What Gives? Why Don't Silver Prices Rise?

That's the headline for the May 26 Commodity Corner column of BARRON'S Magazine (www.barrons.com). It's a must read for anyone interested in silver or gold. The article highlights the current research reports by the Silver Institute (prepared by London-based Goldfields Mineral Service) and the CPM Group. Both services confirm the continuation of silver's multi-year supply/demand deficit and the resultant draw down of world inventories.

The article also quotes the two services as to what the remaining stocks of silver the world possesses and when they can be expected to be fully exhausted (as in zero silver left in world inventories). The Silver Institute pegs total world silver stocks at 650 million ounces (and Goldfield's president is quoted as insisting that this is definitely not a "guesstimate"), while CPM lists the number at 450 million ounces. BARRON'S concludes that using the Silver Institute's figures the world will run out of silver completely in 4 years, while CPM's figures indicate 3 years. The article's conclusion is as long as people continue to sell from inventories, the price will only rise once those inventories are gone.

BARRON'S concludes that using the Silver Institute's figures the world will run out ofsilver completely in 4 years, while CPM's figures indicate 3 years.

I'm not kidding you - that's what the article states. If you don't believe me, just read the column. After you read the article, I would ask you to consider just one thing. I ask you to ask yourself what is your own interpretation of the law of supply and demand. Whether you learned it in Economics 101 in high school or college, or whether you learned it in the great school of life, wouldn't your definition be that when demand exceeds supply prices rise? Would not your most basic understanding of how things work in the real world tell you that inventories could only be bid away from owners in a shortage (when supply is short of demand) with rising prices to induce those owners to sell? Should not common sense dictate that inventories of anything could not be consumed till they did not exist with flat to falling prices? Is this principle not the very cornerstone of the free market? What really gives in silver?

If you are troubled by all this (and you should be), your mind will play tricks on you. It will suggest that something must be wrong with these reports or that the article is leaving something very basic out. After all, if you have followed the price of silver, you know that the price certainly doesn't suggest a shortage or that inventories are in the situation of being completely exhausted. What's wrong here is not the statistics of the research reports - the sad truth is that we are in the midst of the greatest shortfall of a commodity that the world has ever seen and that we will run out of all legitimate world inventories of silver in the time suggested. The article and the researchers are overlooking the real cause of this unfortunate circumstance. That cause was the introduction, about 15 years ago, of the most destructive derivative device ever introduced by the "rocket scientists" on Wall Street - the precious metal loan. This alone is the explanation of how the world could fail to price ration a vital commodity like silver until inventories were vaporized.

Simply put, a metal loan is a device in which an owner of silver or gold inventory (usually a central bank or government institution) is given a contract which, in return for the physical release (abandonment) of the metal in question, promises an interest rate payment and the return of like physical metal in the future. The central banks are only interested in what rate of interest they will receive on their metal, not the current price. Therefore, the price component of the law of supply and demand is being bypassed with the release of this loaned metal onto the market. The loans have proved popular with central banks and other institutional holders as it affords them interest on the value of what were fallow assets. Hundreds of millions of ounces of gold and silver have been uneconomically dumped on the market as a result of these loans. The problem, simply put (for a more complete description, see my letter to the Federal Reserve and the Treasury Department of April 8 - hot-wired at the bottom of this article), is that the metal that the central bankers are turning over in order to get the interest payments, is the very same metal that is being consumed to meet the shortfall between the imbalance of supply and demand reported above. This is the explanation as to how the prices of silver and gold are not rising in the face of widely observed shortages. The central banks and other lenders are deceiving themselves if they believe that the loaned metal can all come back. It is physically impossible for all the metal to be ever returned. Only a very small percentage can ever be returned as the metal has already been consumed and we still have a shortage due to the law of supply and demand being short circuited by the artificial low price.

To answer the obvious question, is this an intentional plan to depress the price of silver and gold to convey a false sense of security to all financial market participants? I honestly don't know if the central banks and others involved actually know what they are doing to the markets. I don't know if there is a conspiracy or they are just plain dumb as dirt. But the effect on price and the resultant distortion of the law of supply and demand is the same in either event. This is what is really behind the disappearance of the world's remaining stock of silver amid flat to falling prices. It is certainly not widespread voluntary price-induced selling. There is not the slightest anecdotal or statistical evidence of that. How long will it continue? Until the lenders are no longer willing to dump their inventory uneconomically on the market or we run out completely.

Ted Butler

(June 1997)