All that Glitters is Silver (November 2010)
By Eric Sprott & David Franklin:
In the four months since we filed the prospectus for the Sprott Physical Silver Trust on July 9, 2010, the silver price has rocketed up 54%, bringing its year-to-date return up to a stunning 68% (!!). Silver has now outperformed all of the other eighteen commodity components that comprise the CRB Commodity Price Index on a year-to-date basis. Silver has been the indisputable star of 2010, and we have been very long the physical metal in many of our mutual funds and hedge funds.
Silver’s performance since June has been influenced by a number of factors. The first and arguably most significant development took place on October 26, 2010 when comments were released by Bart Chilton of the Commodity Futures and Trading Commission (CFTC). The CFTC is the US government agency that supposedly regulates the US futures and options markets. While the CFTC has technically been "investigating" the silver market since 2008, it had revealed nothing about its findings for over two years. Everything suddenly changed when Mr. Chilton, a CFTC Commissioner no less, publicly stated that, "I believe that there have been repeated attempts to influence prices in the silver markets. There have been fraudulent efforts to persuade and deviously control that price. Based on what I have been told by members of the public, and reviewed in publicly available documents, I believe violations to the Commodity Exchange Act (CEA) have taken place in silver markets and that any such violation of the law in this regard should be prosecuted (emphasis ours)."1 These comments quickly triggered a flurry of lawsuits against the purported manipulators and set the silver market on fire. There are now no less than four lawsuits seeking class action status. They all allege that JP Morgan Chase & Co. and HSBC Securities Inc. colluded to manipulate the silver futures market beginning in the first half of 2008. The suits claim that the two banks amassed massive short positions in silver futures contracts that they had no intent to fill in order to force silver prices down for their furtive benefit.
The suits also describe two ‘crash’ events that were set in motion by JP Morgan and HSBC, one in March 2008, and the other in February 2010, after the defendants had amassed large short positions. The suits allege that COMEX silver futures prices subsequently collapsed to the benefit of both banks in the wake of these events.2 The fallout from these accusations has undoubtedly increased the investment demand for silver, and it serves to remember, as we highlighted in the previous article, that investment demand was already understated by at least half by the major silver reporting agencies. It will be hard for them to downplay the recent demand increase, as the volume of silver contracts traded on the COMEX market on November 10th set a new record, surpassing the previous record set in December 1976 by 57%!3 This increase actually forced the CME Group to increase the margin requirements for COMEX silver futures twice in one week in order to maintain some semblance of market order.4
Silver coin sales as reported by the world’s major mints have also been exploding since Chilton’s comments were made. The US Mint, The Royal Canadian Mint, The Austrian Mint and The Perth Mint are all reporting record or near record sales of silver coins.5 The silver Eagle produced by the US Mint set three new records at various points in November: best annual sales, best silver Eagle mintage, and best ever month.6 Money is pouring into silver in all forms, and due to silver’s relatively small market size, this capital inflow is having a huge impact on the silver spot price.
As we outlined in our Sprott Physical Silver Trust prospectus and our June MAAG article, the physical silver market is surprisingly small in US dollar terms. The CPM Group estimates that above ground stocks of physical silver total 1.184 billion ounces in bar and coin form, implying a total silver market size of a mere US$33.15 billion dollars.7 At the end of 2009, approximately 500 million ounces of that 1.184 billion were already accounted for by the silver ETF’s and other large holders. This left approximately 684 million ounces of silver available for sale in 2010. That is hardly enough, in our opinion, to satiate demand.
The money flows into silver in November 2010 have been staggering. Consider the investment demand generated from only two sources: the iShares Silver Trust ETF (SLV) and US Mint coin sales. The SLV added approximately 18 million ounces of silver in November alone; the US Mint sold 4.2 million ounces of silver coins. If you multiply these amounts against today’s silver price of $28, money is flowing into the silver market at an annualized rate of $7.5 billion dollars! At that rate of demand, it won’t take long before all the remaining above ground silver is spoken for.
Silver’s demand profile may also benefit from the outrageous short position that exists in the silver COMEX market. The current ‘open interest’ in silver COMEX contracts totals an approximate 871 million ounces (!!!).8 This means there are paper contracts for over 871 million ounces of silver that have someone betting ‘long’ and someone else betting ‘short’. In the event that the ‘longs’ choose to take physical delivery, there will not be enough silver to supply each buyer. It’s simple math - with only 684 million ounces of silver available above ground, there won’t be enough silver to go around. And considering the rate with which people have been purchasing coins and silver bars this past month, there may not even be enough physical to satiate regular spot buyers, let alone futures market participants.
Considering all the recent developments in the silver market, it seems unlikely that the silver price will stay under $30/oz for long. The large quantity of money flowing into silver from investors, combined with the potential demand from those who are ‘short’ silver that they do not own, will likely end up swamping the physical silver market entirely.
As our dear friend, Marc Faber, espouses in his book "Tomorrow’s Gold", an investor can do very well by only making a few good investment decisions over his or her career. The trick is to make one good investment decision every decade or so, based on trends that will last a number of years.9 In our view, owning physical silver and the associated stocks represents that type of investment opportunity today. If that seems too simplistic, consider that in October 2001 we wrote an article that identified the investment of the last decade. It too was just a simple metal. The article was entitled "All that Glitters is Gold", and it was written when gold was still considered a relic in financial circles. We believe silver will be this decade’s gold, and judging by the recent price action, it’s already off to a great start.