher prices. This has not been the case with precious metals. Precious metals are a political commodity with their price governed by government policy. Government has a vested interest in keeping precious metal prices controlled because gold and silver metals represent a challenge to government fiat currency. A gold or silver backed currency would limit the government’s ability to print money, expand credit and debase the value of the currency. Therefore, governments have a vested interest in keeping the price of silver and gold low and controlled. They do this through the outright sale or leasing of gold or through leveraged paper instruments known as derivatives. This can be viewed by the charts on the right of derivative issuance and dishoarding of gold by the UK/US and the price of gold.
At this point the reader may wonder why supply deficits have not produced higher prices for gold and silver. Outside government sale of gold and silver, the main reason is we have been living off accumulated stockpiles. A lot of the supply deficit in silver is made up by secondary supply that comes from old scrap and coin melt. Governments have also supplied silver to the market from accumulated stockpiles. The U.S. Treasury held 2.06 billion ounces in 1959. A good majority of this stockpile was sold off during the 60’s with the balance used in the minting of Silver Eagles coins from 1986 through 2002.[1] The U.S stockpile has now been depleted. As of 2002 the largest remaining government silver inventories are in India, which is estimated to hold around 87 million ounces.
The net result of 13 years of silver deficits is that through 2002 the cumulative deficit has been 1,525.5 million ounces.[2] This entire deficit was made up from above ground inventories. Silver inventories have fallen from around 2.2 billion ounces at the beginning of 1990 to less than 500 million ounces today. The cumulative draw down of inventories came mainly from investors during the 90’s who had bought their silver in earlier periods at much higher prices. The great equity bull market of the 90’s made many of these investors disenchanted with their returns on silver. As a result, these investors sold heavily throughout this period bringing more supply to the marketplace, which helped to offset silver production deficits. However, there has been a noticeable increase in investor interest in silver with the sale of Silver Eagles by the U.S. mint rising close to 19% last year.
Catalyst #2 Decreased Investor Selling
Buying and Holding
Since investors have been a key source of secondary supply over the last decade, a decrease in investor selling and an increase in investor interest in silver is a second factor that bodes well for silver prices in the years ahead. Investor interest is a key factor because, as stated above, investor selling has been an important supply source making up part of production deficits over the last decade. Although global investors continued to sell last year, the amount of silver sold has been gradually decreasing. In addition to reduced selling investment, demand shows signs of reviving with U.S. government Silver Eagle sales growing from 5.6 million ounces in 1998 to 10.5 million ounces last year.
Markets Changing Preferences
India, which is a major market for silver, is also experiencing a change in investor preference. The latest CPM report noted a change in investor interest moving from jewelry and decorative objects to a preference for buying bullion bars. Part of this may be the rise in silver prices in local currencies. The other reason may be a growing recognition of the investment merits of owning silver. This year the Indian government is willing to allow gold and silver to be traded on Indian futures exchanges. The government has yet to allow the export of silver and gold. However, when and if that happens, it would create both a greater supply of silver as well as a source of future demand by expanding and integrating India with world markets for precious metals. Investor demand for silver occurs mainly in North America, India, the Middle East, and Southern Asia.
In It For The Long Run
Another positive attribute about silver demand is that silver investors tend to be long-term investors. Silver was accumulated throughout the 60’s and in the 80’s. Dishoarding took place only after the U.S. equity mania had taken off during the mid-90’s. This demand may accelerate due to a bear market in equities that has the potential to persist throughout this decade. Debasing currencies around the globe (especially the dollar) and record low interest rates also make silver, along with gold, an attractive investment for hedging against a decline in paper assets. Recognizing that the bear market in equities is far from over, combined with central banks that are injecting vast amounts of liquidity into the world financial system, currency debasement will accelerate, thereby making precious metals more attractive as an investment alternative. In my opinion, this is the greatest wild card for precious metals—especially for silver. The return of investment demand could cause precious metals, in particular silver, to explode. The supply side of silver could not accommodate an influx of investor demand without the catalyst of higher sustained prices for silver.
Catalyst #3 Diminishing Silver Stockpiles
This brings up the third catalyst for higher silver prices, which is dwindling stockpiles. I have already made reference to the huge drawdown in above ground stocks as a result of the deficits of the past thirteen years. According to CPM Group, non-coin inventory is around 419 million ounces with an additional estimated coin inventory of about 487.5 million ounces. The difficulty of estimating silver inventories lies in the fact that much of the world’s silver is now in the hands of individual investors and consumers. Arriving at an exact estimate as to what that amount is can only be estimated.
What is clear from known data of annual deficits is that whatever that supply once was, it has certainly diminished as a result of continuous drawdowns. However, this amount has played a mitigating role in one form or another in making additional supply available to the marketplace. Unfortunately experts can only estimate what remains of that supply. Reported inventories held on the COMEX, Tocom, CBT, and U.S. and Japanese Industry have fallen dramatically over the last four years. These institutional inventories have fallen from 245.8 million ounces in 1996 to 144.4 million in 2002, a drop of 41.3%. [3]
Don't Count on Moms and Pops
Although individual inventories of coin, jewelry, silverware, heirlooms and religious treasures still remain substantial, they remain elusive as a source of supply to the markets. They cannot be marshaled as easily as COMEX inventory to make up shortfalls in supply. What would drive more individuals to part with their silver is not readily known. Suffice to say it would probably be substantially higher prices. This happened during the later stages of the great silver bull market of the 1970s when households brought silverware and other silver items to the market as the price of silver soared. Even then, silver jewelry and religious items may be price inelastic having more personal rather than monetary value.
Paper Market Dominates
What is clear is that the demand for silver continues to remain high with production supply deficits each year. Production has not been able to keep up with demand for several decades. Secondary scrap sales, coin melt and government stockpiles have made up the difference. Today there are no large government stockpiles of silver left in the world outside of India. Coin melt has diminished from its peak in the 1970s and secondary scrap sales are a two-edged sword because they are dependent on silver use. This has many experts asking “when” and not “if” silver inventories reach critically low enough levels to trigger a price reaction in the marketplace.
This drawdown in world silver supplies has been a sleeper and has gone unnoticed by the investment community. This is because the paper markets dominate the silver markets. This can be illustrated by the chart below, which shows the value of annual silver supply versus the trading in paper instruments. The total value of last year’s entire silver usage of 784.8 million ounces is only around $3.6 billion. By comparison, the value of all paper and derivative contracts had a value of $193 billion.[4]
Because most paper transactions are settled in cash, and not bullion, there has never been a need to take delivery or demand it. Most investors have been content to settle their transactions in cash instead of metal. This might not always be the case and remains one of the great vulnerabilities of the silver markets. There simply is not enough silver held in inventories to handle investment delivery should the trend in settlement change from paper to physical. For example, in 2002, 21.9 billion ounces was cleared through London silver markets and 15.7 billion ounces traded on the COMEX. This compares to total production and supply of around 800 million ounces. [5]
What if?
Imagine this. What might happen to the price of silver if investors gradually or suddenly lost faith in paper assets and demanded physical delivery? The fact that this may someday happen shouldn’t be casually dismissed. The value of paper contracts far exceeds the ability of any exchange to handle should physical delivery ever be demanded. As of this writing open interest in silver on the COMEX is 83,905 contracts. Long positions are 79,990 contracts and short positions are the same. It is the long contracts that pose the greatest danger because they could change their preference from one of settling in cash to one of settling in metal. Remember, short sellers have a choice of settling in cash or providing metal. These long positions represent 400 million ounces of potential silver demand. Against this amount there are only 107.2 million ounces of silver on the COMEX of which only 46 million are registered and available for delivery. The other 61 million ounces is in the eligible category and not available for immediate delivery. Many of these eligible ounces are held on the COMEX for storage purposes for either future use or as an investment. Although they could potentially move into the registered category and become available for delivery, it is unlikely all of this amount would do so.
The exchange does have a way out should demand overwhelm supply. There is a clause, which allows for cash settlement or payment for silver. This clause may provide a way out if silver ever gets squeezed. However, news of such a squeeze would certainly translate into higher prices in much the same way that the platinum squeeze did in Japan in the late 90’s.
Catalyst #4 Declining Interest
Besides dwindling supplies, the next positive catalyst and one of my favorites is declining interests in silver by the professional investment community. Over the last few years a growing characteristic of the silver market has been an erosion of the metals market structure.
More bullion and investment banks are exiting the business of providing trading, financing, credit, or storage facilities to the silver market. Last year two major European investment banks closed their Indian trading operations. The volume of contracts traded through the interbank market located in London has declined for the fifth consecutive year with the volume of ounces traded down by 70.6% from 1997. Withering interest can be seen in the chart on the left.
The Pros Are Getting Out
According to the latest CPM Group report, bullion and brokerage companies accounted for the majority of the decline in lost trading activity. More and more of the professional community have been exiting the business because of lack of interest. The market has simply become too small and unprofitable to remain in the business. In 2000 both Morgan Guaranty and Republic’s Delaware facility ceased to be registered as COMEX vaulting facilities.
Institutions have watched the steady decline each year in reported silver inventories from the 350-ounce range to today’s 100 million range. Besides Morgan, more banks are closing down their vaults because there isn’t enough silver available in inventory form to make it worthwhile. This is happening around the globe in money centers in New York, London, and Zurich to Hong Kong. Many of the larger investment banking firms have left or closed down their commodity market operations. Still others only keep a marginal presence. As more professional institutions exit the market, liquidity is reduced.
Rip Van Winkle
This to me is the perfect contrary indicator: professionals exiting the market due to their lack of interest and profitability. Combined with reduced liquidity, diminishing supplies, lingering deficits and few alternatives for investing—whether in bullion or equity—this translates into the potential for enormous opportunity. It might be better said by saying a lifetime opportunity.
Lack of Investment Alternatives
As the CPM Group points out in their recent silver report, investing in physical silver is extremely difficult in North America because there are few available outlets. Small investors, outside the COMEX, account for silver investments. They make their investments either through a local coin shop or by buying Silver Eagles through the U.S. mint. Large investors have found that investing in silver has become more difficult. CPM reported an anecdotal story about a number of medium sized and wealthy investors contacting the firm with an interest in making a $100,000 - $5,000,000 investment in silver. These clients reported difficulty in finding silver of this kind of volume at a reasonable price. The lack of silver investment alternatives from equities to bullion to finding competitive storage facilities has made it much more difficult to invest in silver. There are few outlets for making large silver investments and there are few equity alternatives as well. Add this to the fact that silver is consumed and it is not hard to see how this market can explode to the upside, especially if investor demand returns as confidence is lost in paper.
Catalyst #5 Large Paper Short Positions
Another catalyst for launching silver prices is the existing large short position in silver bullion on the COMEX. These short positions are a potential catalyst if silver prices suddenly move up. This will force short sellers to cover their positions. Silver has been kept within a narrow trading band for the last decade. Prices have been contained between $4-$5 an ounce range. Over the last year and a half that band has narrowed to $4.40 and $4.80. Technically, this reflects a horizontal or consolidation pattern. Since reaching a peak of $50 an ounce back in 1980, the price of silver has declined 90%. Silver has been a steady decline throughout the 80’s and mid-90’s until falling to within its present band of $4-$5 an ounce.
One-Way Trading
The silver market has been a one-way trade for more than a decade. The only way to make money in silver has been to short the metal. The technique has been to go long when silver falls to the lower range of its band at $4. Then you go short as the price of silver heads up towards $5. This one-way trade has dominated the silver markets and remains to this day. Occasionally silver prices have spiked up when supplies are short or demand has increased or on news like when the markets learned that Buffett was buying silver. Besides these occasional forays into higher price zones, silver has been range bound for over a decade. There appears to be strong price support at the lower end of $4 and selling pressure at the upper end towards $5 an ounce. The narrow trading band appears to be edging upward over the last few years, but outside an occasional price spike, it still remains confined to within its narrow trading band.
Paper Versus Physical
A harbinger of what might happen in the future was demonstrated last year with the fall in the equity markets and the decline of the dollar. Investor interests returned briefly to the markets last spring as U.S. equity markets were imploding. Speculators rushed into the silver markets driving prices up quickly. These speculators were mainly momentum traders who started to buy silver on upside breakouts. Because this market is so thin, all it took was a small increase in trading volume to send silver prices skyward. Silver equities performed even better. In fact silver equities outperformed gold shares last year.
The direction of silver prices is more determined by the paper markets than the physical markets. As mentioned, for a decade the price of the metal has been contained within a narrow trading range as traders and short sellers base their buying and selling decisions on technical price patterns. Because there is strong short selling, as silver moves up towards $5 an ounce, the buy and sell range has been ingrained with traders making shorting silver a one-way trade for the last decade. That this condition could exist during a period of large supply deficits demonstrates how paper—rather than physical—dominates and controls the price of the metal. The large silver supply deficits have been unable to act as a catalyst for higher silver prices due to the preponderance of paper silver in relation to physical silver and large above ground stockpiles. These large above ground stockpiles have been depleted by cumulative deficits over the last 13 years by 1,525.5 billion ounces.
At some point in the near future, these above ground stockpiles will fall to critical levels and the price is going to explode like a NASA space launch. It will explode for three reasons. The main one is that it will be in short supply and in the short run there are no large stockpiles to supply a sudden spike in demand triggered by a price rise. Inventories of silver in the form of jewelry, silverware, and religious objects are not the same as silver bullion. They are held for personal reasons and not sold and traded in the same way as the metal. As such they cannot be mobilized to meet demand in the same way that bullion bars held in warehouses can if market conditions change. The price will also explode due to the thin nature of the markets. The actual physical market for silver and silver equities is extremely small. There are less then 10 pure silver mining stocks and the physical market is less then $4 billion. This compares to the trillions that are traded in the currency markets and the hundreds of billions that trade each day in the stock and bond markets. The final catalyst for an explosive price rise is the large perpetual short position that exists on the COMEX, a short position that is 4-6 times the actual amount of silver that could be delivered if investors insisted on physical delivery. Currently, it is almost 10 times the amount of available silver for delivery. (See Five Smooth Stones)
Ripe Conditions
The short sellers have been able to control the markets for over a decade in a one-way trade. History teaches us that markets ignored and silent for decades can abruptly change. I would suggest that given all of the monetary and financial uncertainties that now exist and the fact that central bankers are hell bent on burning the value of their respective currencies, conditions are ripe for an abrupt sea change in the silver markets. The metal has been confined to within a narrow range in part due to the fact that silver is perceived as an industrial metal. With economic weakness prevalent around the globe, the price of silver is also range bound by its association with weak industrial demand. Besides the large perpetual large short positions, economic weakness and the belief that silver is only an industrial metal have kept the price from rising. It is often forgotten that although the primary demand for silver has been industrial—unlike gold—silver is consumed which reduces supply.
Catalyst #6 Expanding Uses For Silver
Another factor weighing in silver's favor is the number of growing uses for silver. The main uses for silver have been primarily for photography, jewelry, silverware, electronics and batteries. Much of this demand is price inelastic. The small amount of silver that is used in applications makes it an insignificant factor. The amount used in the manufacture of a battery, an automobile, a computer, and in jewelry is insignificant when compared to the price of labor and other materials. A doubling in the price of silver would not effect what GM uses in making a car, Energizer in a battery or even David Yurman in silver jewelry. If a highly refined piece of silver jewelry costs several hundred dollars, a $5 dollar jump in its price or a tripling of its price would be insignificant. More important to the price would be its availability.
MAIN USES FOR SILVER
Batteries
Bearings
Brazing and Soldering
Catalysts
Coins
Electrical
Electronics Electroplating
Jewelry and Silverware
Medical Applications
Mirrors and Coatings
Photography
Solar Energy
Water Purification
Today the main use of silver is still photography, jewelry, and silverware. However, new applications are growing each year. Silver is now used as a biocide and as an electrical and thermal conductor. Because silver has unique properties such as malleability, strength and its sensitivity to light and ability to endure extreme temperatures, substitutions are difficult.
Others, such as Dave Morgan, have written extensively on the uses of silver. I will not attempt to elaborate here on the fine work done by others. To find out more about silver and its uses, the reader can go to The Silver Institute website and Dave Morgan’s Silver-Investor.
Catalyst #7 The Return of Silver as Money
The final catalyst for silver is a return of silver and gold to their real purpose which is money used as a medium of exchange. I would like to point out that since the U.S. and the world went off the gold standard by abandoning Bretton Woods and quit using silver as coin, there has been an attempt to treat silver as purely an industrial commodity. However, throughout time—and I’m referring to 5,000 years of recorded history—silver has been the prominent form of money. In fact, its use as money has been more prominent than gold. Emperors, kings and princes and merchants may have transacted business in gold, but the common man used silver. In trade, silver was the dominant monetary metal until the 20th century. It’s use as money has been recorded in the bible's first book of Genesis. Abraham purchased a burial site for his wife Sarah from Ephron the Hittite for four hundred shekels of silver. [6]
A Unique Commodity
Unlike fiat currencies or paper money, which can be created in unlimited amounts, silver—like gold—has all of the properties of real money. It is divisible, durable and utilitarian. It is tangible. Money is a commodity that differs from other commodities because of its use as a medium of exchange. In each country that has its own unit of money (be they marks, francs and now euros), the original use and function of money was always tied to gold and silver. It was only in the 20th century and briefly during the 17th century that countries deviated from the use of gold and silver as true money used as an exchange medium. Paper currencies were used merely for their convenience, but they were all backed and exchangeable for real money: silver and gold. It is only when money began to be viewed in the abstract that it became easier for governments to cast aside the properties that gave currency its monetary value.
The Depreciating Dollar
Since abandoning gold and silver backing of money, the U.S. dollar has steadily depreciated as seen in this chart above. As a result, we have gone from one monetary crisis to the next. What determines the value of money is the same force that determines all goods and services traded in the market. That is supply and demand. As central banks increase the supply of money into the economy and financial system, the value of its worth depreciates. This is an irrefutable law of economics: an increase in the supply of money will lower its value. Conversely an increase in demand for money will raise its value. In a book on money, Murray Rothbard tells us,
“What makes us rich is an abundance of goods, and what limits that abundance is a scarcity of resources: namely land, labor, and capital. Multiplying coin will not whisk these resources into being. We may feel twice as rich for the moment, but clearly all we are doing is diluting the money supply. As the public rushes out to spend its new-found wealth, prices will, very roughly, double—or at least rise until the demand is satisfied, and money no longer bids against itself for the existing goods… Thus we see that while an increase in the money supply, like an increase in the supply of any good, lowers its price, the change does not—unlike other goods—confer a social benefit. The public at large is not made richer. Whereas new consumer or capital goods add to standards of living, new money only raises prices—i.e., dilutes its own purchasing power." [7]
Loss of Confidence in Paper
In the future what will become a major catalyst for silver and gold is a loss of confidence in paper fiat money. As central bankers, in particular the Greenspan Fed, create vast quantities of credit, in the end it will destroy its value. Look at any place in the world where central bankers or governments are creating an endless supply of money or credit and you will find depreciating currencies, financial turmoil and impoverishment of the people. Monetary alchemists cannot create wealth artificially through fiat means. Real wealth comes only from savings, investment and the creation of capital stock. If it were otherwise, all nations on this earth would be rich and its citizens as well.
I believe the present attempt by central bankers to inflate their respective currencies, and especially the policies of the Greenspan Fed, are leading us closer to The Perfect Financial Storm. This is a topic that I will cover in just a moment. For now it is important that the reader understand that the most valuable property of silver is its historic use as money and not as an industrial commodity. Attempts by the silver and gold industry associations to continue to promote the industrial uses of silver or gold are ridiculous. It goes to show you how little is understood about the concept of money. In less than a generation a real understanding of what money “is” and what it "isn’t" has been completely forgotten and obfuscated by the jargon of modern day economics. People in the 19th century had a greater understanding of what money was and were the most arduous defenders of its value. Today fiat currencies are depreciated endlessly; while debate centers on whether the Fed should lower or raise interest rates or pump or siphon money into or out of the economy. No thought is ever given to the consequences of these actions. When crises erupt as a direct consequences of these actions, even greater cries are heard for more of the money narcotic.
A Great Misunderstanding
Today no attempt is made to understand or learn what money “is” or why fiat currencies have been such a dismal failure. The more crises we go through, the greater the financial turmoil. The growing impoverishment of people as a result of the unlimited creation of fiat money is swept under the carpet. Instead, each new crisis causes government and financial experts to try new forms or methods of financial alchemy. The greatest blame for these misfortunes lays squarely at the foot of our educational institutions which have perpetuated discredited economic theories. They have instead become a breeding ground for economic disinformation.
In the forward to Murray N. Rothbard’s "What Has Government Done to Our Money," Lew Rockwell of the Ludwig Von Mises Institute writes, "…government has always and everywhere been the enemy of sound money. Through banking cartels and inflation, government and its favored interests loot the people’s earnings, water down the value of the market’s money, and cause recessions and depressions. In mainstream economics, most of this is denied or ignored. The emphasis is always on the “best” way to use monetary policy. What should guide the Federal Reserve? The GDP? Interest rates? The yield curve? The foreign exchange value of the dollar? A commodity index?”[8] Rothbard’s book on money debunks all of these ridiculous theories and shows why in the end the fiat system of credit money will fail. Every investor should own a copy of this book if they want to gain a better understanding of what lies ahead as a major monetary storm front approaches.
Catalyst #7 The Dollar and Credit Crises
The Credit Market Storm is Brewing
This brings me to my final argument on the case for owning precious metals, especially silver. The world financial system is heading for a major crisis with the dollar-based monetary system at its epicenter. Since abandoning gold backing of the dollar in August of 1971, we have embarked on one of history's greatest experiments in fiat money. Since that fateful day in 1971, debt and credit of every kind has expanded at all levels of society. Just look at these dramatic charts below. Note the advance of debt after 1971.
To anyone who has gotten this far, I commend you highly.....
Unfortunately, rapidly changing circumstances here will not allow me to continue duplicating this essay, so if you want to read the rest of Puplava's fine effort (where gold is also mentioned), please go to:
http://www.financialsense.com/stormwatch/oldupdates/2003/0702.htm
I will take another look.
Thanks.
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Hopefully, this lengthy but truly excellent treatise on Silver will help put some of the pieces in place for you.
Fwiw, the underlined but non-bolded words are active links on the original page linked below.
Comparitively speaking, picking the Ag stocks should be the easy part.... <gg>
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Storm Watch Update from Jim Puplava
July 2, 2003
SILVER
The Undervalued Asset Looking For A Catalyst
by Jim Puplava
Introduction
When I sat down to write The Perfect Financial Storm in the summer of 2000, my storm analogy was based on three storm fronts colliding with each other. Like the real storm on Halloween 1991, three economic forces were turning into storms fronts. The first and foremost storm was developing in the credit markets as a vast mountain of debt was being created. This ocean of money, which had ignited a boom, was now turning into a bust. In order to avoid the consequences of a deflating credit bubble, the Fed embarked on a massive monetary stimulus program. The Federal Reserve was using all of its powers in an effort to stave off the bust and bring temporary relief by manipulating the financial system with the creation of more credit. The result is that today interest rates are at historic lows and credit expansion within the financial system has accelerated even more.
The Fed is now pulling out all stops from lowering interest rates, monetizing debt and using unconventional means to prop up the markets and the economy. It is believed that “unconventional” equates to intervening in the financial markets. In statements going back to 1989, recent research papers and comments made during FOMC meetings, the Fed has made reference to ”unconventional” measures in case current monetary policy becomes ineffective.
Unconventional in this case may mean buying or monetizing various assets. In the January 2002 FOMC meeting reference was made to buying any kind of asset to pump up the system from US equities, government and municipal debt to real estate and gold mines. If one views the second storm front as a bear market in stocks where we have seen a decline for three straight years and despite twelve rate cuts by 2002, unconventional may also mean propping up the stock market. Injecting reserves into the financial system through Federal Reserve Repurchase Agreements is one method of achieving this. When the Fed purchases securities from primary government bond dealers, it pays for these securities with cash, thereby adding liquidity to the banking system. Member firms then have the available cash to carry out Fed intervention in the financial markets through major purchases made in the futures markets or through the purchase of select market weighted stocks that are included in all three major indexes such as Microsoft and Intel.
Mike Bolser, who contributes to The Golden Sextant, has documented this relationship between the increase in Fed repos and the movement of the markets in the charts below. Readers can follow the movement of the repo market at the Federal Reserve Bank of New York, where they are posted daily. In addition piraz.com charts repos daily.
The Four-Step Rally Process
I have written in the past how intervention takes place in my four-step rally process, which is repeated below. This pattern has been repeated consistently since last summer's July rally.
1) Intervene in the market (done by buying futures).
2) Higher stock prices through intervention forces short covering.
3) Stock prices that lurch higher bring in momentum players.
4) If the rally lasts long enough, John Q may move money into mutual funds. This happens just about the time the rally fades.
It is clear that the current market momentum is based on factors other then economics, earnings and valuations. The reason that intervention isn’t freely admitted—as in other countries like Japan where the government is buying stocks—is because the US professes to adhere to free markets. An English statesman in the 18th century expressed it best by saying,
"The moment that government appears at market, the principle of the market is subverted." ~ Edmund Burke ~
The third and final storm front is the economy, which has weakened again. It is clear from recent economic reports that the economy remains anemic. It appears that another stimulus program and more credit and lower interest rates are necessary to sustain it. The recent cut in interest rates has stimulated another round of mortgage refis and it appears that abundant credit is still keeping the housing market inflated. Outside of housing and government spending, there are few catalysts out there to keep the economy propped up. (See Catalyst Part 1) Therefore it appears that more pump priming, more stimuli and other unconventional means will be necessary. The Fed and the government are now engaged in a multi-front program to keep the economy and the markets from collapsing. This includes lowering short and long-term interest rates, running budget deficits through increased fiscal stimulus—both spending and tax cuts—and eventually if necessary debt relief, debauching the currency and any other measure that is necessary to keep the economy out of a depression.
It is apparent from the current policy of pumping money, debauching the currency, and running massive budget deficits that more economic upheaval and financial disruptions are about to revisit us. The result is that all three storm fronts in credit, the economy, and the financial markets could either collide, batter us one after the other, remain contained or isolated, or unite to form one massive storm front. The monetary jet stream and the speculators and policymakers that drive it will determine the route and direction of these multiple financial storms. Whether all three-storm fronts collide to form The Perfect Financial Storm has yet to be determined. What is abundantly clear, however, is that we are experiencing no ordinary economic storm. The bursting of a stock market bubble, gyrating financial markets, a weak economy, rising unemployment and the failure of rate cuts to reignite the economy and markets is obvious. With conventional policy methods failing to achieve their objective, investors must now prepare for unconventional policy changes and the havoc they may bring.
STORM STRATEGY: PRECIOUS METALS
In writing my Storm Series, I touched upon investment strategies that would work under various storm scenarios. Prominent among them was precious metals. As currencies depreciate, especially the dollar, confidence in paper will evaporate. This will cause a flight to real money, which I define as gold and silver. While I believe that both gold and silver will do well under any storm environment, I believe that silver has far more upside potential. From a value perspective, silver has many attractive attributes that are hard to overlook. There are eight, which taken together, add up to explosive upside potential regardless of what happens to the financial environment. They are listed below.
Silver Catalysts
* Supply side deficits now into the 14th year.
* Decreased investor selling.
* Diminishing supply stockpiles.
* Declining institutional and investor interests.
* Large paper short positions.
* Expanding uses for a scarce metal.
* The return of silver as money.
* The dollar and credit crises
Catalyst #1 Supply Side Deficit
Demand Outstrips Supply
One of the most astonishing aspects about silver as a commodity is that demand has outstripped supply for nearly fourteen years, including projected deficits for 2003. Annual silver deficits have run as high as 200 million ounces in boom years and as low as 40-50 million ounces in years of recession. Even in years of economic stress, as in the recession of 1991 or more recently in 2002, demand continues to outstrip supply.
Demand for silver in all categories of use has increased substantially since silver began running annual deficits back in 1990. The largest use of silver comes from photography, jewelry and silverware. Although photographic and silverware demand have edged lower due to a worldwide recession, this demand is still higher today than where it was in 1990.
During recessionary periods, demand for photography, jewelry and silverware may decrease, but supply can also decease since 80% of silver produced is a byproduct of copper, gold, lead, and zinc mining. A good part of last year's decline in mine production was the result of planned closures of copper, lead, and zinc mining operations. The production of these metals is influenced more by economic trends than the price of silver. Photographic demand also influences silver supply since much of the secondary scrap supply is refined from photographic film and chemicals. A decline in photographic demand would also impact secondary scrap supply.
Few Pure Producers
Another aspect about silver supply that is important is that there are very few pure silver producers. In fact you could count them on two hands. This handful of silver producers along with a few governments account for the other 20% of silver mine supply. With the exception of mines in Mexico, Peru and a very few other locations, it has simply been uneconomic to produce silver at these historic low prices. A few junior mining exploration companies have chosen to acquire silver properties and sit on them until such time that sustained prices make it economical and profitable to mine.
Silver Prices "Controlled"
I can think of very few other commodities, besides gold and energy, where low prices continue to persist despite rising demand. Under normal economic circumstances greater demand than supply would lead to higher prices. This has not been the case with precious metals. Precious metals are a political commodity with their price governed by government policy. Government has a vested interest in keeping precious metal prices controlled because gold and silver metals represent a challenge to government fiat currency. A gold or silver backed currency would limit the government’s ability to print money, expand credit and debase the value of the currency. Therefore, governments have a vested interest in keeping the price of silver and gold low and controlled. They do this through the outright sale or leasing of gold or through leveraged paper instruments known as derivatives. This can be viewed by the charts on the right of derivative issuance and dishoarding of gold by the UK/US and the price of gold.
At this point the reader may wonder why supply deficits have not produced higher prices for gold and silver. Outside government sale of gold and silver, the main reason is we have been living off accumulated stockpiles. A lot of the supply deficit in silver is made up by secondary supply that comes from old scrap and coin melt. Governments have also supplied silver to the market from accumulated stockpiles. The U.S. Treasury held 2.06 billion ounces in 1959. A good majority of this stockpile was sold off during the 60’s with the balance used in the minting of Silver Eagles coins from 1986 through 2002.[1] The U.S stockpile has now been depleted. As of 2002 the largest remaining government silver inventories are in India, which is estimated to hold around 87 million ounces.
The net result of 13 years of silver deficits is that through 2002 the cumulative deficit has been 1,525.5 million ounces.[2] This entire deficit was made up from above ground inventories. Silver inventories have fallen from around 2.2 billion ounces at the beginning of 1990 to less than 500 million ounces today. The cumulative draw down of inventories came mainly from investors during the 90’s who had bought their silver in earlier periods at much higher prices. The great equity bull market of the 90’s made many of these investors disenchanted with their returns on silver. As a result, these investors sold heavily throughout this period bringing more supply to the marketplace, which helped to offset silver production deficits. However, there has been a noticeable increase in investor interest in silver with the sale of Silver Eagles by the U.S. mint rising close to 19% last year.
Catalyst #2 Decreased Investor Selling
Buying and Holding
Since investors have been a key source of secondary supply over the last decade, a decrease in investor selling and an increase in investor interest in silver is a second factor that bodes well for silver prices in the years ahead. Investor interest is a key factor because, as stated above, investor selling has been an important supply source making up part of production deficits over the last decade. Although global investors continued to sell last year, the amount of silver sold has been gradually decreasing. In addition to reduced selling investment, demand shows signs of reviving with U.S. government Silver Eagle sales growing from 5.6 million ounces in 1998 to 10.5 million ounces last year.
Markets Changing Preferences
India, which is a major market for silver, is also experiencing a change in investor preference. The latest CPM report noted a change in investor interest moving from jewelry and decorative objects to a preference for buying bullion bars. Part of this may be the rise in silver prices in local currencies. The other reason may be a growing recognition of the investment merits of owning silver. This year the Indian government is willing to allow gold and silver to be traded on Indian futures exchanges. The government has yet to allow the export of silver and gold. However, when and if that happens, it would create both a greater supply of silver as well as a source of future demand by expanding and integrating India with world markets for precious metals. Investor demand for silver occurs mainly in North America, India, the Middle East, and Southern Asia.
In It For The Long Run
Another positive attribute about silver demand is that silver investors tend to be long-term investors. Silver was accumulated throughout the 60’s and in the 80’s. Dishoarding took place only after the U.S. equity mania had taken off during the mid-90’s. This demand may accelerate due to a bear market in equities that has the potential to persist throughout this decade. Debasing currencies around the globe (especially the dollar) and record low interest rates also make silver, along with gold, an attractive investment for hedging against a decline in paper assets. Recognizing that the bear market in equities is far from over, combined with central banks that are injecting vast amounts of liquidity into the world financial system, currency debasement will accelerate, thereby making precious metals more attractive as an investment alternative. In my opinion, this is the greatest wild card for precious metals—especially for silver. The return of investment demand could cause precious metals, in particular silver, to explode. The supply side of silver could not accommodate an influx of investor demand without the catalyst of higher sustained prices for silver.
Catalyst #3 Diminishing Silver Stockpiles
This brings up the third catalyst for higher silver prices, which is dwindling stockpiles. I have already made reference to the huge drawdown in above ground stocks as a result of the deficits of the past thirteen years. According to CPM Group, non-coin inventory is around 419 million ounces with an additional estimated coin inventory of about 487.5 million ounces. The difficulty of estimating silver inventories lies in the fact that much of the world’s silver is now in the hands of individual investors and consumers. Arriving at an exact estimate as to what that amount is can only be estimated.
What is clear from known data of annual deficits is that whatever that supply once was, it has certainly diminished as a result of continuous drawdowns. However, this amount has played a mitigating role in one form or another in making additional supply available to the marketplace. Unfortunately experts can only estimate what remains of that supply. Reported inventories held on the COMEX, Tocom, CBT, and U.S. and Japanese Industry have fallen dramatically over the last four years. These institutional inventories have fallen from 245.8 million ounces in 1996 to 144.4 million in 2002, a drop of 41.3%. [3]
Don't Count on Moms and Pops
Although individual inventories of coin, jewelry, silverware, heirlooms and religious treasures still remain substantial, they remain elusive as a source of supply to the markets. They cannot be marshaled as easily as COMEX inventory to make up shortfalls in supply. What would drive more individuals to part with their silver is not readily known. Suffice to say it would probably be substantially higher prices. This happened during the later stages of the great silver bull market of the 1970s when households brought silverware and other silver items to the market as the price of silver soared. Even then, silver jewelry and religious items may be price inelastic having more personal rather than monetary value.
Paper Market Dominates
What is clear is that the demand for silver continues to remain high with production supply deficits each year. Production has not been able to keep up with demand for several decades. Secondary scrap sales, coin melt and government stockpiles have made up the difference. Today there are no large government stockpiles of silver left in the world outside of India. Coin melt has diminished from its peak in the 1970s and secondary scrap sales are a two-edged sword because they are dependent on silver use. This has many experts asking “when” and not “if” silver inventories reach critically low enough levels to trigger a price reaction in the marketplace.
This drawdown in world silver supplies has been a sleeper and has gone unnoticed by the investment community. This is because the paper markets dominate the silver markets. This can be illustrated by the chart below, which shows the value of annual silver supply versus the trading in paper instruments. The total value of last year’s entire silver usage of 784.8 million ounces is only around $3.6 billion. By comparison, the value of all paper and derivative contracts had a value of $193 billion.[4]
Because most paper transactions are settled in cash, and not bullion, there has never been a need to take delivery or demand it. Most investors have been content to settle their transactions in cash instead of metal. This might not always be the case and remains one of the great vulnerabilities of the silver markets. There simply is not enough silver held in inventories to handle investment delivery should the trend in settlement change from paper to physical. For example, in 2002, 21.9 billion ounces was cleared through London silver markets and 15.7 billion ounces traded on the COMEX. This compares to total production and supply of around 800 million ounces. [5]
What if?
Imagine this. What might happen to the price of silver if investors gradually or suddenly lost faith in paper assets and demanded physical delivery? The fact that this may someday happen shouldn’t be casually dismissed. The value of paper contracts far exceeds the ability of any exchange to handle should physical delivery ever be demanded. As of this writing open interest in silver on the COMEX is 83,905 contracts. Long positions are 79,990 contracts and short positions are the same. It is the long contracts that pose the greatest danger because they could change their preference from one of settling in cash to one of settling in metal. Remember, short sellers have a choice of settling in cash or providing metal. These long positions represent 400 million ounces of potential silver demand. Against this amount there are only 107.2 million ounces of silver on the COMEX of which only 46 million are registered and available for delivery. The other 61 million ounces is in the eligible category and not available for immediate delivery. Many of these eligible ounces are held on the COMEX for storage purposes for either future use or as an investment. Although they could potentially move into the registered category and become available for delivery, it is unlikely all of this amount would do so.
The exchange does have a way out should demand overwhelm supply. There is a clause, which allows for cash settlement or payment for silver. This clause may provide a way out if silver ever gets squeezed. However, news of such a squeeze would certainly translate into higher prices in much the same way that the platinum squeeze did in Japan in the late 90’s.
Catalyst #4 Declining Interest
Besides dwindling supplies, the next positive catalyst and one of my favorites is declining interests in silver by the professional investment community. Over the last few years a growing characteristic of the silver market has been an erosion of the metals market structure.
More bullion and investment banks are exiting the business of providing trading, financing, credit, or storage facilities to the silver market. Last year two major European investment banks closed their Indian trading operations. The volume of contracts traded through the interbank market located in London has declined for the fifth consecutive year with the volume of ounces traded down by 70.6% from 1997. Withering interest can be seen in the chart on the left.
The Pros Are Getting Out
According to the latest CPM Group report, bullion and brokerage companies accounted for the majority of the decline in lost trading activity. More and more of the professional community have been exiting the business because of lack of interest. The market has simply become too small and unprofitable to remain in the business. In 2000 both Morgan Guaranty and Republic’s Delaware facility ceased to be registered as COMEX vaulting facilities.
Institutions have watched the steady decline each year in reported silver inventories from the 350-ounce range to today’s 100 million range. Besides Morgan, more banks are closing down their vaults because there isn’t enough silver available in inventory form to make it worthwhile. This is happening around the globe in money centers in New York, London, and Zurich to Hong Kong. Many of the larger investment banking firms have left or closed down their commodity market operations. Still others only keep a marginal presence. As more professional institutions exit the market, liquidity is reduced.
Rip Van Winkle
This to me is the perfect contrary indicator: professionals exiting the market due to their lack of interest and profitability. Combined with reduced liquidity, diminishing supplies, lingering deficits and few alternatives for investing—whether in bullion or equity—this translates into the potential for enormous opportunity. It might be better said by saying a lifetime opportunity.
Lack of Investment Alternatives
As the CPM Group points out in their recent silver report, investing in physical silver is extremely difficult in North America because there are few available outlets. Small investors, outside the COMEX, account for silver investments. They make their investments either through a local coin shop or by buying Silver Eagles through the U.S. mint. Large investors have found that investing in silver has become more difficult. CPM reported an anecdotal story about a number of medium sized and wealthy investors contacting the firm with an interest in making a $100,000 - $5,000,000 investment in silver. These clients reported difficulty in finding silver of this kind of volume at a reasonable price. The lack of silver investment alternatives from equities to bullion to finding competitive storage facilities has made it much more difficult to invest in silver. There are few outlets for making large silver investments and there are few equity alternatives as well. Add this to the fact that silver is consumed and it is not hard to see how this market can explode to the upside, especially if investor demand returns as confidence is lost in paper.
Catalyst #5 Large Paper Short Positions
Another catalyst for launching silver prices is the existing large short position in silver bullion on the COMEX. These short positions are a potential catalyst if silver prices suddenly move up. This will force short sellers to cover their positions. Silver has been kept within a narrow trading band for the last decade. Prices have been contained between $4-$5 an ounce range. Over the last year and a half that band has narrowed to $4.40 and $4.80. Technically, this reflects a horizontal or consolidation pattern. Since reaching a peak of $50 an ounce back in 1980, the price of silver has declined 90%. Silver has been a steady decline throughout the 80’s and mid-90’s until falling to within its present band of $4-$5 an ounce.
One-Way Trading
The silver market has been a one-way trade for more than a decade. The only way to make money in silver has been to short the metal. The technique has been to go long when silver falls to the lower range of its band at $4. Then you go short as the price of silver heads up towards $5. This one-way trade has dominated the silver markets and remains to this day. Occasionally silver prices have spiked up when supplies are short or demand has increased or on news like when the markets learned that Buffett was buying silver. Besides these occasional forays into higher price zones, silver has been range bound for over a decade. There appears to be strong price support at the lower end of $4 and selling pressure at the upper end towards $5 an ounce. The narrow trading band appears to be edging upward over the last few years, but outside an occasional price spike, it still remains confined to within its narrow trading band.
Paper Versus Physical
A harbinger of what might happen in the future was demonstrated last year with the fall in the equity markets and the decline of the dollar. Investor interests returned briefly to the markets last spring as U.S. equity markets were imploding. Speculators rushed into the silver markets driving prices up quickly. These speculators were mainly momentum traders who started to buy silver on upside breakouts. Because this market is so thin, all it took was a small increase in trading volume to send silver prices skyward. Silver equities performed even better. In fact silver equities outperformed gold shares last year.
The direction of silver prices is more determined by the paper markets than the physical markets. As mentioned, for a decade the price of the metal has been contained within a narrow trading range as traders and short sellers base their buying and selling decisions on technical price patterns. Because there is strong short selling, as silver moves up towards $5 an ounce, the buy and sell range has been ingrained with traders making shorting silver a one-way trade for the last decade. That this condition could exist during a period of large supply deficits demonstrates how paper—rather than physical—dominates and controls the price of the metal. The large silver supply deficits have been unable to act as a catalyst for higher silver prices due to the preponderance of paper silver in relation to physical silver and large above ground stockpiles. These large above ground stockpiles have been depleted by cumulative deficits over the last 13 years by 1,525.5 billion ounces.
At some point in the near future, these above ground stockpiles will fall to critical levels and the price is going to explode like a NASA space launch. It will explode for three reasons. The main one is that it will be in short supply and in the short run there are no large stockpiles to supply a sudden spike in demand triggered by a price rise. Inventories of silver in the form of jewelry, silverware, and religious objects are not the same as silver bullion. They are held for personal reasons and not sold and traded in the same way as the metal. As such they cannot be mobilized to meet demand in the same way that bullion bars held in warehouses can if market conditions change. The price will also explode due to the thin nature of the markets. The actual physical market for silver and silver equities is extremely small. There are less then 10 pure silver mining stocks and the physical market is less then $4 billion. This compares to the trillions that are traded in the currency markets and the hundreds of billions that trade each day in the stock and bond markets. The final catalyst for an explosive price rise is the large perpetual short position that exists on the COMEX, a short position that is 4-6 times the actual amount of silver that could be delivered if investors insisted on physical delivery. Currently, it is almost 10 times the amount of available silver for delivery. (See Five Smooth Stones)
Ripe Conditions
The short sellers have been able to control the markets for over a decade in a one-way trade. History teaches us that markets ignored and silent for decades can abruptly change. I would suggest that given all of the monetary and financial uncertainties that now exist and the fact that central bankers are hell bent on burning the value of their respective currencies, conditions are ripe for an abrupt sea change in the silver markets. The metal has been confined to within a narrow range in part due to the fact that silver is perceived as an industrial metal. With economic weakness prevalent around the globe, the price of silver is also range bound by its association with weak industrial demand. Besides the large perpetual large short positions, economic weakness and the belief that silver is only an industrial metal have kept the price from rising. It is often forgotten that although the primary demand for silver has been industrial—unlike gold—silver is consumed which reduces supply.
Catalyst #6 Expanding Uses For Silver
Another factor weighing in silver's favor is the number of growing uses for silver. The main uses for silver have been primarily for photography, jewelry, silverware, electronics and batteries. Much of this demand is price inelastic. The small amount of silver that is used in applications makes it an insignificant factor. The amount used in the manufacture of a battery, an automobile, a computer, and in jewelry is insignificant when compared to the price of labor and other materials. A doubling in the price of silver would not effect what GM uses in making a car, Energizer in a battery or even David Yurman in silver jewelry. If a highly refined piece of silver jewelry costs several hundred dollars, a $5 dollar jump in its price or a tripling of its price would be insignificant. More important to the price would be its availability.
MAIN USES FOR SILVER
Batteries
Bearings
Brazing and Soldering
Catalysts
Coins
Electrical
Electronics Electroplating
Jewelry and Silverware
Medical Applications
Mirrors and Coatings
Photography
Solar Energy
Water Purification
Today the main use of silver is still photography, jewelry, and silverware. However, new applications are growing each year. Silver is now used as a biocide and as an electrical and thermal conductor. Because silver has unique properties such as malleability, strength and its sensitivity to light and ability to endure extreme temperatures, substitutions are difficult.
Others, such as Dave Morgan, have written extensively on the uses of silver. I will not attempt to elaborate here on the fine work done by others. To find out more about silver and its uses, the reader can go to The Silver Institute website and Dave Morgan’s Silver-Investor.
Catalyst #7 The Return of Silver as Money
The final catalyst for silver is a return of silver and gold to their real purpose which is money used as a medium of exchange. I would like to point out that since the U.S. and the world went off the gold standard by abandoning Bretton Woods and quit using silver as coin, there has been an attempt to treat silver as purely an industrial commodity. However, throughout time—and I’m referring to 5,000 years of recorded history—silver has been the prominent form of money. In fact, its use as money has been more prominent than gold. Emperors, kings and princes and merchants may have transacted business in gold, but the common man used silver. In trade, silver was the dominant monetary metal until the 20th century. It’s use as money has been recorded in the bible's first book of Genesis. Abraham purchased a burial site for his wife Sarah from Ephron the Hittite for four hundred shekels of silver. [6]
A Unique Commodity
Unlike fiat currencies or paper money, which can be created in unlimited amounts, silver—like gold—has all of the properties of real money. It is divisible, durable and utilitarian. It is tangible. Money is a commodity that differs from other commodities because of its use as a medium of exchange. In each country that has its own unit of money (be they marks, francs and now euros), the original use and function of money was always tied to gold and silver. It was only in the 20th century and briefly during the 17th century that countries deviated from the use of gold and silver as true money used as an exchange medium. Paper currencies were used merely for their convenience, but they were all backed and exchangeable for real money: silver and gold. It is only when money began to be viewed in the abstract that it became easier for governments to cast aside the properties that gave currency its monetary value.
The Depreciating Dollar
Since abandoning gold and silver backing of money, the U.S. dollar has steadily depreciated as seen in this chart above. As a result, we have gone from one monetary crisis to the next. What determines the value of money is the same force that determines all goods and services traded in the market. That is supply and demand. As central banks increase the supply of money into the economy and financial system, the value of its worth depreciates. This is an irrefutable law of economics: an increase in the supply of money will lower its value. Conversely an increase in demand for money will raise its value. In a book on money, Murray Rothbard tells us,
“What makes us rich is an abundance of goods, and what limits that abundance is a scarcity of resources: namely land, labor, and capital. Multiplying coin will not whisk these resources into being. We may feel twice as rich for the moment, but clearly all we are doing is diluting the money supply. As the public rushes out to spend its new-found wealth, prices will, very roughly, double—or at least rise until the demand is satisfied, and money no longer bids against itself for the existing goods… Thus we see that while an increase in the money supply, like an increase in the supply of any good, lowers its price, the change does not—unlike other goods—confer a social benefit. The public at large is not made richer. Whereas new consumer or capital goods add to standards of living, new money only raises prices—i.e., dilutes its own purchasing power." [7]
Loss of Confidence in Paper
In the future what will become a major catalyst for silver and gold is a loss of confidence in paper fiat money. As central bankers, in particular the Greenspan Fed, create vast quantities of credit, in the end it will destroy its value. Look at any place in the world where central bankers or governments are creating an endless supply of money or credit and you will find depreciating currencies, financial turmoil and impoverishment of the people. Monetary alchemists cannot create wealth artificially through fiat means. Real wealth comes only from savings, investment and the creation of capital stock. If it were otherwise, all nations on this earth would be rich and its citizens as well.
I believe the present attempt by central bankers to inflate their respective currencies, and especially the policies of the Greenspan Fed, are leading us closer to The Perfect Financial Storm. This is a topic that I will cover in just a moment. For now it is important that the reader understand that the most valuable property of silver is its historic use as money and not as an industrial commodity. Attempts by the silver and gold industry associations to continue to promote the industrial uses of silver or gold are ridiculous. It goes to show you how little is understood about the concept of money. In less than a generation a real understanding of what money “is” and what it "isn’t" has been completely forgotten and obfuscated by the jargon of modern day economics. People in the 19th century had a greater understanding of what money was and were the most arduous defenders of its value. Today fiat currencies are depreciated endlessly; while debate centers on whether the Fed should lower or raise interest rates or pump or siphon money into or out of the economy. No thought is ever given to the consequences of these actions. When crises erupt as a direct consequences of these actions, even greater cries are heard for more of the money narcotic.
A Great Misunderstanding
Today no attempt is made to understand or learn what money “is” or why fiat currencies have been such a dismal failure. The more crises we go through, the greater the financial turmoil. The growing impoverishment of people as a result of the unlimited creation of fiat money is swept under the carpet. Instead, each new crisis causes government and financial experts to try new forms or methods of financial alchemy. The greatest blame for these misfortunes lays squarely at the foot of our educational institutions which have perpetuated discredited economic theories. They have instead become a breeding ground for economic disinformation.
In the forward to Murray N. Rothbard’s "What Has Government Done to Our Money," Lew Rockwell of the Ludwig Von Mises Institute writes, "…government has always and everywhere been the enemy of sound money. Through banking cartels and inflation, government and its favored interests loot the people’s earnings, water down the value of the market’s money, and cause recessions and depressions. In mainstream economics, most of this is denied or ignored. The emphasis is always on the “best” way to use monetary policy. What should guide the Federal Reserve? The GDP? Interest rates? The yield curve? The foreign exchange value of the dollar? A commodity index?”[8] Rothbard’s book on money debunks all of these ridiculous theories and shows why in the end the fiat system of credit money will fail. Every investor should own a copy of this book if they want to gain a better understanding of what lies ahead as a major monetary storm front approaches.
Catalyst #7 The Dollar and Credit Crises
The Credit Market Storm is Brewing
This brings me to my final argument on the case for owning precious metals, especially silver. The world financial system is heading for a major crisis with the dollar-based monetary system at its epicenter. Since abandoning gold backing of the dollar in August of 1971, we have embarked on one of history's greatest experiments in fiat money. Since that fateful day in 1971, debt and credit of every kind has expanded at all levels of society. Just look at these dramatic charts below. Note the advance of debt after 1971.
To anyone who has gotten this far, I commend you highly.....
Unfortunately, rapidly changing circumstances here will not allow me to continue duplicating this essay, so if you want to read the rest of Puplava's fine effort (where gold is also mentioned), please go to:
http://www.financialsense.com/stormwatch/oldupdates/2003/0702.htm
Dan 
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