Silver: Shorting Consumes, Investing Conserves

It is a very simple proposition to explain how “shorting” is an activity which relentlessly, inevitably destroys markets, while investing is a benign activity which inevitably “heals” markets which are out of balance. What makes it difficult to understand this concept is years of media brainwashing branding investors as “speculators” and/or “hoarders”.

To pierce this brainwashing, I will explain these simple principles of arithmetic using an example to which we can all relate. Let’s assume that instead of JP Morgan hating silver that it hated chocolate bars instead. And so to destroy that market (and deprive the world of chocolate bars) JP Morgan began to ruthlessly “short” chocolate bars.

For the sake of argument, let’s assume that this ruthless shorting drove the price of chocolate bars to 10 cents apiece (since shorting always depresses prices). What would happen then? The immediate, obvious consequence is that chocolate bars would be cleaned-out on all the shelves of all the stores around the world, as people stampeded to take advantage of this incredible “sale” on chocolate bars.

However, the full consequences of this shorting are far, far worse. Virtually no chocolate bar-makers on the planet could manage to “break even” selling chocolate bars at 10 cents apiece, as the cost of their materials alone would greatly exceed that price. Most of the world’s chocolate bar-makers would be bankrupted, creating a much, much more severe chocolate bar shortage.

Most importantly, the chocolate bar “crisis” would never end unless/until prices rose substantially. At that artificially low price, it is a mathematical impossibility for there to ever be sufficient supply to meet demand. Enter the investor.

What happens if “investors” began competing to buy up the tiny, remaining supply of chocolate bars? The price would start to rise. That rise in price then “magically” accomplishes two necessary goals: it discourages demand while simultaneously stimulating supply, because as the price goes up more and more chocolate bar-makers can return to the sector.

As the price continues to rise, the market continues to heal. Demand moderates and supply rises until the two meet in equilibrium. Healing complete.

Now, again for the sake of argument, let’s suppose that “investing” in chocolate bars causes the price to rise “too high”. What happens then? The rising price continues to depress demand, while over-stimulating supply, and the pendulum swings past the point of equilibrium. This causes inventories to grow. This growth in inventories then depresses prices, as buyers are no longer willing to pay high prices for a plentiful good, and the market would swing back toward equilibrium.

It is an economic tautology that the price for a good cannot be “too high” if inventories are not growing, as the terms “too high” and “too low” are defined by supply/demand dynamics. If inventories are falling, prices are too low. If inventories are rising, prices are too high (assuming that inventories are at historical norms).

Now that these basic principles of arithmetic have been laid out in elementary terms, let’s apply those principles to the silver market and see where our analysis leads. First of all, it is a matter of common knowledge that JP Morgan is the largest “silver short” in the history of the world.

It has maintained that massive short position for several decades, despite the fact that in percentage terms its short position is much larger than the “long” position of the Hunt Brothers when they were accused of “cornering the market” (i.e. manipulating the silver market) back in 1980. What has been the impact of that ruthless, relentless shorting?

During the 1990’s, the price of silver was manipulated by JP Morgan to a 600-year low (in real dollars). We know this was “manipulation” because it was below the cost of production for nearly every silver mine on Earth, and well over 90% of all silver mines were driven into bankruptcy. Now that is how you destroy supply!

With the silver mining industry decimated by JP Morgan’s manipulative shorting, and demand radically over-stimulated by the 600-year low in the price of silver, the result was exactly what we could have predicted with our hypothetical example of chocolate bars: silver inventories were wiped-out. Between 1990 and 2005 alone, global silver inventories plunged by more than 90%.

Enter the investor. The principle of investing is the epitome of simplicity: buy low, sell high. With the price of silver at an extreme, artificial low; investors began buying silver. Despite the fact that JP Morgan has not only maintained but increased its short position in the silver market, silver prices have begun to steadily rise. Such is the healing power of investing.

It is obvious, however, that there is much more “healing” to be done. It is estimated by Ted Butler, the most respected researcher of the silver sector that roughly 90% of total, global stockpiles of silver have literally been “consumed”: frittered-away in a plethora of cheap consumer goods, with practically none of the silver being recycled because of the low price of silver.

There is less silver in the world today on a per capita basis, and less silver in the world today in relation to the supply of gold than at any other time in at least 600 years, prompting Butler to dub silver “The Rarest Earth”. Obviously, to heal destruction of a market (and an industry) to this degree will require the pendulum to swing to an opposite extreme. It will take many years of high prices to rebuild devastated inventories and stockpiles.

There has been an incessant flow of inane media drivel that silver prices are already “high”. We can resoundingly disprove that nonsense in two different ways. As I noted in my last commentary, we have a 5,000 year price relationship to guide us when it comes to whether silver prices are “high” or “low”: the gold/silver ratio. That 5,000 year ratio has hovered around 15:1. This would make the “natural” price of silver today close to $120/oz, given the current price of gold near $1800/oz.

The more conclusive way of demonstrating that the price of silver is low, not high is that inventories continue to dwindle. Here again we are betrayed by media idiocy. Instead of noticing (and reporting on) the “path of destruction” caused by decades of excessive silver-shorting, the media parrots screech about “speculators”, claiming that “hoarding” is to blame for high prices.

Again we have a very clear analogy to guide us: endangered species. When “poachers” (or other villains) are threatening to wipe out an endangered species, “conservationists” step in. They “hoard” the remaining members of that species – keeping them safe from further poaching, and (hopefully) allowing the species to regenerate its population.

If we replace the word “poacher” with “silver shorts”, and replace the word “conservationist” with “silver investors”, we see precisely what is occurring today in the silver market. After years of excessive “silver poaching” had virtually wiped-out the global silver supply, the silver conservationists have now stepped into the market.

By investing in the tiny remnant of global stockpiles, they simultaneously perform the two “healing” functions which investing always brings to a decimated market: they cause prices to rise, stimulating greater supply (i.e. more mining); and they protect a tiny sliver of the global silver supply from the rapacious silver shorts.

Of course with silver inventories still dwindling (while demand continues to rise), “healing” is too strong a word to describe to what is actually occurring today. To this point, silver investors have only been able to reduce the speed at which the silver-shorts are destroying this market. Healing will not actually begin until inventories begin rising – at which point it will take decades to restore those inventories to healthy levels.

There is nothing either complex or controversial about this analysis. Arithmetic cannot lie. Shorting destroys markets. Investing heals markets. Any analysis to the contrary is invalid.