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Silver Users Fear Silver Shortage

October 25, 2005

Grass Valley, CA (silverstockreport.com) -- The Silver Users Association (SUA), a group devoted to the conflicting goals of keeping silver prices low and keeping silver available for users, stunned the silver investing community last month by repeating the claims made by silver investors and analysts that the silver market is very tight and that any significant investor demand will create a shortage of silver.

The SUA made the bullish case for silver when asking the Securities and Exchange Commission (SEC) to deny Barclay's petition for a Silver Exchange Traded Fund (ETF). Barclay's Silver ETF will require Barclays Global Investors to buy up to 130 million ounces of silver prior to the approval of a silver ETF, in anticipation of investor demand for the silver ETF. But the COMEX division of NYMEX only has 117 million oz. of silver in all wearhouse stock categories combined. Furthermore, COMEX market participants, through approximately 140,000 silver futures contracts at 5000 ounces each, already have claims of up to 700 million ounces of silver--silver that may not exist.

The SUA's position: "The Silver Users Association opposes the creation of a silver ETF because of the concerns that doing so will require the holding of physical silver be held in allocated accounts, thus removing large amounts of silver from the market. By doing so, the ETF will cause a shortage of silver in the marketplace."

The SUA is literally asking the SEC to limit investors' ability to buy silver through an ETF. A silver ETF, which would wearhouse silver for investors, and be easier for investors to buy and sell, makes more sense for silver than gold, because of silver's weight. At $6.80/oz., every $1,000,000 of silver weighs about 10,000 pounds. But there are already limits on silver purchases. At the COMEX, there is a position limit of 1500 contracts per person or entity per month (which is a limit of 7.5 million oz. of silver), and total silver deliveries to all market participants may be limited to 1.5 million ounces in any given delivery month.

Back in May, 2004, the U.S. Commodity Futures Trading Commission (CFTC), which is supposed to oversee and prevent market manipulation and defaults, issued a 9-page report on silver that acknowledged many of the bullish fundamentals for silver, yet went on to say that a short side price manipulation could not exist because there is "unrestricted access to the market, [because] many knowledgeable and well-capitalized traders would readily buy any silver offered at artificially low prices." Michael Gorham, director of the CFTC, in the same report, then contradicted his earlier statement by acknowledging and defending the current position limits that prevent unrestricted access to the silver market. Michael Gorham then resigned from the CFTC about 3 weeks later.

I maintain that limits are evidence of shortages, manipulation, and price fixing that is too low. In free markets with free prices, there are no limits and no shortages, because in case of an impending shortage, supplies are rationed not by limits, but rather, by higher prices. Obviously, those who would advocate limits on purchases, would rather not see higher prices. Today, it appears as if the SUA is more concerned with keeping silver available to its members than keeping silver prices low, since they can no longer continue to do both. The SUA is risking endorsing the bullish story for silver, in an attempt to keep silver available to users, and away from highly capitalized investors who may want to buy silver through a silver ETF.

So, what exactly are the bullish fundamentals for silver? The current bullish supply and demand fundamentals as published (but not well publicized) by the silverinstitute.org and cpmgroup.com are that about 600 million ounces of silver are mined each year, while about 870 million ounces of silver are consumed by industry, jewelry, and photography. The difference is largely met by recycling, and investor selling. In 2004, investor selling ended as 40 million ounces of silver was purchased by investors throughout the year, which drove silver prices up from a low of $4.15 to a high of $8.40/oz.

Historically, the silver to gold ratio was that 15 ounces of silver would be worth 1 oz. of gold. Today, with silver at $7.76/oz. and gold at $472, it takes just over 60 oz. of silver to buy one ounce of gold, thus, silver is much cheaper than gold when compared to historic norms.

Have we hit "peak silver", like "peak oil"? Peak oil proponants maintain that there is about a 40-year supply of oil in reserves. However, according to Ted Butler, (butlerresearch.com), there are only about 16 years of silver in in-ground reserves, worldwide. The silver to oil ratio hit a high of over 1, as $50/oz. of silver could buy more than a barrel of oil at $43/barrel in 1980. Today, with oil prices hitting $70/barrel, silver prices are again at historic lows as compared to oil, as an ounce of silver recently was 1/10th the price of a barrel of oil.

How important is above ground supply? In the copper market, the world is down to a 2-day supply of inventory at the LME: 64,000 metric tonnes. And in copper, since demand is expected to continue to exceed supply over the next year, then copper prices are poised to move up substantially.

But what about the existing above ground supply of silver? Precious metals are held privately, and are not able to be tracked or traced, so nobody truly knows what the above ground supply of silver of might be. However, experts maintain that about 40 billion ounces of silver has been mined throughout all of human history, and that about 90% of that has been irretrevably consumed by industry, jewelry, and photography. Most of the approximately 3-5 billion ounces of silver left is in the form of jewelry, mostly held in India. Silver that is in the form of above-ground, refined, deliverable, identifiable silver is about 150 million ounces, mostly held at COMEX. The U.S. government once held up to 6 billion ounces of silver, but around 2002, the U.S. ran out, and had to buy silver on the open market for its Silver Eagle coin program. The COMEX once had up to 1.5 billion ounces of silver about 10-15 years ago, but today has less than 1/10th of that: 117 million ounces.

Warren Buffet bought 129.7 million ounces of silver in 1997, and "concluded that equilibrium between supply and demand was only likely to be established by a somewhat higher price." Since then, numerous investment analysts and newsletter writers have grown increasingly bullish on silver prices, including: Ted Butler, David Morgan, Jim Puplava, Harry Schultz, Doug Casey, Richard Russell, and many others, including myself. With the addition of the CFTC and the SUA making the bullish case for silver, what knowledgeable silver analyst or commentator remains left to maintain a bearish outlook for silver prices?

So, if there is an impending shortage of silver, how have prices remained low? Well, there is no shortage of silver for industrial users (commercials) who have unrestricted access to silver; there is only a shortage of silver for very large investors (speculators), who are restricted by position limits. Silver prices are also low due to lack of monetary demand, and a general lack of interest or knowledge by most investors. Demonitization of silver started in the 1870's with Germany abandoning silver coinage to move to a gold standard. The last time 90% silver coins were minted in the U.S. for everyday monetary transactions was 1964.

So, how high will silver prices go? Conceivably, if investor and monetary demand continues to increase, silver may not be able to be priced in dollars if the dollar collapses completely. But how would silver be valued if not in terms of dollars? Well, about 100 years ago, when silver was used as money nearly worldwide, a day's wage varied between a silver dime to a silver dollar. A return of monetary demand worldwide, in conjunction with a silver shortage, could conceivably drive silver prices higher than historic norms.

Will higher silver prices hurt the economy? The SUA also says: "This removal of large quantities of physical silver [through a silver ETF] could have a negative impact on silver-industry specific employment as well as the overall economy, both through job losses and inflation." However, higher silver prices will also create jobs in the silver mining industry, which has been devastated by low silver prices. In fact, currently, there are no profitable public silver mining companies in the U.S. And of about 80 silver companies that I follow, there are only about 2 or 3 that are making any profits in 2005 so far, because oil and energy prices (which are a large part of mining costs) have risen faster than silver prices. Thus, once again, if silver prices are below the cost to mine, silver price remain at historic lows.

Whether a silver ETF or whether the growing sense of a silver shortage will drive investor demand for silver remains to be seen.

Interestingly, one way to get around current position limits on silver purchases is to become a "commercial" trader, such as by petitioning the SEC to open a silver ETF. If the Barclays Silver EFT is approved by the SEC, it will trade on the AMEX under the symbol SVL sometime in 2006.

Currently, the world's only ETF that contains silver is the Central Fund of Canada (CEF), (Ticker: CEF), which holds 50 ounces of silver for every 1 oz. of gold, and holds over 90% of assets in precious metals. At a 60 to 1 ratio for silver to gold prices today, about 44% of the assets of CEF are invested in silver. CEF holds about 32 million ounces of physical silver.

Conclusion: If there really remains less than 150 million ounces of silver in above ground refined form, then there is about half of an ounce of silver per person in the U.S., which means that if you have a single ounce of silver, the SUA might say that you have "more than your fair share".

More:

Background:

BERKSHIRE HATHAWAY INC. PRESS RELEASE (Feb. 1998)

U.S. Commodity Futures Trading Commission silver letter (May 2004)

Barclays iShares Silver Trust SEC Application (June 2005)

Nymex Silver Wearhouse Stocks

Barclays Global Investors Press Release on Silver ETF

Occasion for story:

Silver User's Association Policy Position on Silver ETF (Septermber)