The Silver Bank Run

April 18, 2000

Let me stick my neck out here - I think that the news of Handy & Harman's bankruptcy is among the most important events in the silver market of the past fifty years, up there with the US removing silver from coinage, the Hunt Brothers, and Warren Buffett. Aside from the obvious impact on the daily fundamentals, the importance of the bankruptcy of perhaps the largest silver refiner in the world, holds important non-obvious ramifications.

As you know, I have been consistent from my very first day on the Internet in attacking the very premise of metal leasing and forward selling. I have maintained that leasing of precious metals is inherently flawed because you can't dispose of the collateral of a collateralized loan and continue to pretend that the collateral still exists as backing. I claim that is fraud. While most participants and observers of the precious metals scene have come to grasp the significance of leasing and forward selling on the market, I am aware of no recognized analyst who claims they are inherently fraudulent, as do I. Handy & Harman may change that.

The lesson from Handy & Harman is that when you take a simple warehousing process, and convert it to a banking operation, only bad things can happen. I am not principally opposed to the system of fractional reserve banking - for currency and credit. But applying the principles of banking to a physical commodity, such as silver, results only in fraud and heartbreak. Please allow me to explain, it's really very simple.

In a regular banking operation, deposits by customers are lent and re-lent to others customers. Only a fraction of the deposited funds is kept in reserve to pay expected withdrawals. Unexpected withdrawals can be managed with help from the banking regulators. It is a system that has contributed mightily to world development. But take a system that works fine for currency, and apply it to a physical commodity, and you have a guaranteed mess on your hands. Here's why: what works for paper and electronic currency, can't work for a physical commodity. It just can't.

Despite a news black-out on Handy and Harman's bankruptcy, certain facts are certainly emerging. The chief revelation is that Handy and Harman has stiffed anyone holding physical silver with them. This silver can never be returned. It is doubtful that creditors will receive even adequate monetary settlement. The casual observer will note that this is normal, this is what happens in a bankruptcy. But that is not what I see. I see Handy and Harman's bankruptcy as something that had to happen. Just like I see bankruptcy and default as inevitable for anyone trying to mimic the fractional reserve banking practice of currency using physical commodities. This is the certain result of the fraud of metal leasing.

Simply stated, you can't take actual silver metal in as a deposit, and relend or sell the metal to a third party without getting into trouble eventually. It's not possible for such a set-up to not end badly. While silver is fungible, it cannot be created out of thin air, like paper or electronic currency. Because of this, it is only a matter of time before a demand for repayment of metal has to end in default. There is no lender of last resort for depositors and lenders of physical silver. Not only is there no FDIC for silver depositors, the usual ultimate guarantor, the US Government, was itself victimized by H&H - the US Mint is trying to get 2.5 million ounces of silver back from Handy and Harman. The US Government can't get its own silver back, how's it going to protect someone else?

Because you get so much silver for your money, people have naturally resorted to employing others to store their silver for them. This will prove to be a very big problem. If you hold silver in a pool account, or some type of paper bank or deposit certificate, you are at risk of not getting your silver back or of being able to collect when silver jumps. I can understand, for large quantities, the need to employ help in storing your silver. But you must make absolutely certain that the silver you are storing is actually where it is supposed to be. Your silver must be segregated by bar and be bonded and insured. The simplest way to do this is to own warehouse receipts from a licensed exchange, like the COMEX or Chicago Board of Trade. If you own paper silver in any other form, you are taking an unnecessary risk. It would be prudent to switch, immediately, from questionable forms of paper silver into these registered warehouse receipts. Be sure that when you attempt to switch, you will be told that it is not necessary. It is only necessary if you intend to ever collect. I can hardly imagine anything worse than investing hard-earned money in silver, waiting patiently for years for the manipulation to end, and then getting cheated out of a deserved profit because you held it in the wrong form. Don't let that happen to you.

I am not offering investment advice on silver. I am telling you that, mechanically, if you invest in silver, make sure it is in the right form. Own it in your physical possession when possible, but if you own a lot, make sure your certificate is valid. Warehousing is warehousing, banking is something completely different. It is impossible to fractionally reserve silver. Handy & Harman should have stuck to warehousing. Trying to be a bank is what brought them to bankruptcy. Ask yourself this - if the largest silver refiner in the world, a company in business for a hundred years, can disappear overnight with silver at $5 - what will happen when the price jumps and the real silver bank run starts? Do you know where your silver is? You better make sure you know.

 

Ted Butler

April 18, 2000

info@butlerresearch.com

With gold stolen by Conquistador Francisco Pizarro from the Inca Empire in 1532, Spain financed its conquest of Europe.

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