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Silver: Shorting Consumes, Investing Conserves

Articles & Blogs - Silver Commentary

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Comments (10)Add Comment
Jeff Nielson
written by Jeff Nielson, January 26, 2012
Iouhc19, I explained that quite clearly.

ANY shorting puts downward pressure on prices. That downward pressure MUST lead to:

1) HIGHER demand
2) LOWER supply

So as a matter of basic arithmetic, ALL shorting destroys markets (i.e. sends them heading toward inventory default). So it is totally a question of DEGREE. With some TINY level of shorting in a market it could even be "drowned out" by other factors. But any SIGNIFICANT and PERSISTENT level of shorting MUST lead to market destruction over time - with that time being SHORTENED if/when the shorting intensifies.
written by Elie, January 25, 2012
How does ruthless shorting work in both your chocolate example and silver?
Jeff Nielson
written by Jeff Nielson, November 09, 2011
Excellent piece Jeff. It's good to see something slanted at the less informed. It's not necessary to write only for silver aficionados.

I liked how you gave an introduction to supply and demand, shorting, inventory depletion and supply destruction, market manipulation, and GSR all in one piece.

I'm sure that it was a conscious decision not to complicate things by going into naked shorting, and elasticity of supply and demand.

Is this the Canadian spelling of "cozy"?

Thanks GoldenEconomizer!

Last things first, unless I simply can't spell, yes "cosy" is with an "s" north of the border.

With regard to your other remarks, I'm getting the "message" to a large extent that "less is more". When my work is edited by others, the feedback is usually "make it shorter" (lol).

Also, as you point out, there is the issue of making this accessible to the widest audience. It doesn't help to TELL the "average person" that he/she needs to load up on gold and/or silver for financial protection - and then not explain WHY, in a manner which is reasonably straightforward for people new to the sector.

With so MANY reasons/drivers supporting precious metals, we should be able to spread the word without using a lot of complex arguments or jargon. As for the more complicated subjects like "naked shorting" or "elasticity of demand", I'm going to try to cover such subjects in smaller bites - rather than as part of a "big picture" commentary.

Jeff Nielson
written by Jeff Nielson, November 09, 2011
I guess what I was getting at -was that in order for demand to become strong enough to overwhelm supply (I realize demand greatly exceeds supply right now) to the point where the bankers scheme finally collapses, it would appear to me that it would take a rising silver price rather than a falling one.

What I mean is- a rapidly rising price would probably attract so much investor interest (as it seemed to when $50 was approached) that the supply/demand fundamentals would then go so out of whack that suppression would become nearly impossible. It almost seemed like the bankers were able to accomplish their mission and calm down demand when they did the massacre in May and brought prices lower.

Oilersfan, this is a very complicated equation.

Not only do we have to consider the psychological factors you refer to (and of course the manipulation itself), but the supply/demand parameters for silver are very unusual in relation to most other commodities.

To begin with, because many of silver's industrial applications use silver in small amounts, it has very low "demand elasticity" with respect to price - in other words even large price increases have a small impact on demand.

Then you have a market like jewelry, where in economic terms silver is known as an "inferior good" (when compared to gold). Thus the HIGHER the price goes, the MORE people want silver as jewelry.

So putting all this together, it is highly likely that you are correct: the silver market would "detonate" sooner with higher prices than lower ones.

What I frequently remind readers however is "be careful what you wish for..." I remain very concerned that we are on the verge of ANOTHER "silver confiscation" by the U.S. government (perhaps COPIED by other Western governments?). This is why I recommend avoiding bullion funds and accounts.

And for all those people (icnluding myself) who would like to accumulate MORE silver to insure their futures, we have to credit the BANKSTERS for making it still possible to buy silver at under $50/oz.
written by goldeneconomizer, November 09, 2011
Excellent piece Jeff. It's good to see something slanted at the less informed. It's not necessary to write only for silver aficionados.

I liked how you gave an introduction to supply and demand, shorting, inventory depletion and supply destruction, market manipulation, and GSR all in one piece.

I'm sure that it was a conscious decision not to complicate things by going into naked shorting, and elasticity of supply and demand.

Is this the Canadian spelling of "cozy"?

written by Shaffin, November 09, 2011
Thanks for your reply Jeff. Even though you're a Canucks fan, I think we can still get along- haha.

I guess I could have been clearer in my previous post. I completely understand your point on "high" being a relative term.

I guess what I was getting at -was that in order for demand to become strong enough to overwhelm supply (I realize demand greatly exceeds supply right now) to the point where the bankers scheme finally collapses, it would appear to me that it would take a rising silver price rather than a falling one.

What I mean is- a rapidly rising price would probably attract so much investor interest (as it seemed to when $50 was approached) that the supply/demand fundamentals would then go so out of whack that suppression would become nearly impossible. It almost seemed like the bankers were able to accomplish their mission and calm down demand when they did the massacre in May and brought prices lower.

I guess what I'm getting at is- what do you think it will take to finally overthrow the bankers- is this something you just foresee happening gradually or could there be some type of major catalyst that propels the demand to a point where suppression is no longer possible.

I hope I've been better able to describe where I'm coming from.
Jeff Nielson
written by Jeff Nielson, November 09, 2011
Thanks for the support OilersFan (though I be a die-hard Canuck-lover)!

You are completely correct with your observations. The average investor tends to be "his own worst enemy". However, to be fair to the ordinary person, the bankers work VERY hard at making the market "zig" when small investors "zag".

The other observation here is even though many people have been "buying high" with their silver until now, as I discuss in the commentary "high" is a relative term.

If the price of silver was NOT being severely suppressed today, and was ALREADY well over $100/oz, then $50/oz would still seem pretty cheap. The moral of the story here is that even though the emotions of the small investor tend to work against them, as long as they don't SELL the silver they are accumulating then they are still doing themselves an enormous amount of good.

Better to "buy high" than not to buy at all... smilies/wink.gif
written by Shaffin, November 09, 2011
This is a fantastic article. I love the chocolate bar analogy. The one thing that I have noticed though is that investors in reality often buy high instead of buying low. For example, it seemed like when silver was pushing $50, the demand was through the roof. It was tough to get silver in a reasonable timeframe almost anywhere. Any thoughts on this Jeff? I know logically it doesn't seem to make sense, but I think it's human nature to want to buy something when it's going up. Also, any ideas what a possible driver could be to finally make the supply/demand imbalance so obvious that the price of silver finally starts to launch? Thanks.
Jeff Nielson
written by Jeff Nielson, November 09, 2011
Scobes9999, as I understand it, the major industrial users of silver have a VERY cosy relationship with the banksters - and thus it is highly unlikely that any one company (or sector) will make a sudden "grab" for remaining inventories unless/until we are on the imminent verge of final default.
written by Dale, November 09, 2011
Good piece, Jeff! This sure does inspire readers that the silver market has just one way to go, way up.

With the short supply of silver once the price does start to accelerate to the upside, the herd mentality of investors will surely make this market even tighter.

What would the odds be of a large corporation taking a very large stake in silver (for example: a solar power company?) and in doing so make the supply even smaller for other business' and investors. Business' may panic that they will not be able to find the silver to keep products hitting shelves.

Would this cause a situation like with the Hunt Bros?

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