Friday, August 10, 2012 – The Case for Silver and a Few Odd Notes

The Case for Silver and a Few Odd Notes
-by Sinclair Noe

DOW  + 42 = 13,207
SPX + 3 = 1405
NAS + 2 = 3020
10 YR YLD- .04 = 1.65
OIL – .15 = 94.69
GOLD + 3.50 = 1621.50
SILV -.01 = 28.23
PLAT – 14.00 = 1404.00

The case for silver: 

April last year, silver peaked just shy of $50 an ounce, and then fell back hard. Since then, silver has been either off the radar or hated. It has been hovering around $27 since May, testing people’s patience.

As a rule, silver prices usually follow the direction of gold. But as long time silver investors recognize, the moves are amplified both on the downside and the upside. Silver prices are simply more volatile than gold prices. Already in this decade, silver has risen by a factor of 12 from its ten-year low ($48.70 vs. $4.07), while gold has seen about a sevenfold climb ($255.95 vs. $1,895). 

The three biggest silver corrections in the current bull market average to 42.1%. 
Silver corrections are deeper and nastier and take longer for recovery. The average 42.1% correction took 98 weeks and 4 days to recover; using the same ratio, a 46.3% correction would take 108 weeks and 3 days. Counting from the previous peak of April 28, 2011, we wouldn’t break the $48.70 high until May 26, 2013.

Based on this same correlation of corrections to recovery in the gold market, we can expect gold to challenge old highs in the October to November time frame. If we follow the course of the 2006 correction, we can expect a recovery in gold within 58 weeks. Just to refresh your memory, gold set a record of $1895 an ounce on September 5, 2011.  A 58 week recovery puts it near mid-October. 

Gold, since it peaked about a year ago; for the better part of the year it’s been consolidating about 16% below its previous peak of $1,900. Today, at $1,600, gold is back to levels its first saw a whole year ago, but what has happened to the more volatile silver? To really understand, we need to pay attention to is the gold to silver ratio. 

Before the financial crisis, the gold/silver ratio was around 50 and trending downward. That meant at the time an ounce of gold would buy you 50 ounces of silver.  Then in late April last year silver exploded higher. As the silver price rose an ounce of gold bought a smaller equivalent amount of silver, pushing the ratio down below 30. Silver’s price rise back then was parabolic, and at the time I told you it would not last. The extreme levels on the ratio are 30 to 1 and 60 to 1. So, now the gold/silver ratio is at 57.5. That means silver is undervalued relative to gold, and the time frame for gold to pull out of its recovery is setting up over the next couple of months. 

Gold also normally starts its best seasonal period now, as the summer doldrums come to a close. Since its secular bull launched back in 2001, gold has averaged 19% gains between the end of July and the end of May. 

Now, let’s look at the silver chart. Silver appears to have bottomed recently in the $26-$27 range. It’s not the first time this price level has been relevant either. Back in late 2010, $26-$27 acted as resistance where silver’s price had stalled. Late in 2011, and again in the last couple of months, silver has retested those prices, but this time it’s provided support. The $26-27 range is long-term and very powerful support.

Silver contracts are traded on futures exchanges. A useful barometer of who’s long and who’s short silver can be garnered from the weekly Commitment of Traders (COT) reports prepared by the Commodity Futures Trading Commission (CFTC). 

Recent COT reports show that the big speculators (dumb money) are exceptionally bearish on silver right now, at levels reached only four times since this silver bull began in 2002. 

Each time that’s happened since, silver has embarked on an impressive rally, climbing at least 70% and even clocking up to several hundred percent gains. 

There is another important development out of the futures markets;  a report earlier this week that the Commodities Futures Trading Commission (CFTC) would drop its four-year-old probe on silver price manipulation may have been premature. 

According to The Financial Times, the CFTC was supposedly unable to find enough evidence to support the claims after reviewing 100,000 pages of documents and interviews. But Bloomberg News reported that CFTC Commissioner Bart Chilton said silver price manipulation did occur, and he’s intent to find it. 

Chilton wrote: “I continue to believe, consistent with my previous statements and information from the public, that there have been devious efforts related to moving the price of silver. There have also been silver and gold market anomalies outside of the silver investigate window that have raised, and continue to raise, market concerns.”

The silver price manipulation case began in September 2008 when the CFTC received “complaints of misconduct in the silver market” by a group of investors. It subsequently launched an investigation. Two years later, Chilton said “fraudulent efforts” to “deviously control” the silver price had been found. 

He continued lobbying for the investigation and upon hearing the rumored news of its close, he said, “The Financial Times report related to silver is not only premature, but inaccurate in several respects.”

By the way, one of the alleged guilty parties in silver price manipulation is none other than JPMorgan Chase. Silver market watchers for years now have accused JPMorgan of keeping silver prices low through massive short positions on the white metal. No proof of the trades has been found. Some investors have filed a class-action lawsuit against the bank. JPMorgan attorneys have asked for a dismissal, but apparently it isn’t happening. 

Just how realistic is it to imagine there has been manipulation in silver prices? Is this just more conspiracy theory hokum? Well, when you consider the price of metals is determined by the major market makers: Societe Generale, Scotia Mocatta, Deutsche Banke, HSBC, and Barclays. Just remember that Barclays has just admitted to rigging the Libor. That’s not proof they rigged the metals prices, but it does indicate a pattern of behavior.

 Why is this important? Well, if the CFTC ever determines there has been silver price manipulation, then it is safe to figure that manipulation has caused silver to be priced much cheaper than it would be otherwise,and if the manipulation then stops – prices will jump. 

Worldwide, investors are gravitating toward physical bullion, having tripled their purchases since 2007. Clearly, people are becoming apprehensive of the state of the world’s finances, economies, and governments. Demand remains strong. 

Who ever heard of a gold ETF until just a few years ago? But by the end of 2008, gold holdings of ETFs reached a record level of 1,090 tons. Today, according to a July report from Bloomberg that number more than doubled, to 2,188 tons. Thus, ETF holdings now exceed those of China, Switzerland, Russia and many other large and important nations.  These are astonishing levels of demand, where there was almost none just a few years ago.Individual investors through the ETF’s hold more than quadruple that of the European Central Bank. Now, you might think buying a gold ETF is the same thing as buying physical gold. It is not. ETFs like GLD are run by HSBC while the SLV is run by JPMorgan. These ETFs are backed mostly by paper and they are leveraged by up to 30 times. That means that each transaction is backed by about 3% in physical bullion. 

For years, I have heard that investing in physical gold and silver is risky. I heard it when I was buying silver for $4 and gold at $300; I heard it when gold was at $750 back in 2008. You want to talk about risk? Let’s talk about the recent examples of MFGlobal and PFG which show us that a paper certificate is just a piece of paper and an account can be re-hypothecated. 

Through it all, the gold price is rising due to the fundamentals of supply and demand. More and more people across the world are buying. Gold and silver buying and demand growth is happening while global mine output or “supply” is shrinking. And if energy prices go up, then that will cut into mining production and output.

And then there is the role of gold and silver as a safe haven. Think of the metals as a gauge of just how good a job the central bankers are doing their job. Gold and silver prices would be lower – if there was no inflation, if we had maximum employment, if we weren’t about to see the government drive off a fiscal cliff, if we didn’t have massive and unsustainable debt, if we didn’t have re-hypothecation, if we didn’t have central banks cranking up the printing press. 

he federal budget deficit spirals well beyond sustainability and containment at an accelerating pace, and the Fed continues to move with great deliberation to debase and to impair the purchasing power of the dollar, to generate rising consumer inflation.  It is important to remember the Federal Reserve and the U.S. Treasury moved early in the current solvency crisis to prevent a collapse of the banking system, at any cost – their great fear was a deflationary depression. This is the playbook – when faced with deflation, the Fed will inflate. While the Fed’s efforts have been less than satisfying, it would be wrong to think they haven’t had an impact. And the impact was not the purge of the malinvestment which was and remains a requirement for recovery – we have not seen creative destruction work its wonders to heal the financial system. We have seen and will continue to see the Fed artificially stimulating the economy with no viable exit strategy; an inflationary response to deflation.

So we are entering the strongest seasonal period of the year for precious metals, at a time when we have seen corrections typically run their course, combined with  political and economic factors which could help drive explosive demand for silver. That combined with the overextended Gold/Silver ratio, the extreme short position held by silver speculators, the push for physical bullion, and the bottoming price, means silver is being primed for substantial gains.

It’s Friday, so I have a few notes and then I can clear my desk:

A former Barclays trader who was fired by the bank for sending inappropriate emails about Libor “has cooperated” with the federal criminal probe into the alleged interest rate rigging. Lawyers familiar with the investigation say federal prosecutors continue to reach out to individuals to gauge interest in cooperating or taking pleas. They said prosecutors are expected to begin making decisions on charging individuals later this month or in early September.

The Murdoch Street Journal reports The Consumer Financial Protection Bureau intends to require banks to consider a modification request before proceeding with a foreclosure; loan servicers would be required to evaluate homeowner applications for modification within 30 days of receiving an application and  they could not foreclose without reaching a final decision on a modification application. The proposal is still in the planning stage. It is not in effect now. 

The Murdoch Street Journal also has the latest update on the Standard Chartered Sanction Skirting Scandal. You may recall a New York State regulator is doing his job and enforcing laws preventing money laundering for Iran in violation of international sanctions. A hearing is scheduled for next week. Murdoch Street is trying to make it sound like the New York regulator needs permission from the Treasury and the Fed to proceed. He doesn’t. The Superintendent of the New York State Department of Financial Services is a guy named Ben Lawsky; he should be applauded for doing his job. What is crazy is the media, which has sold out to the banks. 

The International Business Times had a story on SCB and it might make some people want to reconsider if they still think corporations are people. If Standard Chartered Bank were indeed a person instead of a corporation, they would be facing possible jail time of 8-four months up to 25 years for intent to defraud, plus 19 years for money laundering, plus 20 years for racketeering. And if the judge was really tough he might consider each act of money laundering as an individual or discrete act of criminality rather than one transaction. But, of course, we all know corporations are NOT people.

You might remember last year a Senate subcommittee found that Goldman Sachs marketed four sets of complex mortgage securities to banks and other investors but that the firm failed to tell clients that the securities were very risky. The Senate panel said Goldman secretly bet against the investors’ positions and deceived the investors about its own positions to shift risk from its balance sheet to theirs. The Senate panel probe turned up company emails showing Goldman employees deriding complex mortgage securities sold to banks and other investors as “junk” and “crap.” And then there were concerns that Goldman executives lied to Congress about these issues. In 2010, Goldman agreed to pay $550 million to settle civil fraud charges by the SEC of misleading buyers of mortgage-related securities. The agreement applied to one of the four deals cited by the Senate subcommittee.

The Justice Department said it would aggressively pursue investigations of “matters affecting our financial system.” Whatever happened to that investigation? Well it concluded today. Justice Department says they couldn’t find any problems.  That should make us all feel better.

Back in 2008, JPMorgan Chase induced credit card customers to transfer loan balances from other lenders to Chase card accounts at low fixed rates. Then they raised the minimum monthly payment from 2% to 5% and if someone was late, they slapped them with higher rates and fees. Chase collected $220 million of up-front transaction fees that their clients paid for Chase’s promotional loans. Today, Chase reached a class action settlement for $100 million. That should make us all feel better. 

The Office of the Comptroller and the Federal Reserve say that banks should set aside capital as a cushion or reserves in case something goes wrong. Generally, the big banks get to create the models that determine how much risk they have and therefore how much they need to set aside in reserves. Now the OCC and the Fed are telling JPMorgan they have to set aside more reserves because of the trading losses by the London Whale. As a result, JPMorgan will have to suspend its stock buyback program. Sheeesh! A bank misplaces 5 or 6 billion or maybe more and all of the sudden people stop trusting them to keep track of the money. 

Regulators directed the country’s five biggest banks to develop plans for staving off collapse if they faced serious problems, emphasizing that the banks could not count on government help. The two-year-old program, which has been largely secret until now, is in addition to the “living wills” the banks crafted to help regulators dismantle them if they actually do fail. The regulators actually think this  shows how hard regulators are working to ensure that banks have plans for worst-case scenarios and can act rationally in times of distress. Again, the banks are creating their own models for this exercise.

Total public debt excluding student loan, mortgage and credit card debt exceeds $15.9 trillion;and that number keeps rising. The national debt has been growing at a faster rate than GDP. The Congressional Budget Office (CBO) report, federal debt will exceed 70 percent of GDP by the end of this year; the highest percentage since the end of World War II when the national debt was 121 percent of GDP.  The CBO also says that  public debt will shrink to 53 percent of GDP this year if the Bush-era tax cuts and other short-term tax breaks expire at the end of the year.

The Commerce Department reports total June exports were $185 billion and imports were $227 billion; so, the result was a trade deficit of just over $42 billion. That sounds bad but it is an 18 month low. Part of it has to do with oil; crude prices settled down and we’ve been paying less for oil. That might change. Exports were better than expected. Exports to Europe actually increased. That might change. 

Earlier in the week we had reports from CoreLogic and Freddie Mac showing home prices in the second quarter were up by the most in 7 years. The number of new delinquencies is declining. Still, about 23 percent of all mortgages are underwater and those homeowners are stuck in their houses. Less inventory tends to prop up prices. 

Crude oil is climbing again, rising to $94 a barrel from a low of $78 in late June. Production outages in South Sudan and the North Sea, Western sanctions that have cut the flow of Iranian oil, Iran’s threat to block tankers passing through the vital Strait of Hormuz, and fears that the violence in Syria could escalate into a wider regional conflict have driven up oil prices.  Seasonal factors are also sending pump prices higher. Gas usually costs more in the late spring and summer because refiners have to make more expensive blends of gasoline to meet clean air rules and because the summer driving season boosts demand.  In the past few weeks, pipelines serving Wisconsin and Illinois ruptured, refineries were shut down unexpectedly because of equipment problems in Illinois and Indiana, and a blaze broke out at a refinery in Richmond, Calif. And then the drought is pushing up the price of energy. The good news is that prices usually drop after Labor Day, when many states switch to blends that include ethanol, yea, corn based ethanol. Sorry. 

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