Silver Shortage
The famous American economist, Milton Friedman, once joked that if you put the federal government in charge of the Sahara Desert, in five years there would be a shortage of sand.
It would be a very negative outcome, as shortage is a sad state in which something needed cannot be obtained in sufficient amounts. Demand exceeds supply. Think about time – there is always too little of it. Or liquor during prohibition. Shortages were very common in the communist economies, as prices were controlled by governments and couldn’t rise to clear the market.
Fortunately, in a free market economy without government interventions in the price mechanism, shortages occur rather rarely and are temporary. Many analysts underestimate the effectiveness of the price mechanism, which was called a marvel by Friedrich Hayek, the 1974 Nobel Laureate in Economics. You see, the scarcity of any commodity, including silver, would increase its price, encouraging new discoveries and production. Simultaneously, a higher price would dishearten some potential buyers, reducing the shortage and bringing the market closer to equilibrium.
Is Shortage of Silver Coming?
However, some analysts worry about the allegedly coming shortage of precious metals. They paint the apocalyptic visions of people waiting in queues and trying to buy silver at all costs, with no single gram of bullion available in the market - permanent shortage. Sounds scary, right? Of course, it does, as the aim of these sellers of fear is to prompt you to buy more silver bars and coins. Using fear and passion counts as one of the most successful selling techniques. But remember, fear is the path to the dark side. Fear leads to anger. Anger leads to wrong investment decisions and hate. Hate and wrong investment decisions lead to wealth decline and suffering.
Silver Shortage and Peak Silver
The idea of silver shortage is strictly connected with the concept of peak silver. Since we – of course! – have already gone beyond peak silver, the mining industry is headed for a dramatic supply shortage.
The only problem is that neither mining production (figure 1 - red line, in tons) nor the total supply (figure 1 - green line, in tons) entered a terminal decline after the peaks in 1990 and 2001, but continued the upward move, as one can see in the chart below. Hence, the silver bulls’ hopes that we reached peak silver in 2015, foreshadowing upcoming shortages, seem to be exaggerated.
Figure 1
Silver Shortage and Manipulation
Many people believe that the silver market is heavily manipulated, as it’s a less liquid market than gold or other markets. The Fed’s sales and leases of silver and naked short selling of the precious metal on Comex led to the growing shortage of physical silver supply, at least in relation to the paper claims on silver. In other words, the belief is that the central banks and the corrupted financial system created more paper silver claims than there is bullion to satisfy them. There is simply not enough silver to back all the paper claims on the white metal. When the paper silver market finally collapses and silver prices cease to be suppressed, they will surge like crazy. "You will see... just look for the silver lining. The day of reckoning is just around the corner."
However, the claims about the disconnection between paper silver prices and physical demand are unfounded and result from the lack of knowledge how the futures market works. The lack of physical delivery in the precious metals futures market is nothing strange, as the majority of transactions in the futures market (not only silver) are without physical delivery and are cancelled out by entering a covering position, because it is a much more convenient way of settling the contract and gaining exposure to the price movements.
Reddit Rally and Silver Shortage
At the turn of January and February 2021, the price of silver skyrocketed to its highest level since 2013, as retail investors flooded the market. It all started one week earlier when Reddit users coordinated their actions and sparked a rally in the GameStop shares. Another post on the r/wallstreetbets Reddit message board under the headline “THE BIGGEST SHORT SQUEEZE IN THE WORLD $SLV Silver 25$ to 1000$” urged investors to buy silver. The idea was to expose a shortage of supply and to push prices up.
As a result, BlackRock iShares Silver Trust, the largest ETF tracking the silver, recorded unprecedented inflows, while silver prices were up more than nine percent on February 1, 2021, the biggest daily gain since the Great Recession.
However, a short squeeze similar to the one that happened in GameStop, is unlikely. This is because the silver market is much bigger and more liquid than GameStop. Before the recent actions inaugurated on Reddit, GameStop had a market cap of $1.4 billion, while the size of the silver market is in the hundreds of billions of dollars or even trillions! The silver to be found in London’s vaults alone is worth $48 billion. So, trying to corner the silver market would be like trying to drain the ocean.
Second, unlike GameStop, there are no holders of massive silver short positions. I mean, of course, there are many entities that have large short positions in the U.S. silver futures market, but these shorts are often counterbalanced by long positions in the London market. Moreover, money managers have actually had a net-long position on the metal since mid-2019. In contrast, GameStop was one of the most shorted stocks in the U.S. before the frenzy.
There is a popular belief that Wall Street has massive naked short positions and is trying to manipulate the silver market. This is a bit of a strange idea, given that the price of silver has increased over the last year, as one can see in the chart below. The rise in silver prices contradicts the story about systematic price suppression via massive shorting.
Figure 2
Regardless, based on this narrative, the Reddit users piled into the silver market to push up prices and trigger a short squeeze. Although retail investors managed to spark a short-term rally in silver prices, any lasting effects are unlikely. Actually, the price of silver is already returning to its “pre-Reddit” level, as the chart below shows.
Figure 3
So, this suggests that there is actually no shortage in the silver market. And, although we could see increased volatility in the near future, fundamental factors should triumph in the long run. You see, it’s true that sufficiently large capital can move almost any market in the short-term. But such short run wild fluctuations (or even aberrations) and coordinated market plays are something different than long-term manipulation. The short-lived character of the Reddit-driven rally in the silver market confirms the view that – contrary to the popular narrative – there is no systematic suppression of silver prices (and gold prices – remember that the gold market is much larger than the silver market).
Conclusions
The story of silver shortage is an old one now, it can be traced back at least to 1998, when analysts started to claim that silver would enter a state of permanent shortage. Surprise, surprise – it didn’t happen. What does it mean for the investors? Don’t listen to the so-called experts who have been calling for the silver shortage for years. Given the relatively large holdings in the world, it’s actually hard to imagine a lasting shortage of the white metal. (Silver holdings are smaller than gold holdings, but still larger than holdings of other commodities.) Indeed, silver usually remains in contango, not in backwardation, which implies that there is no supply shortage. Thus, forget about this idea. Making decisions based on false premises is the shortest way to suffer losses.