Even in a frozen metals price market, it only takes one event to shake off the paper manipulation keeping prices below what supply and demand fundamentals of a free market would dictate. And when that correction comes, it could happen quickly.
The Gold Report: You and David Smith recently wrote a piece titled "Gold and Silver: Heading for a Blue Screen of Death Event." You compared the gut-wrenching panic of suddenly facing a computer that stops working with a precious metals market that seems frozen, in the case of gold, in sub-$1,200/ounce ($1,200/oz) limbo.
But then you suggested that, like a Windows operating system, the metal could be rebooted on its way to once again hitting $1,900/oz. What would it take for something like that to occur? How do you hit Control-Alt-Delete on a commodity?
David Morgan: The retail silver market is very tight and getting tighter. India has historically imported a great deal of silver. As the country became more prosperous and started building its middle class, more gold started going there as well. On the supply side, low prices are detrimental to the recycling of silver so there is less recycling in the market. It has been reported that it is virtually impossible to get gold in size off of the London Bullion Market, yet the prices don't reflect that tightness.
TGR: What is keeping the prices down? What is causing the blue screen of death?
DM: That is tough to answer without treading on the conspiracy theory realm. I don't like to deal with conspiracy theory. I like to deal in conspiracy fact. The fact is that the futures markets allow massive amounts of paper contracts that represent silver and gold and, for that matter, other commodities such as wheat or corn, to be manufactured at will for speculative purposes.
That satisfies the demand without changing the real supply. Someone could buy what they think is a physical amount of metal through a major broker-dealer, but in reality only hold a claim on the underlying asset. This is fairly pervasive throughout the precious metals industry.
The Dutch bank ABN Amro had stored gold for clients for multiple years, and when the bank got into problems, the clients were informed that they would have to take a cash settlement for their gold. The Texas Teacher Retirement System has requested gold be delivered from the Federal Reserve to Texas. That's "in work" and could put more pressure on the paper gold problem if it doesn't materialize.
This problem has come to the fore several times, and yet it has not yet disrupted the market. However, I think that day of reckoning is closer because there is more of this going on and the premiums are so high. That is a direct indication that prices are not reflective of the true supply/demand fundamentals. However, to be fair, the premiums can come back to "normal" once the market quiets down.
TGR: Short of banks not being able to deliver precious metals, are there other black swans that could shake gold and silver prices out of their current state? We had the Chinese stock market flash crash, and gold and silver went up a little bit, but dropped back down again in a few days. The market is still focused on a possible federal Reserve interest rate hike by the end of the year. What could it take to reboot?
DM: Those things have an effect. Physical gold is the most negatively correlated asset to the stock market. That means that we should see an increase in the gold prices in a declining stock market environment. This has taken place at very minor levels so far.
We have seen in the past that small events people would have brushed off in years gone by can mysteriously rock the market if they develop momentum. Jim Rickards talks about the avalanche theory where it's that one additional snowflake that sends everything crashing down the hill. Naming that snowflake in advance is difficult, but we are poised for some kind of disruption.
TGR: When it happens, how quickly could it happen?
DM: These things happen fast. The problem builds and builds and builds, and then just a little bit more pushes the shift faster than you might be able to adjust your portfolio.
TGR: How much higher does silver need to be before the primary silver producers are doing more than just trading dollars?
DM: It varies from mine to mine, but I'd say somewhere around the $22/oz level would be beneficial to most primary silver producers because energy costs are so low currently. If energy costs increase then than number goes up, of course!
TGR: Because silver is often a byproduct, it will probably continue to be produced regardless of the price or the demand. Are there some companies with accidental silver exposure that are worth considering for someone who wants to get leverage on future higher silver prices?
DM: Big mining houses, like Rio Tinto Plc or BHP Billiton Ltd. mine a lot of silver, but they are not leveraged on silver prices. I've actually calculated the impact $100/oz silver would have on their annual statements and it is almost an insignificant difference. These are primary producers of lead, zinc, copper, tin and nickel. The silver component is so small, it doesn't really have much effect.
Some of the zinc properties have pretty good silver exposure. Trevali Mining Corp. is one of those, and we're very happy with that call. We were one of the first to call the upcoming zinc shortage because some massive mines are winding down at the end of their life. Trevali does have a pretty good silver exposure, so it is a win-win. That one has done pretty well for us.