|
When the silver corpse stirs, money doctors run
People
from around the world keep asking me what advance warning for
the collapse of our international monetary system, based as it
is on irredeemable promises to pay, they should be looking for.
My answer invariably is: “watch for the last contango in
silver”.
It
takes a little bit of explaining what this cryptic message
means. Contango is that condition whereby more distant futures
prices are at a premium over the nearby. The opposite is called
backwardation which obtains when the nearby futures sell at a
premium and the more distant futures are at a discount. When
contango gives way to backwardation in all contract spreads,
never again to return, it is a foolproof indication that no
deliverable monetary silver exists. People with inside
information have snapped it up in anticipation of an imminent
monetary crisis.
“Last
contango” does not mean that the available supply of monetary
silver has been “consumed” by industrial applications, as
trumpeted by the cheerleaders of the get-rich-quick crowd. Such
a notion is at odds with the fact that silver has always been,
and still is, a monetary metal. Huge stores of monetary silver
still exist, but are kept out of sight and availability by their
current owners who, for obvious reasons, want to remain
anonymous. “Last contango” is the endgame of the grand
tug-of-war between the money doctors and “We, the People”.
The doctors exiled silver from banking to the futures market
hoping that it will drown there in a sea of paper silver. But
the silver corpse stirs. People withdraw ever greater chunks of
cash silver from exchange-approved warehouses. The money doctors
run scared. If futures trading in silver is unsustainable and
must end in default, then the flimsiness of the house of cards
built of irredeemable promises will be exposed for all to see.
Following the last contango in Washington the money doctors, led
by Helicopter Ben, will follow the example set by the 18th
century Scottish adventurer John Law of Lauriston. He left Paris
in a hurry. In a disguise. Disguised as a woman.
Don’t
kill the goose laying silver eggs
My
main argument justifying the claim that the bulk of monetary
silver has not been consumed is that silver, just as gold, is
far more useful in monetary than in industrial applications.
Provided, I hasten to add, that you know what a monetary metal
is, and you also know how to make it yield a return. Admittedly
very few people do, and fewer still are willing to share their
knowledge with others. Nevertheless, monetary applications of
silver are real. Industrial applications kill the goose that
lays silver eggs. We must also remember that silver consumption
is a relative concept. In Newfoundland tiny silver pieces half
the weight of a silver dime with 5 cent denomination had been in
circulation before 1949. After the country was absorbed into
Canada, these pieces were threaded onto a chain to form
bracelets and necklaces. You may, of course, say that
silversmiths have “consumed” silver but, clearly, these
pieces could re-enter circulation if circumstances warrant it,
as quickly as overnight. While the labor component of the price
of silver cutlery and plate may be greater, again, this is
relative. At a higher silver price it may become negligible.
There is hardly any form of silver consumption the product of
which could not be recycled, provided only that the silver price
is high enough.
The
hairy tale of naked short interest
Every
time the silver price rallies, selling appears and the price
falls back. “Aha”, the cheerleaders cry, “the ‘silver
managers’ are at it again. They are selling silver naked!”
Since the silver managers issue no denial, it is taken as a
confirmation of the hairy tale of naked short selling.
According
to this fable the silver managers gang up against silver
investors in an effort to drive down the silver price, so that
they may cover their naked short positions at a profit. But if
this were true, wouldn’t they sell into weakness rather than
into strength? The fact that an increase in the short commitment
invariably occurs on rallies and it is then reduced on
subsequent dips clearly indicates the absence of malicious
intent. Traders simply take advantage of the variation in the
silver price in order to derive profits from it, much the same
way as hydro plants take advantage of the tides in order to
harness its energy. Nobody suggests that the tide-ebb cycle is
caused by the hydro plants. It is interesting that the
cheerleaders don’t complain when the silver managers buy on
dips. They put a different spin on it. Purchases are described
as the last desperate attempt of the silver managers at short
covering.
Soon
enough this fable of a huge phantom naked short position will be
put to the test. According to the cheerleaders the short
interest should cave in under the burden of unbearable losses.
The silver managers will throw in the towel, and panic-covering
will cause the silver price to go to four digits, non-stop.
“Patience, fellow silver investors, patience! Hang on just a
wee-bit longer! After this last sell-off the price will go
straight up!” Well, we have heard that battle-cry often
enough, long enough. It is getting monotonous, perhaps a little
boring as well.
So
where do we go from here? The cycle of
profit-taking/bargain-hunting/short-covering will, of course,
continue as before. Volatility will grow, quite possibly faster
than the moving averages, maybe far exceeding anything we have
seen so far. The silver price could be up $100 one day, and down
$100 next day, so that a relative top may be indistinguishable
from an absolute top. Lots of investors will be bumped from the
band-wagon prematurely, and they may find it impossible to climb
back. But silver to go to four digits in one fell swoop? No way.
Unless Helicopter Ben’s deeds are as good as his bluffing, and
the air-drop of Federal Reserve notes does start in earnest.
Hedging
or streaking?
I
do not deny that naked short sellers exist. They do. I prefer to
call them “streakers”. Remember “streaking”, the fad of
the 1970's? Young men derived excitement through exhibitionism
as they ran short distances stark naked in busy streets. If the
commercial traders ever run naked, it is likewise for fleeting
moments only. They cover at the first opportunity. Then they may
streak again and cover again. It must be exhilarating. I am not
so sure about its profitability, though.
I
go further. What passes as “hedging” by gold and silver
mining concerns is also streaking. If the miners were hedgers,
then they would plow output into a monetary metal fund and write
covered call options against it. But this is not what they do.
They sell forward their future output, essentially selling
naked, sometimes going out as many as 5 years. Then they cover
part of their short position through purchases of call options.
You can hedge cash gold, but you cannot hedge gold locked up in
ore deposits deep underground that will take 5 years to bring up
and unlock!
“Hungry
pig dreams of acorn”
To
call the gold miners’ forward selling “hedging” is a gross
abuse of language. It should not be permitted by the watchdog
agencies. It is an instance of willfully misinforming the
public. According to a Hungarian proverb “hungry pig dreams of
acorn”. The wheat farmer selling wheat futures before harvest
is not hedging. He is selling forward in order to lock in a
favorable price. He is barred from selling anything in excess of
his current crop. It would be tantamount to selling dreams.
Likewise, the gold miner should also be limited to selling
forward one year’s production.
In
any case, it is not the producer who hedges but the
warehouseman. If the producer calls his forward sales
“hedges”, then he is obfuscating. He wants the buyers of
futures contracts to believe that they are buying something more
substantial than the dreams of a hungry pig.
Streaking
as practiced by gold and silver mining concerns, in contrast
with hedging proper, is a deeply flawed strategy animated by
Keynesian and Friedmanite precepts. The basic assumption is that
spikes in the gold and silver price are an aberration and,
hence, must be temporary. Prices, as everything in economics,
are bound to revert to the mean. The regime of irredeemable
currency is here to stay. The money doctors have perfected
methods whereby we can avoid the pitfalls into which the early
pioneers of fiat currency fell. Take, for instance, the
helicopter. The money doctors of the French Revolution had to
labor without the benefit of air drops of assignats.
Helicopter
and guillotine in aid of monetary policy
This
is not the place to refute Keynesian and Friedmanite fallacies.
Suffice it to say that the helicopter is a dubious asset in the
hands of the Federal Reserve Chairman anxious, as he is, to get
his freshly printed “I-owe-you-nothing” notes into the hands
of the public instantaneously. On the liability side the
Chairman does not have the benefit of another great invention
readily available to the managers of the assignat, namely
the guillotine. As is known, during the French Revolution the
guillotine was used, among others, for the purpose to cap the
price of gold with good effect. So much for hi-tech. As for
lo-tech, absolutely nothing has been learned by monetary science
during the past 200 years to justify the claim that money
doctors can indefinitely entice people to give up real services
and real goods in exchange for irredeemable promises to pay. The
dictum of Lincoln still stands: you can fool some people all the
time; you can even fool all the people some of the time; but you
cannot fool all of the people all of the time.
Money
is not what the government says it is but what the market treats
as such. Silver and gold have been demonetized by the government
through trickery and chicanery: silver in the 1870's and gold a
century later, in the 1970's. Markets have never ratified these
government measures and, presumably, never will in view of the
disastrous record of fiat currencies. Witness the helicopter and
the guillotine, the carrot and stick of monetary policy.
The
principle of reversal to the mean doesn’t work for monetary
metals. Silver and gold mining concerns will find to their
chagrin that their streaking strategy is backfiring. They are
facing horrible losses on their naked short positions. They can
thank their plight to their Keynesian and Friedmanite mind-set,
and to the brainwashing that passes as research and education in
economics departments at all the universities and think tanks of
the world today.
Basis,
the best kept secret of economics
How
many gold mining executives are familiar with the concept of
basis? Maybe one in ten. And how many can use it effectively in
marketing gold? Maybe one in a hundred. Don’t look for a
chapter on basis in Samuelson’s Economics. It is not
there. Don’t try to find its definition in Human Action
of Mises. It is not there either. You have to go to obscure
manuals on grain trading produced by professionals for the
benefit of professionals to learn what it is. As far as I can
tell no economist has ever written about it for the benefit of
laymen.
The
basis earns its name by serving as the most basic trading tool
and precision instrument of the grain elevator operator. In
buying and selling grain he is not guided by the price
and its variation. He is guided by the basis and its
variation. He stands ready to buy or sell 24 hours a day, 7 days
a week. If you wake him up in the dead of the night with an
offer, he won’t ask your price. He will ask your basis. If he
likes it, then it’s a deal, regardless of the price.
Professional buyers and sellers of grain do not quote their
bid/asked price. They have no use for it. They quote their
bid/asked basis.
Recall
that basis is the spread between the nearest futures price and
the cash price. The grain elevator operator buys cash grain
during the harvesting season to fill his elevators to the brim.
He tries to buy cash grain at the widest possible basis (known
as carrying charge). He is planning to sell it when the basis is
getting narrower. His profit is just the shrinkage of the basis.
What is the explanation of this peculiarity? When the grain
elevator operator buys cash grain, he sells an equivalent amount
in the futures market. He must hedge his inventory because the
capacity of his elevator storage space is so huge that even a
minor fall in the grain price will wipe out his entire capital,
if his cash grain is left unhedged.
During
the growing season the basis keeps falling as inventories are
being drawn down. The grain elevator operator tries to sell cash
grain at as low a basis as possible, because he expects to
replace it at a wider basis when the new crop becomes available.
It goes without saying that in tandem with selling cash grain he
lifts his hedges, i.e., buys back his contracts to deliver cash
grain in the future. I repeat, from the point of view of
profitability, the prices at which he bought and sold cash grain
don’t matter. The only thing that matters is the variation of
the basis. Sometimes he buys cash grain at a higher and
sells it profitably at a lower price. How can he get away
with this prestidigitation? Well, he has correctly anticipated
that the basis will shrink faster than the price will fall. He
is aware that he cannot predict the variation of the price,
which is at the mercy of nature. But he may divine the variation
of the basis that depends on human need, which is more
predictable.
Rationing
warehouse space
Moreover,
the basis also helps the grain elevator operator to decide what
type of cash grain to buy and store. Other things being the same
he will buy the grain with the higher basis, and sell the one
with the lower. In this way he can maximize his profit derived
from the shrinking basis. If the basis is higher for wheat than
for corn, then he will keep buying cash wheat in preference to
corn until the basis for corn catches up. Or, suppose, the news
is that corn blight has hit the growing regions. The astute
grain elevator operator will respond by accelerating his sales
of cash wheat, in order to make room for more corn in his
elevators.
The
best way to think about the business of the grain elevator
operator is to assume that he is marketing warehousing services,
including the rationing of warehouse space between competing
uses. His guiding star is the basis. High and rising basis tells
him for which purposes the demand for scarce public warehouse
capacity is the most urgent. Low and falling basis tells him for
which purposes the demand is slack, as people prefer non-public
solutions for their storage problem, e.g., by keeping supplies
closer to home, as often happens in troubled times. Including
digging holes in one’s own backyard.
The
idiosyncrasies of the basis with regard to monetary commodities,
since they can be buried in holes, are quite different
from those with regard to non-monetary commodities, which cannot.
This will be the subject of the last of this 3-part series on
the basis.
Acknowledgement
I
am grateful to Dr. Theo Megalli for calling my attention to the
work of the German monetary scientist Heinrich Rittershausen
(1898-1984) who apparently was the first to make the distinction
between monetary and non-monetary commodities, observing that
the former fails to follow the conventional demand/price
schedule, in his treatise Monetary Theory, now also
available in English translation, see: .
Dr.
Megalli also quotes the remark that has earned many enemies to
Rittershausen in banking, commercial, and industrial circles,
not to mention political circles, a remark that deserves to be
better known: “It was not the gold standard that failed,
but those to whose care it had been entrusted”.
Correction
I
want to thank several readers, too numerous to mention by name,
who pointed out to me an error in my last piece Monetary
vs. Non-Monetary Commodities, see: Under the caption Big
Lie Number Two, in discussing the strategy of writing
covered options, I mistakenly suggested that stop-buy orders,
placed at points where the call options would be exercised,
would kick in as the gold price fell. However, a stop-buy
order would in fact kick in as the gold price rose. The
tenor of the paragraph is also misleading. It suggests that the
strategy can be put on auto-pilot, which is a rhetoric
exaggeration. In fact, the strategy calls for careful
management.
© 2006 Antal
E. Fekete
Professor Emeritus, Memorial University of Newfoundland
Editorial
Archive | Email |
