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JULY 8 2008 11:45PM - The European Central Bank raised by 25 basis points last week but apparently uttered too-soft words about inflation and so the Euro got smacked while the U.S. dollar found some footing. Then over the weekend we got a (temporary?) winding down of the oil panic as traders recalculated the probability that Israel is about to bomb Iran. It should thus come as no surprise, even to conspiracy lovers, that au/ag topped out and have been declining over the past several days. Currently we are in the upper-middle portion of a wide trading range or channel between $16.50 and $18.50 for silver and $850 and $950 for gold. This trading range has been in place since late March and is now very well established. As a result, it provides a couple of very good opportunities.

The first opportunity is that there are some very solid profit and stop loss targets for speculative traders: buy silver at $16.50 with a tight stop and sell at $18.50 with a tight stop, taking exposure both directions as prices swing back and forth. When I say 'tight stop', I don't mean $16.45 or $18.55 and then being completely out of the trade if the stop is triggered. That's how I used to do it before the 24-hour CME Globex trading became available and I rarely made money that way. The chance of an overnight bust was too great and therefore the only alternative was to use options to control the risk. Now with nearly 24 hour trading via Globex, there is much greater flexibility as you can actually look in real time for the bounce-back in prices that typically occur outside the COMEX pit trading hours. In some ways this has increased overall volatility in PMs, but it has also increased the ability of individual traders to stay with positions by 'stalking' the market live and thus avoid losses caused by fast moves in the bid-ask or overnight gaps up or down.

I seldom hear discussions in the precious metals arena about the emergence of CME Globex trading for COMEX contracts, but in my opinion it is probably one of the most important developments ever for individual and small traders. It has helped level the playing field in futures trading to the point where the metal desks of the bullion banks and large, professional traders with direct floor access have substantially fewer advantages (certainly less than they have in the ETFs). I remember a few years ago, Jim Sinclair was extolling the virtues of his brokers because they could place gold futures orders in the NYMEX after hours electronic platform or directly in overseas markets so he wasn't locked into positions by the restricted trading hours in the COMEX pits. Yet just as the electronic CME Globex platform for COMEX futures was being launched, Mr. Sinclair shifted his emphasis toward 'no leverage for the masses' and thus never fully educated his public about this excellent new opportunity. Of course, it is not necessary to use leverage in futures trading--simply fund your futures account in full for the equivalent of each contract you trade.

In any case, let's get back to the idea of the 'stalking' stop loss. Doing it right usually means observing the market in real time once a stop has been initially hit and then trying to re-establish a position on a promising bounce or fade (again with a tight stop). This could be below or above the original stop, and the only way to learn how and when to do it is by getting trading experience. The concept, however, is simple. If support does hold then a decent bounce will likely follow and should more than pay for a few 5 cent losses made in trying to successfully re-enter the market. On the other hand, if support fails, it usually does so fairly quickly and there will not be many chances to incur those 5 cent losses. There are those times when this type of stop loss strategy is unnecessary because support or resistance is very well defined. But in most cases, I have found that it is very difficult to stay with a position at turning points unless you are willing to look for opportunities to jump back in the saddle after getting thrown off once or twice. For example, I would argue that silver at $16.50 is the top of a somewhat soft zone of support that goes all the way down to $16.00. That ride will cost $2,500 per contract and you start to get into some real big trouble if it doesn't stop there. It would be preferable to take a $250 loss from $16.50 to $16.45 and then wait for an opportunity to re-enter. Sometimes it could be above $16.50, or perhaps well below it. And it could take several tries. But if the 'stalking' stop loss is executed properly, what will not happen is the type of thing that can wipe most traders out: helplessly watching the market move against you in the blink of an eye where one minute you have a nicely funded account and the next minute you are down $5,000 per contract and facing a margin call. By contrast, the zone above $18.50 is much better defined, and I would not advise using the 'stalking' stop loss to try getting short there. Instead, I'd opt to go with a more generous initial stop loss, perhaps 10 cents, and if that is triggered, I'd consider switching tack and looking to go long with the former resistance at $18.50 now considered support. In either case, the successful trader may have to keep some unusual hours for a day or two while the price action is resolved, which is a small price to pay for setting up a trade that can generate dollars of return on pennies of risk.

The second opportunity is probably more up the alley of most investors. A clear breakout of the channel in either direction by au/ag will signal that a significant continuation of the move could occur. Any upside breakout (above $18.50 in silver, $950 in gold) at this point would certainly have sufficient momentum to challenge the record highs from March, and I would expect silver to outperform gold perhaps by a margin of 2:1 (with silver very capable of reaching $25 to gold's $1200). Conversely, a downside break ($16.50 silver, $850 gold) could see prices plunge significantly lower, and here silver would no doubt underperform. How much lower? Maybe near $13 for silver on a 'super' plunge. Interestingly, however, I get a low of only around $800 for gold. So, it might pay to be underweighted silver on a channel breakdown but to be overweighted silver on a breakup. For those not wishing to enter or exit positions outright, an alternate option would be to 'arbitrage' between gold and silver. Of course, there aren't many ways for the average investor to do this with low transaction costs (other than futures), which brings me to the ETFs. I've said before that they have their time and place, and it is precisely in the current market. The simplest strategy would be to go all in SLV as silver moves toward $18.50 and all in GLD as silver moves toward $16.50. The idea being to maintain full exposure to au/ag but pre-position for a possible breakout in either direction and thereby both control risk and enhance returns.

Speaking of SLV, I see that Ted Butler has once again found evidence of unreported naked short sales by looking at reported trading volumes in his latest commentary. This time apparently 10 million more ounces of silver have been naked shorted on top of the 50 million ounces since the middle of April. Hello?!? Any unreported naked short sales will be excluded from trading volume by definition, so how is Mr. Butler able to make these determinations? The only possible way would be to know how much the trading volume should be, and then ascribing the supposed shortfall to unreported naked short selling. It sounds like magic to me, but recently it is my own analysis of the silver market that has been compared to an Oracle who tells the future by examining pigeon entrails. I'll leave it to you to decide whose fingers smell of bird-gut.

Moving right along, I will note with some distaste that the junior miners continue to get splattered in a manner reminiscent of something that gets produced in a bird's gut. The latest culprit, which few people seem to be reporting, is the virtual collapse of zinc, lead and nickel prices. Zinc is now trading under 80 cents per pound after reaching over $2/lb last year. Meanwhile, lead is near 70 cents after hitting a high of $1.75 just a few months ago. Similarly, nickel is under $10 after trading near $25 last year. The timelines are different but in all three cases, the decline represents a drop of about 60% from the highs, leaving these metals 'only' up about 100% for the current bull market to date. An equivalent decline in gold and silver would leave them around $500 and $8, respectively. It's a sobering thought. What about copper? For now it seems to be insulated against the fate that has befallen the other base metals, but it may not take a big change in sentiment to get it going in a downward spiral as well. Something like a 5% decline in demand year-over-year would do it, which is entirely possible if we have a moderate global economic slowdown.

Some of you may remember that I started railing over a year ago about the consequences of a housing collapse that would lead to an economic slowdown, which in turn would drive down industrial demand and reduce the need for base metals just as mine production was on the rise. For this reason, I said stay away from base metal miners and explorers and concentrate on those looking for or digging up gold and silver. In the case of silver, this is especially difficult because most 'silver deposits' are actually lead-zinc deposits with high silver credits. But there are some exceptions, particularly in Mexico and South America where silver is accompanied mostly by gold. And in some places (Idaho, northern Canada) the silver is dominant.

Unfortunately, it now appears that I did not repeat the mantra enough to permanently etch it into my brain and so the pigeons have come home to roost. Specifically, what I stated about base metal exposure back then has indeed become a major contributor to the declining share prices of many exploration and mining companies (some of which I own). There are too many examples to list, but those suffering major hits from the lead/zinc fallout include 'primary silver' companies such as Silvercorp, Hecla, U.S. Silver, Impact, Bear Creek, Excellon, Fortuna, Great Panther, Sabina, Silver Eagle, etc. I should note that I haven't changed my own investment approach toward some of these companies--Hecla, Impact and U.S. Silver in particular--as a result of bringing the base metal risk back into focus, but I am in the process of lowering my expectations. On top of lower lead-zinc prices, each of these company is also dealing with its own form of bad timing. Hecla needs to come up with financing to pay for the Greens Creek Mine (it's got a lot of zinc...) and this is pressuring the share price; U.S. Silver just announced the departure of its President Mark Hartmann which the market took as bad news; Impact is getting no respect for its business model that is dedicated to profits first and the company has even lost its newsletter following. Out of the three, U.S. Silver seems to be getting the biggest bum rap so I actually purchased another 5,000 shares at 34 cents today. The current valuation of the company at around $70 million makes little sense if in fact it can soon produce at a rate of 3.5 million ounces of silver per year. That would be $20 per ounce of annual silver production and is anywhere from 3 to 8 times too low.

The above names are just some of the better companies with real prospects and strong opportunities. One standout exception is Pan American Silver, which actually gets a sizeable by-product credit from zinc and has yet to see its price get whacked. It does have less exposure (zinc grade is typically 2-3%) than many of the others , so that is likely a reason. But generally it gets much uglier from there with the primarily-zinc companies like Apex Silver, Metalline Mining, Canadian Zinc, Strategic Resource Acquisition Co. (a zinc deposit with no silver), etc. getting skewered whether they deserve it or not.

On the other hand, many of the silver companies with little base metal exposure are doing fine by comparison. One of my favorites for a while now--partly because of its nearly pure silver--is First Majestic, which has simply refused to sell off amid the ongoing carnage. Others largely holding their own include Endeavour Silver, Genco, Esperanza Silver, Gammon Gold, Kimber, Minefinders, Orko Silver, Silvercrest, Silverstone, etc. This list is no better or worse than the one above, the only difference is that they are mostly silver-gold plays with low(er) to no base metal (lead-zinc) exposure.

What about Silver Wheaton? It is a pure silver play, so it should ideally be outperforming the rest. Well, it doesn't seem to be doing much of that lately. It is possible the price has discounted the risk that some of the mines that have contracted to sell their silver streams to SLW might actually not survive if lead-zinc prices continue to fall. With only $3.90/oz. to show for the silver by-product, the marginal cost of running these mines is higher than other mines that have not sold forward their silver. I haven't examined all the mines that have contracts with Silver Wheaton, but it does appear several might be in trouble if lead-zinc prices fall substantially further without a corresponding easing in mining costs (energy, labor).

Already there is talk in the industry that some projects look shaky at zinc prices just below current levels, and it is altogether possible that several mine startups or expansions that have used higher price assumptions in their feasibility studies will possibly be shelved. Of course that is good news for future lead-zinc prices as supply gets held back, but perhaps it is even better news for silver given that curtailment of proposed lead-zinc projects would mean that less silver production will be coming online compared to recent estimates. If so, this is actually quite a bullish scenario for silver investors, especially those who are still around because they heeded my warning (even though I myself did not) to stay away from base metal exposure when investing in PM companies.

Now, let me clarify that I don't expect lead-zinc prices to fall much further here, and even if they do fall some more, I think we will see them stabilize around $1/lb in the short to medium term. Longer term, I do expect their prices to rise but not soon enough to save some of the questionable mining projects. At the opposite extreme, there are some very robust projects out there that would not be threatened even if lead-zinc fell another 50%. Those are the keepers. In addition, I would evaluate the prospects of the companies in your portfolio using an assumption of $1/lb or lower lead-zinc prices and see if that still makes them 'extremely undervalued', 'highly prospective' or whatever the reason was that got you to buy the shares. While you're at it, I'd suggest you do the same thing with the copper projects using $2/lb, because I have a suspicion that's where the red metal might be headed in due course.

Finally getting back around to au/ag, what's important is that they are now definitely outperforming (most) other metals and I believe this will continue as mounting monetary and financial problems chase people to the safety of real money. This means au/ag most likely will not join the other metals in the '60% backslide to 100% bull market gains'. Besides, it should be at least a bit encouraging that the brutal mid-1970's correction left silver 'only' about 33% shy of its 1974 peak while gold actually suffered a 45% drop. These percentage declines applied to the highs from past March result in a theoretical low of $14 in silver and $565 in gold. That's pretty bad, so why would I say it was 'encouraging'? Well, $14 is actually pretty close to the 'worst case low' I mentioned for silver earlier. More importantly, the theoretical $565 is way below the low we will get in gold. Why? I suspect one of the reasons gold got so badly trampled in the middle of the 1970's bull market was because Pres. Ford repealed the limitation on private gold ownership effective the end of 1974. You would think that would have created a huge amount of demand, but actually it first created even more supply--a typical case of buy the rumor, sell the fact. Fortunately, we are not faced with any similar situations today, and thus I believe we should look at silver's behavior in the mid-1970's for a clue as to what a bad outcome might look like today.

When we do that, we can see a relatively quick decline of 33% from the highs with range trading for several years during which the bottom is revisited several times. This would essentially mean silver prices trading between $14 or so on the low end and perhaps $19 on the high end until an eventual breakout that precedes the next parabolic run-up. I don't have a big problem with that, especially since I see it as the absolute worst case. Many silver miners and explorers should be very profitable and make their shareholders happy if such a 'bad thing' were to happen to the price of silver.

I'll close this long diatribe down with a somewhat repetitive observation but one that is nonetheless necessary to clarify what might otherwise appear like a muddled position (or worse, pigeon gut research). One 'nice' thing about bull market corrections in the price of au/ag is that while they are furious, they also tend to reach their true bottoms very fast. Thus, it's very possible that the correction from the March top has already had its bottom on May 1 when silver briefly flirted with $16. Even if not, the bottom should be in by September at the latest, and I'm willing to place a wager on that with a side bet that a print below $14 is all but impossible. I view this as the absolute worst case. For example, let's say that oil dumps back down to $60 and copper crashes to $1.60 in the next couple of months. The Dow crashes too, through 8000. I think the low in silver should still be no worse than $14 (gold, $800). In such desperate markets, miners and explorers focusing on gold and silver would be incredible values at present prices, although it might take some time for that value to be appreciated and eventually chased by the market. Basically what I'm saying is that the worst case scenario for au/ag might actually be the best case scenario for au/ag miners (and ironically au/ag themselves given that once the miners get going, that could in turn provide some positive sentiment to au/ag).

JULY 2 2008 1:35PM - Many are calling this a breakout in gold and silver and it may be so from a technical perspective but I really don't like the vulnerable backdrop of parabolic oil prices. Last week I stated that a stock market crash might help au/ag break out of a trading range. And so far, lower stock prices seem to be translating to higher PM and commodity prices. But let me qualify this concept now. There is a risk that, at some point, funds will be withdrawn from both stocks and commodities. This happened on a small scale the middle of last August. Oil was about half its current price then and the dollar was substantially higher. Au/ag had a big one day drop and recovered in about a month as they got support from all corners. There might not be a hand to lend any help this time around should oil fail to move much higher while the dollar digs in its heels. It is possible, of course, that the dollar is about to embark on another leg down and oil on another leg up. But compared to the virtually risk-free scenario of last August, such prospects are much less certain. I have a strong suspicion that the 200 day moving averages will be visited again soon by au/ag and that there will be some base building around or slightly below those levels before we get the next true breakout.

If you bought near the 200 day moving averages of au/ag a couple of weeks ago, you've done very well and should have no worries holding for the long term. Speculators, on the other hand, should be on the lookout to unload long positions unless more supportive fundamental factors start to appear.

Other than high oil prices, there is another situation that might have bearing on the near-term outcome of the supposed au/ag breakout. It is the meeting of the European Central Bank tomorrow. It is widely expected that the ECB will raise its benchmark rate by 25 basis points in order to fight inflation. This would be ironic, given that a major reason for commodity speculation is diversification away from the U.S. dollar, which would likely suffer as a result of an increase in the interest rate differential between it and the Euro. Raising rates is appropriate to control overconsumption, an overheating economy, or excess speculation, but none of these seem to be a big problem in the Eurozone today. Indeed, raising the Euro rate would have the exact opposite effect on commodity speculation by spurring it on. Commodity speculation (or demand) can only be controlled by interest rate policy if it involves the currency in which commodities are priced! So, why would the ECB hike rates? The only plausible explanation, which is widely circulating in the financial media, is to pressure the Fed to do the same. In effect, it's a game of chicken with possibly catastrophic consequences. The most interesting thing about it, though, is that no matter what the ECB does, it could be viewed as fundamentally bullish OR bearish for just about every or any market. The sentiment in advance of the meeting has been very much as I laid out -- bullish for au/ag, bearish for stocks. The reaction to the actual announcement in a few hours should be very instructive.

In the case of both big and small gold and silver stocks, they are yelling "Watch Out!" The fact they have placed their sympathy today with the general markets and not the metals is troubling. One implication is that the current move in au/ag is not specific to any particular set of fundamentals but rather generic in the sense that it might be due primarily to a flow of funds into commodities. Should that flow stop or reverse, it could leave au/ag vulnerable to a price decline regardless of any other consideration.

On a related topic, I'd like to comment on Jim Sinclair and others who have been very vocal that junior exploration investors should support their companies by fighting the good fight against naked short selling. They should do this by urging their favorite companies to join a Chamber of Mines where they will gain strength in numbers and by contacting company presidents to ask about cash position and project quality. As sincere as these efforts might be, they will unfortunately create not a single iota of benefit in terms of share price. The only thing that can do that is actually BUYING shares in the companies. If these companies are so extremely undervalued as a result of naked short selling or whatever, then the best possible thing that investors can do is to buy their stock. Even better, if they simultaneously sell the losers and put that money into those with the best prospects, it will help ensure that at least the most deserving companies in the junior market will survive and thrive. One of my pet projects for a long time has been to help identify these top companies and hopefully I can make some headway in the near future. If so, this will be a feature in the new service that I hope to launch soon.

JUNE 26 2008 11:45AM - The Fed did what was expected yesterday so all markets pretty much did what they were waiting to do: the dollar and equities falling, au/ag, oil, commodities and bonds rising. The action in au/ag was particularly strong given the pointless selloff right before the Fed meeting. In effect, the monetary metals simply regained where they were before the non-event happened. We are now once again at the top of the trading range and it looks like some sort of impetus needs to take place before au/ag will move higher. Perhaps it will be a stock market crash seeing that the Dow and other averages are flirting with bear market territory (down 20% from late 2008 highs).

I am in the process of completing a thorough analysis of the silver ETF SLV in light of the recent fearmongering and misunderstanding that has been spread. For now, I have three relevant comments I'd like to share with you. They will be expanded upon in my analysis. The first is that short selling as reported in the short interest listings maintained by each stock exchange does not create new shares. Ted Butler is simply and spectacularly wrong on this account. Each share that appears on the short interest listing has been legitimately borrowed from someone who has agreed to lend the shares. A lender should have no expectation that the SLV long position listed in his or her stock account actually represents shares backed by 10 ounces of silver each because he or she does not actually possess the shares. If he or she does have such an expectation, it is not the fault of Barclays, the broker or anything else but his or her own ignorance. The fact is that possession is not just 9/10ths of the law when it comes to securities, it is the law. For example, it is the party who possesses the shares that receives interest and dividend distributions (the lender of shares is compensated for the loss of this income as part of the borrowing arrangement but is not legally entitled to it) and gets to vote on shareholder matters.

I am not talking about naked short selling, which does not actually result in the possession of any shares. Which brings us to my second point. The allegation that naked short selling can create possession and therefore result in more shares outstanding than have actually been issued is simply wrong. Let's examine this from two different angles. The first is naked short selling that is the result of a transaction reported to the stock exchange and clearinghouse (in the case of SLV, the AMEX and The Depository Trust Company or DTC, respectively). When such naked short selling exceeds certain minimum thresholds -- currently around 100,000 SLV shares for five consecutive days -- it is reported on the Regulation SHO Threshold List. Going back to last December, SLV has appeared on this list for exactly five trading days, February 28 to March 5, 2008. For every other date, the reported naked short selling did not exceed 100,000 shares for five consecutive days. So, while there is no excuse for SLV appearing on the list at all, clearly the reported naked short selling is minimal. But what's important here is that an investor on the receiving end of a reported naked short sale is never actually credited with shares in his or her account, as even Patrick Byrne of Overstock.com personally found out. Moreover, the investor will not receive interest or dividend distributions or proxy materials. And of course if he or she tries to sell the nonexistent shares, that transaction will too be reported as a naked short sale. Thus, it is possible that the appearance of many securities on the Regulation SHO Threshold List is the result of the snowball effect originating with a single "bad" transaction as opposed to a widespread campaign of driving share prices into the ground through naked short selling.

But what about naked short sales that are never reported? This is the second angle I'd like to look at. Unreported naked short selling involves the broker simply crediting a customer's account with shares that do not exist and taking that customer's money. In effect, it is theft, and to the extent there is an attempt to cover it up, it is also embezzlement. When it involves multiple brokers, it is racketeering. Unlike many securities violations, unreported naked short selling is also a serious criminal matter. As such, prosecutorial jurisdiction extends to several federal and all state agencies, making reliance on poor regulatory oversight a very risky proposition. In addition, the strict record keeping requirements of the brokerage industry mean that unreported naked short selling would be easily revealed by subpoena. Then there is the matter of how the ill-gained proceeds of unreported naked short selling are kept hidden. To avoid detection, they must be funneled to a secret bank account that is subsequently used to return funds to customer accounts when the nonexistent shares are sold. If the customer earns a profit, then the shortfall in the secret account must somehow be augmented without detection. This is not as simple a matter as a rogue trader hiding paper losses at some farflung trading desk. Rather, it involves the central operations of the broker and could not possibly escape the attention of the compliance department, internal auditors or external accountants. Thus, the conspiracy must necessarily involve dozens, if not hundreds, of individuals in a capacity that makes them obvious accessories to crime with little to gain from nondisclosure.

In light of the above facts, we need to examine just how likely unreported naked short selling is happening throughout the brokerage industry, especially at the primary brokers that account for the vast majority of customer funds and trading. I will let you make up your own mind since it involves subjective assessment on account of no widespread campaign of unreported naked short selling having ever been reported. But before I move on, let me mention perhaps the most important aspect of unreported naked short selling: that it is unreported. That means there is simply no way to know how much of it is happening since it is . . . again . . . unreported. As such, it does not show up in trading volume and thus nobody, not even the intrepid Mr. Butler, can possibly know anything about it. If short selling does show up in trading volume, then by definition it must also show up in either the reported short interest listing (if the shares are borrowed) or the Regulation SHO Threshold List (if the sale cannot be completed for failure to deliver shares to the buyer). This still leaves open the possibility that some short selling of borrowed shares is not being reported on the short interest listing, and while this would be a big problem in that it misleads market participants, it would not result in the creation of 'phantom' shares for the reasons already explained above.

My third point is that even if the alleged short selling did show up in the volume of SLV shares traded, it would not be possible to quantify its effect on the ETF's silver holdings. The following chart illustrates this point better than I can try to explain in words. Click on the chart for a full-size version.

I have other charts and more to say but will save them for the full-blown analysis.

JUNE 24 2008 4:05AM - I consider Monday a good day for au/ag despite the brutal price drop because oil seems to have finally lost its stranglehold. With silver bouncing strongly from $16.50 yet again and the dollar floundering around the 73.50 level, I suspect we are nearing the final low. The 200 day moving average is now well above $16.00 and still climbing strong, putting a strong floor under silver prices at the same time that I am starting to once again get multiple indications/tingles that another rise lies directly ahead.

One final piece that may have just fallen into place is the sizeable reduction of silver holdings over at the iShares SLV ETF today, which is something that looked predictable given the last few days of SLV trading. At the same time, the Swiss ETF ZKB picked up the SLV slack and then some, adding a very brisk 3 million ounces of silver in just one week, a record by my recollection. Meanwhile, the poor London ETF PHAG can't seem to catch a break as it once again sheds the odd couple of hundred thousand ounces of silver instead of getting with the program and accumulating. It seems like the English might need another rousing bank crisis to get them interested in real money again. Never fear, one is probably closer than they think.

Speaking  of which, our jolly men at the U.S. Fed have decided to get frisky again, insisting that all's well while $317.3 billion of bona fide paper dollars, or more than 40% of the under-mattress-stuffable greenbacks, sit atop the oven. The Fed has no business taking on private loans and other 'assets' that the banks would rather do without because its only defense is a strong balance sheet. But that was 40% ago. Now, behold Chairman Bernanke holding the match, which wouldn't be as big a problem if he knew at all how to cook. Instead, he apparently knows how to pose like Alfred E. Neuman.

Getting back to silver, I would like to address a question that has popped up a few times in the past several days, which is the number of 1,000 ounce bars being flipped back and forth between the bored noblemen of the London metal desks to generate the 121.2 million ounces of daily volume reported by the LBMA for the month of May. The answer is important if not timely considering the recent brouhaha about the possible delays of delivering silver to SLV, the silver ETF. I have several so-so sources and a few enticing clues about the number, but these are not something I am ready to discuss at the moment. Instead, I would suggest that we use an available proxy to estimate the number, and the best one to my knowledge is the COMEX.

We can take average volumes for COMEX trading and compare this to the total outstanding futures contracts as well as the number of ounces held in COMEX approved warehouses. If we do so, we will find that for the month of May, the average daily volume was around 30,000 contracts and the futures-only open interest was roughly 120,000. COMEX warehouse stocks, meanwhile, totaled less than a single day of trading volume. Before going further, it is important to note that silver trading in London is much the same as silver trading on the COMEX, meaning that the intent to make or take delivery is largely secondary to the motive of trading for profit. There have been days when I personally accounted for 20 contracts out of the total COMEX volume of 25,000, entering and exiting positions several times and ending flat for the day. And I trade relatively small accounts.

The main difference between COMEX and London is that the trading instrument is a futures contract at the former and the allocated/unallocated warehouse receipt at the latter. Thus, London is trading physical metal that is present and accounted for while New York is trading metal that can someday, presumably, be deposited with the exchange. Taking this into consideration, we can place a relatively certain minimum on the silver in London of 125 million ounces in constant back and forth trade, all readily available at some reasonably premium to the present price, probably double. Before we go further, it would help to explain that 125 million ounces of silver doesn't actually get trucked around every day. Only warehouse receipts are exchanged in a manner similar to stock certificates. This is possible because metal storage is standardized in London and therefore each 1,000 oz. of silver is just as good at one vault as it is at another.

By analogy to the COMEX, up to another 375 million ounces could be held off the London market, already accounted for in industrial offtake agreements, leases or otherwise committed. This silver would in all likelihood not come to market at less than some multiple of the present price, if at all. Excluded from the grand total of 500 million ounces would be silver held in private portfolios, which is likely to be a pathetic figure (see my above comments about the English needing banking crises to remind them to invest in silver). Also excluded is the silver held by the two ETFs, SLV and PHAG, totaling slightly over 200 million ounces.

Therefore, 750 million ounces of silver (counting 50 million held privately and give or take a couple hundred million) might be held in London vaults by analogy to COMEX. This would all be in 1,000 oz. good delivery form, no coins or retail bars. Obviously this is a much larger number than all of the silver 'experts' insist is out there, but intuitively this number makes sense to me because it is about half the 1.5 billion ounces that I have come to believe is out there in the 1,000 oz. bar form. I use half because London is the most important silver market bar none, and also happens to be where about half the world's observable silver is held. Please don't worry if I'm right as 1.5 billion ounces is no more bearish than 5 billion ounces of gold. The vast majority of this silver is not available to the market under normal conditions or prices.

Unfortunately, due to the secrecy surrounding metal vaulting, there is no way to ever be proven right or wrong about something like this unless prices rise high enough to bring virtually all the silver out of hiding. Even a connected research firm such as GFMS or CPM Group has no idea what the true number might be. They don't even bother to make guesses or estimates by inference for fear of seeming naive. I, on the other hand, have no such problem! I'm even willing to wager that my free estimate is likely to be more accurate than their high-priced ones. In the near future, I'll be refining this modeal by looking at other markets to see if the COMEX ratios for silver hold up or need to be tweaked.

JUNE 18 2008 3:15PM [REVISED AT 6:25 PM] - Ted Butler's latest commentary claims Barclays' iShares silver ETF, SLV, may be in danger of default because the Authorized Participants are unable to obtain bullion due to a possible shortage in London. I have at least six objections to this theory along with several areas of agreement. Let me get straight to the point by summarizing the takeaways. If you are looking for a convenient way to trade silver or obtain some of your au/ag exposure in a manner that permits fast, low cost buying and selling, the ETFs are hard to beat. What Mr. Butler and other experts have said about lack of metal backing, shorting, etc. shouldn't matter to you at this point even if the accusations were true, which they aren't (at least not yet). On the other hand, please don't buy the SLV as a substitute for physical silver held in your own secure possession. The only thing ETFs are good for is tracking prices. There are plenty of circumstances where having some silver would be useful besides buy low, sell high. Alright, let's move on to my critique and be sure to read the last few paragraphs for a useful announcement.

First, the intraday net asset value (NAV) of SLV is consistently near par (as opposed to the published NAV which uses a closing price that often includes timing discrepancies). That means ETF demand is pretty much being satisfied by the amount of silver currently in the Trust, corresponding to the number of shares issued and outstanding. If there were a major unreported short position in SLV being built, that would mean the cash silver price would consistently exceed the ETF price resulting in at least a small, consistent discount to NAV. This is because shorting would tend to depress the ETF price while demand for cash silver could not be similarly suppressed. In fact, slight premiums have been the norm. More on NAV in a bit.

Second, Mr. Butler claims SLV buying is being met by short sales of unbacked ETF shares, yet the latest short interest report shows around 250,000 shares short (representing approx. 2.5 million ounces), which is down from a high of almost 1 million shares in early March. Since then, the alleged shorts--the infamous Authorized Participants--have not only managed to cover 750,000 shares (about 7.5 million ounces) but also added 20 million ounces of silver to the ETF at the same time. How is this possible if no silver is available in London? Shouldn't a few market players other than the Authorized Participants be aware of said shortage, and press the cause by enthusiastically buying shares of SLV? If this demand was being met by widespread shorting on an unreported basis, we should see a slight discount to NAV as per above. Alternatively, if there was strong demand but it was being met by delivery of silver to the Trust, we should see par or even a slight premium to NAV, which is precisely what we see. In any case, a true shortage of silver in London would be revealed by an unusually large, consistent premium to NAV. I've tried to convince Mr. Butler to consider this as a better warning of imminent default, to no avail.

Third, the London-based silver ETF with the unfortunate moniker of "PHAG" has been flat in terms of holdings for several months after a rather large liquidation in early February. Surely this London-based instrument would be an ideal way for a few insiders to game the supposed shortage in London good delivery silver. Yet its silver holdings have been "positively moribund", as I'd imagine a witty Brit might put it. Meanwhile, ETF holdings of gold, platinum and palladium are all up sharply since February.

Fourth, Mr. Butler argues that it is illogical to allow the shorting of metal-backed ETFs using borrowed shares because these investment vehicles are unique in that investors "buy shares of these ETFs because they are assured that this specific metal backing exists. Investors buy shares knowing that the sponsors and custodians guarantee the metal to be there." But in point of fact, this is not the only reason why investors buy these ETFs. They do so because ETFs are convenient and have low transaction fees, because they expect the ETFs to closely track the price of the metals, because they are restricted in the forms of precious metal investments or securities they can hold, and because "they are assured that this specific metal backing exists". In other words, what appears to be the only important reason to Mr. Butler is actually one of four or more important reasons to most ETF investors. There is nothing unique here. The assurance of metal backing is not much different from the assurance that a company is legitimate and generating the profits that it reports. Or that an index fund holds the underlying assets necessary to guarantee fund performance.

Mr. Butler's contention that short selling a metal-backed ETF dilutes the assets is not, however, entirely without merit. Unlike the short selling of a profitable, dividend paying company where the short/borrower is required to compensate the lender by making dividend payments, a short/borrower of SLV (or any other asset-backed ETF for that matter) is not required to put up silver (or Trust assets) as collateral, which would be equivalent performance. Instead, the risk of performance default is managed using posted cash margin and backed by SIPC and supplemental broker insurance. To the extent that an ETF investor should have no expectation that he or she could redeem ETF shares in exchange for the underlying assets, this is not entirely an unfair or inappropriate approach. Furthermore, as this "loophole" applies to all asset-based ETFs, not just gold and silver, SLV is not facing a unique problem. In any case, the severity of the problem is restricted by practical limits on the amount of shares that can be shorted, which is unlikely to exceed 10-20% of the issued ETF shares in the most extreme cases (Mr. Butler's claime of 50 million ounces of SLV shorts is well beyond the range of what's possible, in my opinion). Still, taking default risk into account, I'm not against the idea of requiring margin on gold and silver ETFs to be in the form of allocated gold and silver accounts instead of cash. This would no doubt be impractical from a brokerage standpoint, but it should apply equally to both short and long (margin) positions.

In the final analysis, it would be very difficult to maintain large short positions in an ETF while also making sure the price is closely tracking the underlying asset. This is probably why the short interest in SLV has declined since March. By contrast, if SLV was shorted to the tune of 25-50 million ounces of silver as Mr. Butler suspects, this would represent a tremendous amount of investment demand that would also manifest itself in all the major silver markets of the world, not just in SLV and the American Eagle silver coins! To Mr. Butler's credit, however, I do think we should be adding the published short position in SLV to the issued number of shares in order to arrive at a figure representing what the future metal holdings of SLV will probably look like. Had we done that in early March when the reported short interest peaked at near 1 million shares (almost 10 million ounces worth) and the Trust held 175 million ounces of silver, we could have concluded that those 10 million ounces of shorts would probably make their way into the Trust as the short position was reduced. Sure enough, SLV has actually added 20 million ounces since then. Another way to look at this is to consider whether or not it would be possible to cover a reported short position by delivering silver to SLV in a short period of time. If the answer is no (let's assume by way of example that next year SLV has 250 million ounces of which 20% or 50 million ounces are held short through borrowing), then the threat of which Mr. Butler warns might truly become imminent. Until then, it would probably be premature to get skittish about SLV.

Fifth, Mr. Butler claims the reported short interest may be understated due to "naked" shorting. Let's take a closer look at this allegation. I shall presume that Mr. Butler defines a "naked" short as a sale of shares that are not owned, and have not been borrowed or located, by the seller in time to clear and settle the trade. In the case of SLV, the clearing is done by The Depository Trust Company (DTC). DTC issues to each stock exchange a daily lists of securities that have not cleared within the standard "T+3" (trade date plus 3 days) settlement days if such securities exceed 10,000 shares. The exchanges then calculate certain reporting thresholds under the SEC's Regulation SHO. In the case of SLV, the minimum is 100,000 shares that fail to clear in T+3 over any 5 consecutive trading days. This doesn't have to necessarily be the same 100,000 shares, but there must be at least 100,000 in each of 5 consecutive days. Yes, you are right, that is a drop in the bucket. If Mr. Butler's allegation of rampant "naked" shorting is true, SLV would appear on the Regulation SHO "naked" short report regularly if not every day (see AmexTrader web portal). I sampled a few random days including yesterday, and could not find SLV on the list.

At this point, some of you might be wondering if it is possible that the nefarious "naked" shorters have somehow devised a way to avoid detection by staying off the Regulation SHO list. It's possible, but only if the trades are made between in-house accounts and never reported for clearing to the DTC. Since the DTC keeps track of only the total shares held in the name of each DTC participant and not the individual customer, movements in internal accounts can theoretically go unreported. In fact, it is a common practice to lend and borrow margined stock for shorting between customer accounts at the same broker-dealer. But that is not what we are talking about here. Instead, intra-broker "naked" shorting involves crediting nonexistent securities to the account of a customer when in fact there are no securities being lent from other in-house accounts, and then not reporting such trade for settlement through the clearinghouse. In other words, such hypothetical "naked" shorting is nothing more or less than plain old embezzlement. While not unheard of, this type of fraud would be very difficult to perpetuate on a large scale for long. In any case, even such "naked" short trades can never create more shares than have been issued since the total number of shares recorded by the DTC is not changed. In fact, no "naked" shorting can ever create an artificial supply of shares so large that it could possibly hide something as major as a shortage in a physical market. This is because market participants would be immediately alerted by trading and pricing discrepancies. Certainly we should expect the presence of an unusually large premium or discount to NAV of SLV.

This doesn't mean that, as an example, an offshore fund can't technically engage in a bear raid by selling short a lot of shares that it doesn't own, and has no intention of borrowing, in the hopes that the share price gets driven down to the point where large numbers of shareholders capitulate and thus allow the raider to cover the short at a profit. Several such abuses have been documented over the years, and the SEC has even launched a recent initiative to punish future perps. When it comes to SLV, however, "naked" shorting cannot possibly depress a bulging premium in NAV that would result from a bona fide shortage of deliverable London silver.

Sixth, Mr. Butler claims he is able to discern--simply from the elevated trading volume of the SLV--that silver should have been added to the ETF but was not. This is a rather provocative statement given that there is no direct relationship between trading volume of an ETF and the creation or redemption of ETF share in baskets. Indeed, the SLV's Authorized Participants may create new shares by delivering silver to the ETF for many reasons, including to fill an off-market order for a private client. Conversely, an Authorized Participant may fill a series of smaller market orders of a few hundred or thousand shares by selling short with the intent to cover in T+3 days. Since shares can only be issued or redeemed in baskets of 50,000, this practice might be entirely legitimate. Neither of the above scenarios have anything to do with the volume of shares traded during a particular day. Besides, the stock of Google and other companies trades many millions of shares every day but Google the company isn't involved in any trades itself (though some days employees are probably busy exercising stock options or selling ESPP shares). Trading volume in both stocks and ETFs is mostly just traders, investors, brokers, etc. churning amongst themselves. Sometimes they churn less, sometimes they churn more, but it's not every day that there is such imbalance between the bid and ask that market makers must come to the rescue. In fact, low trading volume is often a sign of illiquidity, and I would expect the SLV's Authorized Participants to be most active precisely during such periods. This appears to be the exact opposite of what Mr. Butler is looking for (new shares added to the SLV when trading volume is high).

In closing, let's revisit the SLV's NAV calculation as I believe it is an overlooked but very important piece of information. In my market indicator section, I display the "Premium/Discount" that is calculated by Barclays accountants every day and sometimes even posted on the SLV website on a timely basis. Unfortunately, this calculation is faulty since it contains timing discrepancies. I won't describe these because Barclays does an adequate job here. Suffice it to say that it is more revealing to analyze the premium/discount to NAV throughout the day as a trend rather than at a single point in time. I personally don't make much of the end-of-day NAV figures calculated by Barclays unless there is a clear trend for several days. For example, a consistent end-of-day premium does tend to result in silver being added to the ETF, after which there is usually a short period of discounts as the new shares are absorbed.

The intraday or real-time NAV is what I personally use most days in my market analysis and trading. Importantly, the intraday method can hypothetically give the exact type of warning about a developing shortage that Mr. Butler claims he can discern from trading volume alone. How? Well, if virtually every trade throughout the day is being made at a substantial premium to NAV, and this goes on for several days, we can rightfully ask why the Authorized Participants are not jumping on the arbitrage profits. For example, if they can buy silver bullion for $20.00 per ounce and exchange it for ETF shares worth the equivalent of $21.00, why wouldn't they do it? The answer is perhaps that there is no silver bullion to be got. Alas, for now at least there appears to be no sign of a "hidden silver default", judging by the intraday NAV.

Some of you are probably asking, where do you get this intraday NAV thingy? Well, you can get the live data and create custom programs to calculate and display it just like the pros, but it isn't gonna be cheap. There are some creative shortcuts, however, including one that I really like, and while I'm not going to give it away for free, it is going to be cheap when I do finally make it available.

Speaking of which, I am at long last going to launch some sort of subscription service very soon--it doesn't look like it will be a fully functional website with all the bells and whistles to start, but it will be something, and it will include stuff like the intraday NAV for both SLV as well as GLD (this has implications for the basis as well) plus other goodies like several basis calculations and trading strategies, as well as stock and option analysis, reader mail and more. Hopefully all the web design work we've been doing in the background will pay off shortly and we'll be able to launch a sophisticated online interface later this year, but I'm not going to put things off any longer for the sake of a picture perfect start. Frankly, I think this intraday NAV feature alone will be worth the asking price of the subscription.

In any case, I still want to get things started on a good footing, so I will be announcing another "free subscription contest" during the next several days as well as contacting everyone who previously expressed interest in the service. So, it wouldn't hurt to keep an eye or two open.

JUNE 16 2008 5:10PM - Oil tried to continue its crusade as the anti-dollar this morning while au/ag played second fiddle, but it was the monetary metals that hung tough when the dust settled. It is only a matter of time before au/ag lead the monetary protest vote, but for now we can at least be thankful that their sympathy moves are very powerful. Indeed, silver's spike earlier today came close enough to my $17.50 target that I decided to take some profits (around the $17.30 area) and I will now be looking for new reasons to add speculative positions. That could happen if silver surmounts today's peak or goes back down to the $16.50 range. I'm inclined to think that the way forward is with the 200 day moving average's support, which has just climbed above $16 for silver. One scenario that might get us back down there but not much further is an end to the dollar rally near the 75 level in the next couple of weeks. Ideally, that would be accompanied by softness in oil to below $125 followed by a slow drift down toward $100.

JUNE 13 2008 4:05PM - The dollar has fought and conquered the 74 level resistance as oil continues to loiter near its record, creating an interesting situation where both are showing strength while au/ag remain on the defensive. One possible way for this to resolve after some requisite volatility is for oil and the dollar to weaken in unison as au/ag take center stage. Along these lines, here is what I said in response to someone who recently dismissed gold because it is "just money". The investment value of gold is that it is mispriced as money, not that it is money itself. To the extent there is recognition of the negative social consequences to most of the commodity "investing" that is currently taking place, this will invite a major popular backlash. Simply put, the commodity market is broken when higher prices resulting from long speculation (hoarding) cannot encourage additional production as a result of NATURAL CONSTRAINTS IN SUPPLY. When this happens, the futures markets are not only unnecessary, they are actually counterproductive. The direct beneficiary is gold (and silver) because bullion hoarding is more socially acceptable and may represent one of the few outlets for commodity exposure in a coming investment crackdown. Those presently hedging dollar exposure with oil or allocating to a broad commodity index for portfolio optimization would be forced into gold and silver, which is where they should be in the first place. In fact, the main historic role of gold and silver are to protest fiscal policy, and only the greed and hubris of Wall Street have permitted a substitution of vital food and energy for that purpose.

Of course, the volatility of which I speak implies that au/ag prices can go down, not just up. So while we may now have entered an attractive buy zone, it could get even more attractive. A reader recently wondered exactly how attractive (or in his words, "too horrible to contemplate") and I threw out that a spike low of $750 in gold and $14 in silver cannot be ruled out. I want you to be prepared should that happen, because that would be an excellent time to mortgage the house (assuming you are in the enviable position of having equity and can find a bank making loans these days) and buy the monetary metals like they are going out of style.

Speaking of which, I couldn't resist buying another 5,000 shares of U.S. Silver today even though their latest production update for May reveals the road to recovery will be drawn out. As such, I have lowered my sales price target for this December down to $1.00, which still represents a theoretical 100% gain from my cost basis around 50 cents on what now amounts to just 20,000 shares acquired out of my planned 50,000 share trading position. I may or may not acquire more shares as I continue to use this trade as an experiment and demonstration in position size, discipline and risk control.

I also bought more Hecla near $8 to almost complete my position in this stock. I will buy more should it fall to sub-$7 levels. The company's need to finance the $700 million cash component of the purchase of the Greens Creek mine appears to be weighing on the stock, providing the buying opportunity. Once the carryover effect of the financing has diminished and the company's ability to repay it out of cash flow from operations has been amply demonstrated (later this year), the stock should be poised to make new highs on its way to $20. I'm not a big fan of stock options, but in this case a good way to play this outcome might be the Jan '09 $10 calls, currently trading at $100 with solid volume. Should the shares reach $20 before expiration--not a poor bet in my opinion--this option would be worth $1,000 for a 900% return. Given the inherent risk in options, I like to look for both reasonable odds and at least a 10-to-1 leverage, and this one has both.

I have a lot more to talk about including Jason Hommel's latest attack, the subject of which is Professor Fekete himself, but alas I am running out of time for today. I plan, however, to write a series of articles over the weekend addressing this unwarranted smear, as well as the dubious claims made recently against the Perth Mint, Kitco's precious metal operations, and the U.S. Mint.

For now, I will wrap up by pointing out that despite all the claptrap from Mr. Bernanke and friends, his balance sheet still shows over $300 billion of Federal Reserve notes at risk of default from credit exposure, representing nearly 40% of the monetary base. The monetary base, if you don't know, is the only portion of the money supply that is not the liability of any private party but is the liability of the central bank and in turn fully backed by the government itself. In a "normal" run on the banking system, it is the monetary base into which everyone would try to scramble with their liquid funds and savings. With 40% at risk, however, most people would probably trot right past the Federal Reserve Note on their way to the tip of Exter's Pyramid, where gold and silver reside. Unfortunately for them, that tip isn't very big and cannot accommodate everyone. In other words, a run on the banking system in America today would mean tremendous monetary demand for gold in preference over paper dollar bills. With a 40% risk exposure, you really should own some real money, even if it is just a few ounces.

JUNE 12 2008 4:45PM - Gold is holding up better than silver, which had the worst performance of just about any commodity today (with wheat and sugar in close pursuit). As a result, the white monetary metal had trouble with its $16.50 support while its yellow comrade stayed comfortably above its own at $850. The situation presented somewhat of a quandary to speculative longs in silver but I think the right decision for now was to hang tough. One reason for doing so is that gold's 200 day moving average has risen all the way up to $855 as of today, so the low of $858 this morning was pretty much a slam dunk technical bounce. Meanwhile, silver's 200dma is just about to cross $16.00, so it seemed natural that the morning's low would gravitate toward that number. In fact, silver stopped somewhat short, bouncing strongly from $16.25. I expect the remaining 25 cent gap to close pretty soon, and it won't require silver to drop any further assuming the sideways price drift continues for at least 2 more weeks.

In any case, we are now officially entering a strong buy zone for both silver and gold, one that may last just a few days or most of the summer. If you've been itching to buy bullion, now is about as good an opportunity as it has been since last August. Tulving is offering specials on silver American Eagles and Canadian Maple Leafs: 100 coin minimum with $20 shipping/handling (will cost you under $1,900). I would expect you can find many other bullion dealers right now who would match this. If I was just starting out or looking to build a nice little position, this is probably the way I would go. Buying now might be a bit early, so be sure to leave some funds for future acquisitions unless you're a gambler.

Once again, it bears repeating that we are now entering a very good buy zone for both gold and silver, and this is the first time I've said as much since last August. Had I been paying better attention, I might have identified the solid opportunity in December as well. In retrospect, it's not a huge missed opportunity since silver is only a couple of dollars higher now than the December low, and we could come pretty close to that number (low $14.00s) over the summer.

Based on the above, I am planning soon to turn my ultra-short-term speculative flag to "green" once I think the immediate risk of further price declines has passed. And while the flag remains green for all other time horizons, the "buy" should now officially be interpreted as "strong buy" vs. "buy like you normally would". In other words, buying bullion is no longer just a good idea if you have some extra dough lying around (lucky you!), it's now also a good idea to raise additional funds for buying bullion by liquidating other assets.

JUNE 11 2008 5:05PM - It's amazing to me that the markets would actually buy Bernanke's recent jawboning about raising rates to fight inflation, and disappointing that oil, not gold, would be leading the countercharge for the truth. The fact is that the Fed cannot raise rates without creating Armageddon and I urge you to visit Jim Sinclair's website at www.jsmineset.com for ample support. This is a seriously embarrassing ploy that has the potential to backfire and send oil prices even higher in protest, since many traders see Bernanke as trying to talk oil prices down in a strikingly brazen and foolish example of academic hubris. On the other hand, there is now the very real possibility of Forced Commodity Liquidations Coming by popular demand, which would likely dampen food and energy prices at least temporarily if not reset them at some lower, though still elevated, level. This has the makings of a "gunfight at the OK Corral" over the summer and we could be in for a period of extreme volatility in virtually all markets. The possible winners? Gold and silver! Assuming, of course, the appetite for commodity exposure does not completely shrivel in the face of legislative restrictions. Why? The monetary metals might be virtually the only outlets for commodity-correlated investment demand left standing after the gunsmoke clears. If I'm right, this could be an incredible au/ag buying opportunity right now and perhaps even better in the next few weeks, with a very quick payoff to follow. One of the greatest beneficiaries could be gold and silver mining companies since they would benefit from high metal prices while seeing their costs decline as a result of lower energy prices. If you sold in May and went away, I'd suggest you at least pay attention this summer as it could be a seasonal aberration.

JUNE 10 2008 2:10PM - Unfortunately, it continues to be all about oil and the dollar. The speculative element behind crude was finally revealed late last week when a mere prediction of higher crude prices resulted in one of the largest daily moves on record. Only once oil settles down will au/ag start trading on their own technicals and fundamentals. At this point, I expect that PM prices will either (1) drift sideways until the 200 day moving averages rise to meet them in the next few weeks or (2) go down soon to the 200 day moving averages possible in sympathy with a decline in oil. Currently, both au/ag are near important support levels again and a break lower cannot be ruled out. Downside is more limited if prices drift to meet the 200 day moving averages as opposed to dropping down to meet them because momentum can result in a significant overshoot to the downside. The way I would speculate on this is exactly the same as the last few times: going long at current levels with a target around $17.50 for ag and $900 for au and a stop below $16.50 and $850, respectively.

Now some words on the basis in au/ag. Both remain "uninteresting" in that they are within a historically normal range (moderate contango) and are not indicating whether one monetary metal is more attractive than the other. There may be other reasons to favor silver over gold but a strict reading of the basis says buy 50/50, and don't expect the end of the world to come next week. I continue to concentrate my basis work on developing the subscription service instead of updating the figures and charts on this website, so unless you are able to do your own basis calculation, you are probably going to have to take my word for it. I do, however, plan to spend more time discussing the basis in the next few days and weeks, starting with the following e-mail exchange I've had recently. Hopefully it will help illuminate some of the concepts as well as provide a slightly different perspective on Professor Fekete's groundbreaking work.

A reader writes:

I have probably thought about no other concept more often than the basis for the precious metals. Yet I am confused by what can be regarded as cause and effect.

Say for example, that I have a metal (not monetary) that I am willing to store in inventory [hoard] and therefore willing to accept price risk [perversely] then if the market went into backwardation, I should like that…as one can make risk free money from selling spot and buying forward (deferring inventory ownership until then and picking the premium.)

If I were a warehouseman, and I held this metal spot and hedged forward (when it was in an appropriately steep contango) and then it subsequently moved into backwardation, then I can sell my inventory, and buy back my forward position for a tidy profit. However, I cannot hold hedged inventory again in this metal, until it has moved into contango.

So does the backwardation cause the hoarders and warehousemen to do whatever they do, or is it the case that the backwardation results from what the hoarders and warehousemen are doing? Or is it a combination of the

two?!

My response:

I think you are on the right track but it would help to define the exact goals and intentions of the hoarder and commercial warehouseman. The hoarder simply seeks to profit from a price rise due to induced scarcity in the near term. Backwardation may or may not result from hoarding. For example, if speculators buy a lot of futures contracts because the spot price is rising, they can keep the basis positive indefinitely. On the other hand, the reason for hoarding is based on the hoarders' assessment of the probability of generating a profit, which is arguably highest for markets already in tight spot supply. Such markets are more likely to be backwarded even without hoarding. In any case, the hoarder could care less about the futures price as long as the spot price is higher in the future. There is an exception to this in that some hoarders may sell call options against their positions, and of course this is more profitable when the price is in contango. At the same time, selling call options will dilute speculative buying power and reduce the basis. All in all, hoarding probably tends to move the basis toward backwardation and dishoarding toward contango.

Warehousemen are an entirely different lot. They merely seek to earn a fair return on their investment. They are essentially in the business of renting storage space. If they don't have inventory, they are not in business, and they won't carry inventory unless they can sell for more than they buy. Of course, any inventory they already hold is fully hedged, so changes in the basis only affect decisions about future levels of inventory. Warehousemen don't really care about spot prices, only the basis. Unlike hoarders, their actions are not going to create backwardation. Instead, warehousemen will refuse to add inventory when the basis is not sufficiently in contango. Ideally, this will create excess supply to drive down spot prices. Warehousing will recommence only when it can be done profitably (once contango is restored to normal levels). An important exception to this may occur at the delivery choke points where product is moved between markets. Here, it is possible for contango to rise and remain at elevated levels (even for futures contracts that are spot month) because of terminal capacity or other factors.

In summary, we can see that hoarding will tend to reduce the basis, perhaps to the point of backwardation, whereas commercial warehouses will be closed to any new storage in response. Conversely, dishoarding will increase contango but new warehousing will ensure that contango does not rise too far. In effect, these are opposing forces but driven by very different considerations. Hoarders seek extraordinary profits that will be pursued until confidence is exhausted. Typically, confidence is long gone before the hoarders reach their goal. Warehousemen seek ordinary profits that will be pursued only while it is reasonable to do so, which is most of the time. In the middle are speculators and producers, making it virtually impossible to discern anything of value by studying the basis in non-monetary metals and commodities in general.

The case of monetary metals, however, is different. True backwardation can occur as a result of ubiquitous, unsatisfied demand. Such demand is unlikely to be based on the profit motives of warehousemen, hoarders, speculators or producers but rather on the monetary needs of savers who wish to eliminate exposure to fiat money. It is possible that profit seekers could act in concert to create conditions for periodic backwardation in conjunction with high investment demand, but this alone is unlikely to maintain pricing dominance in the spot market for long (due in part to the lower transactional friction that exists in the paper market, which seduces market participants to return time and again).

Sustained backwardation is normally impossible when the monetary nature of gold and silver are not universally recognized since that means there will always be someone willing to sell metal in the spot market and buy forward to take advantage of efficiencies (i.e. avoiding storage and insurance fees, earning a return in fiat cash). When gold and silver are widely viewed as a superior form of money, however, fewer people are willing to trade present ownership for the future. Conversely, when fiat returns on cash are negative (real interest rates are negative), gold and silver are increasingly viewed as money.

The Professor's last contango thesis points to a time when the monetary metals reach a tipping point with private, institutional and even government acceptance of their status as the apex of money. This tipping point is probably instantaneous but there would likely exist a broad transition period during which backwardation becomes increasingly