$35+ an ounce! $50+ soon??

I find it hard to believe that some people still think Wall Street is a good place to be within days of a brokerage firm claiming bankruptcy to the tune of 41 billion, where some investors will most likely to lose their life savings. Good news though, apparently only $600 million is still missing and not the $950 million as first thought. The mastermind, a former Goldman Sachs employee and politician, will likely walk away a very rich man.

 

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Depends on what you mean by "Wall Street". So you mean investment banks who physically reside there? I might agree with you. Do you mean all financial institutions? I would disagree. Do you mean all equity instruments in the US, (or world)? I would heartily disagree with that statement.

You may have a difference of opinion. That is fine, that is why they have chat forums.

Do I think equities are the only place to invest? No, but I think most portfolios should have exposure to them, as well as real estate, PM, and fixed rate instruments. I am not smart enough to know what the next superior performing investment will be, so I cheat and simply have exposure to all areas.

Chris

 

I don't follow Silver so I can't speak to that, except that it generally follows the same trend as Gold. There have been predictions for the past three years that Gold would reach $2000 by the "end of the year". Based on that, Silver should reach $50 too.

 

It's not a question of the stocks themselves being worthless but the example brought up about MF Global you were referring to proves yet again, that proper regulation of the financial system has completely disappeared and the people running it have put themselves in front of their customers and everyone else. Suppose you had worked for 30 years, had a 401K that was being serviced by this company and that money is now gone and the CEO gets a $12M bonus when he walks away from this mess?

This was a 200 year old firm, a primary dealer for the Federal Reserve (only 21 in the entire world) being run by the former governor of NJ. You don't get a better reputation than that, yet here we are. They are bankrupt and customer money is gone. This story keeps getting repeated time after time and these guys seem to have immunity to any prosecution. Where is Eric Holder? Where is the SEC? Where is anyone that is being paid tax money to police the system? So my question, is that given this, why would you turn your money over to these people? If you buy stocks in the USA, it goes through wall street, you have no choice. You have direct corruption such at the situation at MF Global, but you have it too in the way the monetary system has been gamed up for just one purpose and that is to take money from people to keep stocks artificially high.

The stock market that I think you are thinking of, doesn't exist now. It's been proven time after time since 2008. Oh and interestingly, in the bankruptcy papers, MF Global was found to owe CNBC close to a million dollars. i.e. They were huge customers of NBC.

 

The majority of people with 401k money will be okay because the accounts are insured up to $500,000 in cash and securities, $250,000 of which may be cash.

The CEO does not get the bonus because the company was not sold before it failed.

The DJIA was as low as 7,449 in 2008, so there have been plenty of opportunities to make money. Even the folks who did nothing except rebalance their asset allocations on a quarterly or semi-annual basis came out ahead from the fluctuations. Of course, as always, those who put money in and forget about it and expect to get rich by doing nothing will be disappointed and you are correct that they should stay out of the market.

 

The problem with this is the applicability of the situation.

If silver drops below $14/oz, it will likely fall all the way to $5 or so per ounce and linger there for several years. This is related to technical buying and miners protecting their interests.

Basically, it costs a miner X dollars to pull silver out of the earth. To stabilize production profits, they will contract out sales three to five years at a time. If silver starts to breakdown (say a drop below $25 per ounce), the miners will start to buy back contracts at a discount.

Here's an example:

Miner A enters into a agreements to produce 20mm ounces of silver at $8 per ounce net ($32 sale price and $24 in fixed production costs). Miner A has excess potential capacity of 18mm ounces per year. 38mm ounces total.

Miner B chooses to test the market and holds no contracts on sales. Miner B's current production costs are $25 per ounce, but the firm is able to participate in current market prices. Miner B has production capacity of 11mm ounces per year.

Miner C is a bi-product producer, so their production costs are actually negative (the industrial metals extracted along with silver sell for more than the total costs of production). Miner C is able to sell silver at virtually any price above $14 per ounce. Market prices above this point are economically profitable for the firm. Miner C's viability as a firm is based upon sustained production of bi-production rather than silver itself. As such, contracts are connected to both base metals and silver. Currently, the contracted price of silver is $29, but includes a stipulation to purchase $7 of industrial metals per unit of silver sold. Miner C has production capacity of 14mm ounces per year, 8mm of which has been accounted for by the contracted model.

Currently, the market dictates a price of $34 per ounce of silver.

Let's assume silver price drops to $25.50 per ounce (25% drop):
Miner A has determined that $24+ is the minimal price that is necessary to remain profitable assuming current production. However, Miner A, like all corporations, has a goal of sustained profitability. This means that money must be spent toward development of new mines and geologists must be paid to survey potential mines. It has been determined by Miner A's analysts that with current market conditions, it will cost at least $27 per ounce to start production in a new mine. As such, a decision is made to cut production by ~32.5% to 26mm ounces per year.

Miner B, due to their business model, must sell at a 50-cent profit, since production costs are fixed. That means that they'll continue to make 11mm ounces available to the marketplace.

Miner C encounters a drop in industrial metal prices, which forces up their "break-even" price to $29 per ounce. As such, Miner C cuts net production (production in excess of contracts) to 0.

At $25.50, silver production available to the marketplace is now 17mm ounces. This is down from 35mm ounces at $34.

If the price drops below $25 per ounce, Miner B closes operations, which removes 11mm ounces from the marketplace. Also, Miner A will start to purchase silver on the open market, as it's cheaper than producing the metal themselves.

This isn't an exact calculation, but the three models are representative of the main types of companies (large exploration, micro exploration, bi-production miner), and should explain why a drop in silver below $17 or so would precipitate a collapse of the market for the metal. Again, if silver breaches $17, there will be no speculators to drive the price back up.

 

BTW, the above explanation also shows why silver won't appreciate above $50 for a while. We need to have "peak silver" to see that happen. Silver needs to be profitable enough for miners to invest $40+ per ounce at a sustainable price. Given that the market for silver gets crushed whenever margin stipulations are changed, the demand is inherently artificial. In order to achieve $50+ silver in our current market situation, you need to see a game changer in consumption for the metal.

 

Very nice analysis. I think that in addition to the game changer in consumption, there could be a game changer in supply that is currently off the radar. For example, a lot of the current world supply is in ETFs like SLV, but when these vehicles are shorted, you end up in a situation where two people think they own the same ounce. Now this can go on for a very long time, but there are also situations where it could lead to a sudden sharp rise in price.

 

When anything is shorted, it has to be borrowed from someone else. So, in the case of SLV, this would be the result:

Person A owns 100 shares of SLV. (100 ounces of silver held in trust.)

Person B shorts 100 shares of SLV. Person B's broker must borrow 100 shares from their holding or from a third party. We'll assume it's from a third party.

Person C is long 100 shares of SLV, but allows person B to borrow their shares.

There are 200 shares of SLV accounted for above. It just so happens that 100 of those shares are "spoken for" in the short transaction. This is why shorts must be placed on margin. You are paying the owner of the shares a form of interest for agreeing to no liquidate their position until you close your short.

The 200 shares still represent 200 ounces of silver in SLV. The perception in the public could be that two (or more) individuals lay claim to the same ounce of silver, but that simply isn't the case.

 

I don't think your analysis is complete. Person B borrows and sells the shares. So in addition to Person A and Person C who own 200 shares representing 200 ounces, there is another Person D who bought Person B's shorted shares and thinks they also own silver. So there are 300 shares sitting in various brokerage accounts on the long side, but only 200 ounces of silver. If the three people had to buy physical silver, the price would move up [theoretically] compared to the situation where they buy SLV when someone else is permitted to short it.

 

Doesn't the same mechanations work in reverse so that on the long side there could be a market dump? I agree on a short squeeze prices could move up until the contracts are settled, but I just want to point out the opposite is also very possible. Ying Yang, just want to balance to overall topic.

 

There are 300 shares sitting long and 100 shares sitting short. The net is still 200 shares long.

Think of it in terms of the actual transaction sequence.

Short seller decides they don't like a company, assuming that the price will be lower in the future. They decide to borrow some shares to sell.

Short holder is comfortable with the company, so they are willing to lend their shares to the short seller. The holder is then paid a portion of the margin fees collected from the seller.

So, the transaction sequence is:

In the past Holder bought 100 shares.

Holder has 100 shares.
Seller has 0 shares.

Seller borrows 100 shares.
Holder lends 100 shares.

Net result:

Seller has 100 shares.
Holder has 0 shares.

Seller now sells the 100 shares to a third-party, the long buyer.

Sellers sells 100 shares.
Buyer buys 100 shares.

Result:

Holder has 0 shares.
Seller has 0 shares.
Buyer has 100 shares.

The idea of a short squeeze has nothing to do with two individuals thinking they own the same 100 shares. It is rather a result of the short seller having an obligation to return the 100 shares to the holder. So long as the seller is willing to allocate cash to cover the "repurchase" of the shares, they can continue to borrow the shares.

So, in your scenario, there are only 200 ounces of silver being held long: Person A has 100 shares and Person D has 100 shares. Person C, does not possess any shares. Rather, they own an obligation from Person B to deliver 100 shares.

There would never be a scenario under which Person C is unaware of their shares being lent. That is why you have to agree to allow the brokerage holding your shares in trust to lend them.

Short squeezes are simply a matter of "who's holding the bag?" after a short-term run-up in prices. Short squeezes in SLV would not be enough to drive the underlying metal above the margin squeeze created by the regulators.

To be honest, if they really wanted to get speculators to stop being long on metals, the market makers should lower the margin costs related to the short end of the ledger, rather than increasing costs related to the long end. This would be similar to how sport-books determine the odds/line on games.

 

On a net basis, everything is okay. But the point I was trying to make is that 200 ounces of physical silver were able to satisfy a 300 ounce demand for silver. The three longs don't necessarily even know that the short exists. So each thinks he has made an investment backed in full by physical silver. The opportunity for playing paper games is endless. For example, the short could take the proceeds from the short sale and use in the futures market.

 

I'm fairly certain (but can't recall why) that isn't possible anymore. I believe commodities ETFs are still governed by futures requirements. Even if they're not legally treated that way by exchanges, most retail investors would be subject to restrictions by their brokerage. For the most part, this would prevent such transactions.

Edit: Also, the scenario is still false. The brokerage would know that the net demand is 200, so the "extra" 100 would be accounted for via the brokerage's holdings. They would be net 0 with rental being paid against their long position.

The problem with your explanation is that you're assuming the holder lending the shares isn't aware that their shares are being lent. The only reason that case exists in the real world is because the brokerage is taking the liability of the shares against their long positions. The actual shorting mechanism requires that shares be available for lending. The moment that a share has been lent for a short, it is no longer a "long" holding of the lender. The "long" is actual a debenture, not the physical holding itself.

 

You're still missing the point. I'm not arguing the mechanics of shorting, which am aware of. I'm arguing supply and demand for silver. Using your example, Persons A, B and D all purchased shares in the expectation that they making an investment in silver. Even if A and D did not have margin accounts that permitted their shares to be lent, the fact that Person B did, and Person C took him up on the offer means that there are 300 long postions for 200 ounces. Presumable Person B originally bought SLV because he wanted exposure to silver -- not because he wanted to give the brokerage company the ability to earn another income stream, and the shorting of SLV permitted this demand to be fulfilled without requiring any silver. If SLV didn't exist, Persons A, B and D would have had to purchase 300 ounces. By using SLV, they only purchased 200. Barrons reports 20 million shares of SLV sold short, so I believe it is permitted. http://quotes.barrons.com/slv

 

I wasn't saying that you couldn't short SLV. I was saying you can't short it then use the proceeds in the futures market for silver. The reason being, my understanding is that the futures market for precious metals has been effectively eradicated, per HR 4173.

FWIW, SLV isn't an ideal tracker of silver anyway.

The inception basket was 50,000 units at NAV. The current NAV represents 48,652.200 units. That means 1,347.80 units were lost since inception due to transaction costs, balance related costs and expenses.

So, 6.25% of the shares outstanding are short. That doesn't seem unreasonable, given the 110/10 long/short method being utilized by most firms for the last six or seven years.

Anyway, back to the point:

In the example, holder (person B) placed the shares up as collateral in their margin account. In return, the brokerage gave an equivalent amount in cash to leverage their position. Think of this as a line of credit. The moment that the line is accessed, the brokerage is entitled to lend the shares as they see fit. This is your margin agreement.

As such, in the example, Person B is well aware that their shares can be lent. This is why brokerages are supposed to give different 1099s for dividends received on shares lent.

 

And I don't think that changes the fact that Person B bought shares of SLV because he wanted exposure to silver. So 3 investors bought 300 shares representing 300 [for illustrative purposes] ounces of silver, but it only took 200 ounces to satisfy the demand.

 

You can't transact precious metals without the physical commodity necessary to fulfill the demand. That was the entire point of HR 4173.

If you're going to say 200 ounces satisfied 300 ounces of consumption demand, you're also saying that 0 ounces satisfied 100 ounces of selling demand. The net balance is still 200 ounces/shares, regardless of how you personally choose to look at it.

This isn't an issue of viewpoint. This is the ledger breakdown:

Initial Transaction:
Debit SLV 200 ounces
Credit Person A 100 ounces
Credit Person B 100 ounces

Margin Lending Transaction:
Debit Person B 100 ounces
Credit Person C 100 ounces
Credit Person B cash equivalent loan of 100 ounces
Debit Person C cash equivalent loan against 100 ounces

Short Transaction:
Debit Person C 100 ounces
Credit Person D 100 ounces

Net Transaction:

Debit SLV 200 ounces
Credit Person A 100 ounces
Credit Person B Margin loan equivalency of 100 ounces
Debit Person C Margin loan equivalency of 100 ounces
Credit Person D 100 ounces

It's not that 200 ounces supplied 300 ounces of demand. I don't know how else to explain this. It doesn't matter if Person B interprets their holding as 100 ounces or not, the reality is that they don't hold 100 ounces. They hold terms to receive 100 ounces once they repay their loan. If no one loans the 100 shares, the short never can occur. It's really that simple. You can respond, but at this point, I'm dropping the issue. I don't know of any other ways that I can explain this to be clear.

 

We'll agree to disagree. I don't know how to make it any clearer that every purchaser of SLV believes they are investing in silver, but the longs outnumber the ounces.

 

I haven't checked the price of silver each day but I think you missed this "guess" by a few dollars. Oops, better luck next time.