Silver's Meteoric Rise and the Conspiracy Theories Behind It

 Silver: Over the last 3 months, Silver has risen 50%, and has doubled over the last 15 months, since I first recommended silver, when it was in the $12 to $13 area. Thanks to the recent burst since August, silver’s performance has now outpaced gold by a good margin. Silver is now benefiting from its twin influences, an improving stock market (since silver is used in the economy, and improving economy means higher silver demand), and a higher gold market, as silver is also considered to be a poor-man’s gold, and does have history as an alternative currency. The main drawback to silver as a personal investment vehicle is the fact that it is not as portable as gold. At current prices, it would take about 36 one ounce gold coins to equal $50,000, which you could stick in your two front pockets quite easily. On the other hand, $50,000 of silver would weight over 100 pounds, and would completely fill up a bowling ball bag.

Based on the charts, Silver is approaching the top of its channel, on a log-normal basis, see attached, which now crosses in the 29.7 area. Will this resistance level stop silver’s meteoric rise? Anything is possible, and quite often, when there are blow off tops, as we are witnessing real time, will BLOW through such resistance lines. One of the keys to a top forming would be if open interest dropped. Notice on the attached graph, the yellow and green vertical lines, which are around the market top in 2008. Open interest peaked at the yellow line, and then proceeded to fall, while the price of silver peaked a few weeks later, at the green line. The fact that open interest fell (by 10%) while silver was making new highs between the yellow and green lines, is a sign that the market was likely making a top. This method of analysis does not always work, but when you see it in action, real time, it is a good indication that a top is coming. Today’s open interest is continuing to rise, as silver is rising, so there are no signs yet of a top from this measure. Should open interest start to fall, then that would be an early warning sign that a top in silver is approaching.


There are many other technical indicators which have suggested that the silver rally is over-done, but those signs have been flashing such, for the last $6-8 of rally, so that is not a viable method to think the rally cannot go any further.


* The Silver Conspiracy Theory – I have been tracking Silver for the last 20 years, and as far back as 1993, I have heard silver advocates claim that silver was in for a major rally. The theory is that silver is a commodity which is being used in industry, as well as an alternative currency. And based on the consumption of silver, the world will eventually run out of silver. Back a while ago, (I do not remember when), supposedly there was 6 billion ounces of silver in existence, and that as silver was being used by industry, countries systematically sold off their silver stocks to meet demand, and to keep the price of silver suppressed. Part of the idea about keeping the price of silver (and gold) suppressed ties into the idea that if precious metal prices stayed low, then that would breed a greater level of confidence in the fiat currency of the US. The conspiracy folks also think that the government is behind the suppression of the price of silver. According to CFTC data, the 4 largest commercial users/hedgers account for 45% of the open “Short” interest in silver futures. It has been speculated that one or more large banks is fronting for the US government, but I think that is far-fetched, but nonetheless, I have heard this more than a few times. 


With 159,000 open contracts, the silver futures market totals approximately 800 million ounces of silver, and this brings to light that just a few entities are really taking a big hit by virtue of the dramatic rise in silver. Who could possibly take such a large loss? Thinking about it, 4 entities have lost $7.9 billion over the last 3 months, and have had to post cash to meet this margin call over this time period.


According to the conspiracy theory folks, the supply of available physical silver has dropped to about 1 billion ounces, (almost the amount of silver represented by the silver futures markets), and as this supply diminishes, then silver is due to rise exponentially. Is silver’s current rise the incarnation of the conspiracy theory coming home to roost? I will leave it right there, without getting too carried away with the theory, except to bring it to light. My interest in silver has been primarily the same as it has been for gold, that is, as an alternative currency alternative. Unfortunately, gold was always weighted heavier than silver in my savings accounts, but that is the way it goes.


* Inflation/Deflation redux – in response to Friday’s blog, a reader sends in this comment:


“Printing money by definition is always inflationary and it is inflationary in all sectors. While home prices have not increased, they would have fallen much further without the quantitative easing, which means they inflated. 


Our system is completely built upon the idea of folks being able to spend their income before the earn it (credit). Unless the Fed is successful in inflating assets, lenders will have no ability to lend borrowers funds for consumer goods because they will have no wealth to provide collateral for those loans.  The only way out is to inflate your way out. Any other scenario leaves you with deep deflation, falling GDP and the potential end to the capitalist system which depends on credit to work. Credit can only be given to credit worthy borrowers and we do not have those at this time. The typical family has lost 38% of their net worth. If you assume the typical family was carrying debt, and they now have less assets and less income, where does the spending come from to move the economy ahead if not from the Fed?” (end of readers comment)


Great comment, and I do agree, that without the Fed stoking inflation, and the government continuing to support credit for the housing markets, that housing deflation would be much greater. However, I do believe that the millions of units of housing’s shadow inventory will eventually lead to another 20-30% drop in home prices. Especially with the shift in political fortunes, I cannot imagine that Congress is going to go along with more housing bail-outs, for underwater home-owners. I could be wrong on this one, but the balancing act to keep millions of underwater home-owners in their home is just going to end poorly, in my opinion.


The best gauge which I have to figure out when housing liquidation has run its course is when the home ownership percentage rate returns to the long run equilibrium of 64%, which is where this ratio was throughout the 1980s and up until 1995. Having reached a peak of 69% at the peak of the housing boom in 2004-5, this ratio has been stuck around 67% (66.9% was the last reading for Q3). With the total housing stock in the US at 130 million units, the drop in home-ownership to the long term norm, means that 3.9 million houses will need to revert from ownership, and likely under-water, to someone who can buy it, and then rent it out. Putting those 3.9 million units on the market will definitely have an adverse effect on prices. This is why I am bearish on housing prices, the economy by virtue of what this next leg down in housing prices will do to the economy, and as well, non-agency securities backed by mortgages.


But the idea of the Fed putting money into the banking system, and monetizing the government’s debts will only provide limited benefits. The most obvious benefit of the Fed’s recent actions is in support of the risk-on trade, and the inflationary consequences which these actions engender. To the extent that a rising stock market creates a positive feedback loop via the wealth effect, then that will help the economy. But the idea that the US as a country will go further into debt to support consumption is a bad scenario, because eventually we will have to pay back these debts, and will not have anything to show for these debts. So, over the short term, I do expect QE2 to have some benefits, but ultimately, debt induced economic growth will only lead to us to where the peripheral EU countries are.


And this brings us to the case of Ireland. Did anyone catch this story which was circulated yesterday, and discusses the dire financial state of Ireland’s fiscal affairs? I will summarize that for you in tomorrow’s blog, since I cannot seem to find a link to it to give you now.


* Did anyone catch the front page of today’s WSJ, which was titled: “Fed Global Backlash Grows; China and Russia join Germany in scolding” Why are all these countries upset? Well, for one, because they hold US dollars as part of their reserves. If you flip to page A15 where the article continues, the heading of a related article is “The Search for a New System”. In other words, the world outside the US is just now realizing that there are too many dollars in the world, especially since the Fed can print them at will, and the Fed does not seem to be concerned about doing so, at an astonishing rate of $600 billion a clip. Gold is clearly the one international stores of value which the BRIC countries are loath to embrace, because they do not have much of it. Most of the world’s gold is owned by the US and the developed western European countries. The way I sort things out, gold (and silver) will be the vehicle which eventually does shines through, as it has a few thousand years of history as the world’s preferred way to hold wealth. The problems to be worked out on the way to a gold standard will be the price, which needs to rise dramatically, in order to balance out against the plethora of fiat currencies, which we seem to be printing by the hundreds of billions. If all currencies were convertible into gold, the price of gold would have to rise dramatically, because the monetary value of the world’s gold supply would not equate to the value of fiat currencies. Additionally, countries which hold much in the way of fiat currencies, think BRICs and oil producing countries, will push up the price of precious metals as they start to diversify out of currencies, and into the more durable precious metals.