By Using False and Incomplete Information, You Will Make Bad Decisions About Gold and Silver

Back in January 1980, when the Hunt brothers pushed up the price of silver to $50, many politically well-connected Wall Street firms were facing massive losses.  Suddenly, the COMEX changed the rules for trading specifically to punish the Hunts and help these Wall Street firms recoup some of their losses.

Among the most outrageous rule changes was a prohibition against new purchases of long silver contracts on the COMEX.  Parties who already owned long silver contracts were restricted to only one option—to sell it to a party holding a short position.  Prices quickly collapsed.

When the December 2010 and March 2011 COMEX silver contracts matured, the available COMEX registered inventories were hopelessly inadequate to meet delivery commitments.  So, as COMEX rules permit, unusually large numbers of these contracts were settled for cash.  There were multiple reports of March contracts being settled for cash at prices more than 30% above the spot price.

As I wrote in CoinUpdate.com last week, there is also a developing shortage of available physical silver outside of the COMEX.  The condition has only worsened in the days since.

On Friday last week, another squeeze was developing with the maturing May silver contracts.  Gold looked poised to jump to $1,600 and silver to surpass $50.  Neither made it.  In fact, silver has dropped nearly 30% from its peak in April and gold is down about 6%.

It looked to me that the Wall Street firms that have huge short positions in gold and silver were on the brink of default on these contracts, if not outright bankruptcy.  So, it is not a total surprise to me that there have been numerous rule changes in the past two weeks by the COMEX and some trading houses to force down the silver price (in particular) and gold.

Many people make investments borrowing money to leverage their results.  As prices rise, it is sensible for the exchanges to raise margin requirements.  However, the COMEX has now raised margin requirements for silver contracts five times over a two week period!  Before these hikes, the minimum margin per contract was $8,700.  On May 9, when the fifth increase takes effect, it will take more than $21,000 minimum per contract!  Note that the last four margin requirement hikes occurred after the price of silver was falling—which does not make sense unless the real purpose is to suppress prices!

Some Wall Street firms have raised the margin requirements for their own customers to as high as $30,000 (see my May 3 column at Numismaster.com for details).

The net effect of these rule changes is that it has left many leveraged investors unable to meet these margin calls.  As a result, a significant number of long contracts have been liquidated this week without regard to the price.

In addition, the mainstream media has given more coverage to the silver market this week than it seems like they have given it over the past few years.  Virtually all of this coverage is along the lines that there are major sellers out there, everyone is taking profits, the “bubble prices” of gold and silver have peaked, and the like.

Each of these themes is filled with incomplete or inaccurate information.  If you refer only to these stories, you will run a high risk of making an incorrect decision about whether to buy, hold, or sell gold and silver.

For instance, one of the stories is that Carlos Slim, the current richest man in the world, has presold more future gold and silver production from the mines that he owns.  I have not seen one story reminding people that Slim’s companies last October reported that they had pre-sold 27% of anticipated gold production through the end of 2013 at an average price of $1,189 per ounce and 43% of expected silver production through the end of 2013 at an average price of $18.71 per ounce.  Although Slim is apparently savvy enough to own such mining interests, he is obviously getting bad advice or making poor decisions on how to maximize his profits in these markets.

Much has been made of George Soros reporting that he has sold a significant chunk of his gold holdings, while little has been reported that John Paulson’s much larger holdings are being held until gold reaches $4,000 per ounce.  Among my own customers, there are those who have sold seven figures worth of paper silver contracts above $49 per ounce on the anticipation that they would be able to replace them with physical silver at lower prices.  These customers of ours expect gold and silver prices to be much higher than they reached in April.  They were not getting out of the market, they were just trying to maximize profits.

As for the claims that the “bubble” has burst, the quantity of open COMEX contracts in the gold and silver markets proves that to be false.  When a bubble market starts to tumble, the quantity of open contracts drops sharply.  The number of COMEX gold and silver contracts has only dipped slightly.

As prices started to fall, some unleveraged owners also opted to take some profits and reduce their holdings or get out of the gold and silver markets.  Because of the heightened volatility, other potential buyers have chosen to do nothing for the time being.  Although these actions helped push prices down further, the main force behind falling prices was the COMEX and Wall Street firms’ increases in margin requirements.

As you might imagine, I have been deluged with visitors, callers, and emails this week asking me what is happening and what will happen in the future.

I do not know where the current bottom will be for silver, but I do expect it to reach bottom soon.  One theory is that the silver market has touched bottoms in recent years when the amount of leverage in commodity contracts is only 7 or 8 to 1.  If this holds, that would point to $34 as being the bottom for silver.  Another theory is that the bottom will be reached when silver gets down to its 200-day moving average.  Right now, that points to a bottom of about $28.00.

I don’t think it is a matter of if, but when silver will recover.  When it does, it will recover quickly, though maybe not as fast as it has declined this week.  It is obvious that the US government, its trading partners, and allies have decided to try to cap the price at $50.  I have little doubt that this will eventually be surmounted—almost certainly this year.

Above all, remember that the fundamental reasons for owning gold and silver for protection against calamities affecting the value of paper assets such as currencies, stocks and bonds have not changed at all as a result of this week’s decline in prices.

Here are just some of the reasons why you should hold and consider adding to your precious metals position:

• The US government is still running such huge budget deficits that it now has to borrow 43 cents of every dollar it is spending!
• During all of this turmoil, the value of the US dollar has continued to decline almost every day except today!
• US Treasury debt is so unpopular among foreign and domestic investors at current low interest rates that the Federal Reserve is now purchasing 85% of all long-term issues!
• State and local governments (including public school districts) have not really done anything to cope with the more than $1 trillion in unfunded retirement liabilities.
• I have not seen the prices of any food products or gasoline drop by 30% this week!  In fact, worldwide food costs are rising at a faster pace this year than ever before!
• The US government is faced with an impossible resolution of its inflation of the money supply (also called Quantitative Easing 2) program that ends June 30.  The government has to make a decision which of two methods it will choose to further destroy the value of the US dollar—either by stopping quantitative easing or by continuing with a new program.
• The jobs market continues to be horrible.  As I understand it, the US needs to create 115,000 new jobs every month so that the rising population’s unemployment rate will be unchanged.  Even if the Bureau of Labor Statistics reports a higher number of jobs, you have to back out this figure and also the number of double-counted new jobs attributable to the birth/death adjustment.
• Residential housing prices have now declined lower than the so-called market bottom in March 2009.  In the latest report, 34.5% of homes sold were bank-owned properties, a much higher proportion than in the past.  Don’t be surprised of home prices continue to fall.

I could go on, but I think you get the picture.

If you make your decisions about what to do about gold and silver on the basis of accurate fundamental information rather than misleading and incomplete mainstream media reports, you will obtain better future results.  There have been numerous short term price drops over the past decade, none of which lasted.

What we are seeing this week, in my judgment, is actually more like a desperate last ditch effort to delay the inevitable explosion in gold and silver prices.  The extremity of these recent actions leads me to expect soaring prices sooner rather than later.

P.S.  One last tip—if you purchase physical metals and don’t leverage your purchases, you won’t find yourself forced out of the market against your will.

Patrick A. Heller owns Liberty Coin Service in Lansing, Michigan and writes "Liberty's Outlook," a monthly newsletter covering rare coins and precious metals. Past issues can be found online at http://www.libertycoinservice.com/ Pat Heller is also the gold market commentator for Numismatic News. Past columns online at http://numismaster.com/ under “News & Articles". His bimonthly columns on collectibles can also be read at http://www.lansingbusinessmonthly.com under “Articles” and “Department Columns.”His radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 AM Wednesday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com.

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