Valuable Silver, Invaluable Advice

June 20, 2003

Nearly three years ago, I wrote an article for the public called "Silver to Zero." The basic premise of that piece, published on October 20, 2000, was that silver is being depleted at a fairly rapid rate - which will, sooner or later, cause the world to begin experiencing a shortage of silver.

Many of my facts came from the CPM Group, acknowledged for its extensive research in all metals. CPM's Silver Survey for the year 2000 had reported that at least 1.3 billion ounces of silver were used during the prior ten-year period, well in excess of the quantity mined. Now, CPM has issued its Silver Survey 2003, and guess what? That's right - not much has changed. The world still uses more silver than it mines - a condition that has persisted now for 14 consecutive years.

That should translate into higher prices - but it hasn't! As a result, silver bulls are getting a bit impatient - and who can blame them? After all, I recognized this obvious disparity way back in my first article, asking: "Why aren't silver prices reflective of the true fundamentals of the market?" However, I also predicted the silver price would not show any significant strength until we see silver inventories near zero.

Now, three years later, that bold statement certainly seems to have been validated, as does the reasoning on which I based it - reasoning that still fully applies: The paper market controls the price.

Over the past three years, both the CFTC and the Comex have been queried numerous times about the silver situation, with probing questions posed about both commodity law and possible market manipulation. Their responses are clouded in the typical bureaucratic mumbo-jumbo, but one thing stands out clearly: The only manipulation that really concerns the CFTC is in the near, or spot, month. That's the only trading arena where definitive rules are in place that the exchange officials can enforce.

To clarify, here's a direct quote from one CFTC letter in response to a question about steps taken to prevent manipulation:

"The market surveillance group also monitors compliance with the Commission's and the exchanges' position-limit rules, which help prevent traders from accumulating concentrations of contracts of a size sufficient to possibly disrupt a market. To monitor those limits, market surveillance staff reviews daily large-trader reports for potential violations. Although bona fide hedgers are exempt from speculative limits, staff continues to monitor hedgers' compliance with their exemption levels. Speculative limits in physical-delivery markets are generally set at a lower level during the spot month (the month when the futures contract matures and becomes deliverable). Lower limits in the spot month are important because that is when physical delivery may be required and when the contract may be more vulnerable to price fluctuation caused by abnormally large positions or disorderly trading practices. The Commission requires that spot-month levels for physical-delivery markets be based upon an analysis of deliverable supplies and the history of spot-month liquidations."

As we said, mumbo-jumbo - so let's do a little translation. First of all, a hedger is a seller - or, as more commonly known, a short seller. And, these good ol' boys are exempt from limits. Yep, sure enough! The CFTC even says they are, by golly. As such, they are allowed to sell as much silver as they want on paper. The sky's the limit! Heck the moon is the limit! In fact, there is no limit!!

So, as a hedger, one can sell as much "paper" silver as one cares to. But, if you want to stand for delivery - i.e., if you want to buy the actual physical metal - then you are subject to limits and, if you try to buy a tad too much, you face the full investigative powers of the CFTC. This situation is similar to the one George Orwell described in Animal Farm: "All animals are created equal, only some animals are more equal than others." In other words, the CFTC says hedgers are exempt - but, "We are watching anyone that might disrupt the real physical silver market."

This is a somewhat contradictory stance since an earlier CFTC letter essentially said that excess selling by hedgers was controlled because, if short sellers drove silver prices to an undervalued level, all buyers had to do was "stand for delivery" and the resulting demand for physical silver would push prices back up. However, as the above quote stated, that notion is apparently invalid since any commodity trader who actually buys too much silver in any given spot will fall under the immediate scrutiny of CFTC regulators.

That regulatory inconsistency provides the answer to a question I've received numerous times in recent years, which is: "With silver so undervalued, why doesn't someone just buy up all the silver on the Comex and be done with it?"

In other words, the answer is they can't - the CFTC is watching for just such a "problem."

So, in summary, here's how the CFTC regulation works: Sell all the silver you want, if you don't really have it, and it's no problem. In fact, you can do it with unlimited abandon. But, contract for and ask to actually receive even one more ounce than the limit - and it's a BIG PROBLEM!!

It's because of this rule that I have a slightly different take on the term "stand for delivery." On the back of the dust jacket for Paul Sarnoff's book, Silver Bulls, there's a picture of William and Nelson Bunker Hunt appearing before Congress, hands raised, swearing to the truth of their testimony about their own efforts to corner the silver market in the late 1970s. Called on the carpet in front of Congress - that's my idea of the true meaning of "standing for delivery!"

Of course, now that I've explained why someone doesn't just buy up all the silver on the Comex and be done with it, I have to expand slightly on my answer: Actually, in spite of the CFTC rules, someone ALREADY HAS bought up the bulk of the market's available silver.

That person is none other than Mr. Warren Buffett himself. Not very long ago, Mr. Buffett bought nearly 130 million ounces of silver - and the impact was far from subtle. In fact, if you look at the Comex inventory before and after the Buffett announcement, you will notice a very rapid depletion of Comex silver. 1

The result is a very interesting situation on the Comex. The overall silver inventory currently stands at about 106 million ounces. However, the eligible category has now climbed to roughly 60 million ounces, while the registered category stands at just 46 million ounces. This is the only time in recent history I can recall that the eligible category has been greater than the registered category.

If you follow the market closely, you know that this is quite significant. Most analysts agree the eligible category is held by long-term investors who are willing to wait. These investors expect much higher silver prices, and their inventory is merely resting in the Comex warehouses. In simple terms, this means the traders and dealers have a mere 46 million ounces; the rest is more or less for display purposes only.

Obviously, this is a bit of an overstatement on my part. While the eligible silver is currently on display and cannot be delivered, all it takes is some minor paperwork to place it back in the registered category. Thus, at some higher future price, this silver can and likely will be sold. Only the long-term holders who currently control this silver know what that higher future price actually will be, based on their own objectives. However, I firmly believe it will prove to be far higher than the current price!

When Nelson Bunker Hunt tried cornering the silver market, what he actually took off the Comex was 50 million ounces. Given the above numbers, we can clearly see that, if Mr. Hunt where to appear in the silver market today, he would be unable to acquire 50 million ounces from the registered category. Although this is a subtle and not well-recognized shift in silver inventories, I'm nonetheless sticking to my basic premise that the Comex physical deliverable supply is dwindling.

As far as I know, those who follow my work - as well as the work of others who comment on the silver market - are tired of hearing about the fundamentals of silver supply and demand over and over again. Let's face it, how many times can you tell people that we've had a silver deficit for 14 consecutive years? The investor says: "Thank you. That's a very nice piece of information - but it's done nothing for the price! All it has done is frustrate me as I've been holding silver for quite some time, and these facts just don't seem to matter to the market."

So, in response to this, I'd like to provide some alternate insights - which will hopefully encourage the bulls one more time. This time, I want to examine the silver market from a slightly different perspective, focusing on VALUE!

Value investing is a cornerstone of long-term growth and asset accumulation. Investors with patience survive the ups and downs of the market and are more likely to emerge wealthy than those who try to ride the market's short-term swings. Let's begin by looking at a few definitions of value.

Value: Relative Worth

The relative worth of silver is very difficult to determine. However, if we look at monetary history, we can find very clear evidence that silver was valued at about 1/12th the price of gold for several hundred years. Why is this? Although it cannot be proven, this is what I call the natural ratio - the ratio at which silver and gold appear in the earth's surface. In other words, for every ounce of gold that has been mined, twelve ounces of silver have been mined. It seems the market determined this natural ratio as the equivalent exchange rate between the two metals when both were used as money. Comex rules can be changed, but this historic ratio of silver to gold is a historic fact and cannot be changed.

Value: Fair Return, or the Equivalent in Exchange for Goods, Services or Money

Again, you'll have to bear with me while I talk a little bit more about monetary history. First, there was once a syndicated cartoon series in several major newspapers called "Another Day, Another Dollar." This cartoon series illustrated the struggles of everyday life. Although the cartoons had nothing to do with silver, it did have an interesting title: "Another Day, Another Dollar." What's so interesting about this is that, at one time, one silver dollar was one average working man's daily wage. If silver were priced at today's minimum wage, we would see that a day is worth almost $50US. However, silver is priced at just one-tenth that amount. That obvious devaluation is further understated by the fact that, relative to the time when this cartoon was popular, the silver supply is considerably smaller, while the dollar supply is substantially greater.

Value: Industrial Importance, or Rate of Usefulness

Many of us determine the worth of something based on how useful or needed the service or good may be. For example, food and gasoline are basic to most of the world, a fact few would argue. Silver is also essential for modern life - but almost everyone is asleep to this fact. Indeed, this is where silver shines - no pun intended. The industrial importance of the metal is almost beyond definition, with the uses for silver far too numerous to list for the purposes of an essay of this size. However, as a reminder, the metal has applications in medicine, photography, computers, cell phones, electronics, batteries, switches, jewelry, coins, and environmental protection - to name just a few.

One argument that personally annoys me is what I call the situational economic scenario. This contention goes like this: If you were in the Mojave Desert and dying of thirst, then a glass of water would be more valuable than gold. This, of course, would be true - but it's a very specific case. Logic demands that, to truly determine value, we examine all cases and only then draw our conclusion. In many parts of the world, water is far more abundant than gold; therefore, it's less valuable.

The area most of the human race is concerned with, however, goes beyond survival, stretching to include security. Generally, as we age, security becomes more and more important to us as individuals - and, in civilized societies, security is largely a function of financial survival. We may not think of investing as financial survival, but anyone who has suffered a tremendous loss in an investment will likely agree with this assessment.

Traditionally, cash savings have been the safest and most certain way to achieve financial security - less risk than any other asset class and minimal potential for loss of principal. As an illustration, people with cash generally survived the Great Depression economically, while people with stocks - or, even worse, assets financed with debt - did not.

The problem with cash savings lies in the value of the currency in which it is held. >From a historic perspective, all paper money has proven worthless over time - and now is no exception, with the roster of world currencies littered with paper of questionable value. The only "currencies" to have remained valuable for thousands of years are gold and silver.

Even the markets for paper securities themselves support this contention. For example, only a few of the stocks that made up the Dow Jones Industrial Average 100 years ago are even in business today. However, one that did survive (until its recent acquisition) was the Homestake Mining company - a company whose assets were denominated almost entirely in gold and silver.

Thus, there can be little question that silver stands tall when assessed on the basis of value. It's just a matter of time until the market snaps to and translates that value into higher prices.

David Morgan ( is a widely recognized analyst in the precious metals industry; he consults for hedge funds, high net-worth investors, mining companies, depositories and bullion dealers. He is the publisher of The Morgan Report on precious metals, the author of Get the Skinny on Silver Investing, and a featured speaker at investment conferences in North America, Europe and Asia. You can receive a free 30 day trial subscription here

1 cubic foot of silver weighs approx 655 pounds whereas 1 cubic foot of gold weighs more than half a ton.