Silver Manipulation, Squeeze or Bull Market? Pt. I – Feb 1998


Manipulation, Squeeze or Bull Market?
Part I

By Martin A. Armstrong
© 02/20/98 Princeton Economic Institute

When you discuss silver, one treads into dangerous ground. To question its value seems to invoke everything just shy of death threats. To many, silver has become a religion. To some, silver is the embodiment of almost a messianic cult where this commodity will rise in defense of all things that are wicked in the financial world. Silver is portrayed as the avenger that will smote those who dare buy stocks and cause the ground the to split wide open into which the Dow Jones Industrials and all its hoards of greedy longs will be hurled to their death. From the ashes of this final battle upon Wall Street, silver will rise like the phoenix to surpass all other commodities leaving gold behind in its dust. Perhaps no other commodity invokes such passion of true believers more so than silver. Even the gold bugs shy in comparison to the glitter of silver’s passionate followers.

Many passionate followers of silver simply block out any notion that a rally might be the product of a concerted manipulation. Of course let silver decline and you will quickly hear the word “manipulator” applied to anyone who dares to take a short position. What is the sad part of this saga is that so many small investors do not have a clue as to the real trading going on behind the scenes. What many will shy away from is the plain and simple fact that there are some very big traders who do not care about direction – only how much money can be made. Within the ranks of this group one quickly finds the hard facts of reality. What goes up also goes down so why not make money along the way. Some of the very same players today who are widely rumored to be involved in forcing silver prices higher are also the very same players who aggressively shorted gold and copper and will soon go for the stops of the passionate longs in silver. To them, it is not a religion – it is simply business. No commodity, stock or bond is immune from the ups and downs of a market. All markets crash when the chorus of willing buyers is all on board and there are no new buyers to come carry the torch further. It is at that moment when profit-taking begins and in the end comes the inevitable change in trend.

There are also misconceptions about the current class-action lawsuit in silver and copper. Some try to portray this suit in silver as only one player. In fact, a class-action lawsuit is significantly different from merely a garden-variety lawsuit. Class-actions are open to EVERYONE and ANYONE who has lost money trading silver. This will include industrial users or the jewelry-trade who were harmed by the 70% lease rates. Such class-actions are NOT funded by one small investor, but are funded by the law firms who are defending the public on a performance basis. While one particular individual may appear as the defendant, it becomes irrelavent as to who that individual is. Such suits allow the small individual to go against a major group or institution on an equal footing.

Unfortunately, we must deal with reality – not bias, passion or prejudice. There is NO question in our mind that silver has been the target of a concerted effort to force its price higher through an all out attack on this market including – forwards, borrowing, options, futures and bogus analytical hype by not so independent analysts. In fact the evidence taken as a whole, suggests that this current rally in silver is merely phase II of a previous attempt to force silver higher, which most likely began back in 1995. And of course there is Warren Buffett who is now being portrayed as Saint Buffett among silver’s passionate followers. Somehow, Mr. Buffett who purchased 129,710,000 ounces of silver is being portrayed as the avenger against those most disgusting of all people – the dreaded shorts and industrial users.

Nonetheless, there are serious questions as to why Mr. Buffett’s order was executed in London at a premium price when the silver was available at a discount in New York all the time. Some have tried to argue that London silver is a better grade of silver than that in New York. Perhaps this myth was propagated by the September COMEX meeting when it was discovered that some silver stored at the COMEX bore hallmarks that had been delisted by London. The “quality” of silver was none the less the same – .999. However, because the hallmarks were of 1974 vintage by firms that no longer existed, prompted the need to have a portion of the COMEX stockpile reassayed making the move of silver from NY to London even more expensive.

Still, in the midst of this passion and confusion, many are afraid to look beyond the hype for the truth may indeed uncover something far less than a natural bull market at work. A closer inspection of the issues behind silver, will reveal that there are indeed players who are up to something very serious and strange to say the least. In fact, the passionate silver supporters are so desperate for a bull market they are willing to look the other way regardless of the facts as long as their precious commodity rises in value.

There is no doubt that silver has been manipulated on numerous occasions both in recent times as well as in the past. Silver has in fact filled the history books with legend, riots, manipulations and financial panics, one of which nearly bankrupted the United States in the process during the late 19th century. Silver was also responsible for bankrupting the Hunt Brothers in 1980 and of course there was the ultimate victim, Ogden Armour, who lost the equivalent of nearly $1 billion per day for 120 days straight following the Great Commodity Crash of 1920. In fact, to date, no one has EVER financially survived an attempt to corner the silver market. As far as gold is concerned, no one has enough money to even attempt such a scheme during this century – at least so far. The last such attempt to corner the gold market took place back in 1869 when Jim Fisk and Jay Gould sent gold soaring to $162 on the New York Stock Exchange creating a wide-scale panic on Wall Street that had to be suppressed by sending in government troops. That Panic of 1869 was the first “Black Friday” in history – the term “Black” referring to the deaths that occurred at the hands of the mob.
Silver Siglos of Croesus 600BC

Silver has been the object of manipulation for centuries. There is NO constant silver/gold ratio that one can find throughout history because governments have also been the manipulators at times. When the first monetary system emerged in ancient Lydia (modern Turkey), there was only “electrum” a natural alloy found in the Sardes river of gold and silver. Because the electrum was natural, the gold content varied considerably from one coin to the next. With smelting technology, it became possible to separate the two metals and a bimetallic monetary system emerged with a ratio establish at 8:1 dictated by Mother Nature herself. The silver/gold ratio has always varied from well over a 1000:1 to as little as 8:1 during the past 4,000 years. However, the silver/gold ratio has been determined purely by current supply. Silver has been so common at times that it was even demonetized from time to time leaving gold as the ONLY acceptable medium of exchange.

Over time, the silver/gold ratio has been established based upon the varying supplies of the two metals in accordance with discoveries. During the California gold rush of the 1850s, gold became so plentiful that the US mint struck 936,789 gold $1 coins compared to only 62,600 silver dollars in 1849 – a ratio of $15 in gold to every $1 in silver. The abundance of gold, however, was quickly displaced when the great silver mines were discovered in the West. In 1878, the US Mint struck $22,495,550 silver dollars compared to $3,020 in gold dollars – a ratio of $7,448 in silver to every $1 in gold. On a weight basis, the Silver Democrats inflated the money supply by coining silver at a ratio of 16:1 (28.73g silver to 1.672g gold). Our illustration of Puck magazine from March 11th, 1885 portrays Columbia drowning in silver dollars worth only 72 cents. This situation became much worse over the following 10-year period.

The silver discoveries in the Western United States during the second half of the 19th century created one of the most passionate debates over this white metal in recorded history. Who can forget reading about William Jennings Bryan and his memorable political speech “thou shall not crucify mankind upon a cross of gold”. Bryan’s memorable words were in fact the campaign plank of the “Silver Democrats” who were trying to maintain the old silver/gold ratio of 16:1 that had existed prior the new silver discoveries. In effect, they were flooding the money supply with overvalued silver with a minting ratio of 7448:1. In reality, the Silver Democrats were merely trying to spend more than they had – not much different from the post World War II era. The problem that they created by trying to artificially keep silver prices at pre-discovery levels led to the near collapse of the United States government itself. In accordance with Gresham’s Law (bad money drives out of circulation good money), people hoarded the much rarer gold and freely spent silver. In the end, the government found that the people paid their taxes only with the inflated silver and the Treasury was left without any gold. This was a critical point in history for without a gold reserve to meet international payments, the US found itself very much in the same position that Korea now stands in 1998. Old J.P. Morgan came to the rescue by putting together a consortium of banks that lent the US Treasury $100 million in gold so it might be able to meet its obligations. Quantities of silver dollars minted dropped significantly following the Panic of 1893. Gradually, from the lowest mintage in 1895 of $862,000 silver dollars, the quantities of silver dollars coined began to rise once again in 1896. The attempt to maintain the overvaluation of silver caused numerous minor financial panics between 1896 and 1903. Finally, the US Mint stopped issuing silver dollars altogether in 1904 following the Panic of 1903 and did not resume issuing silver dollars until after World War I in 1921. In total, the US government issued silver coins in excess of 3 billion ounces between 1878 and 1934. For the most part, the vast majority of that silver coin still exists today not counting more than 2 billion minted after the war. Most of what was melted during the 1980 boom was postwar dimes, quarters and half-dollars along with sterling flatware.

The passionate believers in silver prefer to ignore the real facts about this metal. One of the primary reasons we remain long-term bearish for silver relative to gold is based upon the real facts. Unlike base metals, the majority of silver that has been mined over the centuries STILL exists. Of the more than 10 billion ounces of silver coin minted worldwide during the past 120 years, the vast majority again STILL exists. Analysts who try to put together statistics on above ground stockpiles do NOT have the facts on warehouses in Europe that do NOT report on their holdings. There is NO consideration about how much silver coin is still held by the public. All we can do in this regard is look at the official mintage records of governments worldwide. Throughout history, there has never been a single successful silver “squeeze”. No matter how much money someone has, there is simply far more silver in the hands of the average man on the street to stop any rally as has been the case with central banks and gold. It has ALWAYS been this hoard of silver that pours out in response to higher prices. It was this hoard of silver in the hands of the public that caused the collapse of the market back in 1980. The Hunts had more than 20% of total world supply (Buffett has only 20% of one-year’s mine production) when the public responded in droves. When the dust settled, so much silver had poured into the above ground stocks that the price of silver has yet to recover DESPITE an annual deficit between industrial consumption and mining over the past 18 years.
With all the hype about Warren Buffett taking a position in silver, one must look upon this market from an objective position. Many suggest that Mr. Buffett engages in ONLY long-term investments while others argue that he is infalible – neither of which is true. Therefore, those who want to see silver higher argue that Mr. Buffett will “never” sell. There are two points that must be considered here when trying to separate the hype from reality. FIRST of all, the silver Mr. Buffett purchased was ALREADY the property of someone else sitting in storage be it in New York or London. What has taken place is that silver has moved from one buyer to another. The same amount of silver still exists and NO silver has actually been CONSUMED by industry over and above normal levels. Mr. Buffett’s purchase is NOT a donation to the cause. It will be available for sale at some point in time and at some undefined price. If Mr. Buffett had contracted directly with the mines to purchase silver to prevent it from coming to the market, then one might make a case that “supply” has changed. However, Mr. Buffett has only purchased what was already sitting the vaults in NY and caused it to be at least indirectly moved to London by executing his order in that market rather than New York. Perhaps when Mr. Buffett learns about the TRUE cost of owning silver, it may be available sooner rather than later. Fundamentally, nothing has changed in the supply-demand outlook for silver! Anyone who argues otherwise may have a hidden agenda themselves.

The SECOND point concerning Mr. Buffett’s new silver venture is that he is about to discover the difference between owning stocks for the long-term and a commodity. Keep in mind that holding a physical commodity can be the WORST investment anyone will ever make when you are dealing with an issue of storage. Unlike a stock, which pays dividends and can be kept in a safe-deposit box, the cost to store one contract of silver on COMEX (5,000 ounces) is $18.50 per month. This works out to be 0.37 cents per ounce PER MONTH. After two years, the storage cost and interest loss on the one-ounce of silver amounts to 9 cents for storage and 69 cents in income loss (assuming 5.7% interest). This means that by the end of 1999, Mr. Buffett’s cost for his investment will be $6.53 per ounce ASSUMING his average purchase price was only $5.75. Without a speculative bubble to push prices higher, owning silver can be one of the WORST investments anyone will ever make when the metal is physically being stored. In comparison, the cost to store gold is 7 cents per ounce per month or 84 cents annually – a far cry from the percentage costs incurred when holding silver. Keep in mind that silver takes up about TWICE the vault space at the SAME weight compared to gold. Because the cost to hold this metal is so high compared to others, silver has been the WORST possible investments anyone can make in the metals group. Even if you are holding $1,000 face value of silver coin from 1963, the melt value of that silver at $7 is $5,100. That same $1,000 invested in a bond at 5.5% in 1963 would be currently worth $6,872 and that same value invested in the Dow Jones Industrials, including dividends, would be worth in excess of $13,000. When we compare that $1,000 worth of silver coin to gold, it still falls to the bottom of the investment list. $1,000 worth of gold in 1963 is still worth $8,571 at $300 per ounce. Because of the high cost of owning silver, anyone who holds this metal in a large quantity – LEASES it. By lending out your metal you can reduce this cost factor while you still own silver or gold at your original cost price. While some believe this is a conspiracy to keep prices down, in reality it is a matter of survival. Mr. Buffett may be a shrewd investor, but he is not stupid. Perhaps someone has convinced him of silver’s great opportunity without fully explaining the cost factors of holding the white metal. Unless he is prepared to watch his paper profits be eroded by the high cost of owning physical silver, Mr. Buffett will most likely start to at least LEND his silver into the marketplace sooner rather than later for what he calls a “modest fee.” What Mr. Buffett should be most concerned about is that he himself could one day become a target of a “squeeze”. By lending out his metal, someone else can come in and take delivery and start the game all over again. It is no secret that we have been warning about a manipulation in silver since last August when first published in our World Capital Market Report. nOur warnings were later echoed by Union Bank of Switzerland, Merril Lynch and even Credit Lyonnais Rouse. We have been warning that there was NO change in industrial demand that would account for a sudden decline in warehouse inventories of nearly 50% at the COMEX. We have been warning that silver was being shipped from New York to London where warehouse inventories are NOT reported to the public. Everything we have stated here has now been proven to be correct. Despite the rantings of analysts who have proclaimed a new bull market in silver due to the deficit between mine production and industrial consumption, the announcement of Mr. Buffett’s purchase of 129,710,000 ounces of silver in London confirms that there was NO sudden change in the supply/demand equation. If anything, the cost to mine silver is well below $2 for many companies and the higher prices have now encouraged a burst of new supply headed straight for London.

In the midst of this controversy, there are those who have seriously distorted the facts about how the commodity market functions turning this entire issue of a silver manipulation into a battle between longs and shorts. It has been suggested that users and shorts have manipulated the price of silver lower for the past 15 years. Everything from derivatives, loans and leasing have been characterized as manipulations to keep silver prices lower in some giant conspiracy as if it were a religious persecution against the faithful. What is never discussed in this argument is the fact that in the commodity and futures markets both shorts and longs exist in EQUAL proportions. Futures and cash forwards DO NOT function in the same manner as stock markets. In stocks, short positions are a tiny fraction of the market as a whole. Stocks trade in the same manner as real estate in the sense that someone buys from a person who is already long. If the market goes up in price after the transaction, it is a direct function of demand and the person who sold you the stock or property before only lost the “opportunity” to make further gains. In the futures and forward markets, there can be NO long position unless someone sells it to you. These are contracts for future delivery. Hence, the futures and forward markets must at ALL times be equally balanced. For every long position there must be an equal and opposite short position.

In commodities, the MAJORITY of short positions in a given market are usually physical holders of that commodity or producers. The PURPOSE of the futures and forward markets is to facilitate trade NOT to serve speculators! A farmer needs to lock in his profit on his crop so he does not go bankrupt if prices suddenly collapse below his cost. A farmer is merely trying to make a living not gamble his entire future on what price the crop will be months in advance. Mining companies use the futures and forwards in the same manner. In many cases, small mining operations CANNOT qualify for a bank loan unless they HEDGE their future production at a fixed price against which the bank will then provide credit based upon that GUARANTEED future sale.

It is a serious distortion of the facts to target producers and shorts as if it were some conspiracy against long positions. Metal loans, leasing and forward contracts never stopped the rallies in 1980 and indeed without them there can be NO rally in the first place! If producers are not there to sell forward, speculators will be unable to buy anything. A producer MUST sell forward as a function of staying in business. A speculator must take a view as to what he BELIEVES the future price might be. To distort this free market system into a war between natural business and speculative longs is a gross mistake, which only serves to undermine the integrity of the system as a whole.

To set the record straight, a “squeeze” in futures and forwards is an intentional effort to manipulate a market by attempting to disrupt the natural flow of that market by cornering the immediate supply. The telltale sign of a manipulation is when a market is forced into “BACKWARDATION” a condition when the forward or future price of that commodity is selling significantly lower than the current spot market. Under normal conditions, a producer will sell forward his production as a hedge against an uncertain value. In many cases, the producer may in fact have no plans to actually deliver his commodity on that contract but will sell production on the spot market when it becomes available lifting his hedge simultaneously. When a “squeeze” is as aggressive as what we have seen in copper, platinum, palladium, aluminum and now silver, the casualty here is the marketplace as a whole. What happens when a market is professionally put into backwardation threatens the very existence of the marketplace long-term. The net result of this “squeeze” discourages normal hedging. Producers cannot sell forward into a market that has been artificially forced into backwardation. Therefore, the end result becomes less liquidity and a prolonged “squeeze” threatens the entire viability of the market. No one can sell the current spot contract unless he has the commodity to deliver. What happens when a market becomes manipulated into backwardation causes producers to begin to contract directly with users bypassing the market altogether. This undermines the exchange and ultimately can kill a contract entirely as we have seen in the past.

Since last August, we have been warning “they’re back!” Based upon our own sources and the evidence we have seen on the trading floor of the COMEX, we became convinced that someone was attempting to once again “squeeze” the silver market to force prices higher. Some analysts swore on their reputations that the fundamentals in silver had suddenly changed. One analyst who specialized in metals claimed he could account for “every ounce of silver” but refused to explain precisely where 100 million ounces had disappeared. We warned that the silver was being shipped off to London this time instead of to Delaware, as was the case in 1987. The US government statistics showed that prior to June 1997, only 15% of all silver exports were made to London. However, since June 2nd, 1997, almost 60% of all silver exports from the US were made directly to London. We saw NO truth in the argument that dealers were shipping silver to London on a 3-cent arbitrage as suggested by NYMEX. What we saw in this market was aggressive trading patterns that implied manipulation.