Silver Earthquake
Brian Bloom
The Richter Scale is "A logarithmic scale used to express the total amount of energy released by an earthquake. Although the scale has no upper limit, values are typically between 1 and 9, and each increase of 1 represents a 32-fold increase in released energy." (Source: www.answers.com/topic/richter-magnitude-scale)

The following table has been constructed to give the reader a mental picture of what this means:

In the context of the land of Silver, this begs the questions:

1. How close are we to an earthquake in the land of Silver? and
2. What will be the reading on the Richter Scale were this to happen?

Let's address the second question first

Can we quantify the potential financial damage that will be suffered as a result of pent up energy released in a Silver Earthquake?

The first column in the following table was sourced from the Silver Institute's website at www.silverinstitute.org/supply/index.php

The second column marked "Hypothetical" represent this analyst's WAG as to what "might" happen in the 2005 year. For the purposes of discussion, let's focus on the "Hypothetical" column.

1. Mine output rises 10% in response to silver prices above \$5 per ounce
2. Government sales fall to 10 million ounces given depleted stockpiles
3. Demand for industrial applications rises by 25 million ounces
4. Photographic demand falls by 96 million ounces
5. Photographic scrap recovery falls by 50% of 96 million ounces

It is clear from the numbers in the right hand column that the swing factor required to drive the silver price upwards is going to have to be "Investment". Within limits, if investment demand is greater than 28.6 million ounces, the price of silver will rise in an orderly manner until equilibrium is established.

According to the Nymex website at (www.nymex.com/jsp/markets/sil_fut_wareho.jsp) there are currently 59.5 million ounces of silver bullion "eligible" for delivery into the market (as opposed to "registered" in someone else's name, and not available for delivery).

It follows that the "limit" referred to above is around 88 million ounces. For example, if investment demand for silver rises to (say) 100 million ounces, there will be a 12 million ounce shortfall in the market and Nymex's eligible stockpile will be decimated.

As at May 31st 2005, the number of "open" short contracts on the silver market was 113,358; of which 76% were accounted for by commercial short positions. (source: www.technicalindicators.com/silvcotreport.htm)

By contrast, 69% of the long positions were in the hands of speculators; of which 39% was accounted for by "large" speculators and 30% by small speculators.

76% of 113,358 is 86,152 and, as each contract is for 5,000 ounces of silver this represents a naked short position of 430 million ounces - or about 7.8 months mine output if mine production rises to 660 million ounces per year.

As producer hedging was only about 21 million ounces in 2003; and as the silver prices has been rising, it is a fairly safe bet that it has not been the mines who have been selling short, but the market makers. i.e. It is a fairly safe bet that the shorts are indeed "naked"

About a year ago, this analyst came up with the idea of establishing an offshore investment fund - capitalised to about \$1 billion - for the purpose of investing in silver. Had he been 25 years younger he might have followed through on the idea, because the important fact is that at the current price of \$7.49 an ounce, \$1 billion would buy 133 million ounces of silver; and - as the Hunt Brothers understood -if one can corner the silver market, it will become a seller's market.

Importantly, the Hunt Brothers probably failed because they did not have the Chairman of the US Federal Reserve as an ally. Then, under Mr Paul Volcker, money was a lot harder to come by. By contrast, in today's investment environment under Mr Alan Greenspan, \$1 billion is like confetti. It would be a lot easier today to establish a fund to operate out of the BVI or Cook Islands or some other tax haven and, provided local Prospectus laws were complied with in raising the money, such a fund would be outside the reach of the US regulatory authorities who are prone to change the rules when it suits them. It would have made sense to raise the money in US Dollars outside the boundaries of the USA - in countries which are drowning in these effectively worthless pieces of paper. Further, the Fund would have been large enough to deal directly with some of the key mines; and even pay a premium to market to secure supplies. Probably the most malleable mines (from a negotiating perspective) would be located in Latin America, which happens to be where a large proportion of the world's silver is mined. With a couple of billion dollars one could have even bought the mines themselves - as Messrs Soros and Gates clearly understand.

If the silver market were to become dislocated through the inability of the commercial shorts to deliver, the "large" speculators who are long would be in a position to play high stakes poker with the commercials, and there would be no theoretical upside limit to the price in the short term. Of course, if the price were to go to (say) \$30 per ounce, demand for other uses would wane, and bullion could be diverted from the mines to the commercials over a period of a year or so. But a lot of damage would be done in the interim.

By way of example: If the price of silver spiked to (say) \$30 an ounce, and the large speculators who were in a position to demand delivery chose to do so, the market makers would have to write out cheques for:

39% X 430 million ounces X (\$30 - \$7.40) = \$3.7 billion

(We have ignored the little guy's position on the assumption that the commercials would find a way to screw most of them over)

So there are two questions that arise:

1. Will the Balance Sheets of the commercial shorts be able to withstand a \$3.7 billion knock? (If not, then the regulatory authorities will have a lot to answer for)
2. What is the probability that the land of Silver could experience an earthquake as a result of a spike in pressure flowing from investment demand and/or short covering?

At this point, it would be instructive to turn the reader's attention to another related subject.

"O what a tangled web we weave, when first we practise to deceive".

This famous line in the English language was penned by Sir Walter Scott nearly 200 years ago, and has a particular relevance to the world of High Finance today.

At the heart of the web of financial deception - and it is deception that holds the World's financial system together today - are two spiders.

The first spider is the US Federal Reserve, the activities of which are in blatant breach of the United States Constitution because the Constitution states clearly that only the US Government may issue money. Clearly, as the US Fed is not an organ of the US Government, its money creation activities are illegal. However, the Fed is beyond the control of the judicial system as a result of an arcane law known as "locus standi in judicio". In layman's terms, what this means is that only a directly aggrieved party may sue and, as the people who suffer from a degradation in the buying power of the US Dollar are only indirectly aggrieved - and no direct personal linkage can be established - no private citizen may sue (although the concept of a "Class Action" law suit holds some interesting possibilities). By contrast, the US Government, which directly benefits from the Fed's actions through access to unlimited funding, is certainly not an aggrieved party. (As an aside, the concept of "taxes" is now an anachronism. The US Government has no need to levy any taxes at all in an environment where the Fed can create as much money as the Government needs "out of thin air". It is for this reason that the US President can afford to "appear" to be generous when he talks of tax cuts. In truth, his apparent benevolence is pure garbage in a world of fiat currency unbacked by anything)

The second spider is J.P. Morgan, one of the original architects of the Fed.

According to Mr G. Edward Griffin, in his book "The Creature from Jekyll Island" - of the seven people who met to create the institution now known as the Fed, the following were directly or indirectly representing the interests of JP Morgan:

• Nelson W. Aldridge, Republican "whip" in the Senate, Chairman of the National Monetary Commission, business associate of J.P. Morgan, father-in-law to John D. Rockefeller, Jr.
• Henry P. Davison, senior partner of the J.P. Morgan Company
• Charles D. Norton, president of J.P. Morgan's First National bank of New York
• Benjamin Strong, president of J.P. Morgan's Bankers Trust Company

The reason that this organization is still today one of the spiders at the centre of the web of deception, is that it is by far the largest issuer of derivative instruments in the world (one estimate is that prior to its merger with Chase it had exposure to over 55% of all US based bank derivative contracts), and the word "deception" is used advisedly here - because the risks inherent in these derivatives are "off balance sheet".

No one outside JP Morgan is able to quantify these risks in terms of counterparty exposure. Again, in layman's terms, although J P Morgan will doubtless have issued both "buy" and "sell" derivative instruments in an effort to balance its own risk portfolio, in the end analysis, if any individual organization who is a party to the other side of a contract with JP Morgan should go insolvent, JP Morgan will be exposed to the risk that that organization (the "counterparty") will not honour its contractual obligations.

It follows that if any market (such as the silver market) were to become dislocated, this would more than likely eventually have an impact on the balance sheet of the largest counterparty on earth - J.P. Morgan Chase & Co.

In summary:

• At "Sovereign" level we have the Fed - a privately controlled organization that can provide the US Government with as much funding as it may require for any purpose whatsoever, including war; and
• At "Market" level, we have JP Morgan, which is able to issue as many derivative instruments as it deems fit (without any meaningful external supervision) if it should ever become necessary to exert an outside influence on a market that appears to be in danger of running out of control.

So, getting back to the point at hand, at one end of the scale, we have the potential for a Richter Scale reading of (say) 2 -3 if the Silver market were to become dislocated and cheques for around \$3.7 billion need to be made out. (It is unlikely that JPM will be threatened under such circumstances)

But, at the other end of the scale, we have the potential of a Richter Scale reading of 9, if the silver market problem should cascade into the gold market which, in turn, cascaded into the bond markets as interest rates spiked upwards; and all of this led to the demise of JP Morgan Chase & Co.

The market's perception of the vulnerability of JP Morgan can be seen from the following chart (courtesy Bigcharts.com) - from which it can be seen that the most significant issue is that its price is now tracking below the 48 month (political cycle) Moving Average; and is now once again in a down trend.

Perhaps more importantly, the following Point and Figure Chart (which has been adjusted to a 3 box X 3% reversal to filter out trading static) is showing a potentially serious - but not life threatening sell signal.

Interim Conclusion

If the Silver Market were to become dislocated, the resulting earthquake will have a fallout that seems likely to be containable, and the reading of the Richter Scale would probably be fairly low (say 2-3) - even if the price spiked up to (say) \$30 an ounce.

Which brings us back to the first question:

What is the probability of an earthquake in the land of Silver?

The short answer is 50/50; but the probability is growing; and for us to get a handle on the psychological state of the silver market we need to turn to the charts (courtesy stockcharts.com)

The first - and arguably the most important chart given the recent negative votes elating to the EU Constitution by France and Holland - is a chart of the Silver price divide by the Euro (effectively the Euro Price of silver).

Buy signals were given by all three of the price, RSI oscillator and MACD oscillator during the past week.

The reason the probability of an Earthquake is still only 50/50 is that the following chart - again desensitised to exclude trading static - has not yet given a full blown buy signal. Further, should it do so, the upside target based on horizontal count technique is still below the 2004 peak.

But it needs to be a subject of focus that the Euro price of silver is function of two numbers; viz the dollar price of silver and the Euro exchange rate.

If we look at the dollar price of silver relative to (say) the commodities index, we see that silver has reached an extremely important juncture. As can be seen from the following chart, if the silver price continues along its upward pointing intermediate term trend relative to commodities, it will break up from an equilateral triangle - which, in turn could cause the price of silver to rise strongly relative to commodities in general.

Of particular interest is that silver has already broken up out of the triangle relative to gold:

The level of 0.18 appears to be of pivotal importance and, should it be meaningfully penetrated on the upside, a "new game" might start to emerge.

But the next chart - showing the price of silver relative to that of the US Dollar Index - is showing a picture that is counter intuitive. It is showing a "non confirmation" that may in fact be more in the dollar's favour. Although there is an apparently bullish ascending right angled triangle in favour of silver, the uptrend line can be seen to have been penetrated on the downside, and the MACD is showing descending tops April vs November relative to rising tops in the price.

The above chart represents a warning signal to silver bulls. It is possible that all is not necessarily as it seems. Why is the US Dollar showing relative strength?

Another clue may be hidden in the chart showing the relationship between silver and oil - which shows that silver that in commodity terms is about to become seriously preferred to oil.

The falling wedge should it break to the upside - will be very bullishly in favour of silver. Further, given that the oscillators have already broken to the upside, these buy signals are pointing to a probable upside break from the falling wedge.

The question arises: If the wedge breaks to the upside, will it be as a result of the oil price collapsing or the silver price exploding upwards?

Under normal circumstances, this analyst would be arguing strongly in favour of an upside break in the silver price because:

1. Silver has already broken up relative to gold
2. Silver looks like it wants to break up relative to commodities in general
3. Silver has broken up in the short term relative to the Euro, and looks like it wants to break up long term
4. The Silver:US\$ ratio chart is forming what appears to be a bullish ascending right angled triangle
5. Silver looks like it wants to break up strongly relative to the oil price.

The two areas of negativity -which might mitigate against a Silver Earthquake are as follows:

1. Silver has broken below its upward pointing trendline relative to the US Dollar Index
2. The non confirmation of rising tops in price and falling tops in the MACD of the \$Silver:\$USD chart.

Could it be that the US Dollar is about to rise further because the price of oil comes back sharply?

From the following chart of the Oil Index, it can be seen that the MACD is hugely overbought, and all three oscillators shown are reflecting falling tops from rarified overbought levels.

Why might the oil price fall?

In simple terms, it was China's demand for oil that became the original swing factor for the recent upward explosion in the oil price; but the Shanghai Market is looking VERY unhappy at present. (Chart courtesy Yahoo.com)

A "collapse" in the oil price would be very bullish for the US economy.

Finally, the Silver lease rates are showing signs of possible peaking out given the downtick in the 1 mth - 6 mth rates.

Summary Conclusions

The probability of a Silver Earthquake is 50/50 at present. The ratios are all on knife edges and, if silver breaks up from here we might very well experience a market dislocation.

However, there is tentative evidence to suggest that the silver price may not break up relative to commodities and oil, but rather - because the Shanghai market is evidencing an anticipated slowing of the Chinese economy - commodities and oil may fall relative to silver.

A fall in the oil price might be very bullish for the US economy, and this might be why the Silver:US\$ chart is not as strong as (say) the Silver:Euro chart. It might also be a contributory reason (in addition to the no votes in France and Holland) as to why the US Dollar has been so strong.

But, in the end analysis, Silver is a precious metal - as is gold - and the following chart of the goldollar index is showing a further strengthening - within a bullish ascending right angled triangle of the gold price relative to a rising dollar; and it should be remembered that silver is outperforming gold.

Whilst the triangle can be more easily seen on the weekly chart, the recent strengthening is most visible on the daily chart - which is once again reaching for the limits of the triangle's boundary.

Overall Conclusion

Within the next two to three weeks, the indecisions within the markets should finally be resolved. There appears to be a compelling argument in favour of precious metals - in particular silver - once again taking centre stage.

Nevertheless, nothing is as simple as it seems. There are some unexpected forces at work in the background, not the least of which is the escalating weakness in the Chinese stock market and what this might mean to the world's economy.

The bottom line is that there appears to be a finite probability that the silver market could experience a dislocation and an earthquake of relatively small proportions - which will have significant implications for silver investors, but containable implications regarding the economy as a whole.

Brian Bloom

Australia, June 4th, 2005