Thursday, June 23, 2011

Got Gold Report – Silver Buys Too Much Oil?

Excerpt #3:  Silver-oil exchange rate near 20-year lows, but ratio skewed by low silver prices last two decades. COMEX deliverable silver inventory falls below 30 million ounces. 

This is our third and final excerpt of the Sunday, June 19 full Got Gold Report.  Let’s pick up where yesterday’s excerpt #2 (the post just under this one on the GGR Home page), which left off with the following: 

Do we have to point out that the CDNX is just now trading at a level it first reached back in Q1 of 2004?  Want to take a guess where gold and silver were when the CDNX first touched 1,900 on the way up?  Gold was then dancing either side of $400 the ounce and silver had then managed to print $6 on the upside.  So much for the idea that mining shares leverage gold and silver gains.  Over time, and post a major crash that is a quaint myth.  

We all keep hearing about the coming mania phase of the gold and silver bull market.  It ain’t here yet, and today’s market for the juniors just about has to have a lot more upside potential – if the world manages to hold itself together, we think.      

Silver Buys Too Much Oil? 

Oil/Silver Ratio, since 1990, weekly, using West Texas Intermediate Crude for oil, updated thru June 21.  If any of the images are too small or get cut off click on the top of them for a larger version or click on the title of this post for the full page.  


Someone must have written a piece just lately that says that silver prices will fall soon because it is overvalued relative to oil.  We received several comments along those lines over the past two weeks.  If one only had the last 20 years of data to go by, then that would be a reasonable conclusion as the chart just above shows.  

In 1960, back when U.S. coins still contained 90% silver, the average price of a barrel of oil came in at $2.91 and the average price of silver that year was $0.91.  That’s about a 3.2:1 ratio, so is silver overvalued today relative to oil with the ratio at 2.6 to 1?  

We would argue that for the last 20 years the price of silver was artificially low, and thus the ratio was skewed higher for that period.  We would not at all be surprised to see the oil/silver ratio moving below 2.0 in the not too distant future as the world comes to grips with tight silver supplies and intense demand for metal.  The point is with $100 oil, $50 silver is reasonable in our view if silver is adequately supplied relative to the demand.  

However, we don’t think that there is sufficient silver metal to meet the burgeoning demand for it.  Not as of right now anyway.  We’ll go out on a limb and predict that at some point between now and the end of this Great Gold and Silver Bull, the ratio might be at or less than 1:1.  Don’t bet the ranch on that one, but don’t be all that surprised by it either if/when it comes.  

COMEX Registered Silver Inventory

(On another note) Traders are buzzing because the overall inventory of silver in COMEX warehouses dropped below 100 million ounces just recently, a supporting factoid for tight silver supplies.  Perhaps a more powerful argument is the amount of silver in the COMEX that has a warrant issued for it (Registered silver), or the metal that could actually be taken delivery of by futures contract buyers as of a certain date, has fallen below a very, very low 30 million ounces. 

The other class of metal held in the COMEX vaults is the Eligible category, which can be thought of as metal stored at the COMEX, (which is) ‘Eligible’ for delivery, but not ‘Registered’ for delivery.  Eligible silver is theoretically deliverable at some price, but could also be earmarked by the owner of that metal for other purposes.  

A floor trader once told us, “Registered metal is deliverable to anyone.  Eligible metal is deliverable only to the owner of the warehouse receipt.”  It is more complicated than that, but not a lot and it’s a good way to think about it.       

Ed Steer, who writes a daily commentary blog for Casey Research and is a GATA director had the following chart in his Wednesday offering.  We believe the chart is from Nick Laird at, and thus we have high confidence in the data. 

As of Friday there were 27.97 million ounces of silver held in the Registered category of silver inventory at all the warehouses connected with the COMEX in New York.  The simple reason that the Registered inventory has been falling as the Eligible category has increased is because investors, users and speculators have been taking delivery of silver.  It is not at all hyperbole to say that the amount of available silver marked as available for delivery at the COMEX is now quite small relative to the 37,925 contracts which remained open in the July ’11 contract as of Thursday’s data.

As of Friday there were July contracts representing 189.6 million ounces open or more than six times the amount of silver metal that could be delivered into those contracts. (Ed. Note: As of June 21 the July open interest showed 33,656 lots open.)  

Not that we think that a COMEX default is imminent, we really don’t, but the odds of a failure to deliver keep rising, not falling as the data comes in.  More importantly, the falling COMEX inventory figures speak of tightening silver supplies, as does the continued backwardation condition in the futures strip.  Tightening supplies and strongly increasing demand is the very definition of a bull market, is it not?  

In bull markets we have but three possible positions as speculators.  Leveraged long (the most bullish stance, best taken when a bull market has been pummeled), long, and flat.  In a major bull market we cannot take the short side of the trade, except to hedge, but that is another story, for another time.   


End of the excerpt. 

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That is all for now, but there is more to come.     


The Original
Vulture Speculator

Trading gold, silver and mining shares since 1980 with a focus on taking advantage of volatility extremes, Gene Arensberg analyses the markets through a basket of technical and fundamental indicators and shares his findings from time to time here at Got Gold Report. Mr. Arensberg has been quoted in the Wall Street Journal, Dow Jones MarketWatch, USA Today and dozens of other news organizations.

"I've been a huge fan of Gene and his amazing work for years..."

Brien Lundin, CEO, Jefferson Financial, Host of the annual New Orleans Investment Conference and Publisher of Gold Newsletter

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