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Jeff Nielson is the writer/editor of Bullion Bulls Canada. He came to the precious metals sector as an investor in the middle of last decade, and quickly decided this was where he wanted to focus his career. Jeff's background includes four years of Economics at the University of British Columbia, before he went on to earn his law degree from that same institution.

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Silver: Shorting Consumes, Investing Conserves

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Originally appeared as http://www.bullionbullscanada.com/index.php?option=com_content&view=article&id=22923:silver-shorting-consumes-investing-conserves&catid=49:silver-commentary&Itemid=130 at BullionBullsCanada.com.

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.

There Are 8 Responses So Far. »

  1. Great article though I would add one clarification; I do not believe it is “shorting” per se that is harmful, but *naked* shorting.

    Regular shorting requires a legitimate borrowing and margining (or in the case of futures, commodity backing) process to undertake the short, and actually meaningful carries costs in terms of borrowing and paying dividends and the like.

    Naked shorting of the sort the big silver shorts are doing, however, is destructive precisely BECAUSE the normal cost burdens of shorting have been circumvented, opening the door to a limitless effect. Of course, this means there is effectively no limit on how it can impact and distort the price.

    Sadly, the markets are significantly unstable today in large part because the Wall Street insiders have become adept at naked shorting. This is done not only for futures-market commodities like silver, but for stock market equities they’ve targetted. The stock market is flooded with “phantom” shares produced by the naked shorting process.

    Interestingly, the banksters immediately squeal “foul” when their own stocks are targetted not even by naked but by REGULAR shorting. And usually they get their way and win short-sale bans on their own stocks in times of distress. This prevents people like us from profiting off of our correct predictions that they are doomed.

    Normal, legitimately-executed shorting is essential to the market, as your whole analysis has a flip-side: stocks or commodities may be systematically OVERPRICED. Shorting allows a third party observer to bet on this overvaluation, and both profit from it and help to correct the market.

  2. No Admin, I categorically disagree. “Shorting” is an inherently destructive act. PERIOD.

    It is nothing but bankster MYTHOLOGY that shorting “performs a useful function” in markets. Attempt to specify what that “useful function” IS, and watch me poke holes in it. It is all LIES.

    Shorting ALWAYS distorts markets. It is a TOTALLY “unnatural act” in the world of commerce. The only reason that shorting ever APPEARED to have any “benign” impact in markets is that it tends to counter the CRIMES which the banksters commit on the “long” side of markets.

    Obviously two ‘wrongs’ cannot make a ‘right’.

  3. This is urban legend. Silver traded in the $5 range throughout the 90’s. This year it traded to almost $50 and is now in the $30s. If JP Morgan were net short silver in large amounts since the 1990’s, JPMorgan would be long gone. There very well may be attempts to manipulate the silver market for a short-term (Intra-day) gain, but manipulation over a long term period of a decade or even a year is laughable. I can cetainly believe JPMorgan shorts silver to hedge exposure, but the idea that JPMorgan hates silver is, well, just silly.

  4. JP Morgan’s 300 MILLION-ounce short position in the silver market is a matter of public record, although when the CFTC mentions the “one trader” with a position that large it never mentions JPM by name.

    With corrupt regulators who ALLOW JP Morgan to operate a short position more than TWICE as large as the Hunt Brothers, it would be no surprise that they would never be REQUIRED to settle-up their “bad bet”.

  5. Silver is trading more like an industrial metal than a precious metal.
    Copper is moving down and silver is following. The world economy is slowing down and industrial metals reflect less demand for products that use copper and silver. Gold is a precious metal. If the upcoming contraction is severe it will go down also i.e. deflation.

  6. Bob, this is more bankster mythology. I and others have written volumes on why silver (along with gold) is the best “money” ever known to the world (and obviously a “precious metal”).

    Silver is ALSO the world’s most versatile metal. So essentially the bankster’s argument is because silver is so USEFUL that this makes it less “precious”.

    This is nonsensical. If silver is the best “money” AND the world’s most versatile metal this makes silver MORE “precious” – not less so.

  7. I said silver is “trading” like an industrial metal. I am short silver because it looks very weak technically. Frankly the non confirmation of it’s longtime relationship with gold in one of the reasons I am short. If it breaks below $32 support I believe it will be a quick drop to $21-$23. I will cover my shorts if it rises above $36.90 and go long. I have been a technical trader for almost 40 years. That includes the time the Hunts got squeezed out. I made money during that squeeze and learned the crowd is not always right. Matter of fact they are usually wrong. My opinion about the fundamentals about silver is not relevant in my trading.

    For what it is worth fundamentally, I see deflation ahead for the U.S. I know that is not a popular belief but the unpaid debts are still massive and will default. That process will take a few years and the world economies will stagnate regardless of the the Fed printing money. The defaults will mean a destruction of money to counter the effects of printing new money. The money supply will not explode upward with so much debt being written off. Deflation will be a surprise to the crowd. Initially the dollar will be the choice for safety because it is the best of the worst fiat currencies. In the end the dollar will fail and gold may become legal tender again. Gold is the only real money now but until it is officially legal tender and fiat money is abandoned it will go down as the deflation spirals downward. All asset classes drop in a deflation i.e. depression. The drop in gold will settle out at $1300 near term. Once that support is broken it could bottom out at $600-$800. Like I said I have an opinion about fundamentals but I trade on technicals. Below $32 or above $36.90 is all that concerns me and my position now. If I am right, I will make a lot of money since I entered the trade short at $43 with the view it would break below $36.90. I was right. I cannot lose with my stop at $36.91. I am not trading Gold at this time. If i am right I will take my profits on silver and buy gold for the long term below $1000. Once gold bottoms out then the price will skyrocket as it replaces fiat money once and for all! I guess you could say I am like you in the end when it comes to gold. I see deflation first then hyperinflation as we adopt the gold standard again and the elimination of the Fed.

  8. My mistake Bob for not noting that qualification.

    However, it is EXTREMELY dangerous to engage in trading in silver based on charts. ALL “technical analysis” is based upon a LONG list of assumptions.

    Those assumptions START with “free and open markets” and “perfect information” on the part of investors. If you ever FIND any “free and open markets” just let me know. As for “perfect information”; obviously living in the ERA of propaganda, information has never been LESS “perfect”.

    The precious metals market has DESTROYED countless MILLIONS of T/A jockeys over the years. Don’t add yourself to that list…

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