interesting article on silver from a hedge fund newsletter
Posted: Mon Jul 11, 2011 4:46 pmHedge Fund report on their silver play:
Our average cost base was $17, and our average sale price was $46, generating a 170% profit.
We have explained for almost three years why we own precious metals and mining stocks, as protection
against inevitable money-printing. We bought silver a year after we started buying gold because we
came to believe it had a strong chance of outperforming gold. Its higher industrial use helps it more in
an economic recovery, but more importantly, the extraordinarily large short interest in silver futures
made it more susceptible to a price run-up when demand for precious metals rose. We were reading
stories almost daily about silver’s short interest and about the surrounding trading shenanigans in the
silver futures markets, which the CFTC has been investigating for over two years. For details, see this
New York Times piece.
Putting some numbers to the story: The total annual global supply of silver through mining and scrap
recycling is roughly 980 million ounces. Industrial and jeweler demand for silver is 660 million ounces.
That leaves 320 million ounces of supply for investment purposes. Yet by April over 1.1 billion ounces
worth of claims on silver were trading every day through futures, ETFs, and the physical bullion market.
Over 800 million ounces were trading on the Comex futures market alone. “Open interest” at the
Comex was averaging 1 billion ounces; at any one time, outstanding futures contracts required one
group of traders to buy 1 billion ounces of silver and another group to sell 1 billion ounces. Most of
these futures contracts are either closed out through trades before the delivery date or settled in cash.
But the contract holders can, if they choose, hold on and demand delivery of physical silver.
Meanwhile, the physical silver available for shorts to purchase to meet their potential delivery
obligations kept shrinking, as more and more buyers took delivery and took supply off the market. The
chart below shows the amount of silver sitting in Comex warehouses and registered as deliverable:
(I can't get the chart to paste here, but trust me, it is a straight line decline from 2009 to 2011 in Comex registered supply)
Buy
Sell 90%
Rebuy 20%
Page 4
Supply has fallen from 87 million ounces three years ago to 45 million in January and 27 million today –
less than 5% of Comex’s daily trading volume and 4% of open interest.
We did not touch our silver holdings even as we sold all of our gold last December and January, because
silver’s fundamental investment characteristics are as good as gold, and if even a tiny fraction of futures
holders demanded delivery in a given month, the short squeeze would be immense.
And so it was.
Our 15 months of profitable inaction and our well-timed sale were based on neither luck nor skillful
trading. We followed two simple rules that apply when any security makes a parabolic, straight-up
move, as silver did towards the end: First, don’t sell until it stops going up. Second, sell quickly as soon
as it starts falling, because you’ve likely just seen a blow-off top that will be followed by a rapid decline.
Our average cost base was $17, and our average sale price was $46, generating a 170% profit.
We have explained for almost three years why we own precious metals and mining stocks, as protection
against inevitable money-printing. We bought silver a year after we started buying gold because we
came to believe it had a strong chance of outperforming gold. Its higher industrial use helps it more in
an economic recovery, but more importantly, the extraordinarily large short interest in silver futures
made it more susceptible to a price run-up when demand for precious metals rose. We were reading
stories almost daily about silver’s short interest and about the surrounding trading shenanigans in the
silver futures markets, which the CFTC has been investigating for over two years. For details, see this
New York Times piece.
Putting some numbers to the story: The total annual global supply of silver through mining and scrap
recycling is roughly 980 million ounces. Industrial and jeweler demand for silver is 660 million ounces.
That leaves 320 million ounces of supply for investment purposes. Yet by April over 1.1 billion ounces
worth of claims on silver were trading every day through futures, ETFs, and the physical bullion market.
Over 800 million ounces were trading on the Comex futures market alone. “Open interest” at the
Comex was averaging 1 billion ounces; at any one time, outstanding futures contracts required one
group of traders to buy 1 billion ounces of silver and another group to sell 1 billion ounces. Most of
these futures contracts are either closed out through trades before the delivery date or settled in cash.
But the contract holders can, if they choose, hold on and demand delivery of physical silver.
Meanwhile, the physical silver available for shorts to purchase to meet their potential delivery
obligations kept shrinking, as more and more buyers took delivery and took supply off the market. The
chart below shows the amount of silver sitting in Comex warehouses and registered as deliverable:
(I can't get the chart to paste here, but trust me, it is a straight line decline from 2009 to 2011 in Comex registered supply)
Buy
Sell 90%
Rebuy 20%
Page 4
Supply has fallen from 87 million ounces three years ago to 45 million in January and 27 million today –
less than 5% of Comex’s daily trading volume and 4% of open interest.
We did not touch our silver holdings even as we sold all of our gold last December and January, because
silver’s fundamental investment characteristics are as good as gold, and if even a tiny fraction of futures
holders demanded delivery in a given month, the short squeeze would be immense.
And so it was.
Our 15 months of profitable inaction and our well-timed sale were based on neither luck nor skillful
trading. We followed two simple rules that apply when any security makes a parabolic, straight-up
move, as silver did towards the end: First, don’t sell until it stops going up. Second, sell quickly as soon
as it starts falling, because you’ve likely just seen a blow-off top that will be followed by a rapid decline.