 Exploding the
Myth of Silver Shortage
What does the negative
silver lease rate really mean?
Antal E. Fekete
Gold Standard University Live
Oct 1, 2007
On Thursday, September 20,
2007, the lease rate of silver suddenly dipped into negative
territory. It fell to minus 0.1 percent per annum. I wish Ted
Butler stopped bitching about silver manipulation, and instead
explained the behavior of silver lease rates and the silver basis
to his readers. In particular, he should explain negative lease
rates, and negative basis or backwardation. It may be more helpful
in promoting an understanding of the silver market than telling
fairy tales about raptors and dinosaurs.
I have a long-standing disagreement
with this silver analyst. I hold the view, in opposition to Butler's,
that silver is a monetary metal second only to gold in importance.
Supply-demand analysis of price is not applicable to silver,
still less to gold. The reason is that both supply and demand
are undefinable in case of a monetary metal. There is no way
to quantify speculative supply and demand. Speculators make split-second
decisions and from sellers may become buyers, or the other way
round.
Making predictions for the
silver price on the assumption that it is allegedly scarcer than
gold does not make sense. Silver has been, is, and will continue
to be cheaper than gold for a monetary reason that is the very
opposite of the scarcity argument. The monetary stockpiles of
gold are much larger than that of silver. Therefore there is
less of a threat for the value to drop on account of new additions
to the stockpile in the case of gold than in the case of silver.
It is not the absolute change in mine output that has
an impact on the value of a monetary metal, but the relative
change as a percentage of existing stockpiles. For this reason
gold is more valuable than silver: the huge stockpiles of gold
make the impact of a change negligible. Ergo the value
of gold is more stable. In technical language, the marginal utility
of gold declines more slowly than that of silver.
As a consequence, the specific
value of gold is higher. This means that the value of the unit
weight of gold is higher than that of the same weight of silver.
Once this fact has been firmly established by the markets, it
is not likely to change. The monetary metal with the higher specific
value is more portable both in space and time. In more details,
the cost of transporting the unit of value as represented by
gold is lower. For example, if the bimetallic ratio is 15, then
the cost of transporting the unit of value as represented by
silver is about 15 times higher. Roughly the same rule applies
to the cost of storage as well. This makes gold superior to silver
as a monetary metal. It is more suitable as a vehicle to transfer
value over space as well as over time.
But silver is still a monetary
metal, and for certain application such as parcelling out value
in ever smaller bits, for example, silver could be superior to
gold. And, of course, when it comes to enumerating industrial
applications, silver has a very impressive list. In many cases
there is no substitution for silver. However, do not make the
mistake to think that gold has no industrial applications. It
does but, because of its high specific value, these applications
are mostly submarginal and as such they are ignored.
In 1922 Lenin gave a textbook
example of such a submarginal application of gold. At a meeting
of Communist party activists he famously said that, after the
final victory of Communism world-wide, gold will be used for
the purpose for which it is so superbly fitted, namely, to plate
the walls of public urinals. He did not say that his plan could
not be realized in the workers' paradise because workers would
pick the gold plate of urinals just as fast as the government
was installing them.
Another common mistake people
make when comparing gold and silver is to say that gold is "not
consumed" and therefore practically all the gold ever produced
is still available while silver is "consumed" and,
hence, is getting scarcer relative to gold all the time. The
truth is that both gold and silver are consumed, for example,
in the arts (including jewelry). The difference is in the cost
of recovery, recycling, and refining relative to the underlying
value. Precisely because the specific value of gold is higher,
the cost of recovery for gold is lower, so much so that gold
in the form of jewelry is often lumped together with monetary
gold for statistical purposes. By contrast, silver plate could
not be lumped together with monetary silver because of the substantial
cost of recycling expressed as a percentage of the underlying
value.
Returning to the silver lease
rate, this was not the first time it dipped into negative territory.
The 30-day lease rate was pretty consistently negative between
May 25 and August 4, when it shot up and reached a high of plus
0.4 percent on August 31. The fact that negative silver lease
rates are not impossible but a well-observed fact of the silver
market has exploded the myth of a world-wide shortage of silver.
Come to think of it: lessors of silver are willing to pay lessees
a premium for borrowing the metal. But before you rush over to
ask lessors for free silver, you had better come to a correct
understanding what negative lease rate means. The collapse of
the silver lease rate on September 20 to negative territory meant
panic short covering in silver. The shorts anticipated an imminent
and substantial rise in the price of silver and were running
for cover.
How did they know that the
silver price was poised to rise? They were not led by crystal
balls. They acted on the historic correlation between gold and
silver prices which customarily move "in sympathy"
with one another. On September 10 the gold price was getting
ready to break the resistance level at $700, while the silver
price lagged far behind in relative terms. The peak price of
gold for the past 27 years, $730 an ounce, established in July,
2006, was well within earshot. The corresponding peak price for
silver, $15, established at the same time, was not. Thus gold
was well-placed to make a new high soon, silver selling at $12.75
was not. Nevertheless, if gold moved, it was reasonable to assume
that silver would play catch-up. In the event the price of silver
moved some (on Friday, September 21, it closed at $13.50) and,
according to analyst Clive Maund, "was
set to GO THROUGH THE ROOF."
The point is that if this happens,
as it very well might, the price move will not have been caused
by any kind of shortage. The notion that we have a silver shortage
is preposterous. Most of the silver produced by the mines and
sold by the U.S. Treasury during the past 60 or so years still
exists in monetary form. Monetary silver is owned by private
individuals who entrust it to commercials skilled in making monetary
silver yield a return. This is the reason why silver and gold
are monetary metals: they can yield a (more or less consistent)
return to their holder if traded adroitly and professionally.
This fact may not be too well known, but it is true nevertheless.
"Demonetization" has done nothing to destroy the unique
ability of monetary metals to earn a return. Without a doubt,
the best way of making this happen is through playing the short
side of the market. Sitting on a long position of silver will
not hatch the silver egg, nor is it a very intelligent way to
make silver yield a profit. A better way is covered short selling
which to the uninitiated appears to be naked short selling. It
is not.
The commercials are neither
stupid nor suicidal. They are professionals who make it their
business to call the tops and bottoms in the price moves of monetary
metals. It is well-known that they have an excellent track record
in calling the market. This is not because they are vicious people
who manipulate the market to their own advantage enticing the
poor bulls to enter the slaughter-house. They use methods that
are well-known, pretty standard among professionals, and can
be learned from textbooks. Using these methods they can turn
the variable silver price to their advantage (or to the advantage
of their clients on whose behalf they trade). It is not a cabal.
You can join their ranks if you are willing to study those methods
and go through the training which may be too rigorous to your
taste.
If you are envious, or have
moral objections against other people being able to make money
consistently by trading the monetary metals, then you should
lodge your complaint with the government which is responsible
for "demonetizing" first silver (1873) and, a hundred
years later, gold (1973). Before "demonetization" there
were no commercials, no speculators, and no scalpers who made
money by betting on the variation in the price of monetary metals.
Those who had tried to make a living that way went hungry. The
prices of monetary metals were stable.
Whenever the price of silver
significantly lags the rising price of gold, there may be panic
short covering and the leased silver will be returned to the
lessors in a hurry. If the lessors were not prepared for this
avalanche of silver (because they expected that the leases would
be rolled over), then they may not be able to absorb the silver
flowing back to them. In this case the silver lease rate drops
dramatically and may even dip into negative territory.
It is important to be able
to interpret this correctly. As I said, silver is delivered faster
by the lessees than the lessors are able or willing to absorb
it. Admittedly it is a market aberration, but whatever it means,
it does not mean a shortage of silver. Far from it. It indicates
a relative redundance of silver that momentarily cannot find
lessees in view of an impending rise in the silver price.
The verbiage about silver manipulation
is just so much tilting against the windmill. In his latest commentary
dated September 18 Butler distinguishes between upside
price manipulation or cornering the shorts, and downside
price manipulation or cornering the longs. He adds that while
the former is fairly common, the latter is exceedingly rare.
Downside manipulation results in much lower prices than would
otherwise prevail and, when it ends, the price explodes upwards.
Butler is right on. A corner on the longs is in fact so rare
that it does not even exist, except as a figment of the
imagination of some analysts. The longs cannot be cornered, especially
in a corner lasting for years.
Rumor-mongering about present
or future silver shortages does not bring credit to the
analyst. He should go back to his textbooks and study the market
in greater depth. Above all, he should learn the elementary differences
between monetary metals and non-monetary commodities.
We have had a torrent of short
covering recently. It should have caused a meteoric rise in the
price of silver, as predicted by the analysts. It just did not
happen Yet it may still happen. Suppose it does. Will then the
case for market manipulation be established? Of course not. What
it would show is not that the commercials can and do manipulate
the market and control the silver price that way. It would only
confirm what we have known all along, that the commercials have
a superb understanding of the silver market and can correctly
anticipate impending significant price moves.
* * *
At Gold Standard University
we use scientific principles to study paraphernalia such as the
gold and silver basis, the gold and silver lease rates and their
variation. In addition, we look at changes in the NAV (net asset
value) of gold and silver ETFs (exchange traded funds).
We think the best way to make
a profit consistently on silver and gold holdings in troubled
times is bimetallic arbitrage. At its crudest, this means selling
silver to buy gold when the bimetallic ratio (gold price divided
by silver price) falls, and selling gold to buy silver when it
rises. In this was we always buy the monetary metal at a low
price, and sell it at a high price.
However, as a consequence of
concentrated propaganda-gold-sales by central banks and governments,
not only the gold price but also the bimetallic ratio is falsified.
Therefore there is need for refinement, and for enlisting other
clues, in addition to the bimetallic ratio. We believe that such
more refined clues can be derived from the variation in the basis,
lease rates, the NAV of ETFs, and the like, for both gold
and silver.
Under bimetallic arbitrage
there is no profit taking as exchanging monetary metals
for irredeemable currency is considered a retrogressive step,
utterly dangerous to boot. A simultaneous fall of the gold and
silver price is interpreted not as a fall in value of the monetary
metals, but as a temporary bounce in the value of irredeemable
currencies. The trouble is that it could be a dead-cat- bounce.
* * *
As a preliminary announcement
I mention that Session Three of Gold Standard University Live
will take place in Dallas, Texas, from February 11-17, 2008.
(Please note the change of place and date.) It will have three
parts:
(1) a course on Adam Smith's
Real Bill Doctrine and its Relevance Today, consisting of
13 lectures, from February 11-14;
(2) an open-ended debate on
True and Fraudulent Hedging of Gold Mines, with industry
participation representing both sides of the issue;
(3) a panel discussion entitled
Gold Profits in Troubled Times where paraphernalia such
as the basis, the gold and silver lease rate, the NAV of gold
and silver ETFs and the variation of these will be discussed
with invited experts.
Program (2) and (3) are scheduled
for the week-end February 15-17. The registration fee covers
participation in the debates during the week-end, but it is possible
to register for the week-end program only. Participation is limited;
first come first served. Participants pay their own hotel and
meal bills; a closing banquet is included in the registration
fee.
For the benefit of European
friends of Gold Standard University, Session Three will be repeated
in March, 2008, at Martineum Academy in Szombathely, Hungary,
where the first two sessions were held, provided that a sufficient
number of people register. More details will follow later.
For further information please
inquire at GSUL@t-online.hu.
September 25, 2007
Professor
Emeritus
Memorial University of Newfoundland
email: aefekete@hotmail.com
  Professor Antal E. Fekete was born and educated
in Hungary. He immigrated to Canada in 1956. In addition to teaching
in Canada, he worked in the Washington DC office of Congressman
W. E. Dannemeyer for five years on monetary and fiscal reform
till 1990. He taught as visiting professor of economics at the
Francisco Marroquin University in Guatemala City in 1996. Since
2001 he has been consulting professor at Sapientia University,
Cluj-Napoca, Romania. In 1996 Professor Fekete won the first prize
in the International Currency Essay contest sponsored by Bank
Lips Ltd. of Switzerland. He also runs the Gold Standard
University.
Copyright ©2005-2010 by A. E. Fekete<
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