first majestic silver

The End of the Line

January 17, 1998

Fifteen years is a long time. In the financial world it is an eternity. Take a moment and reflect on what your life was like then, fifteen years ago. What did the world look like and what prices were assigned to the various asset classes. Think about the changes we have all experienced and witnessed in the grand sweep to the present. Think of the monumental events we've seen unfold in the world in the past fifteen years.

No, this piece isn't an expansive walk down memory lane, nor a attempt to handicap the world's future. It's much more specific than that - it's about silver(and by extension, gold). And even more specifically, it's about silver leasing, and how, after a 15 year grand experiment that distorted the very laws of supply and demand, it has finally reached the termination phase. The silver leasing scam is over - all that's left are the defaults, renegotiating and workouts. And of course, the double-talk.

In fact, the double-talk has already kicked in with a vengeance. To wit, the recent threats of class-action law suits and government investigation into the upside "manipulation" of the price of silver, which is still down 90% from its peak and 60% from where it was 15 years ago today. And that calculation doesn't account for inflation adjustment. It's also funny that nobody has questioned just what broad class of plaintiffs the threatened lawsuit seeks to protect. Would it be the 3 or 4 big industrial users, or the 5 or 10 institutional paper shorts? Yeah sure, just like the asbestos or tobacco or breast implant class-action suits, protecting the truly innocent masses.

And don't be surprised with future tactics intended to derail what promises to be a very long and UPWARD sharp price spiral for silver.

But in a way, you can't blame the big silver users and shorts for resorting to such extreme tactics so soon into the new silver bull market. And don't be surprised with future tactics intended to derail what promises to be a very long and sharp price UPWARD spiral for silver. For with the death of silver leasing, the users and shorts know that the game has been radically changed. Gone forever is the chance to steal immense quantities of silver from gullible central banks under the guise of "borrowing". No more will the silver deficit be satisfied with endless supplies from the lenders. From now on, buyers and sellers of physical silver will be subject to the laws of supply and demand, which has not been the case for the past fifteen years.

Before I explain why the silver leasing scam is over, let me try to explain briefly what it is, or was. I know I have written extensively about precious metal lending on these pages before, so if I am too brief, you can reference previous pieces. There has been an on-going deficit in silver for many years. That is, the world has physically consumed more silver than it has produced from all sources each year for many years. Since it is impossible to consume more of a physical commodity than is created currently without drawing from previously produced years of surplus, the silver deficit was balanced with the draw-down from existing stocks. This in itself is not unusual. It is how it works in the commodity world - excess supplies are accumulated in years of plenty and consumed in years of shortfall. This is a restatement of the law of supply and demand. The only thing I am leaving out (though it's strongly implied) is the function of price. Price is the fulcrum that governs the immutable cycles of the supply/demand equation.

As prices rise, production is stimulated and demand is diminished, allowing surpluses to accumulate. When the surplus is too great, the price falls, which curtails production and encourages consumption, eliminating the surplus. This is the essence of the free market. It is what capitalism is based upon. Unfortunately, it is not what the silver (or gold) market is based upon.

For 15 years, the silver market has NOT been a free market because the price component of its supply/demand equation has been removed and replaced with a different component - the lease rate. Please bear with me as I explain. Because of the cumulative effects of the deficit, we have seen the removal or draw-down of over a billion ounces of silver from existing stocks since 1990, according to the mainstream silver research houses (my own research shows a bigger draw-down from 1983, but let's stick to what is generally accepted). Now look at a weekly or monthly price chart of silver from 1990 or 1983. What you will see is this, a basically flat line price pattern (with a few brief blips in the longer dated chart) for a commodity that in the ten years prior to 1983, had been the most volatile of all. How do you effect the transfer of a billion ounces of silver in seven years with no price rise? How do you entice the owners of a billion ounces of silver to part with their property to satisfy the deficit without the incentive of higher prices? The answer is simple, don't deal with them on the basis of price, deal with them on a completely different basis where price doesn't matter. Create a new kind of transaction that supersedes and replaces the law of supply and demand. Create the precious metal loan.

Central banks had large stockpiles of gold and silver, investment bankers had exciting new financial concoctions, the rest is history. Don't let your stocks of metals just lie there, mobilize them. If you can't just sell them, because that would involve reporting the sales and taking flak from different constituents, lend them. You'll get cash flow from an interest rate (low, but so what, just lend bigger quantities) and you don't have to report anything, except the new found revenue stream to your boss. You decided to turn over your silver based upon the current interest rate offered, the current price was immaterial since you planned on getting your metal back someday. Whether it was intentional from the origin of precious metal loans or not, the release of massive amounts of metal to the market distorted the price/supply/demand equation of silver and gold for the past 15 years. You see, the market is not able to distinguish from silver coming to market that is a straight sale or a loan. That's because loans of metal are really sales, since there is no way that the vast bulk of silver loaned can ever be returned. Just because the lenders and borrowers of silver have deluded themselves into believing these were not sales doesn't matter. It is obvious that the metal that came to market as a result of these silver "loans" has satisfied the on-going silver deficits these past fifteen years. It is equally obvious that that silver is gone forever. As I said, if I've gone over this too quickly, please read the prior pieces.

That was then, this is now - the silver lease CON is over! Here's why. Look at the silver lease rates. Back in April/May when I first wrote to the Fed and Treasury, silver lease rates had never moved much above 1% for many years, except perhaps very briefly. Since May 30, however, they're never been below 1%, and recently have hit 8% and 9%, the highest rates in silver lending history. At first, I thought a big silver lender had read my attack on metal loans and decided to withdraw from the market, because of the timing between the attack and the start of the climb in rates ( by the way, you can observe the change in rates on the Kitco web site). Now, however, other indicators lead me to believe that the ten-fold increase in silver lease rates these past six months, means that we have reached the bottom of the barrel of the silver lendable supplies. Remember, the lease rate on precious metal is supposed to be ultra low because there is no inflation risk in the lending of metal. It is this ultra low interest rate on metal loans that makes the whole concept viable. A high interest rate means only two things - lenders are worried about getting their principal back, or there is no more supply to lend. (I've eliminated a big new borrowing demand as a reason, as it makes no economic sense to "borrow" silver at current rates when it is cheaper to buy.) When you really think about it, 8% is the same as 80 or 800%, all are numbers that indicate that the silver loan market is not functioning as intended. Since there is no seasonality in a metal market, there is nothing to suggest that this is a temporary problem.

This being the case, if there is no more supply coming to the lending market, and we still have a huge deficit, the silver market faces a different future than its fifteen year past. With the market deprived of the deficit satisfying silver loans, recorded stocks have sunk to historic lows and the market has entered into backwardation. To long suffering silver bulls we have arrived at the moment of truth.

Now, the only question remains the extent of the coming silver defaults and the timing. That the silver loan market is failing should be obvious, after all, what sane investor would loan metal at this stage? The insidious aspect to the metal loans is that they are cumulative, that is, all the silver ever loaned is about to be called in, either by the lenders who fear for the return of their principal, or the borrowers who are suddenly confronted with shocking interest increases for material long since consumed or disposed of. The real concern is how far the ripple effect of the loan market failure spreads to the entire silver world. The government can buy time by attacking a large speculator or two, and the users/shorts can bring all sorts of lawsuits, but there is a certainty about the law of supply and demand - in the end you can't legislate or sue a silver deficit away. Only more production and less consumption can do that.

After 15 long years, silver looks like it's entering the free market again, where price is the determinant, not some arbitrary interest rate on a fraudulent financial concoction.

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