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Caveat Venditor! Major Discord Between Paper & Physical Silver Supply
The recent bear raid on silver – a 30% drop over only four days – has left many concerned about the sustainability of its historic run…with [many] commentators… making the bubble call. Silver bubble 2.0? Hardly. Anyone who has been fortunate to have been invested in silver over the past few years would unfortunately be used to such blatant takedowns. The Chinese don’t call it the “Devil’s Metal” for no good reason. With so much talk these days about the risks of investing in silver, we think that perhaps it may be timely for us to weigh in on the matter. The silver market is riskier than ever – but for reasons the vast majority of pedestrian commentators have failed to grasp. [Let us explain.] Words: 1517
So say Eric Sprott and Andrew Morris (www.sprott.com) in an article* which Lorimer Wilson, editor of www.munKNEE.com (It’s all about Money!), has further edited ([ ]), abridged (…) and reformatted below for the sake of clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. They go on to say:
Speculative dollars have been flowing into the silver market. Over 1.1 billion ounces worth of silver traded every day in the month of April… in the SLV, Comex futures, LBMA transfers, and the Shanghai Gold Exchange futures instruments [alone which is]…truly a staggering number when contrasted against the actual amount of silver available for investment. To wit, the world will only supply about 979 million ounces this year from mine and recycling of scrap, of which it is estimated that 657 million ounces will be used up for non-investment purposes so, in effect, that leaves only 322 million ounces available this year (or 1.3 million ounces per trading day of available supply) for investment purposes. This means, essentially, that the amount of physical silver actually available for investment is traded 891 times over each day! It really begs the question; just what are people trading in these markets?
The Comex, the largest and most prominent of those markets and which we believe has owned an effective monopoly on silver price discovery for decades…churned over 800 million ounces of silver futures and options on average each day in April. Indeed, notwithstanding the massive but very opaque over-the-counter silver derivatives market, trading on the Comex dwarfs both the physical and the other (known) paper silver markets – combined. Despite its dynamics being relatively complex and generally not well understood by most, the world’s financial community continues to view trading on the Comex as representative of the fundamentals for the physical silver markets. [With] a market built on a high amount of leverage, both the buyers and sellers of Comex futures and options contracts are able to establish a position in “silver” with pennies on the dollar in collateral and even more astonishingly, no physical silver backing the contracts at all. The following charts illustrate just how unreal these markets have become.
In chart A [below] we compare the total open interest in Comex futures and option contracts to the actual amount of silver held in registered inventories able to be delivered against those contracts, since 2009.
Chart A:
Source: Bloomberg, Sprott Asset Management
Chart B:
Source: Bloomberg, Sprott Asset Management
In chart B [above] the steeply-sloping line shows the ratio of open interest (i.e. paper silver ounces) per ounce of physical silver held in inventory. We believe the historical trend of rising open interest and falling inventories deserves considerable attention from anyone attempting to understand the silver market. Although we do note that since October 2010 the trend of rising open interest appears to have abated, the inventories have been evaporating steadily and thus the ratio of the two measures has continued to trend higher. In fact, since 2009 the ratio of paper silver to physical silver has increased fourfold from approximately 8 times to almost 33 times, where it stands today.
What is the significance of this discord between paper and physical supply on the Comex? [If you recall, over 800 million ounces traded each day in April on that market…[but] as at the end of April there were only 33 million ounces of registered inventories to back up all of that paper trading… If just 5% of all of that buying actually stood for delivery the entire inventories would be more than wiped out [but] despite the steady erosion of these already scant Comex inventories – a characteristic which would surely be interpreted as most bullish in other commodity markets – the price of silver has actually declined since April! We endeavour to provide a framework for understanding this phenomenon below.
Selloff Reeks of Manipulation
Those who were following the developments in the silver market in April and May will recall that the CME Group raised both initial and maintenance margins five times within less than a two week span effectively raising the minimum amount of capital required to participate in the silver futures market by 84%. This is significant due to the amount of leverage in the futures market and also due to the losses resulting from the precipitous sell-off which began on Sunday, May 1st, when several thousand contracts were wantonly dumped onto the very thinly traded after-hours silver futures market causing the silver price to plunge 13% within the span of less than 15 minutes. …In our opinion, [such activity] just reeks of manipulation. How else can one explain the dumping of several thousand SI futures contracts within the course of 15 minutes, in one of the most illiquid hours of trading, without seemingly any regard for price or a fundamental catalyst to speak of?… [please refer to the original article* to read the considerable technical information on what effect that would have on the price of a contract that has been omitted here to ensure a fast and easy read for the majority of readers.]
Current Setup Extremely Bullish
Let there be no mistake, we view the current setup as extremely bullish. In our view, whatever froth and excess was present in the paper markets has likely been shaken out in the recent selloff. The remaining longs do not seem willing to part with their silver at these prices…
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What is perhaps most important is that despite what has recently transpired in the paper silver markets, the robust demand fundamentals for silver have not changed in our view. For confirmation of this, look no further than the physical silver market (i.e. the real silver market) which is providing us with evidence almost daily of a sustained bull market for physical silver.
- Demand for coins remains at unprecedented high levels at the US, Perth , Austrian, and Royal Canadian Mints.
- The Chinese, who were net exporters of silver only four years ago, imported 300% more silver in 2010 than 2009 and such large quantities of imports are expected to continue.
- Last year, Indian silver imports increased nearly six-fold, and this year consumption is expected to rise nearly 43% according to the Bombay Bullion Association.
- In Utah, silver (along with gold, of course) will now be accepted in weight value as legal tender.
- According to Hugo Salinas-Price, a prominent Mexican billionaire, there is now “very strong support for the monetization of silver” in the Mexican congress.
- We suspect the Europeans are likely to account for an increasing amount of silver purchases going forward as well.
In fact, we just can’t imagine a better outlook for silver fundamentals. This really makes us question who could be short such massive quantities of silver and why – particularly in those leveraged paper silver markets…
We have a very tough time understanding those bearish arguments against silver. [On one hand] we look at the real silver market, and based on the supply and demand data coming from the real, physical markets for silver, the fundamentals are only getting stronger. [On the other hand] there exists another silver market, which as we’ve shown, is not very connected to the physical realm at all and although silver investors have suffered the tyranny of a rigged paper monopoly over silver price discovery for decades, it appears to us that the tides are turning.
Conclusion
In the age of QE to infinity, investors are being more scrupulous with their capital and, as such, they are demanding physical silver in quantity. With more and more dollars flowing into the silver markets and a finite supply of physical to meet that demand, the theoretical losses for the paper silver short-sellers are near infinite. With such a skewed and obvious risk/reward payoff vastly favoring the longs, we pose the following question:
Who is most at risk in the silver markets: the buyers of a scarce and real asset that serves a growing multitude of purposes, or the sellers, who are short a quantity of silver which may very well not even be obtainable at anywhere near current prices?
Let the Seller Beware!
*http://www.industrymailout.com/Industry/View.aspx?id=288771&q=332372187&qz=8211f9
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Editor’s Note:
- The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
- Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above.
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