Dec 10

See also:

- Eric Sprott To Buy $1.5 BILLION In PHYSICAL Silver

Flashback:

- James G. Rickards of Omnis Inc.: Get Your Gold Out Of The Banking System

- US DEPARTMENT OF HOMELAND SECURITY HAS TOLD BANKS – IN WRITING – IT MAY INSPECT SAFE DEPOSIT BOXES WITHOUT WARRANT AND SEIZE ANY GOLD, SILVER, GUNS OR OTHER VALUABLES IT FINDS INSIDE THOSE BOXES!


- Eric Sprott Fights PM Manipulation Fire With Fire: Calls Silver Producers To Retain Silver Produced As “Cash”

In what is likely the most logical follow up to our post of the day, namely the news of the lawsuit between HSBC and MF Global over double-counted gold, or physical – not paper – that was “commingled” via rehypothecating or otherwise, we present readers with the monthly note by Eric Sprott titled “Silver Producers: A Call to Action” in which the Canadian commodities asset manager has had enough of what he perceives as subtle and/or not so subtle manipulation of the precious metal market, and in not so many words calls the silver miners of the world “to spring to action” and effectively establish supply controls to silver extraction to counteract paper market manipulation in the paper realm by treating their product as a currency and retaining it as “cash”. To wit: “instead of selling all their silver for cash and depositing that cash in a levered bank, silver miners should seriously consider storing a portion of their reserves in physical silver OUTSIDE OF THE BANKING SYSTEM. Why take on all the risks of the bank when you can hold hard cash through the very metal that you mine? Given the current environment, we see much greater risk holding cash in a bank than we do in holding precious metals. And it serves to remember that thanks to 0% interest rates, banks don’t pay their customers to take on those risks today.” And the math: “If silver miners were therefore to reinvest 25% of their 2011 earnings back into physical silver, they could potentially account for 21% of the approximate 300 million ounces (~$9 billion) available for investment in 2011. If they were to reinvest all their earnings back into silver, it would shrink available 2011 investment supply by 82%. This is a purely hypothetical exercise of course, but can you imagine the impact this practice would have on silver prices?” And there you go: Sprott ‘reputable’ entity to propose to fight manipulation with what is effectively collusion, which in the grand scheme of things is perfectly normal – after all, all is fair in love and war over a dying monetary model. Who could have thought that the jump from “proletariats” to “silver miners” would be so short.

From Eric Sprott

Silver Producers: A Call to Action

As we approach the end of 2011, the silver
spot price has admittedly endured a tougher road than we would have
expected. And let’s be honest – what investment firm on earth has
pounded the table on silver harder than we have? After the orchestrated
silver sell-off in May 2011 (please see June 2011 MAAG article entitled,
“Caveat Venditor”), silver promptly rose back to US$40/oz where it
consolidated nicely, only to drop back below US$30 within a two week
span in late September. The September sell-off was partly due to the
market’s disappointment over Bernanke’s Operation Twist, which sounded
interesting but didn’t involve any real money printing. Like the May
sell-off before it, however, it was also exacerbated by a seemingly
needless 21% margin rate hike by the CME on September 23rd, followed by a
20% margin hike by the Shanghai Gold Exchange – the CME’s counterpart
in China, three days later.

The
paper markets still dictate the spot market for physical gold and
silver. When we talk about the “paper market”, we’re referring to any
paper contract that claims to have an underlying link to the price of
gold or silver, and we’re referring to contracts that are almost always
levered. It’s highly questionable today whether the paper market has any
true link to the physical market for gold and silver, and the futures
market is the most obvious and influential “paper market” offender. When
the futures exchanges like the CME hike margin rates unexpectedly, it’s
usually under the pretense of protecting the “integrity of the
exchange” by increasing the collateral (money) required to hold a
position, both for the long (future buyer) and the short (future
seller). When they unexpectedly raise margin requirements two days after
silver has already declined by 22%, however, who do you think that
margin increase hurts the most? The long buyer, or the short seller? By
raising the margin requirement at the very moment the long contracts
have already received an initial margin call (because the price of
silver has dropped), they end up doubling the longs’ pain – essentially
forcing them to sell their contracts. This in turn creates even more
downward price pressure, and ends up exacerbating the very risks the
margin hikes were allegedly designed to address.

When reviewing
the performance of silver this year, it’s important to acknowledge that
nothing fundamentally changed in the physical silver market during the
sell-offs in May or mid-September. In both instances, the sell-offs were
intensified by unexpected margin rate hikes on the heels of an initial
price decline. It should also come as no surprise to readers that the
“shorts” took advantage of the September sell-off by significantly
reducing their silver short positions. Should physical silver be priced
off these futures contracts? Absolutely not. That they have any
relationship at all is somewhat laughable at this point. But futures
contracts continue to heavily influence spot prices all the same, and as
long as the “longs” settle futures contracts in cash, which they almost
always do, the futures market-induced whipsawing will likely continue.
It also serves to note that the class action lawsuits launched against
two major banks for silver manipulation remain unresolved today, as does
the ongoing CFTC investigation into silver manipulation which has yet
to bear any discernible results.

Meanwhile, despite the needless
volatility triggered by the paper market, the physical market for silver
has never been stronger. If the September sell-off proved anything,
it’s the simple fact that PHYSICAL buyers of silver are not frightened
by volatility. They view dips as buying opportunities, and they buy in
size. During the month of September, the US Mint reported the second
highest sales of physical silver coins in its history, with the majority
of sales made in the last two weeks of the month. Reports from India
in early October indicated that physical silver demand had created
short-term supply issues for physical delivery due to problems with
airline capacity. In China, which reportedly imported 264.69 tons (7.7
million oz) of silver in September alone, the volume of silver forward
contracts on the Shanghai Gold Exchange was more than six times higher
than the same period in 2010. It was clear to anyone following the
silver market that the physical demand for the metal actually increased
during the paper price decline. And why shouldn’t it? Have you been
following Europe lately? Do the politicians and bureaucrats there give
you confidence? Gold and silver are the most rational financial assets
to own in this type of environment because they are no one’s liability.
They are perfectly designed to protect us during these periods of
extreme financial turmoil.

And wouldn’t you know it, despite the
volatility, gold and silver have continued to do their job in 2011. As
we write this, in Canadian dollars, gold is up 23.4% on the year and
silver’s up 6.8%. Meanwhile, the S&P/TSX is down -12.3%, the S&P
500 is down -5.1% and the DJIA is up a mere +0.26%.

So here’s
the question: we think we understand the value and great potential in
silver today, and we know that the buyers who bought in late September
most definitely understand it,… but do silver mining companies
appreciate how exciting the prospects for silver are
? Do the companies
that actually mine the metal out of the ground understand the demand
fundamentals driving the price of their underlying product? Perhaps even
more importantly, do the miners understand the significant influence
they could potentially have on that demand equation if they embraced
their product as a currency?

According to the CPM Group, the total
silver supply in 2011, including mine supply and secondary supply
(scrap, recycling, etc.), will total 1.03 billion ounces. Of that, mine
supply is expected to represent approximately 767 million ounces.
Multiplied against the current spot price of US$31/oz, we’re talking
about a total silver supply of roughly US$32 billion in value today. To
put this number in perspective, it’s less than the cost of JP Morgan’s
WaMu mortgage write downs in 2008.

According to the Silver
Institute, 777.4 million ounces of silver were used up in industrial
applications, photography, jewelry and silverware in 2010.12 If we
assume, given a weaker global economy, that this number drops to a flat
700 million ounces in 2011, it implies a surplus of roughly 300 million
ounces of silver available for investment demand this year. At today’s
silver spot price – we’re talking about roughly US$9 billion in value.
This is where the miners can make an impact. If the largest pure play
silver producers simply adopted the practice of holding 25% of their
2011 cash reserves in physical silver, they would account for almost 10%
of that US$9 billion. If this practice we’re applied to the expected
2012 free cash flow of the same companies, the proportion of investable
silver taken out of circulation could potentially be enormous.

Expressed another way, consider that the majority of silver miners today can mine
silver for less than US$15 per ounce in operating costs. At US$30
silver, most companies will earn a pre-tax profit of at least US$15 per
ounce this year. If we broadly assume an average tax rate of 33%, we’re
looking at roughly US$10 of after-tax profit per ounce across the
industry. If GFMS’s mining supply forecast proves accurate, it will mean
that silver mine production will account for roughly 74% of the total
silver supply this year. If silver miners were therefore to reinvest 25%
of their 2011 earnings back into physical silver, they could
potentially account for 21% of the approximate 300 million ounces (~$9
billion) available for investment in 2011. If they were to reinvest all
their earnings back into silver, it would shrink available 2011
investment supply by 82%. This is a purely hypothetical exercise of
course, but can you imagine the impact this practice would have on
silver prices? Silver miners need to acknowledge that investors buy
their shares because they believe the price of silver is going higher.
We certainly do, and we are extremely active in the silver equity space.
We would never buy these stocks if we didn’t. Nothing would please us
more than to see these companies begin to hold a portion of their cash
reserves in the very metal they produce. Silver is just another form of
currency today, after all, and a superior one at that.

To take
this idea further, instead of selling all their silver for cash and
depositing that cash in a levered bank, silver miners should seriously
consider storing a portion of their reserves in physical silver OUTSIDE
OF THE BANKING SYSTEM. Why take on all the risks of the bank when you
can hold hard cash through the very metal that you mine? Given the
current environment, we see much greater risk holding cash in a bank
than we do in holding precious metals. And it serves to remember that
thanks to 0% interest rates, banks don’t pay their customers to take on
those risks today.

None of this should seem far-fetched. One of
the key reasons investors have purchased physical gold and silver is to
store some of their wealth outside of a financial system that looks
increasingly broken. The European banking system is a living model of
that breakdown. Recent reports have revealed that more than €80-billion
was pulled out of Italian banks in August and September alone. In
Greece, depositors have taken almost €50-billion out their banks since
the beginning of 2010. Greek banks are now completely reliant on ECB
funding to stay afloat. The situation has deteriorated to the point
where over two thirds of the roughly 500 billion euros that banks have
borrowed from the ECB are now being deposited back at the central
bank. Why? Because they don’t trust other banks to stay afloat long
enough to get their money back.

Silver miners shouldn’t feel any
safer banking in the United States. Fitch Ratings recently warned that
the US banks may face severe losses from their exposures to European
debt if the contagion escalates. There’s very little at this point to
suggest that it won’t. The roots of the 2008 meltdown live on in today’s
crisis. We are still facing the same problems imposed by over-leverage
in the financial system, and by postponing the proper solutions we’ve
only increased those risks. We don’t expect the silver miners to corner
the physical silver market, and we know the paper games will probably
continue, but the silver miners must make a better effort to understand
the inherent value of their product. Gold and silver are not traditional
commodities, they are money. Their value lies in their ability to
retain wealth in environments marked by negative real interest rates (),
government intervention (3), severe economic uncertainty (3) and
vulnerable banking institutions (33). Silver’s demand profile is
heightened by its use in industrial applications, but it is the metal’s
investment demand that will drive its future performance. The risk of
keeping all of one’s excess cash in a bank is, in our opinion,
considerably more than holding it in the more enduring form of money
that silver represents. It’s time for silver producers to embrace their
product in the same manner their shareholders already have.

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