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Exposing Silver Mythology, Part I

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Advanced economic analysis involves high-level mathematics at least as complex as the realms of physics or engineering, accompanied by equally convoluted jargon. As a result, it is virtually incomprehensible to the ordinary person.

Conversely, the basic principles of economics are very straightforward. Indeed they could be summarized as little more than a combination of common sense and simple arithmetic. As a result, fundamental economic analysis is highly accessible to the ordinary person – because of its relative simplicity.

What then are we to make of the fact that the self-described (mainstream) “experts” on the silver market; the quasi-official sources for data on the silver market; and the primary regulator of the silver market all regularly and consistently demonstrate complete ignorance of even the most elementary of economic principles? Are we to attribute this to gross incompetence, inherent bias, or an intentional attempt to deceive?

I will leave it up to readers to reach their own conclusions. This piece will simply lay out the positions of these individuals and entities (past and present), lay out what little reliable data is available to us; and then apply the simple, common sense principles of economics to this data. It will focus on the three most basic aspects of any market: supply, demand, and inventories.

First, however, I will refer readers to some previous, elementary economic analysis. As I established with simple numbers (and logic), in any market shorting always “consumes” while investing always “conserves”. In other words, in any market which is dominated by shorting we will see a substantial increase in consumption, and (over time) a radical decline in inventories/stockpiles. On the other hand, in any market dominated by investors (who are invariably mis-labeled as “speculators”), we will see consumption decline and inventories swell – due to the rising prices generated by increased investor-buying.

Meanwhile, the entities/individuals mentioned previously do not merely regularly engage in analysis which is wildly erroneous, but in many cases is totally perverse. It is with respect to this last point where it becomes more difficult to ascribe this behavior to mere incompetence and rather more likely that there is some degree of malice involved.

In order to show how the inaccuracy of this analysis is not only extreme but consistent, I will refer primarily to the most up-to-date opinions on the silver market today; along with an “open letter” from the CFTC from 2004, and the GFMS “World Silver Survey 2003” – which primarily covers developments in the silver market during 2002, one decade ago.

Readers must first understand that there are two ways of characterizing “supply and demand”. It can be described as current orders versus total stocks, or it can be described in terms of production versus consumption. It is the latter definition which is exclusively taught in our educational institutions, and for a very good reason: it is only by examining supply and demand in terms of production versus consumption where we can obtain any useful information about the future direction of any market.

Conversely, the mainstream “experts”, the CFTC, and the quasi-official record-keepers for the silver market never use the latter definition. Instead, they always use the much less useful former characterization – and then reach one absurd conclusion after another through relying upon this inherently flawed data.

Why is production versus consumption the only valid basis for analyzing supply and demand? Obviously the entire purpose of analyzing any market is to determine whether it is in balance, or whether it is out of balance – either through over-supply or excess demand (in order to correctly price the market). Examining production versus consumption data instantly provides us with the answer to that question.

Noted silver researcher Ted Butler has concluded that the silver market has been out of balance (in the form of excess demand) for more than fifty years, with total global stockpiles of silver declining by well in excess of 80% over that period. More recently, data supplied by the other quasi-official source of data for the silver market (the CME Group) shows that silver inventories plummeted by approximately 90% just from 1990 through 2005 – during which time the price of silver fell to a 600-year low (in real dollars).

Simply, every year (for as far back as reliable data exists) production (i.e. mine supply) has been exceeded by demand, and generally by a huge margin. It is the most elementary principle of markets (and arithmetic) that no market can remain out of balance forever, and in particular any market experiencing excess demand must reverse itself (at the very latest) when inventories reach zero.

Irrespective of whether we are referring to excess supply or excess demand, there is only one market mechanism which can ever correct imbalances: price. Where there is excess demand, prices must rise long enough and high enough to cool demand and stimulate supply until (at the very least) balance is restored. Where there is excess supply, the reverse must take place.

By definition, every year, decade after decade, silver prices have been “too low” because every year excess demand (and a supply-deficit) remains in this market. This utterly unequivocal pattern means that silver prices have been artificially too low year-after-year, decade-after-decade since such extreme and relentless destruction of inventories and stockpiles, over a very, very long time horizon cannot plausibly be considered a “natural occurrence”.

Yet this is what GFMS had to say about the silver market of 2002, with silver prices hovering near their 600-year low:

this mix of supply/demand factors means silver is unlikely to move substantially outside of its 2002 trading range.

GFMS reaches this conclusion despite immediately noting afterward that:

this annual average [price], however, remains low historically; excluding 2002, the last time the average price was lower than 2002’s was in 1993. [at the 600-year low]

We have a market which has perennially been seriously out of balance, and where that balance can only be restored by substantially higher prices. And yet with prices near the 600-year low, we have the quasi-official record-keeper for the sector saying that prices are just fine.

Incompetence? Bias? Deliberate deception?

Further discrediting GFMS, in that same report it notes that:

...it appears silver output will fall again in 2003 as base metals producers are forecast to further scale back their operations and little new additional capacity is scheduled to come on stream.

With silver mining already extremely depressed by the 600-year low in price, with inventories already having plummeted by more than 75% over the preceding 12 years, and with GFMS itself predicting that production will fall (again) in the upcoming year, it still concludes that prices are just fine. This is not “economic analysis”, it’s “creative writing” (i.e. fiction).

There is only one source of “new silver” in the entire world: mine production. Any/every other ounce of silver which comes onto the market represents a draw-down of inventories/stockpiles. By definition, this is absolutely unsustainable as inventories are finite and (obviously) can never go below zero.


As we see in the chart above, every year production (i.e. mine supply) has been exceeded by consumption, with the supply-deficit exceeding mine production by greater than 35% every year, and generally by well over 40%. This can never be more than partially offset by “recycling”, as unlike the gold market, every year hundreds of millions of ounces of silver are literally “consumed” – used in industrial applications, but not recycled. In other words, this is not a market which is merely “slightly” out of balance, but rather one which has been in extreme imbalance every year – with that supply-deficit made up out of plummeting inventories.

Yet here we have the other quasi-official record-keeper for the sector (the CPM Group) claiming that since 2005 silver inventories have not only reversed themselves, but have roughly quadrupled over that period of time. How does the CPM Group reach a conclusion which is 100% contradicted by the data of its bookend, GFMS? The chart below provides the answer, when it notes that “inventories include silver backed exchange traded funds”.

These funds represent out-flows of silver. When I go to a silver dealer to buy an ounce of silver, every ounce I purchase decreases inventories by one ounce. Yet in the fantasy-world in which the CPM Group dwells, when someone purchases an ounce of SLV (a privately-owned fund) inventories somehow increase.

This is utterly perverse. There are only two scenarios in which the data presented in the chart above could be transformed into something rational:

1) SLV unit-holders are digging their own silver out of the ground (and refining it).

2) Each ounce of silver which SLV unit-holders purchase, and which is purportedly being held for them by that kind and benevolent Oligarch, JP Morgan, is in fact sitting in JP Morgan’s vault with a “for sale” sign attached – available to anyone willing to ante-up the current spot-price of $30/oz.

We know that SLV-holders are not digging/refining their own silver. So unless we conclude that JP Morgan is simply pretending to hold silver for those unit-holders (and is actually, secretly selling it off), we have the CPM Group portraying out-flows as in-flows.

Incompetence? Bias? Deliberate deception?

Amazingly, the apparent inability to correctly understand and apply even the simplest principles of economics (and markets) extends to the regulatory body which presumes to possess the expertise to adjudicate in these market: the CFTC.

In Part II, readers will get a large dose of déjà vu: a detailed examination of how the CFTC viewed the silver market back in 2004, and the extraordinary conclusions which it reached at that time.

 

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Comments (11)Add Comment
Jeff Nielson
...
written by Jeff Nielson, January 25, 2012
Thanks again for the support, Apberusdisvet!

Yes, you are quite right that are "issues" worth raising with respect to the Silver Institute (or the World Gold Council on the gold side). I'm not going to touch that in this particular series, for one specific reason.

While we might not be "fans" of the Silver Institute, we must remember that this is AN INDUSTRY TRADE GROUP. As such, it has no "duties" with respect to either objectivity or even HONESTY.

Conversely, with respect to GFMS and the CPM Group (the record-keepers), the CFTC (the regulator), and the media (the reporters) there ARE "duties" (legal or otherwise) for these entities to be honest/objective.

The lack of objectivity of these entities is utterly beyond question, while readers must draw their OWN conclusions when it comes to the subject of HONESTY.
apberusdisvet
...
written by apberusdisvet, January 25, 2012
Thanks Jeff for exposing the quite palpable progaganda and purposeful disinformation out there on silver supply/demand. I hope that in your Part II you will explore the true agenda of the Silver Institute that can be determined just by examining its Board of Directors. Almost every paid troll on financial sites that claim that supply will always exceed demand, cites this fraud entity.
HonestAbe
...
written by HonestAbe, January 24, 2012
I took Calculus courses in 1990-1991 in the Engineering field and I will agree that the complexity and difficulty level was extremely challenging and the failure rate was also high, in the range of 40-50%. They did not introduce Calculus in high school in my district back then. However, I will state that there are varying levels of difficulty in offering Calculus. I later reviewed supposedly the equivalent Calculus course that a friend took in a general Science field and the homework, mid-terms, and final exams only had questions bordering on a basic level of challenge, whereas the same equivalent course in Engineering was at least triple the level in difficulty and complexity. So I can see how they can now offer introductory Calculus at the high school level if you can "dumb it down" so significantly in a first year university level course between Science and Engineering fields.
0
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written by Mathdaddy, January 23, 2012
As a high school calculus teacher for the last 20 years, I would agree that advanced economics may not be as rigorous as the physics and engineering, but in a world that lacks a true economic education much less the basic principles involved; economics is a difficult cultural concept.

The difficulty in understanding sound economics , IMHO, stems from liberating minds from the fiat system that holds us hostage; they need to be open to alternatives. I had a student look at me in AP Calculus with the most curious expression after I told them, " I no longer trust my bank to protect my wealth."
Jeff Nielson
...
written by Jeff Nielson, January 23, 2012
Citizen Doctor, referring to calculus as "high school mathematics" is absurd. In fact, not only is calculus obviously UNIVERSITY subject matter, but even at that level universities have been "dumbing down" their calculus courses for decades - because of the sky-high failure rates.

At the time I studied second-year calculus (BEFORE much of this dumbing down), only 1/3 of students PASSED THE FIRST TIME - and the ONLY people who ever enroll in second-year calculus are math majors, economics majors, physics majors, and engineering majors.

It was my CALCULUS PROFESSOR who told me that economics ranked at least equal to those other fields in terms of the complexity of its mathematics - and since he does NOT have your own academic biases, I'll choose to trust his opinion on this subject.
Norbull
...
written by Norbull, January 23, 2012
Citizen Doctor, as a Professional Engineer I know where you are coming from, but don't miss the excellent economics lessons offered here because you feel Jeff has overstated the complexity of the black art of higher economics!
Regretably it is the decisions of politicians and economists that ultimately decide whether major engineering gets funded so engineers really need to improve their knowledge in this field.
0
...
written by Citizen Doctor, January 23, 2012
Citizen Doctor, you shouldn't comment on things you know NOTHING about.


That was my point, exactly.

When I studied calculus, I took TWO years of calculus - rather than the only 1 year required.

And even then I found regression analysis to be EXTRAORDINARILY complex.


Calculus is a high school subject. It is a bare minimum entry level requirement for the lowest-level introductory course for both Engineering and Physics majors. Regression analysis and even the Black-Scholes option pricing formula, which won a Nobel Prize in Economics, are comparable to routine undergraduate engineering and physics but are quite basic compared to more advanced levels of those subjects.

You are claiming that advanced economic analysis is at least as complex as engineering and physics. This statement undermines your credibility. Your retort that I know nothing about these subjects further undermines your credibility. I have a doctorate in physics, and have taught engineering at the university level. About half of my students over the years who found engineering too difficult during their first year or two changed their majors to Business Administration or Economics because they found it easy by comparison.
Jeff Nielson
...
written by Jeff Nielson, January 23, 2012
Quick question with regards to the world silver supply/demand chart - I noticed there was 61K of supply as a silver producer's hedge in 2010....does this mean that there was actually 796,000 ounces produced? The hedge of 61K ounces is clearly added to supply.

Seems like quite a jump in production from 09-10....especially if you consider the "dehedge" in 09....would that mean they are stating that producers pulled an extra 100K ounces out of the ground? Seems like a big increase.


Narmore4141, I have to confess to not knowing how they "account" for these hedges. Most likely this is a NEW producer forced to do some hedging as part of their financing to go to production, OR a base metals producer "hedging" their silver byproducts.

With forward selling like this, they may ACCOUNT for the hedge in the current year, even though that forward selling COULD be spread over a significant period of time.
Jeff Nielson
...
written by Jeff Nielson, January 23, 2012
Citizen Doctor, you shouldn't comment on things you know NOTHING about. When I studied calculus, I took TWO years of calculus - rather than the only 1 year required.

And even then I found regression analysis to be EXTRAORDINARILY complex.
0
...
written by narmore4141, January 23, 2012
Great article! Quick question with regards to the world silver supply/demand chart - I noticed there was 61K of supply as a silver producer's hedge in 2010....does this mean that there was actually 796,000 ounces produced? The hedge of 61K ounces is clearly added to supply.

Seems like quite a jump in production from 09-10....especially if you consider the "dehedge" in 09....would that mean they are stating that producers pulled an extra 100K ounces out of the ground? Seems like a big increase.
0
...
written by Citizen Doctor, January 23, 2012
Advanced economic analysis involves high-level mathematics at least as complex as the realms of physics or engineering...


No way. Not even close.

Incompetence? Bias? Deliberate deception?


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