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ARCHIVE: Jan 2007 | 2006

FEBRUARY 28 2007 12:00PM - Out of office, no commentary today.

FEBRUARY 27 2007 9:30AM - Silver and gold weaker today despite a falling dollar as global stock markets drop on fear the world's biggest economies might be slowing. The precious metals stocks are getting a double whacking as they are falling in sympathy with both bullion and the general stock markets. We remain in dangerous territory with the possibility of volatile up and down moves of massive proportions.

In stock news, Oremex -- a stock I have previously placed on an undiscovered silver stock and potential Ten Bagger list -- yesterday reported that the ejidos (land owners) of the Tejamen project have opted now to renew surface access rights, which is always a big risk in Mexico. This has probably been long in coming and is complicated by the fact that part of the deposit (which would be mined by open pit methods) lies under the village of Tejamen itself. Therefore, you don't really want to see an outright opposition to land access when you may have to end up moving a village. Now, it is expected that Oremex will pursue the matter through the Mexican legal system but that can be time consuming, uncertain and costly. I suppose the one positive for Oremex shareholders (if there can be such a thing under the circumstances) is that there wasn't a lot of value assigned by the market to the Tejamen project. That is little consolation, however, if you bought the stock at C$0.70 over the last several days only to see it plunge to a low of C$0.35 for a 50% loss.

This episode is a stark reminder of the risk that mining and exploration stocks represent. From my perspective, what has started out as a long-term value play has now turned into a very long-term value play likely to be resolved through litigation. I wish that I could provide a more nuanced analysis of this and other silver stocks in this forum so as to better present the risks and opportunities, but unfortunately such an exercise would essentially amount to a research report which would require resources and costs that as an individual investor I cannot justify. However, I am looking at some possible solutions to this and will report in the future should I come up with something workable.

FEBRUARY 26 2007 11:00PM - Silver and gold continue their upward momentum.

FEBRUARY 23 2007 2:00PM  - Silver takes off on its march (by March?) to new highs while gold rises moderately, not quite completely free of its restrains. At this point, the precious metals are trading mostly on their own as they take less of a cue from the dollar, crude oil, commodities or what have you. As a result, major volatility in both metals may lie ahead with the possibility of punching out to new highs (and by a wide margin) not out of the question. As for Commercials on The Ropes, that prognostication so far has been incorrect as both gold and silver open interest on the COMEX has continued to grow after slowing down (and in the case of gold, even reversing) in the past few days.

For those who didn't notice, Silverstone Resources has reached an agreement in principal with its spin-off parent Capstone Mining whereby it will acquire all of the by-product silver produced at the Cozamin Mine at a fixed price of $4.00 per ounce in exchange for an up front payment US$20 million in cash and additional consideration of US$24 million in the form of 19.35 million Silverstone Special Warrants (exercisable at a price of CS1.45 per share). Yes Virginia, this is a clone Silver Wheaton deal and one that I had originally heard rumors about at the SF Gold Show. So it seems that the Silver Wheaton model is not dead but may in fact be making a resurgence, even if in a more modest size (the deal is for roughly 10 million ounces of silver). For some reason, this news has not appeared in the usual places and little has been written about it by the gurus. Regardless, it does have implications for the silver market which should not be ignored and for that reason I will cover it in detail even while the so-called experts ignore it.

As far as Silverstone's valuation, is this a good deal for them? Well, at $14.00 silver, the presumed 10 million ounces of silver is costing them $8.40 per ounce ($4.00 deferred price and $4.40 up front -- $44 million divided by 10 million ounces). Thus, there is an undiscounted present value of $5.60 per ounce or US$56 million plus an option value which can be calculated using methods such as Black-Scholes (I will try to do this next week). This compares to a present market cap of roughly US$37 million but a fully diluted market cap (assuming exercise of the existing warrants and options plus the Special Warrants and the private placement to raise the $20 million cash) of roughly US$100 million. The fully diluted market cap should actually be somewhat lower for reasons that I will discuss at a later date (this applies to all stocks, not just Silverstone) and therefore we can see that the undiscounted present value of US$56 million is right in line with the current stock price even when we exclude the Black-Scholes option value. Yet this still leaves at least one factor not quantified, and this is the risk that Cozamin will not produce the projected ounces of silver during the term of the agreement (although this may be mitigated to a degree by the terms of the agreement). For now, I'll just say that Silverstone doesn't appear grossly undervalued or overvalued based on this deal and much of its near term prospects likely depend on the extent to which newsletter advisors and retail investors get excited about the story (something which has not yet happened). Therefore, an investment in Silverstone at this point is probably mostly a speculation that it will be discovered by investors in the coming days and weeks. Next week, I will try to analyze in detail the extent to which Silverstone's share price fairly values the Cozamin deal in order to determine whether or not there is a long-term investment opportunity.

I would like to point out two more things today. First, the recent emergence of a fundamental factor in the gold market -- buying by the central banks of emerging economies even as the central banks of developed economies slow their sale -- has been strengthened by the possibility that a Central Bank buys 20 tonnes of locally mined gold for its reserves. The central bank in question is South Africa and while it remains to be seen whether or not this is actually what happened in this instance, a very bullish trend appears to be in motion. Along with a reduced level of hedging by mining companies (resulting in net de-hedging), the supply-demand balance may be shifting in favor of higher prices even as traditional sources of demand start drying up (as demonstrated by the recent GFMS gold demand figures).

Lastly, I wanted to point to yet another commentary that questions the existence of the U.S. gold reserves, this time going as far as speculating that "Deep Storage Gold" held in the U.S Mint's custody actually means "unmined gold" instead of gold in "deep storage" underground vaults. After a lot of speculation rife with paranoia and logical incongruities, the writer innocently concludes:

"If monetary authorities were really on the ‘up and up’ – they could debunk everything presented here in a N.Y. minute - by simply opening the vaults of Ft. Knox and West Point to a proper, independent, third party audit."

Yet there is one operative concept in this statement that is assumed as fact whereas it is actually the key reason why the argument falls flat: the word "simply". The truth is, there is nothing "simple" about opening the gold vaults to third parties. The reasons for this should be obvious to anyone who understands the security industry or how government bureaucracy actually function. Among the key considerations are: cost vs. benefit (can the government really quantify in terms of dollars and cents its supposedly improved standing with a few conspiracy nuts), logistics (providing security clearances, dealing with constantly changing auditors not to mention the requirement under government auditing standards to rotate between auditing firms every three years, dealing with the Treasury seals on over 90% of the gold, re-assaying and weighing, etc.) and compromise of security (many of the security measures are known by only a few high-clearance individuals but these are measures which may be compromised during a third party audit regardless of the care taken). James Turk himself struggled with the question of "what's the big deal with a third party audit?" after having concluded to his own satisfaction that the gold was being properly audited by the Treasury Dept. and therefore was more than likely still there. The considerations that I outlined above are sufficient to also answer his question. And when I do get around to writing a reply to Doug Gnazzo's Gold Reserve Audit: Part II, I will be sure to address this topic in addition to pointing out Turk's successful mission for the very truth (which he concluded in 2000) that Mr. Gnazzo -- as a deeply skeptical man it seems -- presently still seeks.

FEBRUARY 22 2007 12:00PM  - Despite higher oil prices and a technical breakout, silver and gold were not able to add much to yesterday's impressive rally and both metals are trading down overseas after the NY close.

The Silver ETF added 1 million ounces two days ago despite a low NAV premium which might have been a sign of short covering at that point but then yesterday the NAV premium shot up to 3.50%, indicating a significant demand for silver from ETF investors. I have yet to complete my chart of silver ETF price, volume and NAV premium/discount so I am not able to divine much more meaning from this other than that it is obviously a positive sign. As for short covering, silver futures have not experienced this at the COMEX as open interest continued to increase yesterday, although at a much reduced pace, but gold did see the liquidation of some 3,000 contracts. This type of action, however, is not that unusual as the rally last fall also saw liquidation in gold and silver COMEX open interest only to see a top form a few days later even as open interest continued to fall. So much for conspiracy theories or Commercials on The Ropes. In truth, it will take a substantial timeframe to establish that commercials are in fact covering short positions en mass due to fear of further losses instead of some other reason. I'll keep an eye out for this as I'm sure most of the gurus will too.

Yesterday, I mentioned Pan American Silver as a "marginal" producer of silver, which was a mistake as I should have said "variable margin" producer meaning that its margin is influenced by fluctuating cash production costs as well as metal prices, unlike Silver Wheaton's margin which is only impacted by silver prices. Well, PAAS reported last night a stellar quarter during which its cash production cost for silver continued to remain extremely low by historical standards, averaging $1.89 per ounce in 2006 which is a 57% improvement over 2005. This is even lower than Silver Wheaton's cash costs thanks to significant by-product credits at Pan American's mines. However, Pan American's profit still remains more sensitive to fluctuating metal prices due to its overhead and other costs, but I probably need to temper the comment that Silver Wheaton is much more of a defensive silver stock than Pan American based on production margins at this point in time. Instead, Silver Wheaton's defensiveness vs. Pan American is probably more the result of SLW's direct leverage of silver prices to its bottom line earnings.

Indeed, two other major silver producers, Hecla and Coeur, have also been enjoying increasing earnings after struggling to post decent profits as the metal bull market has raged. These two silver companies are somewhat further out on the scale in terms of price sensitivity compared to Silver Wheaton and for some silver investors they may represent an interesting investment opportunity. For example, Hecla's 2006 trailing P/E ratio is just over 14 while Coeur's is a little less than 16. Also, it is difficult to imagine Coeur getting beat down much lower than it is already.

FEBRUARY 21 2007 2:00PM - Silver and gold each up over 3% as a slightly higher than expected (0.3% vs. 0.2%) increase in core CPI inflation was all the spark the precious metals needed to fly. Crude oil also helped as it went up on geopolitical tensions while the dollar also rose but did little to hamper the metals' impressive move. As mentioned yesterday, silver and gold were in perfect position for a powerful technical rally. As it currently stands, both metals are in genuine breakout territory but it wouldn't be that unusual to see a reversal. Further, silver and gold are now less than 10% from their bull market peaks from last May and therefore represent an acceptable entry point only for the nimblest of momentum traders.

Having said that, there are still some silver stocks which represent good value for the money in the mid to longer term. Therefore, it would still be appropriate to make moderate and selective purchases at current levels especially for those who are severely under-allocated in silver stocks. I've talked about many of these stocks in previous commentaries. So instead of repeating myself, I am going to explore a different way to look at a few silver stocks that have recent news out with significant implications.

First up is Pan American Silver, one of the Big 3 silver stocks which many investors shy away from because of its size (over $2 billion market cap) and share price (near $30). Yet despite its size, Pan American just announced that it has added 20% to its Proven & Probable Reserves net of 2006 production, an admirable feat. No wonder this stock has lately outperformed silver bullion as the chart below shows. Yet PAAS has not yet recovered its full leverage to silver from the beginning of 2006. What I am trying to demonstrate here is that silver stocks should be viewed in relative terms and there are solid, profitable strategies to be found with most of them. Although I don't personally view PAAS as the most prospective at the present moment, it certainly deserves some consideration especially if you think silver prices are headed much higher in the near term (more on this in a moment)

Next I wanted to follow up on Silver Wheaton, which is also one of the Big 3 silver stocks and is not widely owned by retail investors due to a belief that it is simply too large to generate big returns. Skirting that issue, I have discussed Silver Wheaton at various times in the past as having a revolutionary model that will change the face of mine finance. Recently, however, I have started to doubt the near term probability of such a bold prediction especially as Silver Wheaton has settled for taking equity stakes in junior explorers with large silver deposits instead of acquiring new streams of silver production. Therefore, it is somewhat heartening to hear that Silver Wheaton is Looking for Deals and I hope these deals are true to form. In particular, the clock is ticking on Silver Wheaton's option on silver production from Penasquito (owned by Goldcorp). Like PAAS, Silver Wheaton made significant strides in 2006 despite its size (Silver Wheaton More Than Triples Fourth Quarter and Annual Results). Unlike PAAS, however, SLW has not outperformed silver bullion of late as the below chart shows. This may be partially due to Goldcorp making a secondary offering of some of its SLW shares in late 2006 which created quite a bit of new supply to the market. Yet one of many positives to Goldcorp's reduced stake in Silver Wheaton is that it is no longer the controlling shareholder and this should reduce any conflict of interest in negotiations surrounding the Penasquito option.

A technical analysis of PAAS and SLW might conclude that PAAS is likely to outperform SLW in the coming months. Yet there are several important factors which should be kept in mind. One of the most presently relevant factors is that SLW might be more of a defensive silver stock at this point and PAAS might be more of a momentum stock. To wit, they are likely to behave differently depending on which way silver prices are headed in the near future. This is partly because PAAS is a variable margin producer with significant sensitivity to both rising and falling silver prices while SLW enjoys wide margins which are not in grave danger even if silver falls to $10. The above two charts provide some visual support for this hypothesis. Therefore, the decision in the short term between owning SLW and PAAS may come down to each investor's belief about where silver prices are headed in the near future. The long term involves a more complex analysis and at some point I hope to fully flesh out an investment approach for each silver stock that takes many of these considerations into play.

In the meantime, I will keep making cursory overviews of prospective silver stocks such as Silver Quest, which has just announced some interesting drill results at its 3Ts project in BC. This is certainly not an ore deposit as yet but the company's potential is positive considering that with less than 20 million shares outstanding (24 million fully diluted), Silver Quest has a market cap under US$12 million. Furthermore, the company has several other projects currently under exploration. But what might make Silver Quest particularly interesting is the management expertise along with the fact that the mineralization discovered so far might be amenable to bulk mining. Also, the grade is rather low which certainly creates some risk but also increases the leverage to metal prices. In summary, Silver Quest is a high risk, pure exploration play which can still be acquired on the cheap. The reason I bring this stock up today is that it is a good contrast to the Big 3. I do own some shares of Silver Quest and Pan American (not major positions) and may in the near future look to build a defensive position in SLW (most likely at the expense of PAAS).

The last thing I wanted to discuss today is an analysis of the Production of Large Silver Mines Through 2030 based on the Top 20 Undeveloped Silver Deposits according to Mines Management. As has been pointed out, this Top 20 list is somewhat incorrect but it isn't so far off as to totally negate its usefulness. In the analysis, the production of these Top 20 deposits was combined with the anticipated production from large existing mines and compared to anticipated silver demand to show that an annual deficit of 500 million ounces of silver might exist by 2030. Furthermore, the supply deficit would presumably start expanding in 2011-2012 and never look back. While this is an interesting exercise, the analysis is unfortunately missing a number of important factors and makes unsubstantiated assumptions that create significant doubt about the accuracy of its conclusions. For example, demand is assumed to grow at constant rates year after year while the majority of mine output (from smaller mines, which make up over 60% of annual silver production) is completely ignored. In addition, the effect of metal prices on production due to mining previously uneconomic deposits is not considered. Regardless, I applaud the effort and hope that it will be built upon by Mr. Blake or others to create a more accurate model. Ideally, GFMS, CPM Group or other professional outfits with expertise and capacity should make public their own long-term projections.

FEBRUARY 20 2007 3:00PM - Silver down only about 15 cents (1%) as gold drops over $10 (1.5%) in sympathy with falling crude oil and a slight rise in the dollar. This is actually quite a healthy development as both silver and gold were due for a rest and now have neared the bottom of their up trend channels from which powerful technical rallies can sometimes commence. Meanwhile, fundamentals continue to be muted.

There is quite a bit of commentary out in the past few days that provides guidance on near-term and long-term silver and gold prices as well as various topics related to the precious metal markets, yet there doesn't appear to be anything new or compelling. Perhaps this is the result of the prolonged and (relatively) orderly nature of the ongoing rally or simply everybody being careful. In any case, I am going to remain faithful to the mission of this website by focusing the discussion and postings on need-to-know and must-act-on material (of which there is currently a dearth). On the left bar of the home page, however, I provide links to a wide range of sources that cover the silver market. I pore through these sources every day and I encourage everybody to do the same since I'm sure these sources contain many market nuggets that I have failed to uncover.

One topic which seems to be making the rounds in the past few days is an important one to the silver market: the emerging uses of silver as a nanotechnology antibacterial agent. A couple of examples from the current roundup include this and this. It seems like every type of product from hospital pajamas to socks, bandages, food containers, spray disinfectants and washing machines is being laced with "silver nano particles", which are being touted as the ultimate germ fighters. A number of prominent metal analysts have even ventured to predict that germicidal use of silver is set to become a major source of new demand in the next few years.

Personally, I have some major reservations about this. First, there have been few scientific or medical studies that prove the efficacy and efficiency of silver as an antibacterial agent in real world situations. Yes, silver clearly works to some degree, but can its benefits be measured and quantified? Not yet, it seems. Second, just how much silver will actually be used in the nanotechnology industry if and when silver is widely accepted for its antibacterial properties? I've read various reports but my own estimates place the total amount of silver that might be used in this manner in the range of several million ounces per year. That is good for demand but by no means spectacular. Third, there might be a backlash against silver from environmentalists (who are some of the very people who might otherwise be drawn to silver as a natural alternative to chemical germicides) because many of them suspect silver to be toxic to the environment. In fact, the EPA has recently launched a program to look into nano particle silver in consumer products and the FDA is also increasingly getting into the act. It is not clear what the result will be but this article gives a pretty good overview of the current status. In summary, the jury is still out on the impact on silver demand of the emerging nanotechnology/antibacterial industry and it is likely to be a few years before a significant effect, if any, will emerge.

Finally, I wanted to point to yet one more market commentator - Lord William Rees-Mogg -- who apparently views rampant monetary inflation to primarily be an asset price phenomenon as opposed to a price driver of goods and services. Lord Rees-Mogg does believe that rising asset prices will eventually trickle down to goods and services but admits this has not happened yet. In the context of my prior inflation/deflation discussion, this is important because the rising price of gold so far has not been the result of hidden price inflation as is claimed by many commentators but rather due to the same global liquidity which has alit the prices of many asset classes from real estate to stocks, bonds, commodities, art, etc. The consequence of this is that CPI and PPI are likely to be more accurate than most detractors tend to suggest. Therefore, the inflation-adjusted price of gold in terms of general price inflation may turn out to be properly measured by CPI after all. And unlike others who prefer to measure gold with reference to a one day spike high of $850, I think a more valid measure of gold's current potential would be the average gold price (e.g., moving average) near the top of the previous bull market. This same method could be applied to silver. In fact, over the next few weeks when I have a little more time, I plan to create a chart of the long-term fair value of gold and silver in relation to general price levels as a means to help gauge the current price level of precious metals compared to historical norms. I have not yet seen this type of analysis on the Internet, so if anyone wants to beat me to the punch, please go ahead.

FEBRUARY 19 2007 5:00PM - Light overseas trading and little change in silver and gold on this U.S. Presidents' Day.

COMEX open interest in silver is up to almost 158,000 contracts of combined futures and options and is starting to reach extended levels while the open interest in COMEX gold has actually reached record levels. In particular, the commercials have been increasing their short positions to accommodate the rise in large speculative longs. Meanwhile, retail nonreporting positions are largely sitting out this move. This is a familiar pattern that has preceded the end of each precious metal rally during the current bull market and while the party can certainly go on for a while longer, the fat lady can be heard in the background practicing her solfeggio in preparation for the last song.

As COMEX open interest has grown, so has COMEX warehouse stocks of silver which now stand at more than 116 million ounces. Still, the pace needs to pick up if there truly is some suspicion out there that another run on COMEX silver is about to be made. Therefore, this is an important indicator to monitor in the next two or three weeks.

Next up, the NAV on the silver ETF continues to remain low (0.40%) which may be an indication of subdued ETF investor appetite for new silver as the 5 million ounces added almost two weeks ago continues to be digested.

Finally, I wanted to mention that I am going to be quite busy this week with various projects and my daily commentary is likely to be abridged and focused solely on critical developments, if any. Furthermore, I have not had time to update the silver news and commentary and will only be able to do so sporadically as the week progresses. As usual, new material will be easy to find since I always highlight in yellow the current week's additions.

FEBRUARY 16 2007 1:00PM PDT - Silver up 5 cents to close at $13.95 and gold up almost $1.90 to close at $668.50 (based on Kitco prices) as crude oil and commodities in general were firmer on a day when the dollar also found its legs. Economic reports, meanwhile, painted a picture of moderating inflation with core PPI up 0.2% (overall PPI fell 0.6%) and a struggling housing market, renewing worries about the possible economic impact of a housing bust. Given this data, the markets did not appear to move in the expected direction today (one might argue the dollar should have been down) but this can probably be explained by the complicated economic picture that is emerging. It appears to me that traders in many markets are picking through the data and finding themes to support their positioning while ignoring everything else as market noise. And while that strategy can be effective at certain times, I'm suspicious about its propriety at inflection points such as the current situation. Yet one more reason to remain cautious and vigilant.

I would like to expand on my discussion yesterday of the 2006 gold supply and demand figures by pointing out that the general impression in the media to the World Gold Council (WGC) announcement is that gold demand appears to have increased during 2006. Yet it was only the dollar amount of gold demand that increased while demand measured in tons actually fell by 10%! Now, why didn't WGC headline the fact that demand for gold actually fell during 2006? Could it be that they want to put the best face on the gold market realizing that we might now be in a new paradigm where the total dollar demand for gold may rise year after year even as the traditional measure of demand (tons or ounces) will stagnate or even fall? This brings up an interesting point that I have seldom seen discussed by the precious metal analyst camp: some traditional gold markets have a finite supply of dollars to spend on gold and therefore higher prices may mean lower overall demand in those markets. For example, will the Indian gold market -- which has historically been responsible for 20-25% of global gold demand -- be able to maintain that percentage as the gold price rises? More pointedly, could this effect (greater dollar demand but less tonnage demand) be largely responsible for that ubiquitous market truism that higher gold and silver prices result in greater investment demand? Sure, when investment demand is measured in dollars, it is easy to see this truism as happening (not only in precious metals but virtually every market). Yet what about physical demand itself? Seems to me that if the latest data represents a trend and not an anomaly, a lot of thinking needs to be rethought about precious metals somehow being a special investment category where higher prices drive incrementally higher demand.

On a different note, I also would like to follow up on yesterday's discussion about the inherent problems with silver basis data. At long last, I have decided to chart the daily basis figures starting with last November, which is when I began to religiously track it. The chart can be found here and can also be accessed by clicking on the little symbol next to the daily basis in the Market Indicators table on the home page. A few caveats. The data in this chart has not been normalized and therefore it likely contains pricing artifacts that tend to muddle the picture. Also, it is difficult to show the absolute basis and relative basis on the same chart because of the orders of magnitude separating the two figures (later, I will chart these separately). Lastly, the absolute basis will tend to decline as it approaches a futures month and suddenly jump when contracts are rolled to the next futures month. Therefore, the large swing in the absolute basis at the end of last November should be ignored (the futures contract was rolled at that time from December 2006 to March 2007).

For those who haven't read the explanation of the basis, the absolute basis is the difference between the spot price of silver and the futures price for the nearest contract delivery month (currently March 2007) while the relative basis is the absolute basis divided by the number of days remaining until option expiration for the nearest contract delivery month (as of February 15, the March 2007 options expire in 7 days, so the relative basis is equal to the absolute basis divided by 7).

Although this initial attempt is limited in its usefulness, there are some interesting patterns that appear worthy of comment and further analysis even on such a rudimentary chart. I'll try to cover this next week as well as publish long term historical charts of both the silver and gold basis going back to the 1970's. For now, I am hopeful this chart will turn out to be the humble beginnings of a powerful new approach to studying the silver market.

FEBRUARY 15 2007 3:00PM PDT - Give and take in silver and gold today as the metals continue to struggle with resistance while the dollar and crude oil settle down after several days of frantic trading. Little has been accomplished by the markets this week on a technical basis and so it appears traders will have to remain patient a while longer.

A slight premium has returned to the silver ETF which may indicate that the dealers are having some success distributing the 5 million ounces of silver they added to the ETF holdings last week. I have not yet completed my analysis of ETF premiums and trading volume so I don't know if a 0.81% premium is significant but I do know that it is neither unusual nor extreme. More on this hopefully in the next few days.

Basis Realities

Today's reading of the basis in silver (minus 7 cents absolute and minus 0.9 cent relative) is a good example of the problems with basis calculation that have prevented me from fully analyzing and charting historical silver price data.

The problem is two-fold. First, cash settlement prices as reported for the COMEX are often incorrect or subject to subsequent adjustment. For example, the COMEX cash silver price for yesterday, February 14, 2007, is currently being reported by various sources as 13.93, 13.96, 13.97 or 14.04 (I suspect that some of these sources are using the London fixing, Kitco price or other source instead). Sometimes one source appears more accurate while at other times a different source appears to be correct. Since normalizing the data by switching between sources would add a degree of subjectivity, I have refrained from doing so in the past. I may yet have to do this in order to be able to make sense of the historical data but I hesitate to normalize the daily figures. This can result in anomalies such as today's basis reading. Had I used an alternate source of pricing, the basis reading could have been as high as plus 4 cents absolute and plus 0.5 cents relative.

Second, daily volatility in the silver price (particularly near close) can introduce differences between closing futures and spot prices that mask their true relationship during the trading day. That is to say, the basis may be in flux throughout the day resulting in an average basis which is much different from the closing basis that I report. Since the closing price is just a snapshot in time, it can naturally only tells us about the last trade of the day.

The reason I bring up these issues is because I want to make sure everyone is aware of the limitations in the basis indicators. In the future, I plan to improve on my methodology to minimize or even eliminate these problems but for now I seem to be one of the only -- if not the only --  person to regularly track and discuss this subject in the public domain.

ETF and Supply/Demand Revisited

The World Gold Council reports Record Dollar Demand for Gold in 2006. This is not surprising given the rise in gold prices but what might be interesting to some is that actual demand in terms of tonnage has declined moderately since 2004. In fact, the consulting firm GFMS, sponsored by World Gold Council to produce an annual gold survey, has increasingly relied on sources of identifiable investment demand to help balance the supply picture in gold as jewelry demand first stagnated in 2005 (against a backdrop of rising supply) and then actually fell in 2006. Therefore, we see that increasing ETF holdings in gold have been included as a source of "identifiable" investment demand as if such demand is the equivalent to the minting of new bullion coins and bars or jewelry fabrication (each of which involves changing gold from one form into another).

In reality, the source of ETF bullion is unidentifiable yet it is clearly bullion owned by somebody else before it becomes bullion owned by the ETF. As a result, I would argue that it is not appropriate to break out ETF demand as a category on the same level as fabrication demand. This line of reasoning is similar to the commentary last year titled The Myth of the Gold Supply Deficit in which it was argued that gold supply really represents all available above ground investment holdings. Thus, annual mine supply and recycling are but a drop in the bucket when compared to investment sentiment, of which ETF demand is clearly a part. In further support of this, I would like to point to a secondary "plug" that GFMS had to create in order to make the numbers work -- the so-called category of "Other retail investment" which has supposedly been negative in the past three years! Please note that this plug is on top of the venerable "inferred investment" plug which at times in the past has also been called "implied (dis)investment".

I believe GFMS first got into the problem of mistaking investment sentiment for bona fide supply and demand when it included mine hedging and central bank gold sales in its figures a few years ago. It should really have kept these figures in separate tables but once down the path, it was difficult to turn back. Also, even if misleading, the data as presented by GFMS does seem to make sense when it is viewed as the "visible" portion of the market. Unfortunately, as we are all painfully aware, it is primarily the "invisible" part that drives the precious metals.

In the case of silver, the GFMS approach may create an interesting situation for 2006. As I discussed on February 9, the inclusion of ETF demand in silver supply and demand figures would probably leave a rather large and unstable "plug" in the form of "implied" or "inferred" (dis)investment for the year. Assuming that silver fabrication has not dropped precipitously in 2006, the plug would be somewhat similar in size to the ETF demand itself, which would clearly point out the folly of breaking out ETF demand just because it is a visible component (of a much larger but invisible picture). I guess we will just have to wait and see how GFMS plans to deal with this when it publishes the 2006 silver market summary.

In the meantime and if gold is any indication, an interesting trend may be in the offing. I am talking about the possibility that the precious metal ETFs may so far have done nothing more than substitute one form of demand for another (and not necessarily all that effectively). In the 2006 supply and demand figures prepared by GFMS, this is easy to see. "Jewellery" consumption apparently dropped by almost 350 tons between 2005 and 2006 while the ETFs picked up 265 tons, or roughly 75% of the slack. No doubt jewelry demand dropped as a result of higher gold prices, but this doesn't negate the apparent fact that the ETFs failed to pick up as much gold as jewelry dropped. One possible interpretation of this is that jewelry demand at gold prices above $600 is more price sensitive than ETF demand.  More importantly, the real impact of ETFs on the gold market may come when jewelry demand becomes less sensitive to gold prices relative to the ETFs. In particular, I am curious to observe how this might play out with lower or more stable gold prices: could both jewelry and ETF demand increase, for example? I'm also looking forward to studying the pending silver figures to see if there might be a similar relationship between the silver ETF and silverware.

Interconnected Smorgasbord

A plethora of interesting topics -- with indirect but important implications for the silver market -- were covered today by various news and editorial sources. I'll try to spin them together in a way that hopefully shows why it is important to remain rational and even handed when it comes to studying the markets.

First off, I have long held that governments and financial market participants have an incredible range of creative (and dangerous) tools at hand to mitigate what at times can appear to be impending financial disasters. For example, derivatives have provided a means by which economic risk has been spread across the global financial system at the same time that systemic risk has been concentrated in the hands of a few money center banks. The "beauty" of this may not be clear to those who disdain or do not understand modern financial practices: governments cannot allow money center banks to fail and therefore the collective will of 6 billion people is behind our current economic "miracle". This means that a financial shock would have to be very massive in order to derail the arrangement, which is precisely the opposite of what many people argue (that a minor event could precipitate the end). So yes, derivatives are a house of cards that can bring everything down, but the flip side is that the house is going to withstand more than a few puffs from the hungry wolf. Where am I going with this? The sorry state of the housing market, of course! Specifically, a New Way to Hedge Your Home's Value which doesn't appear to be a hedge at all but rather a way to tap future, nonexistent equity from a house just in time to supplant the traditional sources of mortgage funding that are starting to dry up. I have privately argued for some time now that many new financial products will be created before a residential housing meltdown might successfully become a depression-inducing catalyst and blow down the financial house of cards. This new "mortgage product" is likely to be just the beginning.

But that doesn't mean the day of reckoning can be permanently put off so everyone should start (or continue) to keep 10% of net worth in gold and silver bullion in their own secure, hidden, direct possession. More importantly, as I have mentioned before, this discipline should be passed down to future generations because that is how long the game of musical chairs might go on despite the incessant calls from the doom and gloom crowd that the sky is falling. But please do be careful to purchase bullion from reliable sources so you don't end up being a plaintiff in an affair such as Coin Companies Accused of Defrauding Consumers, Targeting the Elderly in Texas Lawsuit. Instead, read my Bullion page and other sources on the Internet to learn which dealers are reputable and how to best invest in bullion. I plan to add much more useful information to my bullion section so please keep checking back.

Next, we hear that it is apparently the End of the affair for commodities as far as institutional money managers are concerned. Instead of worry, however, we are heartened by the news for it surely means there is life yet left in this bull market.

Continuing on, we illustrate our doubt about the sanity of those who despise central banks in favor of government control of money by pointing to episodes such as Bernanke, Sparring With Frank, Says Fed May Lift Rate. Am I the only one who believes that our monetary system would have been destroyed more than a few times since 1913 if the federal branch of our government was directly behind the driver's seat of money creation? True, there isn't that much to celebrate when it comes to the dollar, but I still think the Fed deserves a subdued Yip, Yip, Hurray! for being able to keep the party going for so long. Our current standard of living, such as it is, can be directly tied to the Fed's (not always successful) effort to remain apolitical and nonpartisan.

Finally, lest we get too lucid and giddy about the future, Chris Puplava gives us A Bird's Eye View of the U.S. Consumer showing just how much trouble there is to dig out from.

FEBRUARY 14 2007 10:00AM PDT - Silver and gold first rise sharply, then hit by significant selling pressure as they attempt to cross resistance with the help of a dollar free fall on Bernanke's softening rhetoric on inflation. The dollar is trading around 84 on the index and appears very unhappy that prospects for a rise in interest rates have become a little dimmer. It is quite possible that the dollar will now continue to weaken which could be the boost the precious metals need to break free and soar to new highs. I am not confident enough about this scenario, however, to change my comfortable stance. Therefore, I continue to maintain significant exposure to the upside by holding quality silver stocks while limiting risk by culling illiquid, highly speculative companies from my portfolio as well as maintaining a significant amount of dry powder.

There has been very little change in the silver market indicators over the last two days and I continue to await confirmation that metal supply is tightening. For now, this does not appear to be the case so I still believe the current market action is technical and seasonal in nature. What this means is that a substantial move higher will more likely be in the form of a spike, perhaps difficult to trade, then a sustained rise.

FEBRUARY 13 2007 12:30PM PDT - Spot silver was up approx. 1.5% for the day to $13.85 as it raced away from gold which was almost unchanged despite a sharp drop in the dollar (due to report of big trade gap) and a strong rise in crude oil (expectations of higher demand in 2007). Today's action in silver appears to be a recalibration of its position vis-a-vis gold as opposed to independent price action. Both silver and gold are obviously still looking for that excuse to break free from their reigns with the likelihood of resolution growing by the day. Unfortunately, there isn't a high probability of either a break higher or a reversion lower at this point. Therefore, a careful precious metals trading portfolio should ideally be balanced as to both upside exposure and downside risk.

In my own case, this has meant trading out of the more speculative, illiquid positions into liquid, high quality stocks while continuing to hold significant amounts of cash. A similar positioning is probably also warranted for strict buy-and-hold portfolios although to a lesser extent -- for example, this might be a good time for any re-balancing left over from tax-loss selling. On the other hand, those investors who are underexposed to precious metals should still find it possible to slowly build a portfolio at current levels but I would emphasize the world "slowly" because many of the premier silver stocks are quite richly priced at the moment. This isn't necessarily a bad thing since 52-week highs are likely to be surpassed in the future, but investors looking for less of a sticker shock are left with a small if interesting field of possibilities including Avino, Bear Creek, ECU Silver, First Majestic, Impact and Silver Wheaton (of these, I currently own First Majestic and Impact).

Moving over to the fundamental side, COMEX warehouse stocks of silver have climbed above 115 million ounces with the Registered category in a clear up trend as my updated chart clearly shows . This pace, however, will probably need to accelerate before we can conclude that traders are anticipating a large volume of physical delivery on March COMEX futures contracts.

In the meantime, the NAV on the silver ETF has quickly plunged into negative territory (a discount of 0.66% as of this Monday) after last Thursday's premium of almost 2%. ETF trading volumes last Friday and this Monday were good but not spectacular and certainly not sufficient to eat through the 5 million ounces of silver added by dealers last Thursday. That is, ETF dealers are probably still holding most of the ETF shares they acquired last Thursday when they delivered 5 million ounces of silver to the ETF. They most likely acquired the ETF shares in an effort to take advantage of the hefty 2% NAV premium that existed in the ETF last week, but as of yesterday, this premium turned into a 0.66% discount as dealers appear to have aggressively sold into the premium. Since there wasn't much of a resulting increase in trade volume, it should be apparent that retail and institutional silver demand via the ETF is probably not as strong as last week's 5 million ounce addition would imply. On the other hand, silver demand tends to fluctuate wildly and the 5 million ounces may yet be absorbed by ETF investors in the coming days. One sure sign of this would be the return of a healthy NAV premium. I'll keep my eyes peeled.

Finally, I wanted to briefly mention a couple of news articles which may help to refine my discussion of the base metal tug-of-war which I described a few days ago. The first is Base Metals – The fundamentals still matter which strikes me as a well-balanced and realistic assessment of important market fundamentals during the next year or two. What I find most interesting about this analysis is that it attempts -- in broad strokes, unfortunately -- to explain not only the various factors expected to influence metal supply and demand but the sensitivity of metal prices to those factors as well. One of those factors is the possible disruption to mine supply due to expropriation such as that currently taking place in Bolivia. It appears that not only mines but smelters and presumably other infrastructure providers are at risk of nationalization, a process which at a minimum will temporarily disrupt operations if not permanently impair operating efficiency. This, of course, is quite ironic given the official reason for the seizures: under-utilization. So perhaps we should not rule out the near-term possibility of elevated production from nationalized mining infrastructure since there will be quite an incentive to prove that socialism works. In fact, it may take a few years before the well-documented impact of a centrally-planned, non-incentive based economic system begins to exact its toll in the form of declining production and inefficiency.

FEBRUARY 12 2007 12:45PM PDT - Silver and gold significantly lower as the dollar climbs just above 85 on the dollar index and oil prices drop on supply data. This week should be interesting as the precious metals remain near resistance levels which, if cracked, could portend a breakout to much higher prices. On the other hand, a failure to surmount the resistance zone could result in silver and gold trading back down toward the bottom of their recent range. I personally do not feel very confident about the probability of either scenario taking place because there are strong arguments for both higher and lower prices. Therefore, I believe the best approach right now is to be ready for either possibility and to patiently await which one it actually turns out to be.

While this wait-and-see approach is favored by a number of commentators at the moment, the cautiousness is generally overshadowed by fantastic predictions of the near term riches to be had in precious metals as the following small sampling of recent prognostications seems to suggest:

Timing the Gold Bull: Fireworks on the Horizon

Precious Points: Now Boarding the Flight to Quality!

HUI Index Set to Advance to 700 - 900...

The AMEX GOLD BUGS INDEX (HUI): Still a Golden Opportunity to Buy Gold Shares? Follow-up No. 6

An Objective Look at Gold and Gold Stocks

Most significantly, some of these comments represent 180 degree reversals from just a few weeks ago apparently due solely to rising prices of silver and gold -- prices which have yet to break free from resistance.

Further, the current situation is set against a backdrop of consensus estimates for 2007 which predict higher gold and silver prices compared to 2006.

Looking at the overall sentiment, it appears to me that the bull train in precious metals is pretty much standing room only at this point. And while seasonal and technical factors do point to a major rally, there remains a significant amount of risk that is probably being overlooked by the majority of analysts, experts and investors.

FEBRUARY 9 2007 4:00PM PDT - Silver and gold rocket higher on technicals and speculative fear while crude oil and the dollar vacillate. For the day, silver is up 15 cents (over 1%) while gold is up $9 (1.3%) but both are still just a hair shy of full breakout mode which would occur once the secondary highs -- just a few ticks above now -- from July 2006 (for gold) and December 2006 (for silver) are surmounted. Action early next week could be critical. In the meantime, precious metal stocks refused to play along as both the HUI and XAU were in negative territory at the close with many individual silver and gold stocks fairing rather poorly.

The dichotomy between precious metals and mining stocks is likely due to Fed comments (not by Bernanke but a couple of Regional Presidents) to the effect that persistent inflation may prompt the Fed to raise interest rates. No timeframe was given but the markets are on pins and needles (see my comments from yesterday) such that even an accidental brain fart from the peanut gallery is bound to set of a bout of panic selling or buying, as the case may be. What I'm trying to say is that gold and silver were up on inflation fears due to a healthier-than-expected economy while mining stocks were down on interest rate fears in sentiment with the general equity markets. No, it doesn't make sense to me either!

Silver ETF Boom

An apparent strong positive for silver is the 5.5 million ounces added yesterday by the silver ETF (SLV) which puts its holdings at a new record of 125 million ounces. On the other hand, ETF investors did not have the stomach for that much silver just a couple of months ago and ETF holdings were subsequently pared back. So we might wish to be patient with the current additions to see how they will be digested.

Back in December, I speculated that the large addition then to the silver ETF might be due to short covering by dealers but I was probably incorrect. Instead, it appears to have been an attempt by dealers to buy low and sell high, which they apparently failed to do on that go around. The January reduction in ETF holdings was likely the