April 21, 2011

Gold (NYSE:GLD ) and silver (NYSE:SLV ) have surged to new record nominal highs in dollar terms (all time and 31 year) with the dollar falling sharply on international markets. Silver has continued to surge in all currencies and has surged to a new record nominal high of $46.25/oz (£27.85/oz and €31.54/oz) on growing rumours of a short squeeze involving a billionaire or state interest attempting to corner the silver market (see FT news story below).

Bloomberg Composite Silver Inflation Adjusted Spot Price – 1975-2011 (Weekly)

Traders and technically minded investors are firmly focused on silver’s record nominal high of $50.35/oz. Some with a longer term fundamental focus continue to see silver in triple digits if it is to match the real record highs of $130/oz seen in 1980. The inflation adjusted silver chart puts the present sharp rise in the all important historical context.

The massive concentrated short positions of some Wall Street banks have incurred serious losses and a desperate attempt to close their futures positions due to the tight physical marketplace may be leading to a short squeeze. This is something that GoldCore and a few other analysts have warned of for some time.

Cross Currency Table

We have long said that the very small silver market was ripe for cornering by private or state interests and that appears to be happening on some level. However, there are an increasingly large number of silver buyers who realize the market can be cornered and they are buying in anticipation of this event.

The blogosphere has again been ahead of the curve and dismissal of much circumstantial evidence of silver manipulation, a short squeeze etc. as “conspiracy theories” is becoming less easy to do. It looks like many investors internationally and one or a few private individuals and states are cornering the silver market.

At one stage the Hunt Brothers cornering of the market was a “conspiracy theory” – it soon became fact.

Silver’s volatility is set to increase and sharp corrections are likely, however the sharp falls seen after the Hunt Brothers manipulation ended are unlikely today given the very strong supply and demand fundamentals.

US Dollar Index – 5 Year (Daily)

Gold’s movement today, unlike in previous weeks and months, is very a function of dollar weakness as gold has remained at the same price in terms of other major currencies.

The degree of complacency regarding the risk of the dollar coming under severe pressure remains high (as seen in Financial Times Lex column on gold and the U.S. dollar today – see below).

Below the lows of 71.32 on the US Dollar Index (see chart above) is unchartered territory and the U.S.’ massive $14 trillion plus debt will likely lead to the dollar continuing to fall particularly against gold. In a worst case scenario, it could lead to a form of a run on the dollar when speculators smell blood as happened to sterling when the Bank of England was “broken” by George Soros.

(Financial Times) Silver surge prompts conspiracy theorists

In 1980 it was the Hunt brothers. In 1998 it was Warren Buffett. And in 2011?

For anyone unversed in the history of the silver market, those dates refer to market squeezes that caused surges in the silver price. The talk among some conspiracy-minded traders and analysts is that something similar could be happening today.

It is easy to see why: during the past 12 months the price of silver has risen 154 per cent, outpacing gold (32 per cent), wheat (65 per cent), oil (45 per cent), and indeed almost any investment you’d care to mention.

Perhaps the most telling measure, the ratio between the price of silver and that of gold (ie the price of an ounce of gold divided by the price of an ounce of silver) has dropped to 33.5 times – after averaging 60-70 during the past decade.

The last time the ratio fell even close to this level was in 1998, when Warren Buffett’s Berkshire Hathaway quietly accumulated a huge position in the silver market, driving prices up 90 per cent in a few months to what was then a 10-year high of $7.90. On Wednesday, silver hit $45.37.

Before that, the last time the ratio was below 40 was in the early 1980s, following the most notorious silver market squeeze – that of William Herbert Hunt and Nelson Bunker Hunt, two billionaire oil baron brothers.

Is something similar happening today?

The silver market is never short of a wild rumour. The difference this time, though, is that the conspiracy theories are being seriously considered by senior figures in the industry.

As one senior banker puts it: “I just do think it has the smell of somebody with a pretty significant buying programme … Silver is the sort of market that every decade attracts someone.”

The reason why the conspiracy theories have taken hold is because few traders or analysts can see a convincing reason for silver’s astonishing rise. According to data from consultancy GFMS, the silver market was in a surplus of 178m ounces last year.

Crucially, of course, that surplus was mopped up by investors. But visible investor positioning is hardly overwhelmingly positive – indeed, last week, even as silver prices rose, investors cut their bullish positions in the US futures market by 8.4 per cent.

Hence the conspiracy theories. Some of the whispers making the rounds in dealing rooms in London and Zurich include:

A Russian billionaire with an eye for silver has been discreetly buying (for some reason Russia seems to be the most popular location of this putative billionaire – he or she could also be Middle Eastern or perhaps East Asian).

There has been a secretive silver buying programme by the People’s Bank of China or some other central bank (but China is the favourite).

Chinese traders are using silver imports as collateral to obtain credit in a similar way to copper – thus vastly inflating the country’s silver demand.

It is impossible to say if there is even a grain of truth in any of these tales. While some traders are taking them seriously, others believe the rise in prices is perfectly well explained by very strong, inelastic industrial demand plus extremely high retail demand in the US, India and China.

One explanation for why the silver market is confusing to many bankers and traders may be that they typically deal with large investors and so see little of the flow to retail investors and industrial consumers.

What is certain, however, is that with the view that silver is a speculative bubble so widespread, a sharp and painful correction can’t be ruled out.

Again, history may be informative. After the Hunt brothers’ squeeze in 1980, the price of silver collapsed 80 per cent in four months; the Hunts were later sanctioned for market manipulation and went bankrupt.

And following Warren Buffett’s silver play in 1998, the price of the metal dropped 40 per cent and Berkshire Hathaway recorded its worst annual results on record, relative to the S&P 500, in 1999.

Tyler Durden is the founder of Zero Hedge .