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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 that became famous. 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” (www.321gold.com, September 20, 2007).
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 lessors 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 not long term, the corner lasting for
years.
Rumor-mongering about
present or future silver shortages do 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 ETF’s
(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 ETF’S, 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
rise of the gold and silver price is interpreted not as a fall in value of
the monetary metals, but as a 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 offer two extra features: an
open-ended debate on TRUE AND FALSE HEDGING OF GOLD MINES with industry
participation, and a panel discussion entitled GOLD PROFITS IN TROUBLED
TIMES, where the variation of the lease rate and the NAV will be debated with
invited experts. Session Three is scheduled to take place in February, 2008 in the United States.
The program will be repeated in March, 2008, at Martineum Academy
in Hungary,
where the first two sessions were held, provided that there is sufficient
interest. As soon as plans get finalized further announcement will be made.
Antal E. Fekete
Gold Standard University
aefekete@hotmail.com
Copyright © 2007, Antal
E. Fekete
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