Is There A COMEX Silver Shortage?

June 12, 2011

Earlier this week, several websites and blogs that I follow announced that the "registered" silver at the COMEX exchange dropped below 29 million ounces ("registered" means the amount of silver available for investors to buy at the exchange.) This was touted as an "all-time low." While I could not find a complete data set on COMEX silver inventories, this 29 million ounce number is definitely the lowest since 1988, and is lower than the number of ounces available in 1980 (roughly 55 million), when the COMEX changed the rules on the Hunts to help bring the price down. I should point out that when you add in the "eligible" category you get another 73-odd million ounces of silver, which is still higher than when Warren Buffet was involved in the metal, though even then the "registered" category never dropped below 32 million ounces. So it is important to note that the total inventories at the COMEX are NOT at all-time lows.

Before I continue, it bears repeating that the COMEX cannot officially default or "run out of silver" because the exchange is not required to deliver physical metal to traders. So in the most literal sense, there cannot be a COMEX shortage, because the COMEX can never run out of silver. This does not mean that the COMEX cannot be replaced by some other price discovery mechanism, or ignored by the physical market. And it certainly does not mean that the price of silver can't move higher.

I also need to point out that long-time COMEX observer, Ted Butler ( reminds people that the distinction between "registered" and "eligible" may simply be a clerical distinction that in and of itself may not mean much. However, Butler has been consistently stating that the "turnover" in COMEX impresses him, and does indeed seem to indicate a very tight physical market. In other words, it looks to him that a lot of the silver at the COMEX is in fact unavailable for some delivery needs and has to be procured elsewhere.

I did find it interesting that so little silver is in the eligible category myself because up until 2008, according to the CPM Silver Yearbook, more silver at the COMEX was available for delivery than not. Oftentimes at a ratio of 2 or 3 to 1. Now, it is the exact opposite.

Another important reason that many silver watchers obsess about the COMEX is because they know that of all the precious metals, the difference between paper ounces versus physical ounces of silver is greater than the other metals, at anywhere from 150 to 200 paper to physical ounces (this can also be confirmed in the CPM Silver Yearbook.)

So people pointing to this development in registered silver inventories have a point- silver is very popular at the moment. Of course to anyone following the metal, this fact is expressed in the price: silver is basically at all-time highs having spent far more time above 30 dollars an ounce this year than in 1980.

However, there is a larger story here -- a story about much more than the COMEX (again an institution that really can't have a shortage). Instead, it is a story about the investing public and how dramatically their attitudes toward silver have changed in just the past four or five years.

Investors versus Traders in the Silver Market: Who Is Winning?

2006 was an important year in silver, because it marked the first time in 16 years that investors had begun to buy more silver than they sold (either in physical form or through trusts or holding companies). It marked the end of a powerfully demoralizing silver bear market where private investors sold over 2 billion ounces of silver- a pretty amazing number. Average investors had been far more bearish on silver than gold during this time, by the way, which is part of what makes the last five years so dramatic (and may also explain silver's parabolic price move.)

2006 also saw the introduction of the iShares Silver ETF, now the world's largest silver ETF with over 300 million ounces of silver. Within a couple of years several other ETFs were established, like the Zurich Cantonal Bank's Silver ETF, as well as the Sprott Physical Silver Trust. These entities allowed investors unprecedented ease of gaining exposure to silver with brokerage accounts, and have played a large role in popularizing silver investing (in addition to the Central Fund of Canada, which has been in existence since 1961.)

More evidence of the bullish shift toward silver by the public came in 2008 during the financial crisis. As has been remarked elsewhere repeatedly, the large downdraft experienced by silver in 2008 came largely from the liquidation of large, paper long positions at the COMEX. While the COMEX does not have that much physical silver, it is without a doubt the market maker in terms of paper silver ounces, doing north of 70% of all paper trading volume in silver. This is why people pay attention to the inventories held there. But even as the silver price was being knocked lower on paper in 2008, millions and millions of physical ounces were being snapped up either by direct retail investment or through holding companies and trusts. And sure enough, by 2009, silver had recouped nearly all of its gains lost during the market meltdown of the fall of 2008. I think that was the first clue as to the power of the private investor demand for silver. This is another way of saying that while the COMEX can hardly be ignored as the world price maker in silver, it is not always in charge of the market price for the white metal.

Looking Back At The Last Silver Bull

During the phase of the last bull market in silver net investment (starting in 1963 when retail investors were allowed to buy silver bullion and not ending until 1989-after the official bull market was over) it has been estimated that investors only became net sellers during about 7 or 8 of those 24 years.

Beginning in the 1960s, silver "buying" came both from investing in bullion, as well as from people simply hoarding silver coins still being produced by the U.S. mint until all silver was finally removed from U.S. coinage in 1968. By 1970, investors had purchased or hoarded over 1 billion ounces of silver. Then, during the next 19 years, silver net buying led to the hoarding of an additional billion ounces of silver bullion. (A historical perspective is provided in the 2009 CPM Yearbook, p. 8-10; and The Silver Institutes's World Silver Survey, 1990, 6-9).

How much net buying has gone on in the last five years? Only about 500 billion ounces, or a quarter of as much done between 1963 and 1989.

What caused silver disinvestment last time around

So the tectonic shift made by investors into silver in 2006 is likely far from over. This is all the more true when you consider the conditions that made investors sell their silver between roughly 1990 and 2005. While it is correct that the price of silver had been declining for some time in the 1980s (largely due to the Hunt's Corner blowing up coupled with positive real interest rates), silver investors had been fairly resilient during the 80s, having continued to buy a full eight years after the 1980 peak, albeit in decreasing amounts. Also remember that the average silver investor probably does not put more than 5-10% of their money into the metal, so they are able to absorb large percentage losses since those losses comprise such a small part of their overall net worth. So what caused these hardened silver investors to sell their silver beginning in the 1990s? It was seeing other people getting much more money on other investment opportunities in the go-go 90s. Silver investors weren't that afraid of losing money alone. But if you are losing money while other people are making a killing in stocks or junk bonds or real estate (as was the case between 1989 and 2005), then you might consider dumping even your small holdings of silver.

But that was then and this is now. Can anyone out there tell me what kinds of assets in the coming years are going to make people want to dump their silver hedges? Any ideas? Any?

To go back to what has been driving silver higher (investors): if only 5 years of net investment in silver has taken the metal from roughly 7 dollars to over 35 dollars, and the amount of that net investment today has only equaled about 500 million ounces, how high will silver go if, over time, investors buy the two billion ounces of silver that they did in 60s and 70s?

I think you already know my answer. Of course the real reason to buy some silver is as a systemic financial hedge -- you shouldn't be too concerned about the fiat price. But many people are concerned about the price of silver, and others claim silver is (or was) in a bubble. I think the facts say otherwise.

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