Saturday, December 11, 2010

The Gold & Silver Shortage---A Future Brick Wall

Commodities are the only game left in town. This is the one market that Ben can’t effectively control. And this could be his downfall. The real cost of borrowing money is zero if you factor in inflation. This has a win win effect for investors buying futures. In simplified terms, the future price of a commodity future one year out would have a premium. It would be the interest on the money for the term of a year, needed to purchase the commodity on the spot market, plus storage costs over the year before delivery. So a free ride with interest charges, with incidental storage costs and an add in for the volatility cost.

Commodities as a whole are rising in price. A lot of it is inflation related. Since there is no cash return for dollars in the bank; commodity speculation is the new frontier open to abuse. In the futures pit, one trader will sell the future delivery of one million barrels of oil, say for November 2011. At the maturity date for that trade, the seller delivers the oil or buys his contract back. All contracts are matched buyer to seller. If you are speculating, you never want to take delivery. The speculator sells naked contracts for delivery if he believes the price will drop and he buys contracts when he thinks they will increase in value. This person will close out the deal by selling or buying the opposing trade back. Margins are as low as 6 percent. So to control one million in gold, you need 60K in face money.

The commodities market has a valid justification for its existence; it helps take the risk out of business ventures. An airline would buy jet fuel futures a year or two out to limit upside costs. The company is not sure what the future market price will be, but buying a futures contract for later delivery, locks in their costs. If a gold company has production costs of $800 an ounce and plans to produce 1000 ounces of gold, they would sell 10 futures contracts for delivery say 6 months out at $1300 an ounce. This guarantees that they will meet their payroll and keep the bookkeeper happy.

For every 100 futures trades, only 10 are real (a commodity actually changes ownership from one holder to another). All the rest of the transactions are speculation. A problem can arise in the futures market if the prices take off. All of the buyers of gold and silver futures might demand delivery---especially if the price increased dramatically.

The Hunt brothers tried this in the 1980’s and successfully cornered the silver market. They were buying it and taking possession. Needless to say prices took off. The Hunts had a legal corner on the market and it was about to ruin a majority of the Chicago Board of Trade (who were opposite the trade). So the CBOT changed the rules on the Hunt brothers and limited the number of contract that could be held, to 10 million oz and all contracts over that amount, had to be liquidated. Naturally that saved the ass of every scumbag CBOT trader and bankrupted the Hunt brothers.

With a little thought, it doesn’t take much Gray matter to figure out that one can run the futures market with only a small amount of real gold changing hands, and at the same time have several million ounces of contracts being traded daily.

Many people have their gold and silver stored in bullion banks. IMHO, I don’t think even one of those banks could payout on a modest 10% run on the bank. That’s why it takes up to 30 days for delivery when you request it. They have to go out and buy it on the open market.

The question we need to ask is “Have we built a gold and silver bubble, or is this perceived increase in price, a measure of how bad this quantitative easing has gotten?” The futures market could turn into a tar pit if everyone decided to take delivery of their gold and silver.

Bernanke has tinkered with reality. Maybe, its gold and silver’s turn to tinker with Ben’s QE2. Do you know where your gold and silver are? They might not be where you thought they were.

The $20 coin at the left, was in circulation 100 years ago and has kept its value quite well. The old money is no longer in circulation; it's worth quite a lot more than the 20 dollar bill it represents today, go figure.

Copyright 2010 All rights reserved


rob in ns said...


I've been looking at those coins for past couple of days. The question I keep asking myself is where does one store wealth when it seems everything is an illusion. I keep thinking about the movie "The Matrix" wondering which I should swallow. I'm not one of the doomers worrying about end of Mayan Calender. I truly believe that the world is in no danger of ending but there is a paradigm shift coming. The trick is making sure one is on right track when it happens.


goodrich4bk said...

I own gold and silver, all of it physical either in CEF or in my hands. So I don't disagree with your premise. Still, your historical comparison of the value of a $20 gold coin vs the value of 20 dollars is not really relevant. Because dollars earn interest and gold does not, you need to compare the value of $20 coin with the $20 dollars AND the additional dollars of interest earned over the comparison timeline. For example, $20 in 1932 (the last time dollars were convertible by Americans into gold) would have earned over $300 of interest by now (assuming short rates equalled inflation over that period of time). And if you actively managed that $20 by deftly moving it around to get the highest rates during that period, you could have probably tripled that return. still, that would only be a value of $950 vs. $1400 for the gold coin.

Jim in San Marcos said...

Hi Rob

I think all we can do is diversify. Gold, silver, stamps, gems, all seem to hold value. Real estate is kind of iffy, its a highly visible government tax source.

The real rich (the people with lots of toys) will pay the most, the luxury homes, yachts, Mercedes are easily taxable. If we all lose 90 percent, the expensive toys of the rich will eat up the other 10 percent of their wealth as maintenance expenses. The rich go broke and burn out fast, kind of like shooting stars in the night sky.

This is going to hit us in our retirement savings. We will see it as inflation---with an attitude. The government can't spend its way out debt; the idea that it's possible is laughable.

Tyrone said...

Off-topic. This is insane...


Jim in San Marcos said...

Hi Jeffery

10 years back we would have been in agreement. I've always held that gold is a bad investment, it pays no interest. But times have changed (for a while). If you bought gold a year ago for $900 an ounce, you could pocket a $500 dollar profit. In the meantime, your dollars in the bank did absolutely nothing at 1 percent interest and 6 percent inflation.

The real question is "Is gold increasing in value or is our currency going to hell?" It depends on who you ask, and thats real comforting, isn't it?

Jim in San Marcos said...

Hi Tyrone

Your post might seem off topic, but if you lose your savings and are over the age of 55, unemployed and have a handgun, your going to make people pay. I think this is just a preview of what to expect as things get worse. People want to strike back at an abstract thing like government, but when they act, they have to pick on real people (representing the organization) who are just as innocent as themselves.

Congress has always voted against abolishing the right to own handguns. When the Constitution was written, a flintlock pistol was the firearm of the day. That is an OK firearm to me (it's a pain to reload plus someone could beat you to death with an umbrella while you are reloading). I think Congress will have to finally act on handguns, they are going to realize that these silver foxes might want to take a Congressman with them when they decide to leave this world, and for good reason.

Tyrone said...

I agree. There will always be people that want to strike back at the bureaucracies, which often seem to be 'above the law'.

Watching the protests by the students and citizens in the UK, I was struck my two things that they chanted at the 'Bobbies' and organizations,
"Shame on You", and
"Your Job's Next".

rob in ns said...

I really don't see the point in investing as long as you have a mortgage anyways. Right now I can take $400.00 and put on house. That takes one month off the end of mortgage. Basically I double my money in about ten years. This will work as long as inflation doesn't take off. The jury is still out on whether that will happen so until told differently I'm going by old saying "A Bird in hand is worth Two in Bush."

Ohio Loan Officer said...

One thing is for sure--- the US dollar is doomed. Paper money will be worthless once hyperinflation sets in.
To have a hedge you will need to be in some commodity-- a commodity people need.

People will need to have a form of exchange. That is why I'm buying silver. Gold is getting too pricey. If it comes down to needing a currency to buy groceries and gas a one oz gold coin will be too cumbersome; too hard to breakdown to a smaller denomination. Especially if the value shoots up to $3,000 an oz. A silver dollar, worth approx. $25 today but likely to go to $100 or $200, will be a more manageable means of exchange.

It is said non-perishable food could be an item of barter. That is true but the US has such vast food resources that I think it unlikely there would be widespread food shortages. Nevertheless, it is a wise idea to have a reasonable stockpile of can goods on hand.

I do know one guy who is stockpiling ammo as his hedge. His thinking is if rioting occurs Martial Law would be declared and gun shops forced to close. The demand for ammo would inflate the value. Ammo can be stored for long periods of time if conditions are right. Imagine paying two 9mm rounds for a loaf of bread.

Anonymous said...

I'd be worried that guy with gun would just put them in gun and demand his bread back. Anyway I don't think we will have that sort of societial meltdown but you never know. If things get that bad I'm heading for the hills.


Jim in San Marcos said...

Hi Ohio Loan Officer

I think that "the dollar is doomed" is a bit of a stretch. Just add an extra zero onto the price of everything. It tends to make you madder than hell when you realize what it means to people who have saved their whole life for retirement. They are the ones who get to pay the bill.

This printing of money could destroy the middle class just like it did in Germany in the 1920's. It doesn't look good from here, but I don't think that it will live up to our worst expectations.

You could try protecting your wealth as you suggest with gold silver or some other asset like a home.

If we were to have a currency collapse, the results could be quite horrible. You wouldn't be able to run down to the supermarket or gas station to make a purchase with silver coins. A collapse of the financial system would literally stop all deliveries nation wide of food, gas etc. Figure from there, a good 10 days of looting. Then martial law and a new government.

So if you are getting ready to retire, be nice to your kids, you're going to need them just to eak out a subsistent existence.

Jim in San Marcos said...

Hi Rob

I agree with you, a home is a store of value, just like gold. It has the added quality of utility. My grandfather use to say "A home is the worst investment you'll ever make, but a necessary one." I would count a home as the equivalent of holding 150 ounces of gold--a great inflation hedge.

Anonymous said...

I'm getting ready for Thunderdome!

Ohio Loan Officer said...

The guy with the ammo--- if it came to trading with that I'm sure he'd have his AK47 with him. He converted it illegally to full auto. He figures if it comes to him having to travel around with it no one will be checking for Class 3 permits anyway.

As for the Thunderdome comment----
I know a farmer out my way that has a 1500 gallon tank of gasoline buried. There is no visible pump to tip off potential thieves. In Yugoslavia in the 1990s the only way most people were able to buy gas was from someone with a can on the side of the road. Of course at a very premium price.