(Rationing is a form of price fixing!)

Silver Stock Report

by Jason Hommel, May 24th, 2008

I know many of you saw the WSJ article, “Losing a Mint: Curb on Coin Sales Angers Collectors”

Due to overwhelmingly growing popular demand, The U.S. mint has sold twice the amount of one ounce Silver Eagle coins as last year (6.8 million since the start of the year), and is forced to ration their available coins to their 13 authorized dealers, one of whom says he would like to buy 5 times as many Silver Eagles as the mint will let him, 500,000 per week, instead of the 100,000 he is allocated and limited to buy.  (That would corner the market on Eagles.  500,000 x 52 = 26 million oz.)

The U.S. Mint typically has sold about 10 million ounces of Silver Eagles per year for the last 5 years, which used to be 1% of the overall silver bullion market, and now might be 2% of the silver market of about 1000 million ounces per year when you add in recycling of 250 million ounces, and government selling, and mine supply of about 650 million ounces.

The shortage of Silver Eagles should serve as a warning to people who think they own silver, but only own a paper promise of silver instead.

The paper silver market is about 100 times bigger than the physical silver market, just as the physical silver market is 50-100 times bigger than the market for Silver Eagles.

If there can be a quick shortage of Silver Eagles due to popular and rational public investment demand, when they are only 1-2% of the silver market, how quickly can the entire silver market seize up when merely the paper silver market decides to enter the physical silver market?

Um, I’ll take a guess.  How about next week?  Or maybe it already did, and that might explain some problems over at the Perth Mint.

But I’m not arguing that only the paper silver certificate holders might want physical silver.  The fact is that gold investors, which is a market 1000s of times bigger than the silver market, can also decide to enter the tiny physical silver market, and that bond investors, which is a market 100,000s of times bigger than the silver market, can also decide to enter the physical silver market, etc.

I would have thought that more people would have understood the economic significance of delivery delays and rationing, and that it proves there is a shortage.

From wikipedia:

“In market economics, rationing artificially restricts demand. It is done to keep price below the equilibrium (market-clearing) price determined by the process of supply and demand in an unfettered market. Thus, rationing can be complementary to price controls. An example of rationing in the face of rising prices took place in the Netherlands, where there was rationing of gasoline in the 1973 energy crisis.”

“A reason for setting the price lower than would clear the market may be that there is a shortage, which would drive the market price very high.”

It may surprise you to know that I’m not too concerned about the U.S. Mint rationing Silver Eagles.  After all, we ought to be grateful that they are, indeed, doubling supply for us, so far.  The reason why I’m not too concerned is that the U.S. Mint has rationed Silver Eagles before in the last few years, so this is standard procedure for them.  The long wait recently is unusual, but my sources tell me that there was one batch of 500,000 blanks that were substandard, and were returned to the other mint that made them.  Whether that was real, or an excuse, I don’t know, but the Mint is saying they are making twice as many as normal, and that’s good, because they are adjusting to increased market demand.

I’m far more concerned with the delivery delays from the Perth Mint.  The reason is the difference between the two mints.

The U.S. Mint does not have a certificate program, and does not claim to have a large operating pool of metal.

The Perth Mint, supposedly, has an operating pool of $880 million Australian dollars worth of physical metal that it is holding on behalf of certificate holders, and it cannot redeem those certificates or handle physical purchases in a timely manner, which is suggestive of having run out of their operating pool of metal, since rationing and delivery delays are evidence of a shortage!

The reason why I’m so harsh on the Perth Mint is that they are the ones who appear to be breaking promises right now with delivery delays, not the U.S. Mint.  

I continue to hear reports that the major private mint, the Northwest Territorial Mint, is having shipping times to customers about 6-8 weeks out. 

What is frustrating is that none of these mints appears to be operating according to free market principles.  The most basic is this: They ought to raise prices, before running out of inventory.  The raising of prices is a method they should all be using to gain more profits, and signal to the market the impending shortage of silver before it actually arrives.  

I suspect that the reason why they do not raise prices “before running out of inventory” is because none of the three mints has any inventory, and thus, they do not know how to raise prices as inventory levels go down, since they don’t have any inventory levels that can change that they can track and look at as an internal signal to themselves to change prices as necessary.  

Raising prices as inventory levels drop could work like this: their last 100 ounce bar should at least sell for a 100% premium, right?  And perhaps the last 10% of their inventory could sell for maybe a 50% premium, the last 20% of their inventory could sell for a 20% premium, their last 30% of inventory should sell for a 15% premium, and when they get down to 50%, they start charging a 10% premium, and no special premiums of they have 50% or more of their inventory levels and business is normal, or something of that nature.

I suspect that if they are always short on inventory, they would try to always keep their own prices as low as possible to get new customer orders, and use customer money as a means to “float” or to use it as operating expenses, and thus, would prefer that prices go down between the time that they get an order and the time they would have to deliver, and thus, they wouldn’t want to signal to the market that a shortage is taking place, which would make prices go up.  I would suspect that shorts would want to hide the fact that they are short, from the market.  

Operating short was a great way to make money in the silver minting business from 1980 to 2003, as extra profits could always be realized between a long lag time between an order and delivery.  But that’s not going to work in a rising market.

I suspect that since they charge “too low” prices, they always have trouble not making enough money, which is why they are short on inventory, which is a vicious self-imposed cycle of economic pain that they are in.

In other words, it’s not a conspiracy, it’s their own stupidity, and bad business sense that has them trapped, and has us all waiting on long delivery times.  

In other words, I suspect that they fear that if they raise prices, they would not get customer orders.  

I urge them to trust in the free market, instead, which provides a way out, and a good solution for their own self-imposed problems!  I urge them to raise prices for their unique minted products that are in short supply so that they can make a real profit by serving the needs of the market.  

Some people have been paying $25-40/oz. for Silver Eagles lately, due to the short supply.  On ebay, I’ve heard that 100 ounce bars are selling for up to $20/oz. or higher during this last consolidation, and prices have not come down very much.  At least ebay is a free market that is actually working, even if little supply is available.

Perhaps our mints ought to take pricing cues from ebay?!

The market appears to really need turning 1000 oz. comex bars into real products that most investors want.  This is a dramatic new change in the silver market that is developing this year, and it’s not surprising to see the mints get caught not being able to adjust to it quickly enough.  In past years, if 250 million ounces of silver was from recycling, and only 50 million ounces of new net investor demand, I suspect that most investor demand used to be able to be met mostly through selling old products, not newly minted bars.  With investment demand in 2007 up to 75 million ounces, and perhaps double that or more in 2008, things are changing.

And if the mints don’t adjust with higher prices, well, maybe someone ought to go into business and compete with them, and supply the real needs of the market.  Other mints or dealers ought to advertise silver available for immediate delivery, and charge extra for that unique competitive advantage over the other dealers.

If you know of a private mint in the U.S., or a coin dealer, who has 50,000 ounces of one ounce physical silver rounds available for immediate delivery, please email me a picture of the physical goods, and I’ll mention your offer in my next email.  (Don’t mention 90% bags, there’s plenty at www.fidelitrade.com I still hear.)  


Jason Hommel