A Permanent Shortage of Silver

November 14, 1998

A practical definition of the word shortage as it pertains to a tangible commodity would evolve around supply being insufficient to meet demand. A more precise definition would refine the meaning of that insufficiency to apply to the inability of current production to meet current demand. Since all commodities have some sort of inventory, any imbalance of current demand exceeding current production will automatically necessitate a draw down of inventories, almost always by increasing prices. This is the essence of the supply/demand equation. Inferred in this basic definition of a commodity shortage situation is the inherent temporary nature of such a shortage. After all, a tangible commodity can not operate in a persistent deficit condition, once inventory is depleted, new production must at least equal current consumption, and more likely exceed it, in order to replenish inventory. With no inventory, it is impossible for demand to exceed supply, period. Shortages are, by definition, always temporary.

So is the title of this piece an oxymoron - how can there be a permanent shortage? Not to get too abstract, it depends on your definition of the word permanent. For me, meanings like continuous, durable and enduring come to mind, or simply, something that lasts a long time. Since most commodities have a seasonal production/consumption cycle, shortages are typically corrected in a growing season or two. Minerals are not bound by the seasons, so it may take longer to erase a deficit, but a few years has always been sufficient. Surpluses could continue for prolonged periods, but deficits can go no further than practical inventory depletion. Then the inevitable cycle of inventory replenishment must begin. But if it took an extraordinary period of time to balance a tangible commodity deficit, say instead of a year or so, something like fifty years, then I would apply the term - permanent shortage. And I see, clear as day, a permanent shortage of silver straight ahead.

Fifty years is an incredibly long period of time when talking about commodity cycles. How could I reasonably substantiate my statement that silver will be locked in a deficit supply/demand position for 50 years? A permanent shortage. Please hear me out.

The model for determining the length of the continuing silver deficit, as it would be for any other commodity, is to determine the price level it would take to encourage sufficient new production and choke off demand, once inventories are depleted in a practical sense at the then current price level. While the model may be simple, because there are varied and numerous producers, consumers and inventory owners, and potential new owners, all of whom have a specific price which will alter their behavior and ownership, figuring the net effect on the market at any time/price is more challenging. This is, in fact, what commodity analysis is all about. But where do I get off calling for a shortage situation in silver to last for the rest of our time on this earth?

It is said that to see the future, we must study the past. Fortunately, the historical record of silver is rich and well documented. Taking that rich historical record and applying it to the model for normal commodity analysis, a shocking future vision emerges for silver.

To look ahead 50 years, it would be appropriate to look back fifty years to gain a sense of perspective. Half a century ago, at the end of World War II, total known stocks of silver amounted to ten billion ounces (with the US government holding 4 billion ounces of that total amount). At that time, we were just entering an era of unprecedented global economic expansion that has lasted to the present. In this era, silver was consumed in a variety of vital modern applications at a phenomenal rate. Today, known stocks of silver have shrunk over 95%, to maybe a half a billion ounces. The nine and a half billion ounce draw down in total silver inventory, was the result of the persistent shortfall between supply and demand, which continues to this day. Not coincidentally, the current 200 million-ounce annual deficit in silver mirrors the long-term trend line average. This continuing deficit is remarkable in that there has been decent growth in world production of silver over the past 50 years, but obviously not enough to satisfy the surge in industrial demand.

Herein lies the crux of my permanent shortage argument. If the world has consumed 95% of total known inventory of silver over the past 50 years, what will the future hold when the last practical inventory of silver is depleted at current prices, and supply from current production must satisfy current demand? If you think I'm alluding only to sharply higher prices, you are not getting my drift. I am talking about massive market dislocations that will dominate the silver landscape for the rest of our collective lives. Here's why - there is no practical price that I can imagine that would allow silver inventories to grow by virtue of current production exceeding current demand. I'm not talking about producing an extra 10 billion ounces, like we had 50 years ago; that will never happen. After all, that massive inventory buildup took the world thousands of years to accumulate because there was no industrial demand to that point. I'm stating we couldn't even produce 1% of that (a real 100 million ounce surplus) under the most extreme conditions. We are in a box.

Because so much silver has flowed from inventories over the past 50 years (a lot of it uneconomic, as in US government releases at the bequest of the Silver Users Association, and the leasing scam), there has developed a structural imbalance between the free market forces of supply and demand. This structural imbalance is so great and so well formed that it is impossible to think in terms of a rational equilibrium price that would balance the supply/demand equation in a normal sense. I know that higher prices will have a probable effect on total supply in terms of changes in ownership of existing inventory, but I am hard pressed to come up with what the equilibrium price would have to be to balance the deficit once inventories are truly depleted. This depletion of inventories is certain because we are in an obvious deficit, but the timing is uncertain. You can't judge the moment of truth of inventory depletion in normal economic analysis terms because the main supply at the margin comes from an uneconomic source - the fraudulent central bank leasing of silver. Tell me when the leasing ends (as it most certainly will), and you will probably see a double or triple on silver that day.

But a double, or triple, on silver in a day would only go a small way to altering the structural imbalance between ongoing production and ongoing industrial demand. Maybe such a quick price move may induce some holders to sell, but you can't be sure of potential buyer behavior. Depending on any number of unknowable factors, conditions at the time may induce new buyers to overpower old sellers. So the real question is, what effect would a quick double or triple have on the behavior of the real producers and consumers?

We often hear how the supply and demand for silver is inelastic, that is, changes in the price of silver do little to alter the amounts used and produced. But there's a different way of stating that fact. Imagine you are a mine producer or industrial consumer of silver and you see the price double or triple. One thought will flash through your mind - what price will I stop using (or start mining) silver? Say you are Eastman Kodak and the price goes to $15 quickly. Since there are no substitutes, is there any price at which you will deliberately shut down your company instead of passing on costs, albeit reluctantly? If you are Asarco or Barrick, at what price do you commit years and hundreds of millions of dollars to open a copper or gold mine to get at the by-product silver?

This is not to say that there will not be any response taken by real producers and consumers. There most certainly will be changes in producers and consumers behavior that will have an impact at the margin temporarily. But running down inventory or modifying the refinery mix are short-term reactions. In a just- in-time world, how much can you run down inventories by delaying purchase? Besides, this only strengthens my thesis that a double or triple would result in little if any change to the structural deficit, and in fact, would prolong it. You see, it will be only changes in the short term aspects of the market such as uncovering previously unavailable inventory, delays of purchase and the refining for silver instead of gold or copper in response to quick gains in price. The structural deficit will be largely unaffected for a very long time. The bottom line is the silver market will remain tight for many years to come, regardless of changes in inventory ownership and violent price action.

In summary, we have an indispensable ingredient of modern life in a structural supply deficit that has been fifty years in the making, with no chance of real balance except at prices many times current price levels, which in turn are at an inflation adjusted 50 year low. That alone would represent a scenario that was bullish beyond extreme. In order to distill my message I have intentionally avoided reference to the things people normally discuss in the debate on silver, such as, inflation, currencies, war, the stock market, hedge funds, Y2K, world economic crises, etc. I've tried to stick to bedrock fundamentals, industrial production, consumption and inventories. Silver to me is like the shrinking water hole on the African plains. When the elephants and lions (Kodak, Dupont and Fuji) come to drink, all others will be deprived.

Even in trying to stick to one point, the industrial fundamental situation in silver, any objective analysis would be woefully incomplete if it did not mention the short position and the leasing scam. As I have attempted to point out in prior articles, silver has the largest listed and OTC short position the world has ever seen, well over a billion ounces. This position is well in excess of either annual world production or known inventories. It is absolutely amazing that The CFTC or any banking authority has not questioned the economic incentive of the shorts. In addition, another, and separate, billion ounce short position exists via the leasing scam, which will never, ever be paid back. To this day, ongoing leasing by the central banks of silver continues to frustrate the laws of supply and demand, and deepens the structural imbalance, guaranteeing the permanent shortage.

Aside from the obvious danger to the shorts, I think it is the paper longs that are in real jeopardy from the huge short position. How so? With the real silver long-term situation so tight as to leave you in awe; the last thing this market needs is the largest paper short position in history. Given the historical precedence, when the crunch comes, paper longs will not be able to convert to physical, as their contracts proclaim. It is just not possible. There is too much paper and too little real metal. In the crunch, at the watering hole, paper won't hold up. Not COMEX paper, not any paper. Then we will learn the difference between paper silver and silver. I can't say when this will happen; only that it will happen. In fact, I can guarantee it will be the biggest force majeur in history. Now that I think of it, holding physical silver offshore would be the most prudent step a prudent investor could take to further prevent emergency confiscation of physical stocks. Have you ever wondered why Warren Buffett went to the trouble of buying physicals held in London? In the long run, your only defense against the shrinking watering hole, the permanent shortage, is real silver in a real safe place.

For the record, allow me to state a couple (not all) of the reasons why I post these articles on the Internet. One is somewhat selfish, the other is not. First, I am looking to establish an unquestioned record of what will happen in silver, based on the true fundamental situation, well in advance of the market violence I see ahead. There will be plenty of commentary after the fact, most of which will continue to miss the real story. Instead, the focus will be on lawsuits, forced liquidations, market emergencies, accusations of manipulation by the longs, and defaults on previously sacrosanct contracts. Everything but the real story. Maybe by stating the true situation up front, the intentional confusion will be less successful. Second, if my writings convince anyone to convert even a small amount of money into real physical silver at current levels, I know I will have done them a favor. If things get ugly, it may be what keeps them alive economically. If things stay rosy, the permanent shortage will bestow a windfall. In any event, the long-term risk reward is spectacular. A thousand ounce cash position can only lose a negligible amount in the worst, worst case. In a best case it could buy you a car, or even a house.

The term “carat” comes from “carob seed,” which was standard for weighing small quantities in the Middle East.