The Real Lenders of Last Resort

February 4, 1999

A number of market observers have noted that the current excitement in the silver market is occurring exactly one year after Warren Buffett's announcement of his big silver purchase. Last year at this time the price of silver surged and the lease rate skyrocketed to shocking levels. If you think the timing of the current volatility in the silver market is just coincidental with last year's move; perhaps you will permit me to argue otherwise. I contend that the sole cause of the current volatility in silver is precisely what occurred exactly one year ago.

Just a brief recap of what transpired last year at this time: After months of rumors of mysterious large purchases of silver by a group intending to manipulate the price upward, and against a backdrop of threatened lawsuits and government and exchange investigations, it was announced that Warren Buffett's company, Berkshire Hathaway, had purchased approximately 130 million ounces of silver. Mr. Buffett subsequently explained that he had followed the silver market for thirty years and was attracted to it on the supply/demand fundamentals alone. The lawsuits and investigations disappeared, and the price of silver, along with lease rates peaked within a week of the announcement, and remained relatively comatose for a year, until a few days ago. That is not to understate the stresses in the silver market a year ago. After all, the real price of silver, the lease rate, surged almost a hundred fold for the one-month variety (from .84% to 80%) in roughly six months, due to Mr. Buffett's purchases. Then things quieted down, with one-month lease rates quoted around one per cent as recently as a few weeks ago.

But things got decidedly unquiet in silver in the past few days, with lease rates surging once again. Here's why it's not a coincidence that the rates are surging exactly one year after the last great lease rate spike - the leases that were entered into a year ago, just came due. A year ago, the one-year silver lease rate exceeded 20% and that was on $7 silver. That's a far cry from the 3% on $5 silver that was available until a few weeks ago. So when the one-year leases came due, starting a few days ago, the lenders of silver said, "no thanks, I'll take my silver back". If you've read any of my previous articles, you know that presents a problem - a billion ounce problem. That problem is that the leasing scam is predicated on more and more new metal being loaned to satisfy the deficit. There is no provision in the leasing scam for metal being returned. It is not possible for there ever to be net repayments of metal. With an ongoing deficit, it is just not possible. The only way to temporarily avert the certain coming default in metal loans is to placate the lenders by offering higher rates to dissuade them from calling in their metal. And that, in a nutshell, is what is happening right now. And don't think for a second, that the published lease rates necessarily reflect the private rates being offered by desperate borrowers who have no choice but to pay whatever the lenders demand.

But the lenders, unlike the borrowers, do have a choice. They can extract whatever the traffic will bear, and roll over their leases, or they can look into the future and see what will happen at the next roll over, or the one after that. At some point, metal lenders will measure the return on principal against the return of principal. And it's just possible that that contemplation is currently in play. For if one or two big lenders of silver, say a Buffett or a Philippine Central Bank, decides that the lease scam jeopardizes the return of their metal, and refuse to roll over at any rate offered, then the lease con is over and the price of silver will be the price of silver, not some make-believe Wall Street concocted interest rate.

What are the prospects of a big silver lender or two ignoring the siren call of the coming usurious interest rates and demanding that their metal be returned? I don't know. But if I were a metal lender (admittedly absurd), it would bother me a bit, that after such a long period of low rates, as soon as I signaled my intention to not renew my leases, the borrowers strongly resisted returning my metal by offering rates that escalated daily. It would make me wonder if they could return it at all, if they had to. It would also bother me, that unlike a year ago, when Mr. Buffett's purchase obviously impacted the market temporarily, that this year there was no hint of any large purchase currently. In other words, just my leases coming due, and not being rolled over, was enough to send the market into a tizzy. If I were a lender, it would upset me to realize that the market needed my collateral that much.

Regardless of how this current drama in silver is played out, there is another point becoming obvious. New silver supplies for lending are drying up. Otherwise, there wouldn't be such a strain being caused by existing loan rollovers. I thought that was true a year ago and I've come to realize why my timing was off. This is speculation, so treat it accordingly. When Warren Buffett purchased his silver, I think even he was surprised with the fanfare and resultant strain his purchase put on the market. Being the respected establishment figure that he is (in addition to being a cracker-jack investor), he was loath to cause a market default by demanding all the deliveries he was entitled to. He knew the shorts couldn't deliver. So he let the shorts off the hook by leasing back a good chunk of his silver. Now the lease is up. Is he going to let them off the hook again? Maybe he will, but remember, he has a fiduciary responsibility to his shareholders, and you can be sure he's concerned about the ultimate return of the silver.

But whether the current battle of the expiring silver leases is resolved by rollover or the return of collateral or default, the lesson of the current silver turmoil should be clear to everyone. That lesson is that metal loans are fraudulent and manipulative. They are inherently flawed. How many crises must occur before that is obvious? How much longer before the market rejects the premise of the destruction of collateral as a normal requisite in these stupid transactions? How can our army of market regulators not see this fraud? What do they do all day?

The silver lenders of last resort might want to think this through before they decide to roll over their loans or call their silver in - is this the way metal lending was supposed to be? Don't you find it odd that the borrowers seem so aggressive? Do their explanations of how they plan to repay your metal reassure you? Just what is your protection in the event of systemic default?

Due primarily to the California Gold Rush, San Francisco’s population exploded from 1,000 to 100,000 in only two years.