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ARCHIVE: 2006

JANUARY 31 2007 12:30PM PDT - Silver and gold were up strongly today on a weaker dollar, stronger oil, rising geopolitical concerns, reports that Russia has been increasing its gold reserves, and good old fashioned buying. The silver ETF added 1 million ounces yesterday after dumping 3 million ounces last week. Both silver and gold are now within striking distance of breaking out of a trading range going back to last summer. Should they succeed, the momentum can certainly carry them for quite a bit, perhaps challenging the highs from this past May. On the other hand, the trading range could just as well reassert its control over the metals. For now, I sit tight.

JANUARY 30 2007 4:00PM PDT - Silver and gold up moderately as the dollar was mildly weaker and the energy complex got support from expected cold weather and OPEC production cuts.

I have given up on "free" statistical charts available on the Internet and have started my own charts of the COMEX warehouse stocks and London lease rates to be followed by other charts including ETF silver holdings, the basis, futures spread, etc. These charts are available by clicking on the small symbols next to each statistical figure in the Silver Alerts table on the home page.

Strategic Nevada vs. Sterling

Strategic Nevada Resources (SNS), the new owner of the Crescent mine in the Silver Valley of Idaho, received a glowing write-up by Bob Moriarty yesterday. In his piece, Mr. Moriarty compared Crescent management to Sterling, slamming the latter for ineffectual decision-making. Unfortunately, Mr. Moriarty is about 18 months too late in publicizing his candid assessment of Sterling. His timing is bad for other reasons too, being that SNS appears to be following in Sterling's early footsteps of mistakenly arousing high shareholder expectations only to have them bashed later as reality sets in. This could take some time for SNS as the full weight of reality has not yet hit Sterling shareholders after more than 3 years. Yet the value differential between the two companies has now become so lopsided in favor of Sterling that extreme speculators might consider taking an outright trading position in Sterling with a planned holding period of 3 to 6 months. I would base this speculation purely on property fundamentals as neither company has a man at the helm with exploration or mine development experience (well, actually Sterling's Ray De Motte now has over 3 years of experience but little good has that brought him so far).

Inflation?

In an article a couple of days ago titled Inflation, prices and economic growth, Paul van Eeden wrote the following:

In a hypothetical situation of monetary inflation with no change in the production of goods and services, prices would increase in direct proportion to the inflation rate: a 10% increase in the supply of money would cause a 10% increase in prices for all goods and services.

A little later, he also stated that:

The bottom line is that a 10% increase in money supply causes a 9% devaluation of your money.

I would like to provide some very basic caveats to these statements by Paul van Eeden in line with my recent discussions about the Fed, deflation and helicopter drops.

Goods and services are NOT the only items upon which a money supply can be "spent" and therefore the price of goods and services does NOT increase in direct proportion to the money supply. There are many keys to understanding this. I will discuss four of them below but these are only the tip of the iceberg.

First, the quantity of goods and services can increase solely because of productivity gains such that a growing supply of money will not necessarily result in higher prices. In fact, a growing supply of money will be necessary to keep prices from falling significantly. Falling prices are the functional equivalent of a rise in interest rates so they tend to curtail new business investment. As a result, monetary authorities try to prevent general price levels from falling. To consistently do so, they must target some rate of monetary inflation above zero. This is true even when deflationary depression is not a concern.

Few people seem to recognize that despite the technological advances of the industrial revolution, productivity gains occurred primarily during periods of positive monetary inflation. In turn, monetary inflation corresponded with the greatest increases in the general standard of living. People living in 1900 were materially not much better off than people living in 1800 or 1700. On the other hand, the average person living below the poverty line in 2000 had a higher standard of living on a historical basis compared to just about every one of his or her predecessors.

Monetary inflation was simply necessary to support a growing debt load which in turn was necessary to support a growing industrial infrastructure which could not be financed from internal profits. High technology in particular tends to be that way, often requiring a payback of many years or decades. I wouldn't be typing on this computer at the moment -- or any computer for that matter -- if it wasn't for monetary inflation.

I am not trying to justify the current debt spiral in the U.S. nor am I saying that monetary inflation is good. On the other hand, it is not inherently bad. Sure, over time you have to add extra digits to prices but if the world had a reason and the willpower to do so, there could be a systematic revaluation of all foreign currencies via a global drop of a digit or two. And I am decidedly not saying that a gold monetary standard is bad. What I am saying is that there needs to be an efficient system of expandable credit which encourages productivity gains and gold does not fit that bill.

Second, money can be, and is, spent on capital investments such as stocks, bonds, other paper assets, houses, etc. Prices of these assets can and do increase when there is more money chasing them so clearly some portion of an increase in money supply is not being spent on goods and services. What I am trying to say is that monetary inflation (and increase in the money supply) translates to price inflation for BOTH goods and services (CPI, PPI or some other measure) AND for capital investments. But since there is no way to accurately predict how each dollar added to the money supply will be spent, there can be no direct method for calculating price inflation for goods and services. This is why the government goes through a convoluted process of surveying consumers and producers.

So, is there any way to ballpark what portion of an increase in money supply is spent on goods and services vs. capital investment? Maybe, but in order to do so, we need to recognize that money supply can be represented in several ways. Traditional definitions of money supply start with the M0 monetary base (cash and currency) and then increase with M1 demand accounts, then with M2 time deposits and money market accounts, and finally with M3 (now unreported) large time deposits, eurodollars and repurchase agreements. Yet out of these components of money supply, only M0 and M1 are directly available for the actual purchase of goods and services with M2 and M3 increasingly distant from the transaction.

Were we to stop here, we might be led to believe that an increase in M1 (which includes M0) should result in a proportional increase in the price of goods and services. Well, we'd be closer to the truth than assuming the same about an increase in M2 or M3. But the fact is that currency exchange rates, the amount of imports and exports, labor and factory utilization rates and other factors have an important but largely unquantifiable effect on domestic prices. For example, the mobilization of underutilized labor in an exporting country with a low standard of living can result in a decrease in the price of some manufactured goods bound for an importing country even as its M1 money supply increases. Let's also not forget that checks can be written to buy stocks. Therefore, we must be careful to draw only general conclusions about changes in price levels resulting from an increase in transactional components of money supply.

A third key to understanding why monetary inflation is not the same as price inflation is that the world has changed in the past few decades. I am talking about universal access to credit: credit cards, home equity lines of credit, company credit facilities, aggressive point-of-sale financing, etc. This is a phenomenon which appeared in the U.S. only during the last 20 or 30 years but has played an increasingly important role as a source of transactional funds. It is just starting to make inroads in other countries. The old model of borrowing money from a bank, then depositing these borrowed funds in a demand account (M1), is largely irrelevant these days. Instead, transactional credits are directly accepted as payment in the modern point-of-sale environment. Usually, credit is more convenient than cash (M0) or check (M1) and sometimes it is even encouraged.

The effect of the increasing use of transactional credit is that consumer debt levels can grow as a direct result of the purchase of goods and services. This was not the case 30 years ago and therefore credit expansion may have become an important source of price inflation today as compared to when most economic theories on inflation where formulated and tested by fire. Simply put, the availability of transactional credit allows a higher level of demand, and therefore it results in higher prices, then would be the case without this credit.

Wait a second, not so fast! A transactional credit does in fact result in an increase in M1 money supply just like a traditional credit since the merchant who accepts a credit will end up with cash in his or her merchant bank account in a few days. Yet the important difference remains that the increase in money supply occurs BEFORE a cash transactions and AFTER a credit transaction. And why is this important? Because, as I stated above, we cannot determine how much of a general increase in money supply is spent on goods and services, but we can determine how much of an increase in consumption credit -- all of which represents an increase in money supply -- is spent on goods and services. In the latter case, it is close to 100%.

Yet some of this transactional credit boost to M1 -- in the bank account of a merchant -- is probably temporary as foreign trade imbalances tend to move transactional dollars into offshore reserves, some of which are later recycled back into various components of the money supply to the extent foreign central banks buy U.S. Treasury securities directly from domestic sources. A perfect example is Jim Bob using a Visa card at Wal-Mart to buy a product made in China. The net result is the Chinese owning Treasury securities, the repayment of which ultimately depends on whether or not the collective Jim Bobs of America pay their Visa card balances. Thus, the Chinese in this case have boosted demand for goods and services by fully subsidizing the purchase of their own product -- essentially providing in-house financing -- without an otherwise necessary change in the money supply.

Given the number of complex factors involved, it should be pretty obvious at this point that drawing a direct correlation between an increase in debt and price inflation is not possible but that it might be more accurate than drawing a direct correlation between the money supply and price inflation. But I still have one more point to explain.

A fourth key is recognizing that transactional credits has been fueled in part by the increase in stable monetary items in the form of some M2 and M3 components, namely time deposits and money market accounts. These components of the money supply, in turn, represent in part a net savings of real wealth held by what I will call net savers.

On the opposite end are net debtors who are actually the source of an increase in demand for goods and services caused by transactional credit -- an increase manifested in M1 at least over the short term. It makes no sense for a net debtor to have significant savings in the form of time deposits, money market and other accounts earning much less than the interest rate on credit cards and lines of credit. But there is a major exception: 401(k) and IRA tax deferred accounts. Money is funneled into these accounts even by net debtors since the incentive for doing so transcends the interest burden of debt. Namely, these accounts avoid the even greater burden of taxes. Thus, I will refer to net debtors with tax deferred accounts as "tax savers".

Net savers and tax savers -- excluding foreigners and financial intermediaries such as banks and true hedge funds -- are the primary holders of M2 and M3, and they are by definition risk averse to the capital markets since they would otherwise "spend" their money on capital investments. Now keep in mind that tax savers put most of their retirement funds into capital investments so it is only the smaller "cash" portion of their account that I am talking about. Still, this is a lot of money.

If you understand the above, you should be able to make the highly counterintuitive deduction that net savers and tax savers are actually contributing to spending on goods and services by placing their savings in banks and with other financial intermediaries. A good example of this is money market accounts which fund the extension of product financing by manufacturers. Without the money market accounts, product financing would not be as readily available and fewer purchases would be made.

So, how many net savers are out there and how much are they adding to the money supply? It is impossible to determine but, as traditionally calculated, savings is the difference between disposable income and consumption of goods and services. In recent years, the U.S economy has experienced rising consumption and stable disposable income. Therefore, economics tells us that savings must have fallen. I would presume net savers are not thriving in this environment.

On the other hand, there are legions of tax savers out there because the incentive to avoid taxes is greater than the incentive to avoid paying interest on debt. And since tax deferred accounts are a relatively new invention -- arriving on the scene like transactional credit less than 30 years ago -- they have had an impact on money supply which traditional studies of inflation and the experience of the 1970's simply cannot validate.

But here is the really important part. Both modern net savers and tax savers can easily move funds from cash to mutual funds and vice versa without using demand accounts (writing checks), something that was impossible a generation ago. These sentimental movements can now create major fluctuations in the availability of money supply -- without any apparent change in its size or composition -- to support spending on goods and services vs. capital investment. On the flip side, large changes in the money supply -- both up and down -- should be possible without a major fluctuation in the availability of money to support spending on goods and services vs. capital investment. Simply put, it takes increasingly more and more monetary inflation to be meaningful to price inflation. Or perhaps it would be more accurate to say that monetary inflation and price inflation are becoming less correlated.

Given the above, my personal suspicion is that the true rate of price inflation is not very different from the official CPI and PPI figures but that this only gives part of the inflation picture since there is no published figure for API (asset price index). If there was, we would likely see that API makes up some of the "shortfall" in CPI and PPI. In contrast, CPI and PPI were much higher during the 1970's, another period of rapidly advancing money supply, precisely because API was timid. Thus, gold flourished in the 1970's partly because it was a competitor to other asset classes at a time when the increasing money supply was going into the prices of goods and services and not investment capital.

Today, gold should not count on a lot of help from an increasing money supply if much of it is going offshore or into assets which are competitors to gold. Instead, gold should count on eventually becoming the ultimate stopgap to an eroding fiat whereby "full faith and credit" become meaningless because the central bank is willing to monetize all debts via helicopter drop. In such a scenario, only "true" money -- the monetary base -- would have any real value and that value would be measured by the amount of gold held in treasury. There would emerge a dual currency of sorts: (1) gold and the monetary base supported by gold and (2) a securitized currency backed by all credit dollars with the Fed acting as clearing agent. The former would be held by savers who sought protection from changing prices while the latter would be held by investors looking for income from changing prices. Thus, gold holders would become hedgers and credit holders would become speculators and all would be well with the world. That is to say, nothing would really change.

JANUARY 29 2007 12:00PM PDT - Silver and gold down in sympathy with the metal and energy complexes today despite a slight weakening of the dollar below 85 on the dollar index. Economic reports out this week should extend the see-saw action with a bullish bias for silver purely on technicals. Open interest in COMEX silver was up about 10,000 contracts over the prior week with a significant rise in commercial shorts. The commercial short position is nowhere near a record but the willingness to aggressively accommodate speculative longs is a bit troubling to bull fundamentals.

JANUARY 26 2007 3:00PM PDT - Moderate weakness in silver and gold today as the dollar punched through the 85 level. The metals continue to trade in a bullish mode although stiff chart resistance can be found directly above current levels. Commodities were also weak in general today although the energy complex was up.

Meanwhile, the basis and spread in silver futures recovered strongly yesterday following the past few days of the basis declining toward zero and spreads tightening somewhat. Tightening of spreads could mean that physical (fundamental) demand is outpacing speculative demand which is a good sign of a sustained rise in prices during a bull market (although spreads aren't very good at pinpointing the timing). As an example, the "observed" spread in the table above was mostly in negative territory around May of last year when silver was trading near $15 on the back of the silver ETF launch but this did not portend a sustained rise in price above the $15 level.

Rather, it probably meant that $7.50 silver (the level from which the rally had launched the previous fall) would probably not be revisited during the remainder of this bull market. In fact, one could make a pretty convincing argument that silver will not go much below $10 if ever again. In making such bullish predictions, we do need to keep in mind that silver's long-term uptrend is around $9 at the present and therefore the bull market would remain intact even if silver did trade for a while under $10 (but only a little while). Clive Maund in recent analyses has provided charts which show the long-term uptrend lines for gold and silver (see Gold Market Update and Up, Down or Sideways? - a Strategic Review). These are good charts to keep in mind.

Besides the above, are there uses for the futures spread in silver analysis other than to indicate a tightening of physical supply? Sure there is. For example, calendar spreads in futures can be a very profitable trading strategy if you learn how to use them properly, which requires studying the spreads themselves. These studies eventually lead to a deeper understanding of the various speculative and fundamental forces that drive silver prices. Even more powerful insights can be gained by combining the futures spreads with trading volume, open interest and commitment of traders data. In fact, I have been researching, paper (and sometimes real) trading and back testing various methodologies involving spreads and market data for a few years now and have uncovered what appear to be a few profitable setups.

JANUARY 25 2007 4:00PM PDT - Silver and gold retreated from an early rally but closed up for the day as the dollar recovered somewhat from a beating overseas. Metals in general were stronger today and silver in particular has been leading the charge. And even though the dollar sits just below the important 85 level on the dollar index, both gold and silver are significantly higher today than the last time the dollar vacillated around these levels in November. Clearly, silver and gold have detached somewhat from their dollar link, a development some believe is due to a flight to safety as geopolitical tensions are once again on the rise while others seem to think this is a result of renewed hedge fund speculation. Whatever the reason, none of my indicators have yet confirmed a fundamental basis for the move and therefore I am participating with suspicion.

Resource Stocks Popular?

Another report on the Vancouver show by Sean Brodrick of the Martin Weiss publishing empire confirms that attendance by both exhibitors and delegates was phenomenal and therefore interest in the resource markets continues to be high. This is important because investors are obviously looking for the next resource play and they appear to have additional funds to deploy into the markets. Meanwhile, the popularity of gold continues to grow as indicated by this commentary which has Google and Goldcorp sharing top spots among the recommendations of the best 100 amateur stock pickers over at www.marketocracy.com, a site similar to the Motley Fool Caps site where amateur investors recommend stocks as I discussed on December 7 of last year (see Archives).

My point was and is that popularity is a relative thing and there will be no easy way to determine the top of the bull market in silver and gold by simply looking at magazine covers or by listening to conversations at a cocktail party. By the way, I never did start tracking on a weekly basis the top gold and silver stock recommendations of the Fools but if anybody wants to know, it looks something like this today as compared to last December:

Number of Rated Silver Stocks: 6 today, 6 then

Total Rated Stocks: 3,588 today, 2,889 then

Most Rated Silver Stock: Silver Wheat (279) today, Silver Wheaton (293) then

Number of Ratings for Top Silver Stock: 242 today, 164 then

Most Rated Gold Stock: Goldcorp (135) today, Goldcorp (145) then

Number of Ratings for Top Gold Stock: 456 today, 300 then

Most Rated Stock: Apple (4,394 ratings) today, Microsoft (3,337)

And here are the key measures of popularity:

Rated Silver Stocks to Total Rated Stocks: 0.17% today, 0.21% then

Most Rated Silver Stock to Most Rated Stock: 5.5% today, 4.9% then

Rank of Most Rated Silver Stock: 279 today, 293 then

As a result of this somewhat tongue-in-cheek "analysis", it is clear to me that silver stocks have only marginally gained in popularity with the average investor since last December 7. Silver Wheaton continues to be the most popular silver stock out of the 6 stocks that are on amateur investor Fools' radar but there are still 278 non-silver stocks (among them only two gold stocks: Goldcorp and Northgate Minerals) which are more popular. Therefore, there should be little concern at this point that investors have an unhealthy obsession bordering on mania when it comes to resource stocks in general and silver stocks in particular.

Greenspan Admits to Gold Conspiracy?

I am going to go off on a tangent here to debunk a major fallacy among gold conspiracists which continues to rear its confused head. The latest telling appears in a KitcoCasey interview with Chris Powell of GATA in which a "famous" speech made by Greenspan in 1998 purports to be evidence of central bank manipulation of the gold price. Here is what Mr. Powell said:

GATA believes that the cover under which central banks have been acting has now been blown so totally that only the willfully ignorant can fail to see it. And they point to the public record to bolster their claim.

For instance, there were a few key words uttered by former Fed Chairman Alan Greenspan when he appeared before Congress in July of 1998. Greenspan was testifying as to why the Commodity Futures Trading Commission (CFTC) should not concern itself with regulation of derivatives traded in the over-the-counter market.

Greenspan argued that, “There is no reason to believe either equity swaps or credit derivatives can influence the price of the underlying assets any more than conventional securities trading does.”

One might think the chairman guilty of a surprising naïveté, or perhaps something a bit more sinister, but that’s a topic for another day. The relevance here is that gold, in addition to being a fundamental currency, is also a commodity, and as such the CFTC is responsible for oversight of its market.

Greenspan waved off the necessity for the CFTC to regulate gold derivatives, telling Congress to fear not, that the “central banks stand ready to lease gold in increasing quantities should the price rise.”

Oops. Bet he wishes he hadn’t let that slip. As Chris points out, “Greenspan was telling Congress that the purpose of gold leasing was not what the central banks had been telling the world—to earn a little money on a dead asset. The real purpose of gold leasing was to suppress the gold price. His remarks are still posted on the Federal Reserve’s Internet site.” [they are—we checked]

Now here is my reply.

The manner in which former Fed Chairman Greenspan's speech in 1998 -- the one in which he supposedly admits to central bank manipulation of gold -- became the "smoking gun" for the gold conspiracy camp is typical flawed logic. In the speech, Greenspan stated in part that "...central banks stand ready to lease gold in increasing quantities should the price rise".

Gold conspiracy advocates now simply quote this as "central banks stand ready to lease gold in increasing quantities should the price rise". But in the seemingly innocent act of truncating a sentence to its last few words, the theory-mongers have very effectively taken a concept out of context and corrupted its meaning for their own narrow purposes (to prove that central bank gold manipulation exists).

Taking the statements of an alleged participant or apologist of a conspiracy out of context and then turning the words around to make them seem like a slip of the tongue is a favorite tactic among conspiracy theorists. This same tactic results in selective focus on ambiguous bits of physical evidence in attempts to cast doubt on the validity of official explanations of complex events even though the vast majority of the evidence is conclusive. Thus we find that a few scattered incongruities and inconsistencies which can readily be explained by chance, circumstance or contrary evidence are instead held up as proof that sinister government plots were behind the Kennedy assassination, the terrorist attacks on 9/11 and the long suffering gold price.

In the latter instance, we are to believe that a supposed slip of the tongue by Mr. Greenspan has betrayed a tightly guarded secret of the entire financial establishment. And even though this secret is allegedly rotten, pervasive and long-standing, the conspirators have managed to hide all but a couple of similarly shaky bits of "evidence", each of which is also a purportedly damning slip of the tongue.

In the case of Mr. Powell, he correctly states that the whole point of Greenspan's speech was his assessment of risk in the unregulated over-the-counted derivatives market. But Mr. Powell fails to properly explain that Greenspan's assessment hinged on his belief that manipulators in the over-the-counter market are unable to effectively restrict supply and that is why they cannot influence asset prices. Instead of mentioning this very important tenet of Greenspan's speech, Mr. Powell instead finds it both surprising and relevant in his personal opinion that Greenspan may be naive about what influences asset prices and that all derivative gold transactions should be subject to regulation because gold is a commodity. Yet these points are completely irrelevant to the central message of Greenspan's speech; why Mr. Powell brings them up is beyond me.

What is relevant is that Greenspan was only talking about manipulation of the markets through attempts to restrict supply and corner an asset. This has nothing to do with "what the central banks had been telling the world—to earn a little money on a dead asset."  This is simple misdirection on Mr. Powell's part and represents nothing more than an attempt to substitute his own agenda (arguing that central banks have lied about why they lease gold) for Greenspan's agenda (arguing against derivative regulation). But this is Greenspan's own speech after all, so shouldn't at least his agenda be mentioned before being substituted?

Read Mr. Powell's words again and notice how he carefully and adroitly avoids the subject matter of Greenspan's speech altogether! He asks the why (as in "why the Commodity Futures Trading Commission (CFTC) should not concern itself with regulation of derivatives traded in the over-the-counter market") but instead of providing Greenspan's own answer, Mr. Powell substitutes his own while claiming that it is actually a slip of Greenspan's tongue ("Greenspan waved off the necessity for the CFTC to regulate gold derivatives, telling Congress to fear not, that the 'central banks stand ready to lease gold in increasing quantities should the price rise.'") Brilliantly, Mr. Powell implies that the CFTC does not need to regulate gold derivatives because central banks are already in control of the gold price through leasing! And were we to leave it at that, I would understand why many people might be duped.

But this time we are not going to leave it at that.

To start out, I'm going to wonder why Mr. Powell and others of his persuasion never mention that within this very same speech Greenspan invokes the example of the Hunt brothers' unsuccessful attempt to corner the silver market:

"Even trading on exchanges does not in itself eliminate all endeavors at manipulation, as the Hunt brothers' 1979-80 fiasco in silver demonstrated. The primary source of regulatory effectiveness has always been private traders being knowledgeable of their counterparties. Government regulation can only act as a backup. It should be careful to create net benefits to markets."

Greenspan clearly contends that regulation alone is not enough to discourage manipulation and often it is not even desirable. He makes a strong case for the free markets to be left to their own devices ("private traders being knowledgeable of their counterparties" ) with regulation acting as a backup, and then only when regulators "create net benefits to markets".

In this sense, it is completely nonsensical for Greenspan to have slipped on his tongue earlier in the speech by admitting that central banks actively regulate the over-the-counter gold price. After all, he is providing numerous examples of why institutionalized regulation of over-the-counter markets is largely unnecessary. To wit, Greenspan is arguing against government interference and for free markets! So why in the heck would he make a shocking admission that regulation of the gold price is necessary? The answer is that he isn't. Instead, he is actually saying that regulation of the gold price is unnecessary!

To claim otherwise that "central banks stand ready to lease gold in increasing quantities should the price rise" is really just a slip of the tongue would mean that Greenspan was intentionally repudiating the central, pro free market, argument of his speech! The equivalent would be a murder suspect trying to carefully construct an alibi during interrogation in the midst of which he suddenly pens a confession admitting he is the killer. That is exactly the type of insanity we must accept as realistic if we are to believe that Greenspan's tongue slipped (despite this being a prepared speech).

I will repeat this because it needs repeating, Greenspan made his comments about gold only in the context of manipulation of the most common and dangerous kind: the attempt to drive prices substantially higher by restricting supply and cornering the market. He did this for good reason since the history of commodity trading is replete with cornering attempts to the exclusion of virtually every other manipulative practice. This is the important part GATA won't explain to you in the hopes that you will feel stupid for believing otherwise ("only the willfully ignorant can fail to see it") and therefore you will likely avoid trying to figure it out for yourself.

I will repeat this again just so that I can't be accused of glossing over this point, it was only in the context of Greenspan denying the ability of derivative counterparties to corner the markets that Greenspan discussed gold. And he specifically singled out the yellow metal because it is an asset which has a finite available supply and whose market can conceivably be cornered by furious attempts to secure available bullion. The clear, and only logical, implication of Greenspan's statement about gold is that central banks would be a supplier of gold as a last resort if an otherwise successful restriction of supply were to drive the price to a level at which gold derivative defaults threatened the financial markets.

That is the only thing Greenspan said about gold. He made no general statement about central bank gold activity as might be implied by the fragment "central banks stand ready to lease gold in increasing quantities should the price rise". Don't believe me? Well, Greenspan's meaning becomes entirely, obviously, irrefutably, logically, sensibly, abundantly, truthfully and unambiguously clear as soon as his statement is put back into the context from which it has been ripped:

"Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise." [emphasis mine]

Now, please don't take the above words to the opposite extreme to argue that central banks have only leased gold, if ever, to thwart an attempted corner of the gold market. Or that central banks have never leased gold in response to a price rise which did not involve cornering the market. Greenspan said nothing of the sort and so his speech provides neither evidence for or against central bank leasing outside corner attempts when "private counterparties restrict supplies of gold". Indeed, central banks are not infallible and it certainly is plausible that bureaucratic hubris may have contributed to some gold leasing in vain attempts to regulate exchange rates via currency dominated gold prices. But there is absolutely no logical connection between this possibility and a claim that central banks have engaged in a concerted effort to suppress the gold price in all currencies as evidenced by an alleged slip of the tongue of the top central banker when he said "central banks stand ready to lease gold in increasing quantities should the price rise".

Perhaps the absolute simplest way to explain my point is that Greenspan did not in any way imply that central banks are concerned with a price rise in gold. Rather, the central banking concern revealed by Greenspan involves the risk to financial markets should a corner attempt on gold cause a derivative counterparty to be destabilized. In such an event, Mr. Greenspan is simply pointing out that central banks will use whatever means they have available to them. In the case of the LTCM crisis in 1998, it was to provide liquidity. In the case of an ongoing attempt to corner the gold market, providing liquidity would not make a difference and therefore "central banks stand ready to lease gold in increasing quantities should the price rise".

Let me illustrate the very real concern over cornering the market with a hypothetical example. Suppose that I approach various firms (counterparties) around the world that are known to deal in over-the-counter derivatives involving metals and with whom I enter into contracts pursuant to which I am promised the delivery of 20% annual mine supply of iridium metal within the next 12 months. I agree to pay twice the going rate for this iridium in exchange for haste and discretion. Suppose further that iridium is a tight market with virtually no inventory stocks or sources of supply other than mine output. Next, suppose that I go around to most of the world's platinum group mines and purchase 90% of their forward iridium production for the next 12 months. Again, I pay a hefty premium compared to the current market price but I don't mind because I plan to make the money back and then some.

How? Why, a good old fashioned short squeeze, that's how! By acquiring 90% of supply while at the same time contracting for others to sell me 20% of supply, I have cornered the market. Try as they may, my counterparties will be unable to acquire all of the iridium they are required by contract to sell to me in 12 months. In effect, they will have to buy it first from me -- being the only source of iridium -- just so they can turn around and sell it right back to me at the much lower, predetermined contract price. In such a scenario, my profits (and counterparty losses) would technically be infinite since I get to name my own iridium price even if the counterparties are short just one measly ounce of iridium. The effective contract-clearing price of iridium, however, is limited to my counterparties' combined net worth. Otherwise, I will end up as one creditor of many in bankruptcy if I'm not careful. Now, suppose my counterparties include many of the world's largest banks...

Well, a perfectly executed corner serves to transfer the cornered counterparty's net worth to the cornering counterparty. In turn, the perfect cornering asset is one with a small but active market and finite supply. In this sense, iridium is probably not a realistic example. In fact, Greenspan states in his speech that there are no realistic examples in the modern marketplace. That is, with the possible exception of gold, a risk which he trivializes by making his allegedly infamous statement.

In conclusion, Greenspan is explaining why the free market provides both a better pricing and policing mechanism than a market in which central banks and regulators constantly intervene. This is so axiomatic a concept that an admission of central bank control of the gold price is fatal to the argument. Therefore to consider Greenspan's quip about gold as a slip of the tongue must necessarily fall into the same category of insane logic which would have you believe it is realistic that a recalcitrant murderer intent on foiling a successful interrogation would accidentally pen a written confession.

JANUARY 24 2007 5:00PM PDT - Silver and gold recovered impressively from an early swoon with both closing marginally up for the day on the back of firming copper and oil prices. A stronger dollar did not seem to impede the metals' progress.

The silver ETF has dropped 3 million ounces from its holdings since Monday and is now 6 million ounces off the record 122 million ounces held as recently as January 12. Some of this appears to be dealers taking back out a portion of the more than 10 million ounces of silver they put into the ETF back in December. At the time I speculated that this silver was for dealer short covering -- a bullish indicator -- but now it is increasingly looking like it was meant for anticipated demand from ETF retail buyers, who simply may have ended up not being able to stomach that amount of silver. Of course it is not known what the ETF dealers did with the silver bullion once they removed it from ETF vaults and so it would be premature to conclude that the drop in ETF holdings represents a temporary source of silver supply. Regardless, this latest development may be one more feather in the cap of the speculative vs. fundamental nature of the latest rise in silver prices.

I did not have an opportunity to attend the 2007 Vancouver Investment Conference, but in Impressions of Vancouver, we find that the author observed a well-attended show with standing-room-only presentations and sold out booths but still not as strong in attendance as last year. Meanwhile, a private correspondent reported to me that Sunday saw record attendance, the show floor was packed with people and the main speaking hall was standing-room-only, that the new exhibitors were disproportionately represented by new uranium explorers, and according to his list there were about 500 total exhibitors this year compared to 350 last year. Based on these reports, it appears that investor interest in the resource sector is healthy but not frothy.

There is much to talk about in terms of silver stocks but I only have time to cover two topics today. The first is Esperanza, which reported that it has extended the strike length of the Ayelen vein at San Luis to 1,400 feet. Perhaps more importantly, two holes have probed deeper (more than 400 feet) and hit the Ayelen vein in high grade, if not spectacular, intercepts. This is important since I pointed out earlier that probing of the nearby Ines vein at depth failed to intercept any mineralization, creating some uncertainty as to whether these veins were open down dip or perhaps they were offset by post-mineralization faulting. This is no longer a concern down to at least 400 feet on the Ayelen vein and in the meantime the drills have started turning on the Ines vein to explore exactly what is going on over there. Esperanza also reported that prospecting has resulted in the discovery of four additional nearby veins.

The second item is with respect to Silver Wheaton and its right of first refusal on the purchase of silver from Goldcorp's Penasquito, a mega gold and silver project in Mexico. Royal Gold reported today that it has closed its $100 million Peñasquito Royalty Transaction consisting of a 2% Net Smelter Return, which comes on the heels of Goldcorp's announcement on Monday that it has obtained the Permits for Penasquito Mine. I previously discussed on December 29 of last year that perhaps Silver Wheaton is losing its edge on these types of transactions and that is why it has been acquiring stakes of junior silver exploration companies, the most recent being Strategic Nevada Resources which owns the Crescent mine in the Silver Valley of Idaho. Some correspondents have a slightly different take on the developments surrounding Silver Wheaton, one that argues a net positive for silver investors. I've morphed a few of the comments into a single explanation which hopefully does justice to these viewpoints:

Silver Wheaton is transforming the company from its original business model into something more similar to a conventional stock fund. Of course, it is obtaining rights of first refusal to buy future silver production from the deposits it is investing in, but it's not a given SLW will be successful in obtaining those rights.

And all this is good news, maybe not for Silver Wheaton shareholders, but for silver investors because it is an indication that silver hedging from mining companies may be over. Silver Wheaton may have just been a stop along the road.

The original business model was not that enduringly fantastic for long term investors in Silver Wheaton. The idea to buy future silver production from an established mine allowed SLW to present itself to shareholders, from a financial point of view, as a never ending call option on silver with a "nominal" strike price of 3.90 US$/oz. And, also, to be the only 100% silver company.

Furthermore, they could grow their silver production fast, without opening a new mine and so without adding to silver supply that could depress the price of the commodity.

What a fantastic idea, but...

Well, the strike price is "nominal" because the contracts SLW has with the miners (Luismin, etc.) also include up front cash and stock payments which are not reflected in the strike price. That is, SLW paid substantial sums up front to obtain the "nominal" strike price of 3.90 US$/oz. When combined, the up front payment and the strike price can be viewed as the "equivalent" strike price, which would undoubtedly increase in the case of additional or replacement contracts in unison with an increase in the silver price during a bull market advance. That is to say, the "nominal" strike price could only be maintained in future deals at 3.90 US$/oz if larger and larger up front payments are made.

So, what happens to early established positions in SLW if the company keeps entering into new contracts as the silver price rises? Shareholders will see their "equivalent" strike price rising from the current level to higher and higher amounts. They bought SLW because it was like an option at 3.90 US$/oz with an option premium - the up front payment - a financial model that is relatively easy to understand. But if management wants to keep growing the company based on its original business model, it will have to buy increasingly expensive contracts, and this dilutes the original shareholders who bought early (when contracts where cheap). SLW also eventually turns into a royalty play as the strike price becomes a smaller and smaller component of the total outlay which is increasingly dominated by a large up front payment. There is nothing wrong with royalty plays per se, but that is not the model advanced by Silver Wheaton and it does not appear to be one that management wishes to embrace.

In fact, when the "equivalent" strike price of new contracts exceeds the average cash cost of primary silver miners, Silver Wheaton no longer represents a compelling conduit for investor participation in a stream of silver production (even with silver from a by-product source). Instead, standard royalty financing might become more compelling for miners since they not only get more money in advance but they also get to retain most, if not all, of the upside from the higher metal prices about which miners are increasingly confident. This could be why SLW may have discontinued its initial business model, as it simply may not make sense anymore. This could also be why the Penasquito and Dolores projects recently got financed through royalty programs. Instead, SLW seems intent on growth by taking a stake in advanced stage deposits, which is increasing the risk profile and, as I said before, turning it into more and more of a stock fund.

But, do they need to grow? Not necessarily. Perhaps the relevant question should be, why do they still want to grow? Perhaps part of the answer has been given by Rob McEwen during his fight for a shareholder vote on the Glamis acquisition by GoldCorp: management may want to grow a company regardless of the best interest of shareholders simply because compensation rate and esteem within the industry are often seen as commensurate with company size.

JANUARY 23 2007 9:45AM PDT - Silver and gold both in upside breakout as dollar falls and commodities strong across the board. The rally may be the result of strong physical demand but my fundamental indicators have not picked up any major signs of a tightening supply. So I continue to believe the current move is speculative and technical in nature.

JANUARY 22 2007 12:00PM PDT - Silver showed surprising strength today as the gold rally was halted by a rising dollar. Silver is now near the top of its recent range and price action this week could be instructive.

There are a lot of topics I'd like to cover this week but I've been very busy so I haven't had much time to think, much less write, about them. I hope to do so later this week so please keep checking back.

JANUARY 19 2007 12:00PM PDT - In almost a mirror image of the move yesterday, silver and gold rallied as crude oil firmed. Gold was especially strong into the close with intraday charts indicating the shorts were literally "saved by the bell". In the meantime, fundamental silver data continues to argue against getting carried away just yet.

I have more to write but no time so I will be back over the weekend.

JANUARY 18 2007 12:00PM PDT - Gold and silver down on oil weakness and some economic data pointing to lingering strength in the economy which could keep interest rates, and therefore the dollar, steady for some time to come. I mentioned back in December that we could have a series of conflicting economic reports for a few months until a clearer direction for the economy emerges. This type of back and forth economic news is supportive of rangebound, aimless markets.

JANUARY 17 2007 2:00PM PDT - A few days ago I mentioned that the ultimate comparison of a silver stock should be to silver itself. Silver bullion cannot suffer a business failure but silver stocks can and often do. Therefore, there is no reason to own silver stocks unless they can compensate for the business risk by significantly outperforming silver bullion during the intended holding period.

One caveat here is that we must also consider enacted tax rates at the time of sale. For example, stocks held over one year are currently taxed at a maximum of 15% as long-term capital gains while bullion is taxed at a maximum of 28% as gains on collectibles. In 2010, the long-term capital gains tax is likely to increase to 20%, narrowing this gap somewhat. In the meantime, legislation could eliminate the tax gap entirely but current efforts appear to be floundering. I have little doubt that there would be positive investment demand due to opening "gold and silver to a brand new market of investors who may have been reluctant to purchase metals in the past based on the tax situation."  With enough grassroots support, this type of measure has a chance of passing despite the difficulty of overcoming the distinction between numismatics (which would continue to be taxed as collectibles) and bullion. Perhaps people like Mr. Gnazzo can help make a real difference by starting a letter writing campaign to support the re-introduction of this important legislation. It would be a shame to instead let the voice of the people go to waste on preposterous demands for a gold reserve audit.

Okay, let me get to the point of this missive. Sean Rakhimov over at www.silverstrategies.com has undertaken the effort of charting the comparison between the price of silver and each of the stocks featured on his site. The results seem to indicate that the silver-to-share price ratio might in fact be a useful investment tool. Whether a particular stock outperforms or underperforms the price of silver is important in itself, but perhaps these charts can also be used for more nuanced analysis. For example, many of the charts show flag and triangle formations on the verge of breakout while others show trend channels in command.

Many of the formations in Sean's charts are not visible on the stock charts themselves. This is because Sean's charts isolate some of the effect of changing silver prices