Storm Watch Update
SILVER
the
undervalued asset looking for a catalyst
by Jim Puplava
www.financialsense.com
July 2, 2003
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Storm Watch Update |
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When I sat down to write The Perfect Financial Storm in the summer of 2000, my storm analogy was based on three storm fronts colliding with each other. Like the real storm on Halloween 1991, three economic forces were turning into storms fronts. The first and foremost storm was developing in the credit markets as a vast mountain of debt was being created. This ocean of money, which had ignited a boom, was now turning into a bust. In order to avoid the consequences of a deflating credit bubble, the Fed embarked on a massive monetary stimulus program. The Federal Reserve was using all of its powers in an effort to stave off the bust and bring temporary relief by manipulating the financial system with the creation of more credit. The result is that today interest rates are at historic lows and credit expansion within the financial system has accelerated even more.
Unconventional in this case may mean buying or monetizing various assets. In the January 2002 FOMC meeting reference was made to buying any kind of asset to pump up the system from US equities, government and municipal debt to real estate and gold mines. If one views the second storm front as a bear market in stocks where we have seen a decline for three straight years and despite twelve rate cuts by 2002, unconventional may also mean propping up the stock market. Injecting reserves into the financial system through Federal Reserve Repurchase Agreements is one method of achieving this. When the Fed purchases securities from primary government bond dealers, it pays for these securities with cash, thereby adding liquidity to the banking system. Member firms then have the available cash to carry out Fed intervention in the financial markets through major purchases made in the futures markets or through the purchase of select market weighted stocks that are included in all three major indexes such as Microsoft and Intel. Mike Bolser, who contributes to The Golden Sextant, has documented this relationship between the increase in Fed repos and the movement of the markets in the charts below. Readers can follow the movement of the repo market at the Federal Reserve Bank of New York, where they are posted daily. In addition piraz.com charts repos daily.
The Four-Step Rally Process I have written in the past how intervention takes place in my four-step rally process, which is repeated below. This pattern has been repeated consistently since last summer's July rally. 1) Intervene in the market (done by buying futures). It is clear that the current market momentum is based on factors other then economics, earnings and valuations. The reason that intervention isn’t freely admitted—as in other countries like Japan where the government is buying stocks—is because the US professes to adhere to free markets. An English statesman in the 18th century expressed it best by saying, “The moment that government appears at market, the
principle of the market is subverted.” The third and final storm front is the economy, which has weakened again. It is clear from recent economic reports that the economy remains anemic. It appears that another stimulus program and more credit and lower interest rates are necessary to sustain it. The recent cut in interest rates has stimulated another round of mortgage refis and it appears that abundant credit is still keeping the housing market inflated. Outside of housing and government spending, there are few catalysts out there to keep the economy propped up. (See Catalyst Part 1) Therefore it appears that more pump priming, more stimuli and other unconventional means will be necessary. The Fed and the government are now engaged in a multi-front program to keep the economy and the markets from collapsing. This includes lowering short and long-term interest rates, running budget deficits through increased fiscal stimulus—both spending and tax cuts—and eventually if necessary debt relief, debauching the currency and any other measure that is necessary to keep the economy out of a depression. It is apparent from the current policy of pumping money,
debauching the currency, and running massive budget deficits that more economic
upheaval and financial disruptions are about to revisit us. The result is that
all three storm fronts in credit, the economy, and the financial markets could
either collide, batter us one after the other, remain contained or isolated, or
unite to form one massive storm front. The monetary jet stream and the
speculators and policymakers that drive it will determine the route and
direction of these multiple financial storms. Whether all three-storm fronts
collide to form The Perfect Financial Storm has yet to be determined. What is
abundantly clear, however, is that we are experiencing no ordinary economic storm.
The bursting of a stock market bubble, gyrating financial markets, a weak
economy, rising unemployment and the failure of rate cuts to reignite the
economy and markets is obvious. With conventional policy methods failing to
achieve their objective, investors must now prepare for unconventional policy
changes and the havoc they may bring. STORM STRATEGY: PRECIOUS METALS In writing my Storm Series, I touched upon investment strategies that would work under various storm scenarios. Prominent among them was precious metals. As currencies depreciate, especially the dollar, confidence in paper will evaporate. This will cause a flight to real money, which I define as gold and silver. While I believe that both gold and silver will do well under any storm environment, I believe that silver has far more upside potential. From a value perspective, silver has many attractive attributes that are hard to overlook. There are eight, which taken together, add up to explosive upside potential regardless of what happens to the financial environment. They are listed below.
Catalyst #1 Supply Side Deficit Demand
Outstrips Supply Demand for silver in all categories of use has increased substantially since silver began running annual deficits back in 1990. The largest use of silver comes from photography, jewelry and silverware. Although photographic and silverware demand have edged lower due to a worldwide recession, this demand is still higher today than where it was in 1990. During recessionary periods, demand for photography, jewelry and silverware may decrease, but supply can also decease since 80% of silver produced is a byproduct of copper, gold, lead, and zinc mining. A good part of last year's decline in mine production was the result of planned closures of copper, lead, and zinc mining operations. The production of these metals is influenced more by economic trends than the price of silver. Photographic demand also influences silver supply since much of the secondary scrap supply is refined from photographic film and chemicals. A decline in photographic demand would also impact secondary scrap supply.
Silver
Prices "Controlled" At this point the reader may wonder why supply deficits have not produced higher prices for gold and silver. Outside government sale of gold and silver, the main reason is we have been living off accumulated stockpiles. A lot of the supply deficit in silver is made up by secondary supply that comes from old scrap and coin melt. Governments have also supplied silver to the market from accumulated stockpiles. The U.S. Treasury held 2.06 billion ounces in 1959. A good majority of this stockpile was sold off during the 60’s with the balance used in the minting of Silver Eagles coins from 1986 through 2002.[1] The U.S stockpile has now been depleted. As of 2002 the largest remaining government silver inventories are in India, which is estimated to hold around 87 million ounces.
The net result of 13 years of silver deficits is that through 2002 the cumulative deficit has been 1,525.5 million ounces.[2] This entire deficit was made up from above ground inventories. Silver inventories have fallen from around 2.2 billion ounces at the beginning of 1990 to less than 500 million ounces today. The cumulative draw down of inventories came mainly from investors during the 90’s who had bought their silver in earlier periods at much higher prices. The great equity bull market of the 90’s made many of these investors disenchanted with their returns on silver. As a result, these investors sold heavily throughout this period bringing more supply to the marketplace, which helped to offset silver production deficits. However, there has been a noticeable increase in investor interest in silver with the sale of Silver Eagles by the U.S. mint rising close to 19% last year. Catalyst #2 Decreased Investor Selling Buying
and Holding Markets
Changing Preferences In
It For The Long Run Catalyst #3 Diminishing Silver Stockpiles
What is clear from known data of annual deficits is that whatever that supply once was, it has certainly diminished as a result of continuous drawdowns. However, this amount has played a mitigating role in one form or another in making additional supply available to the marketplace. Unfortunately experts can only estimate what remains of that supply. Reported inventories held on the COMEX, Tocom, CBT, and U.S. and Japanese Industry have fallen dramatically over the last four years. These institutional inventories have fallen from 245.8 million ounces in 1996 to 144.4 million in 2002, a drop of 41.3%. [3] Don't
Count on Moms and Pops Paper
Market Dominates This drawdown in world silver supplies has been a sleeper and has gone unnoticed by the investment community. This is because the paper markets dominate the silver markets. This can be illustrated by the chart below, which shows the value of annual silver supply versus the trading in paper instruments. The total value of last year’s entire silver usage of 784.8 million ounces is only around $3.6 billion. By comparison, the value of all paper and derivative contracts had a value of $193 billion.[4]
Because most paper transactions are settled in cash, and not bullion, there has never been a need to take delivery or demand it. Most investors have been content to settle their transactions in cash instead of metal. This might not always be the case and remains one of the great vulnerabilities of the silver markets. There simply is not enough silver held in inventories to handle investment delivery should the trend in settlement change from paper to physical. For example, in 2002, 21.9 billion ounces was cleared through London silver markets and 15.7 billion ounces traded on the COMEX. This compares to total production and supply of around 800 million ounces. [5] What
if? The exchange does have a way out should demand overwhelm supply. There is a clause, which allows for cash settlement or payment for silver. This clause may provide a way out if silver ever gets squeezed. However, news of such a squeeze would certainly translate into higher prices in much the same way that the platinum squeeze did in Japan in the late 90’s. Catalyst #4 Declining Interest
More bullion and investment banks are exiting the business of providing trading, financing, credit, or storage facilities to the silver market. Last year two major European investment banks closed their Indian trading operations. The volume of contracts traded through the interbank market located in London has declined for the fifth consecutive year with the volume of ounces traded down by 70.6% from 1997. Withering interest can be seen in the chart on the left. The
Pros Are Getting Out Institutions have watched the steady decline each year in reported silver inventories from the 350-ounce range to today’s 100 million range. Besides Morgan, more banks are closing down their vaults because there isn’t enough silver available in inventory form to make it worthwhile. This is happening around the globe in money centers in New York, London, and Zurich to Hong Kong. Many of the larger investment banking firms have left or closed down their commodity market operations. Still others only keep a marginal presence. As more professional institutions exit the market, liquidity is reduced. Rip Van Winkle Lack
of Investment Alternatives Catalyst #5 Large Paper Short Positions Another catalyst for launching silver prices is the existing large short position in silver bullion on the COMEX. These short positions are a potential catalyst if silver prices suddenly move up. This will force short sellers to cover their positions. Silver has been kept within a narrow trading band for the last decade. Prices have been contained between $4-$5 an ounce range. Over the last year and a half that band has narrowed to $4.40 and $4.80. Technically, this reflects a horizontal or consolidation pattern. Since reaching a peak of $50 an ounce back in 1980, the price of silver has declined 90%. Silver has been a steady decline throughout the 80’s and mid-90’s until falling to within its present band of $4-$5 an ounce.
One-Way
Trading Paper
Versus Physical
The direction of silver prices is more determined by the paper markets than the physical markets. As mentioned, for a decade the price of the metal has been contained within a narrow trading range as traders and short sellers base their buying and selling decisions on technical price patterns. Because there is strong short selling, as silver moves up towards $5 an ounce, the buy and sell range has been ingrained with traders making shorting silver a one-way trade for the last decade. That this condition could exist during a period of large supply deficits demonstrates how paper—rather than physical—dominates and controls the price of the metal. The large silver supply deficits have been unable to act as a catalyst for higher silver prices due to the preponderance of paper silver in relation to physical silver and large above ground stockpiles. These large above ground stockpiles have been depleted by cumulative deficits over the last 13 years by 1,525.5 billion ounces.
Ripe
Conditions Catalyst #6 Expanding Uses For Silver Another factor weighing in silver's favor is the number of growing uses for silver. The main uses for silver have been primarily for photography, jewelry, silverware, electronics and batteries. Much of this demand is price inelastic. The small amount of silver that is used in applications makes it an insignificant factor. The amount used in the manufacture of a battery, an automobile, a computer, and in jewelry is insignificant when compared to the price of labor and other materials. A doubling in the price of silver would not effect what GM uses in making a car, Energizer in a battery or even David Yurman in silver jewelry. If a highly refined piece of silver jewelry costs several hundred dollars, a $5 dollar jump in its price or a tripling of its price would be insignificant. More important to the price would be its availability.
Today the main use of silver is still photography, jewelry, and silverware. However, new applications are growing each year. Silver is now used as a biocide and as an electrical and thermal conductor. Because silver has unique properties such as malleability, strength and its sensitivity to light and ability to endure extreme temperatures, substitutions are difficult. Others, such as Dave Morgan, have written extensively on the uses of silver. I will not attempt to elaborate here on the fine work done by others. To find out more about silver and its uses, the reader can go to The Silver Institute website and Dave Morgan’s Silver-Investor. Catalyst #7 The Return of Silver as Money The final catalyst for silver is a return of silver and gold to their real purpose which is money used as a medium of exchange. I would like to point out that since the U.S. and the world went off the gold standard by abandoning Bretton Woods and quit using silver as coin, there has been an attempt to treat silver as purely an industrial commodity. However, throughout time—and I’m referring to 5,000 years of recorded history—silver has been the prominent form of money. In fact, its use as money has been more prominent than gold. Emperors, kings and princes and merchants may have transacted business in gold, but the common man used silver. In trade, silver was the dominant monetary metal until the 20th century. It’s use as money has been recorded in the bible's first book of Genesis. Abraham purchased a burial site for his wife Sarah from Ephron the Hittite for four hundred shekels of silver. [6] A
Unique Commodity
The
Depreciating Dollar “What makes us rich is an abundance of goods, and what limits that abundance is a scarcity of resources: namely land, labor, and capital. Multiplying coin will not whisk these resources into being. We may feel twice as rich for the moment, but clearly all we are doing is diluting the money supply. As the public rushes out to spend its new-found wealth, prices will, very roughly, double—or at least rise until the demand is satisfied, and money no longer bids against itself for the existing goods… Thus we see that while an increase in the money supply, like an increase in the supply of any good, lowers its price, the change does not—unlike other goods—confer a social benefit. The public at large is not made richer. Whereas new consumer or capital goods add to standards of living, new money only raises prices—i.e., dilutes its own purchasing power." [7] Loss
of Confidence in Paper I believe the present attempt by central bankers to inflate their respective currencies, and especially the policies of the Greenspan Fed, are leading us closer to The Perfect Financial Storm. This is a topic that I will cover in just a moment. For now it is important that the reader understand that the most valuable property of silver is its historic use as money and not as an industrial commodity. Attempts by the silver and gold industry associations to continue to promote the industrial uses of silver or gold are ridiculous. It goes to show you how little is understood about the concept of money. In less than a generation a real understanding of what money “is” and what it "isn’t" has been completely forgotten and obfuscated by the jargon of modern day economics. People in the 19th century had a greater understanding of what money was and were the most arduous defenders of its value. Today fiat currencies are depreciated endlessly; while debate centers on whether the Fed should lower or raise interest rates or pump or siphon money into or out of the economy. No thought is ever given to the consequences of these actions. When crises erupt as a direct consequences of these actions, even greater cries are heard for more of the money narcotic. A
Great Misunderstanding In the forward to Murray N. Rothbard’s "What Has Government Done to Our Money," Lew Rockwell of the Ludwig Von Mises Institute writes, "…government has always and everywhere been the enemy of sound money. Through banking cartels and inflation, government and its favored interests loot the people’s earnings, water down the value of the market’s money, and cause recessions and depressions. In mainstream economics, most of this is denied or ignored. The emphasis is always on the “best” way to use monetary policy. What should guide the Federal Reserve? The GDP? Interest rates? The yield curve? The foreign exchange value of the dollar? A commodity index?”[8] Rothbard’s book on money debunks all of these ridiculous theories and shows why in the end the fiat system of credit money will fail. Every investor should own a copy of this book if they want to gain a better understanding of what lies ahead as a major monetary storm front approaches. Catalyst #7 The Dollar and Credit Crises The
Credit Market Storm is Brewing
Along with this expansion of credit, the value of all paper currencies have declined in purchasing power. During the 1970s, inflation was manifested in the value of “things” as in commodities. Investors and citizens lost all faith in government and paper money, which led to a preference for owning tangible goods, especially gold and silver. This can be seen in the charts of gold and silver from the 70’s below.
The
Rise of Bond Market Influence The concept of lender of last resort has expanded the moral hazard. Today’s financial institutions—whether they are financial intermediaries or hedge funds—have no regard for risk. The risk of loss or financial failure, which governed lending and investment decisions in the past, no longer holds sway over today’s billion-dollar financial bets. Central banks, especially the Greenspan Fed, have shown a greater degree of intolerance for financial failure of any kind. The bigger the institution and the greater the risk it takes, the greater chances are that any failure or mistake will be met by bailouts of one form or another. In the end, it is the taxpayer who pays and stands behind this risk. Addicted
to Debt and Leverage Last year total credit in the U.S. expanded by $2.3 trillion. This enormous amount of debt was divided between nonfinancial credit (60%) and financial credit (40%), which compares to national savings of only $286.7 billion.[11] Credit is the fuel that drives the American economy. It is also what drives the U.S. financial markets. By driving down short-term interest rates, the Fed has engaged the whole spec community and driven them into a wild orgy of speculation in the carry trade. Hedge funds and speculators can borrow short at rates of 1% and then invest that borrowed money in higher rates from Treasuries paying 3-4% to junk debt paying over 10%. This leveraged money employed in the carry trade is what drives the bond markets. Whereas in the past the bond markets reacted to short-term policy changes in short-term interest rates, today the bond market acts on behalf of itself. The Fed’s role has been relegated to one of moral suasion; trying to influence the participants towards a directed outcome. An example of this is the May 5th Fed meeting where the Fed announced it was worried about deflation even while real inflation of goods we need from food to energy heats up in the economy. The policy statement—which was nothing more than moral suasion—was an attempt by Fed officials to direct the spec community and herd them into playing the yield curve. The result was that money moved into the long-end of the market, driving down interest rates in an explosive bond rally that took 10-year rates down to the 3% level and drove the long bond into the 4% zone. This in turn ushered in lower mortgage rates, which led to another round of mortgage refis putting more debt money into the hands of consumers. The policy objective is to lower the carrying cost of debt in order that more debt can be accumulated (translation: additional consumer spending). Consumer spending now accounts for 90% of U.S. GDP. The U.S. economy has transformed itself from an economy that saved, invested and produced goods into an economy that borrows, consumes and trades off asset bubbles. (See Debt Valley and We Are Consuming All of Our Seed Corn) Financial
Speculation
Funny
Numbers Any reference to earnings, valuations or any other measure of value is artificially inflated by using a whole new set of different metrics. I find it difficult to believe that economists, analysts, and investment strategists are incapable of comprehending what “is” and what "isn’t" earnings, what “is” and what "isn’t" an ordinary business expense, or recognizing that stock options are a payroll cost. I believe we have developed a whole new set of metrics for valuation. Why? If investors really understood what they were really paying for earnings, it would scare the hell out of them.
We
John Q's Just Don't Get It "…the policy obsession with inflation is paving the way for a crisis of immense proportions. In a cruel but familiar twist of logic, the only antidote to this forthcoming crisis will be a deliberate and coordinated reflation of the large developed economies. The crisis is destined to replace the inflation of the 1970’s as the defining economic event of today’s adult generations, just as the second Great Depression of 1929-39 became the dominant experience of the generations recently deceased."[12] Is this not where we are today as Fed officials talk about reengineering a return of inflation and ramping up prices in the economy? The same tools that created asset inflation are now being redeployed in an effort to create goods inflation throughout the whole economy. Not recognized is that the surfeit of credit that grossly distorted asset prices also led to malinvestments and excess capacity in the economy. It is the main reason why capex spending has been so anemic. You aren’t about to build a new factory when existing factories run idle. The truth of the matter is this: what is really being attempted here is to keep asset bubbles inflated in the stock, bond and real estate markets. These inflated asset values provide the collateral that backs the credit and consumption bubble. Read
Between The Lines What is not clearly understood by policymakers, academics,
economists or investment strategists on Wall Street is the precarious position
of the world’s debt-based financial system. That financial system is heading
straight into the path of a giant storm front. Like the Titanic on that fateful
night, the financial system is steaming at full throttle right into a path of a
wide swath of icebergs oblivious of any risk. Investors, consumers and citizens
are the passengers on board that ship. They believe that it is unsinkable and
that the ships captain, Mr. Greenspan, is infallible and capable of steering clear
of any financial icebergs. Most don’t understand how quickly a ship can sink—or in this case—how quickly inflated asset bubbles can deflate. It is time to
become financially prepared. THE ROLE OF PRECIOUS METALS
Gold is Compelling
This disparity in values is also reflected in the Dow and the price of gold. Based on the closing prices on the day this essay segment was written, that ratio was 26.34 (Dow Industrial close of 9079.04 and a gold close of 344.70). This movement to under valuation as a result of gold’s long-term bear market and the Dow’s long-term bull market can be viewed in the charts of the Dow vs. Gold on the left. This ratio of over valuation to under valuation reflects the movement of markets between bull markets in paper to bull markets in commodities or “things” as I like to call them. Eventually markets correct and reverse themselves, which is what the paper and precious metals markets are now doing. Eventually this ratio should approach 1:1. Many such as Richard Russell believe that this ratio will reach that point when the Dow and gold prices cross 3,000. This makes for a compelling case for owning gold and precious metals equities. Investors have done well over these past three years by buying gold bullion and investing in precious metals stocks. I believe that this new bull market in gold and precious metals is only in its formative stages. Investors would do well now to add to their current positions or to begin accumulating if they haven’t done so already. Various advisors recommend a minimum position of 5-10% in a portfolio. Given the nature of the monetary storm fronts ahead of us, a 20% weighting is preferable and even higher depending on age, risk tolerance and levels of wealth. Silver is Even More Compelling As convincing as the case is for gold, the case for silver is even more compelling. This can be viewed by the next graph that shows the ratio of the Dow and the price of silver. As of the close of June 26th that ratio was 2006.42 based on a 9,079.04 close on the Dow and a close in silver of $4.525. Gold and silver are clearly undervalued in relation to stocks.
By far, silver is the more undervalued of the two precious metals. This is visible in the chart of the ratio of gold/silver on the left. Gold has appreciated and broken out from its bottom back in 2001. Meanwhile silver has been kept within a narrow trading range of $4-5 dollars for more than a decade. This is surprising given the fact that in between two recessions and a booming economy, silver has run continuous deficits. I can think of no other asset besides gold where this remains the case. The investor is led to believe that this present state of the silver markets is natural. Can you think of any other asset where this is so? If demand far exceeds supply, natural economic laws would dictate a rise in price until supply and demand are in balance. Natural
Laws Do Matter Market pricing mechanisms would work to lower demand and raise prices until supply and demand were back in balance again. I would challenge anyone to dispute this simple truth of economic law. I would also go a step further and challenge anyone in the financial community, especially bullion bankers, to explain how this apparent supply/demand aberration functions. Do they think people are this stupid? I guess they do. Demand increases each year with supply unable to meet demand and this results in annual deficits. Yet the price of the metal goes nowhere. It is kept confined within a narrow range and never allowed to break out of this range. How
"They" Combat The Price of Silver The CFTC pays no attention to the amount of these short positions in relation to available inventory. The thought of large deliveries isn’t even considered or the fact that it could ever become a problem. Current CFTC rules favor the short sellers. In fact laws are in place that make it difficult to take delivery since delivery is limited to no more than 1,500 contracts a month or 7,500,000 ounces of silver. Even then this amount could be changed arbitrarily by the Exchange. There is an Exchange rule that says delivery is also limited to amounts that are “customary” or “ordinary.” For example in the month of July, if normal delivery is 500 contracts, in a period of crisis, they could in effect limit delivery in that month to 500 contracts. Because most contracts are settled in cash and taking delivery has never been considered a problem, short sellers have been able to put in place large short positions without ever being squeezed. Most people would rather settle in cash rather then bullion. That may not always be the case as the value of cash evaporates with the depreciation of the dollar. As U.S. financial difficulties increase and the dollar loses more of its value, the movement out of paper will accelerate. This is going to lead to increased demand for real money and that means silver and gold. A large short position on the COMEX that goes well beyond the ability of the Exchange to deliver will then become a problem. The Exchange at this time might go to cash settlement without ever releasing available inventory. If that happens, we will be at the crisis stage—a time when demand for physical metals will be high. The
problem is that investors who are long may not be able to take delivery, since
COMEX inventory levels are far below long positions. An example would be
today’s 79,990 long silver contracts representing 400 million ounces of silver
against only 46 million ounces that are held in registered form available for
delivery. One can only imagine what open interest and long positions would rise
to in a period of crisis or in a short squeeze. Suffice it to say that in any
crisis where metal is demanded, there would be a problem getting delivery. One
only needs to look at the platinum and palladium crises in Japan to see what
will happen here. (See The
Big Squeeze) CONCLUSION The Catalyst is Here
Precious metals stand in sharp contrast to the fiat currency system that now dominates global finance. This system of credit and paper money—with nothing to back it—is now heading straight for a financial crisis with the dollar at its epicenter. The
Depreciating Dollar The present madness or delusion at the Fed that they can create prosperity through massive debt creation is about to be shattered. The trade deficit, the national and state governments' deficits and America’s total outstanding debt dramatically show that this giant mountain of debt is about to reach its upper limits. When consumers no longer have the ability to borrow money or extract equity out of their homes, when the housing bubble begins to deflate, when foreigners no longer buy our paper or even worse—refuse to accept it as payment—the crisis will be upon us.
M-M-Mania There is another aspect about the U.S. today that is much different than 1930 or Japan in 1990. Today the U.S. is the world’s largest debtor nation. In 1930 the U.S. was the world’s largest creditor nation as Japan is today. The fates of creditor nations are much different then the fates of debtor nations. The U.S. is fortunate to have its currency function as the world’s reserve currency. This allows the U.S. the ability to export its inflation to the rest of the world. We can simply print as many dollars as we need and use those dollars as payment for the goods we import. This system only functions as long as other nations are willing to accept our paper dollars in exchange for their manufactured goods or raw materials. Global
Financial Changes Coming
This shift out of the dollar will accelerate as a flood of dollars hits the financial system. These dollars entering the world's financial system is the result of our burgeoning trade and current account deficit. At the moment, the dollar's fall has been temporarily arrested through the process of intervention. However, as the amount of debt increases in our economy, as the trade deficit gets bigger setting new records, as the government's own budget deficit expands and grows even larger, confidence in the dollar will evaporate. There will be a rush for the exit gates. I fully expect that when this happens, the U.S. will impose capital controls in an effort to contain the crisis and keep it from spreading. The capital controls could come in the form of different color money—one inside the country and one for outside the U.S. There will be an effort by the Fed to restrict the free flow of dollars out of this country as there will be an effort to keep dollars from returning.
The New York Times recently published an article about the U.S. government seizing money in foreign banks. The government’s justification was that it was ill-gotten money. This was done without warning or the due process of law. [13] There have been similar instances in our past where in a time of crisis, the government has seized assets. The most blatant example of this was the 1933 confiscation of gold by the Roosevelt Administration. [14] Many believe (just like they did back in 1932) that it could not happen here again. I believe that it will. Debtor nations always resort to policies of asset confiscation when they get desperate. They seize assets, put in capital controls and shut down banks. The recent example of Argentina should be fresh in everyone’s mind. When governments get desperate, they will do anything in their power to keep functioning. Capital controls never work. They only hasten the currency's collapse. Who
or What Will Be Their Scapegoat? If there is one point that I hope to make in this entire essay, it is this: The dollar is heading for a crisis never imagined before in this nation’s history. The U.S. is no longer the nation it once was. The U.S. is no longer self sufficient in manufacturing, no longer self sufficient in energy and no longer self sufficient in capital. This will make the upcoming crisis that more severe. We can’t function without energy, so we have to import it. Many of the things we use from farm equipment to industrial machinery are no longer made here. Just look around your house and examine the labels of the things you buy and where they are made. You will see how dependent we have become on foreign manufacturing. Chances are that your TV, stereo, computer, printer, cell phone, clothes, tableware or car were manufactured overseas. We consume and don’t save. We must borrow money from the rest of the world to pay for our own consumption. What happens when the rest of the world says "No!"? We are not an empire as many would suggest. Our only form of tribute is getting foreigners to accept our dollars. We use gentle persuasion when necessary and overt persuasion when we are threatened. But the U.S. can’t place an army in every country to enforce the acceptance of our dollars. The
1930s All Over Again?
A
Monetary Storm on The Horizon IT'S TIME TO GET PREPARED FOR THE STORM The best way to get prepared is to get out of debt and to start building an ark in order to ride out the coming storm of the century. This means owning and accumulating precious metals both silver and gold.
Another strategy to consider is keeping or storing your bullion outside the country. Avoid storage in U.S. banks or foreign banks that do business here in the U.S. Bullion held in U.S. banks could be subject to confiscation by the Fed when the monetary storm hits in full force. Why do you think Warren Buffett took delivery of his silver overseas?
When the price of bullion skyrockets and becomes unavailable, there will also be a mad rush for anything associated with gold and silver. Equities would move even faster than the price of bullion. At some point during the crisis, all of that money is going to be looking for safety and there are very few safe choices. Most money will move into foreign currencies because it is the only market large enough to accommodate it. However, the big move will be in the metals market both in bullion and in the precious metal equities. If you are buying precious metal equities, you want to own unhedged companies with good properties, mines in safe jurisdictions and companies with good cash flow and a strong balance sheet.
I began this series of essays with the title “Catalyst.” I saw the precious metals market—especially silver—as a sleeping giant waiting for a catalyst to ignite it. That catalyst I believe will be a financial and monetary storm that is kindled by an unforeseen or unexpected event, either geopolitical or financial. Monetary authorities are desperately trying to keep the financial markets under control, but they are gradually losing their grip. That is usually how these maelstroms begin. Something happens that is unexpected that turns the tide of events. A bomb is dropped, an archduke is shot, a stock market crashes and suddenly the course of history changes. History has a way of repeating itself. The same mistakes are made over and over again as if to remind us of Santayana’s dictum that those who fail to learn from history are doomed to repeat it. Each generation must learn by making its own mistakes. It is human nature and hubris to think we are smarter then those who have gone before us. Human nature never changes. It is the same today as it was yesterday. All knowledge is folly unless it is turned into wisdom. Sadly, it is wisdom that we lack most both in Washington and on Wall Street. So history's same calamities are about to revisit us. It is time to prepare. ~ JP Footnotes | |||||||||||||||||||||||||||||||||||
This brings up the third catalyst for higher silver prices,
which is dwindling stockpiles. I have already made reference to the huge
drawdown in above ground stocks as a result of the deficits of the past thirteen
years. According to CPM Group, non-coin inventory is around 419 million ounces
with an additional estimated coin inventory of about 487.5 million ounces. The
difficulty of estimating silver inventories lies in the fact that much of the
world’s silver is now in the hands of individual investors and consumers.
Arriving at an exact estimate as to what that amount is can only be estimated.
This to me is the perfect contrary
indicator: professionals exiting the market due to their
lack of interest and profitability. Combined with reduced liquidity, diminishing supplies, lingering
deficits and
few alternatives for investing
At some point in the near future, these above ground
stockpiles will fall to critical levels and the price is going to explode like a
NASA space launch. It will explode for three reasons. The main one is that it
will be in short supply and in the short run there are no large stockpiles to
supply a sudden spike in demand triggered by a price rise. Inventories of silver
in the form of jewelry, silverware, and religious objects are not the same as
silver bullion. They are held for personal reasons and not sold and traded
in the same way as the metal. As such they cannot be mobilized to meet demand
in the same way that bullion bars held in warehouses can if market conditions
change. The price will also explode due to the thin nature of the markets. The
actual physical market for silver and silver equities is extremely small.
There are less then 10 pure silver mining stocks and the physical market is less
then $4 billion. This compares to the trillions that are traded in the currency
markets and the hundreds of billions that trade each day in the stock and bond
markets. The final catalyst for an explosive price rise is the large perpetual
short position that exists on the COMEX, a short position that is 4-6 times the
actual amount of silver that could be delivered if investors insisted on
physical delivery. Currently, it is almost 10 times the amount of available
silver for delivery. (See 
The bond markets today have become the final arbiter. The Fed’s main
function is to keep supplying liquidity to the financial system in its role of
lender of last resort.
Just as “clicks” and
“stickiness” were used to sell investors overvalued (and in some cases
worthless Internet and technology stocks), pro forma numbers are used in the same
way to sell investors an overvalued stock market. The same applies to the
economic numbers which are now made up entirely of pro forma numbers from
hedonically indexed technology sales, imputed rents, hypothetical income from
no-fee checking accounts and slimmed down inflation numbers as a result of
technology improvements, to seasonally massaged employment numbers capable of
making lost jobs disappear.
Throughout
this essay I have identified several factors that build a strong case for
precious metals, especially silver. The most important point to understand is
that silver and gold represent real money that is not someone else’s
liability.
America’s
debt problem is so large now that the only way out is to inflate our way out of
it. The appetite for government spending in this country is insatiable. We are
running not only large current account balances with the rest of the world, but
we are also incurring large budget deficits that could run as high as $400
billion and go still higher. At the same time we are also about to add a major
new entitlement at a time we are at war. It is back to guns and butter again,
although this time our debt levels are far greater. This means that with
government revenues declining and government spending accelerating, the
government is now actively printing dollars to finance its deficits. This is
what is causing the dollar to depreciate.
Here
we are seventy years later doing the very same thing. It began with the
Chairmanship of Alan Greenspan in 1987. Since his tenure at the Fed, money
creation has known no limits. This can be seen in the chart of M3 Money Supply
Index since his reign began in 1987. There has never been anything like it in
world history. The only similar comparison would have to be John Law and 17th
century France. Yet Greenspan’s money creation penchant makes John Law look
prudent by comparison. It would be safe to say there has never been anything
like this in monetary history. This is alchemy taken to the outer limits. What
Greenspan has done and is now in the process of doing is the equivalent of
creating a monetary Frankenstein. The only problem is that he does not know how
to control the monster. Frankenstein is loose and traversing the monetary
landscape wrecking havoc on anything he touches. We must now prepare ourselves
for the consequences.
