Weekly Commentary

WEEKLY COMMENTARY

October 1, 2002

Make The Switch Now
By Theodore Butler

Last week, in response to my recent article, "Hot Potato", a reader sent me the following question -

Hi Ted,

I was re-reading your latest and came across this statement..."please
keep in mind that there are other, separate and distinct additional
components to the total silver short position - the leasing short
position and the short position caused by commercial banks (especially
European banks, and particularly large Swiss banks)".

Can you explain the European and Swiss bank situation? Why would they,
of all organizations, be short the metal? How long have they been like
that?
*************************
This is something that is very important for silver investors to understand, this "short" position created by the issuance of silver certificates by banks. This short position is separate and distinct from the COMEX short position, the leasing short position, and the OTC and LBMA (London Bullion Merchants Association) short positions, although there is some inevitable overlap and inter-linkings. The commercial bank silver certificate short position, particularly concentrated in European and, especially, Swiss banks has come about because silver is silver, and bankers are bankers. Please allow me to explain.
You've seen me write before, you get too much for your money with silver. Because silver is so cheap, the physical volumes involved for relatively modest amounts of money can be formidable. Unless you have unusual storage capacities (and bless you, if you do), there will come a time where you will have to employ someone to store your silver for you. Let me illustrate this point with a comparison to gold, silver's sister precious metal. Using current wholesale prices, $125,000 will get you, roughly, 400 ounces of gold, or around 30 lbs. You could put this amount in a sturdy briefcase, and move it at will, making commercial storage optional. That same $125,000 will get you, roughly, 28,000 ounces of silver wholesale, or 2000 lbs of metal. That's one ton of metal. If you can store such quantities personally, great, do it. Most folks, however, will have to use some type of storage facility for such quantities, or more. That's the price you have to pay for getting too much for your money.
Now, some folks might say that is a big negative for buying real silver - you can't physically move significant dollar amounts on a moment's notice. Let's look at that objectively. Yes, it is true that gold, or diamonds, or rare stamps and coins are much more mobile than equivalent dollar amounts of silver bullion. But, so what? Commodity analysis is predicated on supply and demand and future price expectations, not fleeing authorities or crossing borders in the middle of the night. Of course, if such mobility insurance is important to you, because of such personal circumstances, then you must prepare as you see fit. But that has to do with some type of escape planning, not investment analysis. I can only speak for myself (and what I perceive to be the situation of most readers) in that I'm not looking to escape in the middle of the night, just to make some money on an investment basis, so mobility is not a factor that matters to me.
Once it's been established that you have more money to invest in silver than you can physically store on your own, the decision to have it stored for you is easy. The problem is that the same careful thinking and analysis that goes into the decision of whether to invest in silver, is often not present in the decision of where and how the silver will be stored. Here, I think many silver investors may be making a big mistake. That mistake is in assuming that just because you may have a piece of paper that reads that you own silver, that there is real silver backing that piece of paper. In fact, I would assert that the vast majority of silver pieces of paper, such as foreign bank silver certificates, pool accounts and all leveraged contracts have no real silver behind them. How could they? No one can provide evidence of more than 150 million ounces of verified silver bullion in the world, yet we have billions of ounces of silver promised by various pieces of paper.
One reason why we have much more silver promised on paper than exists is, as shown above, because silver needs to be stored, when dealing in large amounts. The second reason is because bankers will be bankers. That is, it is a normal and acceptable practice for bankers of all stripes to promise to pay all depositors on demand, because we all know that all depositors won't demand to withdraw all their assets at once. Please understand that this is not an indictment on the banking system. I know full well how the fractional reserve system operates, and I am not condemning it. It is the way of the modern world, for better or worse. In the event of a bank run by depositors, at least in the US, safeguards have been built into the system, by the FDIC and Federal Reserve to contain and isolate such rare occurrences.
My point is different. It is this established and, generally, smooth-working system that we have all grown used to, including the bankers. But this system has been designed around paper currency (including checks and loans) and electronic money. The system has not been designed for physical silver metal. The problem is that the bankers have behaved as if the system can apply to a metal, just as it applies to currency. It can't. There is no Federal Reserve, nor FDIC that can be called upon to deliver truckloads of silver metal, like can be called upon to deliver paper currency in a bank run. There is no silver guarantor of last resort, as silver is no one else's liability. Either the silver is there, or it's not there. Believe me, in most cases, it's not there. But the foreign bankers don't realize that. They think a silver certificate is the same as a currency-denominated certificate of deposit. They look at it through bankers' eyes. I look at it through a silver analyst's eyes. I see it differently than they do.

It's not just that the foreign bankers see it differently. What they have been doing, issuing and letting their silver certificates remain unbacked by real silver, is an immensely profitable business. For twenty years, or more, by not having to go out and buy and store real silver whenever a customer buys a silver certificate, the foreign bankers have been printing profits for themselves. Their customers give them cash upfront, and not only do these banks have full use of that cash, they do not have to pay any interest on that cash, and get this - they charge storage fees, for silver that doesn't exist. It's better than stealing, because if you just stole the money from someone, you wouldn't get to charge additional storage fees. It's a racket.
Now, I have surmised that there may be a billion ounces of silver involved in these certificates, but I think the figure may be much, much more. Here's my reasoning - while a billion ounces of silver may be a lot of silver, it sure isn't a lot of money. Five billion dollars, over twenty years and all the banks that are doing this is peanuts. One man, Warren Buffett, bought almost a billion dollars worth of silver, by himself (of course, he couldn't get full delivery when it came down to it). I personally witnessed one transaction recently, where one entity bought 10 million (paper certificate) ounces from a major Swiss bank. You don't think, over the span of 20 years and the hundreds, or thousands, of banks involved in this silver certificate scam, that there hasn't been 100 others like this entity? What's five billion dollars, spread over hundreds, if not thousands of banks worldwide?
There are two things that should come to every silver investor's mind. One, is there silver behind my certificate? There most likely is, if you a have a certificate that spells out the serial numbers on the bars, or a specific description of the silver held (bags of coins for instance). There probably is, if the storage function is separate and distinct from the dealer selling you the silver. There probably is, if it's registered in your name and not the name of your dealer. If you have all three, no sweat. But, if you hold a certificate where the silver is not described specifically, or is unallocated form, or is in a pool account, or there are no storage charges, you would be wise to assume the silver doesn't exist. That doesn't mean you will automatically lose, when silver takes off, but it becomes a question then of the credit quality of the entity you are doing business with, which is a very different analysis than the merits of silver. You would then be betting upon the financial viability of a dealer whose books you have not analyzed. Appearances can be deceptive. Remember, a few years ago, the then largest silver refiner in the world, Handy and Harman Refining, suddenly went bankrupt and all silver pool owners and depositors were left in the cold. Also, there may be small print wording in these unbacked silver certificates that may prevent you from getting your silver in physical form, or that deny you the true world price at the time you may wish to sell.
The second thing, concerning silver certificates, that should come to every silver investor's mind, is the market implications that a silver price rise would have on those issuing non-silver backed certificates. This is what I was mainly referring to in my mention that these certificates are a separate and distinct short position. Please think this through. Even if you are not worried that your dealer may renege or go out of business (in the case of a large Swiss bank, for instance), in the event silver rises in price dramatically, the implications for the silver market will be profound. While those who have been issuing these non-backed silver certificates have profited immensely over the decades by having free use of their silver depositors' money, there is a cost to be paid for those profits in the event of a silver price spike. Even if the depositors' don't demand their silver (I don't think they will), many will want to cash out at high silver prices. The issuing banks will be liable for those profits, and the only way the banks can limit their liability is to offset their suddenly very naked silver exposure, is to buy silver in some form, paper or physical. At some price trigger point, $8, $12, $20, these banks will panic and buy enmasse. Ask yourself this - if the silver short sellers that these banks have been for decades, suddenly turn collective buyers at any price, to the tune of hundreds of millions, or billions of ounces - who will be there to sell to them such quantities? Still think $50 or $100 per ounce is unreasonable?
My advice here is not aimed at only new silver buyers, I am speaking to those who have bought silver already, over the years, with no input from me. My advice for those holding paper silver in questionable form is to get your silver into unquestionable form. Get out of pool accounts and unallocated silver, and into real and allocated silver. Hold your silver in hand or with someone you trust. The additional costs will prove well worth it. Make the switch now, while you can. Don't wait for the price to rise, it may be too late. I can't think of a worse outcome than for someone to have invested in silver for a long time, to be denied a profit when the price rises, because he held the wrong form of stored silver. Please don't let that happen to you.