Is the Silver Market Too Small to Buy?

Silver Stock Report

by Jason Hommel, Nov 13, 2003

This week a popular gold community advisor warned that investment advisors create a self-fulfilling prophecy when they influence market participants to buy small market cap stocks.

    I agree completely.

    But this other advisor then went on to imply that such advice to buy small market cap stocks is not valid, or not legitimate, and he implied that the best advice is the kind of advice that cannot influence the market. He further implied that the only valid investment advice is if you advise people to buy large market cap stocks that don’t move up or down in response to advice to buy or sell it.

    I couldn’t disagree more.

    The reason why I write is to convince other people to take prudent actions. If I feel the best course of action is to buy an undervalued small market cap stock, then that’s the advice I’ll give, and the advice is not invalid just because the market is small. In fact, the very fact that the market is small, and the price is cheap, is the exact reason you want to be buying in the first place. That’s how you discover the undiscovered values that enable you to buy low and sell high.

    I think it is rather inconsistent for a gold community advisor to claim that only large market cap stocks are valid investment picks. After all, it was not long ago that the market cap of the entire gold stock market was as low as about $25 billion.

    It is completely irrational to claim that you should not advise people to buy into a sector, because if people followed your advice, and went into that sector, it would move up.

    If less than 1% of the value of the bond market and if less than 1% of the value of M3 moved into gold, the dollar value of gold would explode, and perhaps collapse the entire dollar system.

    The bond market is about $15 trillion. 1% is $150 billion. M3 is about $9 trillion. 1% is $90 billion

    The annual mine supply of gold to market was 2600 tonnes in 2002. At $400/oz., that’s $33 billion. The annual demand of gold is reported to be 4000 tonnes. At $400/oz., that’s $51 billion.

    Do you see the comparative size of these markets? Ponder that for a moment.

    If the 1% ($150 billion) of the bond market and 1% ($90 billion) of M3 tried to buy physical gold in a year, that would be a demand of $240 billion for gold. At $400/oz, that would be a demand for 600 million ounces, or 18,661 tonnes, which would completely overwhelm the gold market by several orders of magnitude of demand greater than exists today.

    Obviously, if you advise people to sell bonds and dollars and buy gold, gold will move up. Does that make it an irresponsible thing to advise people to buy gold?

    Likewise, it is not irresponsible, or any less valid, to advise people to buy into the smaller silver market and silver stocks. The fact that the silver market is so small is exactly the reason to buy into the sector now.

    So, who is really giving irresponsible advice?

    I think it is irresponsible to advise people to buy Futures contracts. I believe there has been an excessive creation of Futures contracts, to the point where fulfillment is impossible.

    The bullion banks, as reported by GATA, reportedly owe 15,000 tonnes of gold to the central banks that they cannot repay, because if they went into the market to buy that much gold, the market price would scream upwards.

    Several large mining companies also owe lots of gold, more than they can repay without moving the market to the upside against themselves.

    Defaults on promises to pay in gold are inevitable. If the big traders must default, what makes the little traders think that their Futures contracts will be honored?

    I believe Futures contracts will default, and that the paper longs may get nothing, or a cash settlement, when they run out of silver or gold to deliver.

    I believe the dollar is fraud. I believe bonds are fraud. I believe fractional reserve banking is fraud. I believe Futures contracts are fraud. I believe it is a moral failure to be deceived by fraud, and that it is a moral failure to buy or sell Futures contracts.

    The purpose of Futures contracts is to divert investment demand away from gold. The existence of Futures contracts does this through many ways. First, a wealthy person who may be interested in buying gold will be encouraged to buy Futures contracts instead, because the gains are said to be greater if gold goes up. Therefore, this person buys a paper promise, instead of buying physical gold, and the investment demand has been properly diverted.

    Second, after the wealthy person buys a Futures contract, the price of gold is manipulated downward by the expiration date, so that the Futures contract expires when the gold price is lower than the paper contract price. Therefore, the paper contract expires, “worthless”.

    Third, if the price does go up, the person who bought the paper contracts is rewarded with more paper dollars, which again diverts investment demand away from physical gold, because the paper game worked brilliantly in the mind of the sucker. Thus, the paper pushers succeed either way.

    Fourth, another wealthy person may feel that he may always have the opportunity to buy a Futures contract for gold, instead of buying gold itself. Therefore, this other investor may think, “If gold really begins to take off, then I’ll buy a Futures contract, but not today.” This also diverts investment demand away from physical gold, since the buying decision is delayed. This person will not buy gold until after the Futures market collapses, and then they will realize (too late) the difference between a paper promise and gold. Here are the key differences:

    An expiring paper contract is no substitute for gold. Gold does not rust. Gold does not expire. The same piece of gold lasts for thousands of years. That is one of the very important properties that makes gold valuable in the first place. Virtually every other asset you can buy decays in value over time, whether a car, or a house, or a dollar due to constant erosion of inflation. A Futures contract expires over time. This is the exact opposite of gold.

    A paper promise is no substitute for gold. Gold is payment in full. A paper contract can be defaulted on. Gold cannot default. Contracts can fail. The excessive creation of Futures contracts, and the few entities who are creating most of them, (the bullion banks that are already short the 15,000 tonnes) virtually guarantee performance failure.

    Admittedly, stocks have many disadvantages. Companies can go bankrupt. Stocks can be diluted as companies issue more stock. But stock ownership is ownership of an asset — the metal in the ground. Yes, silver stocks are risky, and I advise people to be prepared to be able to lose 100% of their stock investment. Does the other advisor warn people of the default risks of owning a Futures contract? I wonder.