Silver: The Undervalued Asset Looking for a Catalyst

It has been reported that this article was circulated on the Chicago Board of Trade shortly after its release in 2003 when silver was trading at $4.60 an ounce.


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.

The Fed is now pulling out all stops from lowering interest rates, monetizing debt and using unconventional means to prop up the markets and the economy. It is believed that “unconventional” equates to intervening in the financial markets. In statements going back to 1989, recent research papers and comments made during FOMC meetings, the Fed has made reference to ”unconventional” measures in case current monetary policy becomes ineffective.

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.

Source: G. Michael Bolser

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).
  2. Higher stock prices through intervention forces short covering.
  3. Stock prices that lurch higher bring in momentum players.
  4. If the rally lasts long enough, John Q may move money into mutual funds. This happens just about the time the rally fades.

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.” - Edmund Burke

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.

Silver Catalysts

  • Supply side deficits now into the 14th year.
  • Decreased investor selling.
  • Diminishing supply stockpiles.
  • Declining institutional and investor interests.
  • Large paper short positions.
  • Expanding uses for a scarce metal.
  • The return of silver as money.
  • The dollar and credit crises

Catalyst #1 Supply Side Deficit

Demand Outstrips Supply

One of the most astonishing aspects about silver as a commodity is that demand has outstripped supply for nearly fourteen years, including projected deficits for 2003. Annual silver deficits have run as high as 200 million ounces in boom years and as low as 40-50 million ounces in years of recession. Even in years of economic stress, as in the recession of 1991 or more recently in 2002, demand continues to outstrip 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.

Few Pure Producers

Another aspect about silver supply that is important is that there are very few pure silver producers. In fact you could count them on two hands. This handful of silver producers along with a few governments account for the other 20% of silver mine supply. With the exception of mines in Mexico, Peru and a very few other locations, it has simply been uneconomic to produce silver at these historic low prices. A few junior mining exploration companies have chosen to acquire silver properties and sit on them until such time that sustained prices make it economical and profitable to mine.

Silver Prices "Controlled"

I can think of very few other commodities, besides gold and energy, where low prices continue to persist despite rising demand. Under normal economic circumstances greater demand than supply would lead to higher prices. This has not been the case with precious metals. Precious metals are a political commodity with their price governed by government policy. Government has a vested interest in keeping precious metal prices controlled because gold and silver metals represent a challenge to government fiat currency. A gold or silver backed currency would limit the government’s ability to print money, expand credit and debase the value of the currency. Therefore, governments have a vested interest in keeping the price of silver and gold low and controlled. They do this through the outright sale or leasing of gold or through leveraged paper instruments known as derivatives. This can be viewed by the charts below on derivative issuance and dishoarding of gold by the UK/US and the price of gold.

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

Since investors have been a key source of secondary supply over the last decade, a decrease in investor selling and an increase in investor interest in silver is a second factor that bodes well for silver prices in the years ahead. Investor interest is a key factor because, as stated above, investor selling has been an important supply source making up part of production deficits over the last decade. Although global investors continued to sell last year, the amount of silver sold has been gradually decreasing. In addition to reduced selling investment, demand shows signs of reviving with U.S. government Silver Eagle sales growing from 5.6 million ounces in 1998 to 10.5 million ounces last year.

Markets Changing Preferences

India, which is a major market for silver, is also experiencing a change in investor preference. The latest CPM report noted a change in investor interest moving from jewelry and decorative objects to a preference for buying bullion bars. Part of this may be the rise in silver prices in local currencies. The other reason may be a growing recognition of the investment merits of owning silver. This year the Indian government is willing to allow gold and silver to be traded on Indian futures exchanges. The government has yet to allow the export of silver and gold. However, when and if that happens, it would create both a greater supply of silver as well as a source of future demand by expanding and integrating India with world markets for precious metals. Investor demand for silver occurs mainly in North America, India, the Middle East, and Southern Asia.

In It for the Long Run

Another positive attribute about silver demand is that silver investors tend to be long-term investors. Silver was accumulated throughout the 60’s and in the 80’s. Dishoarding took place only after the U.S. equity mania had taken off during the mid-90’s. This demand may accelerate due to a bear market in equities that has the potential to persist throughout this decade. Debasing currencies around the globe (especially the dollar) and record low interest rates also make silver, along with gold, an attractive investment for hedging against a decline in paper assets. Recognizing that the bear market in equities is far from over, combined with central banks that are injecting vast amounts of liquidity into the world financial system, currency debasement will accelerate, thereby making precious metals more attractive as an investment alternative. In my opinion, this is the greatest wild card for precious metals—especially for silver. The return of investment demand could cause precious metals, in particular silver, to explode. The supply side of silver could not accommodate an influx of investor demand without the catalyst of higher sustained prices for silver.

Catalyst #3 Diminishing Silver Stockpiles

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.

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

Although individual inventories of coin, jewelry, silverware, heirlooms and religious treasures still remain substantial, they remain elusive as a source of supply to the markets. They cannot be marshaled as easily as COMEX inventory to make up shortfalls in supply. What would drive more individuals to part with their silver is not readily known. Suffice to say it would probably be substantially higher prices. This happened during the later stages of the great silver bull market of the 1970s when households brought silverware and other silver items to the market as the price of silver soared. Even then, silver jewelry and religious items may be price inelastic having more personal rather than monetary value.

Paper Market Dominates

What is clear is that the demand for silver continues to remain high with production supply deficits each year. Production has not been able to keep up with demand for several decades. Secondary scrap sales, coin melt and government stockpiles have made up the difference. Today there are no large government stockpiles of silver left in the world outside of India. Coin melt has diminished from its peak in the 1970s and secondary scrap sales are a two-edged sword because they are dependent on silver use. This has many experts asking “when” and not “if” silver inventories reach critically low enough levels to trigger a price reaction in the marketplace.

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 .6 billion. By comparison, the value of all paper and derivative contracts had a value of 3 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?

Imagine this. What might happen to the price of silver if investors gradually or suddenly lost faith in paper assets and demanded physical delivery? The fact that this may someday happen shouldn’t be casually dismissed. The value of paper contracts far exceeds the ability of any exchange to handle should physical delivery ever be demanded. As of this writing open interest in silver on the COMEX is 83,905 contracts. Long positions are 79,990 contracts and short positions are the same. It is the long contracts that pose the greatest danger because they could change their preference from one of settling in cash to one of settling in metal. Remember, short sellers have a choice of settling in cash or providing metal. These long positions represent 400 million ounces of potential silver demand. Against this amount there are only 107.2 million ounces of silver on the COMEX of which only 46 million are registered and available for delivery. The other 61 million ounces is in the eligible category and not available for immediate delivery. Many of these eligible ounces are held on the COMEX for storage purposes for either future use or as an investment. Although they could potentially move into the registered category and become available for delivery, it is unlikely all of this amount would do so.

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

Besides dwindling supplies, the next positive catalyst and one of my favorites is declining interests in silver by the professional investment community. Over the last few years a growing characteristic of the silver market has been an erosion of the metals market structure.

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

According to the latest CPM Group report, bullion and brokerage companies accounted for the majority of the decline in lost trading activity. More and more of the professional community have been exiting the business because of lack of interest. The market has simply become too small and unprofitable to remain in the business. In 2000 both Morgan Guaranty and Republic’s Delaware facility ceased to be registered as COMEX vaulting facilities.

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

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—whether in bullion or equity—this translates into the potential for enormous opportunity. It might be better said by saying a lifetime opportunity.

Lack of Investment Alternatives

As the CPM Group points out in their recent silver report, investing in physical silver is extremely difficult in North America because there are few available outlets. Small investors, outside the COMEX, account for silver investments. They make their investments either through a local coin shop or by buying Silver Eagles through the U.S. mint. Large investors have found that investing in silver has become more difficult. CPM reported an anecdotal story about a number of medium sized and wealthy investors contacting the firm with an interest in making a 0,000 - ,000,000 investment in silver. These clients reported difficulty in finding silver of this kind of volume at a reasonable price. The lack of silver investment alternatives from equities to bullion to finding competitive storage facilities has made it much more difficult to invest in silver. There are few outlets for making large silver investments and there are few equity alternatives as well. Add this to the fact that silver is consumed and it is not hard to see how this market can explode to the upside, especially if investor demand returns as confidence is lost in paper.

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 - an ounce range. Over the last year and a half that band has narrowed to .40 and .80. Technically, this reflects a horizontal or consolidation pattern. Since reaching a peak of 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 - an ounce.

One-Way Trading

The silver market has been a one-way trade for more than a decade. The only way to make money in silver has been to short the metal. The technique has been to go long when silver falls to the lower range of its band at . Then you go short as the price of silver heads up towards . This one-way trade has dominated the silver markets and remains to this day. Occasionally silver prices have spiked up when supplies are short or demand has increased or on news like when the markets learned that Buffett was buying silver. Besides these occasional forays into higher price zones, silver has been range bound for over a decade. There appears to be strong price support at the lower end of and selling pressure at the upper end towards an ounce. The narrow trading band appears to be edging upward over the last few years, but outside an occasional price spike, it still remains confined to within its narrow trading band.

Paper Versus Physical

A harbinger of what might happen in the future was demonstrated last year with the fall in the equity markets and the decline of the dollar. Investor interests returned briefly to the markets last spring as U.S. equity markets were imploding. Speculators rushed into the silver markets driving prices up quickly. These speculators were mainly momentum traders who started to buy silver on upside breakouts. Because this market is so thin, all it took was a small increase in trading volume to send silver prices skyward. Silver equities performed even better. In fact silver equities outperformed gold shares last year.

Source: StockCharts

Source: Gold-Eagle
Based on the price of silver & AEM, SIL, PAAS, PENOLES, HL, SSRI & CD

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 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.

The 3-Stage Silver Rocket

  • Short Positions
  • Thin Market
  • Short Supply

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 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 Five Smooth Stones)

Ripe Conditions

The short sellers have been able to control the markets for over a decade in a one-way trade. History teaches us that markets ignored and silent for decades can abruptly change. I would suggest that given all of the monetary and financial uncertainties that now exist and the fact that central bankers are hell bent on burning the value of their respective currencies, conditions are ripe for an abrupt sea change in the silver markets. The metal has been confined to within a narrow range in part due to the fact that silver is perceived as an industrial metal. With economic weakness prevalent around the globe, the price of silver is also range bound by its association with weak industrial demand. Besides the large perpetual large short positions, economic weakness and the belief that silver is only an industrial metal have kept the price from rising. It is often forgotten that although the primary demand for silver has been industrial—unlike gold—silver is consumed which reduces supply.

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 dollar jump in its price or a tripling of its price would be insignificant. More important to the price would be its availability.

Main Uses for Silver

  • Batteries
  • Bearings
  • Brazing and Soldering
  • Catalysts
  • Coins
  • Electrical
  • Electronics
  • Electroplating
  • Jewelry and Silverware
  • Medical Applications
  • Mirrors and Coatings
  • Photography
  • Solar Energy
  • Water Purification

Source: The Silver Institute

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

Unlike fiat currencies or paper money, which can be created in unlimited amounts, silver—like gold—has all of the properties of real money. It is divisible, durable and utilitarian. It is tangible. Money is a commodity that differs from other commodities because of its use as a medium of exchange. In each country that has its own unit of money (be they marks, francs and now euros), the original use and function of money was always tied to gold and silver. It was only in the 20th century and briefly during the 17th century that countries deviated from the use of gold and silver as true money used as an exchange medium. Paper currencies were used merely for their convenience, but they were all backed and exchangeable for real money: silver and gold. It is only when money began to be viewed in the abstract that it became easier for governments to cast aside the properties that gave currency its monetary value.

The Depreciating Dollar

Since abandoning gold and silver backing of money, the U.S. dollar has steadily depreciated as seen in this chart above. As a result, we have gone from one monetary crisis to the next. What determines the value of money is the same force that determines all goods and services traded in the market. That is supply and demand. As central banks increase the supply of money into the economy and financial system, the value of its worth depreciates. This is an irrefutable law of economics: an increase in the supply of money will lower its value. Conversely an increase in demand for money will raise its value. In a book on money, Murray Rothbard tells us,

“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

In the future what will become a major catalyst for silver and gold is a loss of confidence in paper fiat money. As central bankers, in particular the Greenspan Fed, create vast quantities of credit, in the end it will destroy its value. Look at any place in the world where central bankers or governments are creating an endless supply of money or credit and you will find depreciating currencies, financial turmoil and impoverishment of the people. Monetary alchemists cannot create wealth artificially through fiat means. Real wealth comes only from savings, investment and the creation of capital stock. If it were otherwise, all nations on this earth would be rich and its citizens as well.

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

Today no attempt is made to understand or learn what money “is” or why fiat currencies have been such a dismal failure. The more crises we go through, the greater the financial turmoil. The growing impoverishment of people as a result of the unlimited creation of fiat money is swept under the carpet. Instead, each new crisis causes government and financial experts to try new forms or methods of financial alchemy. The greatest blame for these misfortunes lays squarely at the foot of our educational institutions which have perpetuated discredited economic theories. They have instead become a breeding ground for economic disinformation.

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

This brings me to my final argument on the case for owning precious metals, especially silver. The world financial system is heading for a major crisis with the dollar-based monetary system at its epicenter. Since abandoning gold backing of the dollar in August of 1971, we have embarked on one of history's greatest experiments in fiat money. Since that fateful day in 1971, debt and credit of every kind has expanded at all levels of society. Just look at these dramatic charts below. Note the advance of debt after 1971.

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.

Transference of Inflation to Financial Markets

The regime of fiat money took a new twist during the late 70’s and early 80’s as governments turned to central banks for advice. That advice eventually led to the transference of inflation from the economy to the financial system. Central bankers used interest rates as a tool to restrain borrowing by individuals and businesses. At the same time they recommended a reduction of government borrowing and the substitution of financing government deficits through the selling debt instruments to domestic and foreign investors. Inflation from this point forward would manifest itself in the form of rising financial asset prices as money and credit found an outlet in the financial markets. A secondary result of this policy is that a greater portion of America’s debt now lies in the hands of foreign institutions.

Peter Warburton wrote in “Debt and Delusion,” this new system of finance led to a movement away from conventional bank lending towards capital market finance. As a result of this transformation, the most important centers for the creation of credit have now become the capital markets. [9]Today financial intermediaries, government sponsored entities and Wall Street Security firms have become the creators and distribution centers for expanding credit. The traditional form of lending rooted in the banking system was completely displaced by the capital markets. In that process the Fed and other central bankers lost a great deal of their authority to regulate credit.

The Rise of Bond Market Influence

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. The avoidance of a deflationary debt collapse has become the Fed’s main objective. The Fed has always worked to provide a safety net for the banking system. However, that role is inadequate given the proliferation of numerous financial entities today—each of whom are large enough to precipitate a financial collapse. The LTCM crisis in 1998 was just a prelude of things to come.

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

”For the moment, anarchy in the global financial markets masquerades as an agent of national prosperity and personal freedom. It is a compelling disguise, underpinned by many clever arguments and supported by many persuasive advocates." [10] One of the underlying theses of Warburton’s “Debt & Delusion” is that citizens and governments have become heavily addicted to debt and no longer care about its consequences. This has become more clearer with each passing day as policymakers both in Washington and on Wall Street advocate even more credit and debt in order to solve America’s economic malaise.

Last year total credit in the U.S. expanded by .3 trillion. This enormous amount of debt was divided between nonfinancial credit (60%) and financial credit (40%), which compares to national savings of only 6.7 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

In addition to the bond market bubble, which feeds off a continuous supply of cheap credit, a portion of that credit also goes into financial speculation in the stock market. It has become apparent that the Fed is once again trying to reinflate the stock market bubble along with keeping the real estate bubble inflated in order to avoid a deflationary debt collapse and another depression. Having expanded credit throughout the 90’s and now the 2000s, the Fed created a giant asset bubble first in stocks, then in real estate. The Fed is now in a fretful state because of the consequences of seeing these bubbles deflate. The result would be the possible collapse of the financial system and a depression. In trying to fight and prevent these two events from occurring, it is expanding credit, monetizing debt, intervening in the financial markets, debasing the currency and using every means of persuasion to direct the markets in an effort to achieve a certain outcome. In this one sense the U.S. economy and financial markets no longer operate freely, but are now centrally planned.

Funny Numbers

At the moment the Fed is trying desperately to keep asset bubbles in equities, bonds, mortgages, real estate and consumption from deflating. In order to do this, financial markets have taken on a whole new language that is divorced from fundamentals both in the economy and in the financial markets. Instead of earnings based on GAAP (Generally Accepted Accounting Principles) we now get CRAP (Cloudy Reporting Accounting Principles).

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.

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. In a bubble economy based on credit, everything is an illusion—including wealth. We feel more "prosperous" as a result of inflating asset bubbles. However this too is an illusion. This wealth is all leveraged and not owned and it is subject to asset deflation.

We John Q's Just Don't Get It

This inability to comprehend what is money and distinguish it from fiat credit also blinds us from understanding inflation. By recognizing only inflating goods prices as inflation, it has kept us from recognizing asset bubbles when they occur. If financial assets such as stocks and bonds or real estate appreciate far beyond fundamentals, we see this in light of a bull market, not as another form or manifestation of inflation. Inflation has and always will be a monetary phenomenon. Again quoting Burton,

"…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

All of this talk about deflation is a ruse. Real goods or things that we need are experiencing real inflation. All of that credit inflation in the financial sector is spilling over into the real economy resulting in rising prices. The cost of food and energy are up. Oil prices are near a barrel—so much for lower oil prices after the end of the Iraq war. Natural gas prices are hovering over and we haven’t hit the winter months when demand rises due to weather. Medical costs along with insurance premiums are soaring, tuition costs are up, the cost of entertainment is going up from the cost of admission to a baseball game to the cost of a movie ticket. Even more detrimental to the economy is the rising cost of government in the form of higher taxes. This is visible in the raising of income taxes, sales taxes, property taxes and fees by governors and mayors across the U.S. Here in California the governor by fiat just tripled the tax on motor vehicle registration. And even though the President just lowered income taxes, the Federal government will take back about a third of that tax decrease through the hideous and deceitful alternative minimum tax. This hidden tax will in the future ensnare more and more Americans by the end of this decade.

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 brings me back full circle to the purpose of this essay, which is the role precious metals will play in surviving these storms. As the debt-based fiat money system begins to unravel with each new financial crisis, confidence in government and fiat money will evaporate. The interest in real money is picking up as reflected in the price of gold. The crossover of longer-term moving averages clearly shows that gold has begun a new bull market. Likewise, a crossover of the S&P 500 shows just the opposite. We are in the early stages of a new bear market in stocks.

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 .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 -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

The financial experts would now have you believe that the natural laws of economics do not apply to the silver markets. Anytime silver rises in price, it is kept contained through the use of derivatives or short positions. In other words, the price of silver is being managed. This is why we have supply deficits. The natural market mechanism of price is not allowed to work in the silver markets. Plain and simple: the price of silver is managed and controlled. If it wasn’t, silver prices would be a lot higher than they are today.

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

Each time the price of silver rises, you will find a sequence of events taking place. The first thing that happens is that short positions on the COMEX go ballistic or the sale of options increase until the price of silver is capped or brought down. The size of these short positions is always larger than available silver supplies. Most of the time they are 4-6 times greater than available supplies that could be used to satisfy delivery. The size of these short positions is not limited by CFTC laws. This is because there are no limits on speculative positions except the current spot delivery month. Since there are no limits to the amount of silver that can be shorted or options contracts sold, they can increase in sufficient size and grow exponentially until the price of silver is capped or brought down.

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)


The Catalyst Is Here

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.

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 dollar's recent declines have been arrested through active intervention in the currency markets. However, history shows that planned intervention eventually fails. The markets always, and I say always win out in the end.

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.

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 0 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.


There is plenty of talk about deflation today that strikes me as complete nonsense. Inflation is a monetary phenomenon. As the chartss of the M’s on the above right indicate, the money supply is increasing with M3 jumping by 0 billion last month, an annualized rate of .75 trillion! That amount of credit creation is inflationary. It is why the cost of everything you need from food and energy to services is escalating.

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

A movement has begun to shift away from the dollar. This movement is only in its formative stages. Countries in the Middle East are talking about changing payment for oil from dollars to the Euro. It began with Iraq. Saudi Arabia is considering it, along with Venezuela as well as Indonesia. Other nations in the Middle East and in Asia are considering going to a gold backed currency. Then there is the introduction of the Euro which now competes with the dollar. One of the reasons the dollar has fallen over the last 18 months is that institutional money is shifting into the Euro. Central banks have also begun a program of diversifying their reserves from dollars to the Euro and even gold. China’s central bank last year bought 200 tonnes of gold.

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.

Desperate Measures Are Coming

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?

Despite the failure of these policies, they are repeated over and over again throughout history. Politicians are incapable of leveling with the people. They have a very hard time admitting that they have misspent and mismanaged the nation’s economy. Instead they look for scapegoats—anyone that they can blame for their own mismanagement. As the currency is debauched and spirals worthlessly downward in value, it will be blamed on currency speculators, foreigners or the owners of precious metals. In times of crisis, government always needs a scapegoat. The wrath of the people becomes too great and it needs to be assuaged. The scapegoat, whomever or whatever is chosen, becomes a deflection for politicians to use to distract citizens from the real cause of the crisis which is too much money creation.

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?

Some believe that the next dollar crisis will bring war with the rest of the world. In a similar fashion, we seem to be following in the footsteps of the 1930s from trade wars and tariffs to giant government spending programs funded through credit and the inflating of the currency. It is hard to believe that after what we went through during the 1920s and 30’s, we would repeat the very same mistakes today. Yet that is exactly what we are doing now. The 1929 Crash and the Great Depression that followed were directly attributable to the expansionary credit policies of the Fed during that decade. The crash that resulted and the subsequent Depression that followed can be blamed on inept monetary and fiscal policies. It was the narcotic of credit that led up to the Crash. Let me repeat that thought. It was irresponsible fiscal and monetary policies that turned a stock market crash into a prolonged depression.

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.

A Monetary Storm on the Horizon

What is coming is a monetary storm that, if met up with additional storms in the financial markets and in the economy, will collide to bring us the Perfect Financial Storm. When I began my Storm Series back in July of 2000, I still believed that we had a chance of avoiding the Perfect Financial Storm. If we had only let the bubble deflate, the malinvestments to be liquidated and market forces to restore balance, the Perfect Financial Storm might have been avoided. It might have been painful, but we could have worked our way through it. Instead the Fed has fought a credit bubble by creating additional bubbles with credit. So today we not only have a bubble in the stock market, but even bigger bubbles in the bond market, in real estate, in mortgages and in consumption. There is now way out of what is coming. There is no going back to the way things were. There is too much speculative capital in the financial system, too much debt in the economy and too many asset bubbles. Greenspan has taken us beyond the point of no return. The only thing left to do now is to get prepared.

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.

Accumulate Precious Metals

I would recommend owning both silver and gold with a greater weight given to silver. Silver has more upside potential given its scarcity and price decline. It has already lost 90% of its value since reaching its peak back in 1980. I would take physical delivery of your gold and silver purchases whether you are buying bars or coins. Avoid storing your gold or silver in unallocated form. When you store bullion in an unallocated form, you become an unsecured creditor of the bullion bank. This means you are subject to the bullion bank’s solvency. Under no circumstances let yourself be talked into taking delivery and title in either unallocated, pooled or certificate form. A gold or silver certificate is some else’s promise to pay you either gold or silver. It is in effect an IOU.

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?

Own Gold & Silver Equities

In addition to owning bullion, you should also consider gold and silver equities. Pure silver equities are in fact rare. I can count them on my two hands. In the financial storm that is coming, there is going to be a mass exodus out of paper with people looking for a safe haven that isn’t someone else’s liability. This will create an enormous demand for precious metals. There simply isn’t enough available silver and gold bullion to handle this demand. There are tens and tens of trillions of dollars invested in paper assets. Just imagine what will happen when some of this money moves into precious metals. The money will be moving into bullion first and then equities.

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.

Consider Foreign Government Bonds

There simply aren’t a lot of alternatives in a monetary and financial crisis besides silver and gold. There are foreign currencies, but they are merely a substitute for silver and gold. All countries are deprecating their currency. It is simply a question of how much and how fast they are doing it. If you are uncomfortable with too large a position in precious metals, then your next choice would be to own government bonds of a strong currency country—if there is such a thing.

Get Out of Debt!

I might add that you don’t have to be rich to get yourself prepared. You can begin by doing your best to get out of debt or at least stop taking on more debt. However, if you are heavily indebted, I feel the time is running out for you unless you begin liquidating that debt now.

If in Cash, Consider a Small Investment

If you are just beginning to invest, you can start out by investing in coins or a precious metals mutual fund. If you are fortunate to be able to invest more, I would look at owning bullion in larger quantities. You can even invest in mutual funds that strictly own bullion, several which own that bullion outside the jurisdiction of the United States.

Begin Now!

You must understand that the time for becoming prepared is running short. You must begin now without hesitation. Some people are perpetual procrastinators; while others are doubting Thomases. Not unless they can see the storm clouds directly overhead are they ever prepared to act. If you are one of these types, I don’t know what else to tell you other than to challenge you to think for yourself.

  • Do you believe that asset bubbles can continue forever or that debt can bring prosperity?
  • If you have a lot of debt, do you really feel secure or wealthy because of it?
  • If you are banking on the government or the Fed to bail you out of your problem, is bankruptcy and welfare a desirable option?
  • Look around you. Open your eyes. Read the headlines.
  • Ask yourself what is it that you see?
  • Become informed. Get educated.
  • In the final analysis, the only person responsible for your outcome is yourself.

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


[1] CPM Group, Silver Survey 2003, p.31
[2] Ibid, p.27
[3] Ibid, p.17
[4] Ibid, p.26
[5] Silver Standard, 2002 Annual Report (pdf), p.26.
[6] Book of Genesis, chapter 23, verses 10-15.
[7] Rothbard, Murray N., What Has Government Done to Our Money?, p.32-33.
[8] Ibid., P.9.
[9] Warburton, Peter, Debt & Delusion, Trafalgar Square, 1999, p.12-19.
[10] Ibid, p.18.
[11] The Richebächer Letter, June, 2003, p.2.
[12] Warburton, Peter, Debt & Delusion, Trafalgar Square, 1999, p.35.
[13] Lictblau, Eric, US Cautiously Begins to Cease Millions in Foreign Banks, The New York Times, May 30, 2003.
[14] Smith, R. Maurice, Preparing to Survive The New Age/New World Order, Preparedness Publications, Inc., Reno, 1995, p.197.

* John J. McCusker, "Comparing the Purchasing Power of Money in the United States (or Colonies) from 1665 to Any Other Year Including the Present" Economic History Services, 2001,

** Where not specifically stated, charts courtesy of CNNMoney, and Bloomberg.

* Full Disclosure *

The author, James J. Puplava, owns silver and gold bullion & equities as well as foreign government bonds for client and personal accounts.

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